Credit ratings... made simple

What is a credit rating?

A credit rating is a rating agency’s opinion of the creditworthiness of a borrower.

When an RSL wants to borrow money through a bond issue, it will usually group together with other RSLs and use a “special purpose vehicle”, a company set up to issue the bonds. The vehicle will be credit rated by a rating agency – for RSLs, this is usually Moody’s Investors Service or Standard & Poor’s.

The agency will also assess the credit rating of the RSLs that borrow from that vehicle to ensure they are acceptable. This will not normally be published and the cost is included in the price of setting up the vehicle.

But if an RSL is to issue bonds in its own name – for example, if it needs a lot of money (£200m plus) – or if it wants to demonstrate its strength when winning tenders or looking for merger partners, it may pay an agency to do a credit rating.

If it is pleased with the rating, it will make this public.

What sort of organisations are interested in a housing association’s credit rating?

Investors in RSL bonds, such as pension funds and insurance companies, are interested in the credit rating of the bond issuer (the special vehicle or the RSL). Banks that are not familiar with the sector could also use credit ratings to decide whether to lend to housing associations. Before making a loan, a bank would perform an examination of a potential borrower’s credit privately, but would be mindful of any external rating available for that organisation.

An RSL’s quality of credit, whether externally rated or not, will affect its cost of borrowing. What may appear to be small variations in ratings will affect the price; a very important factor to the RSL.

What do the ratings mean?

Different agencies’ ratings have slightly different meanings. Standard & Poor’s rating of “AAA” is its highest, meaning the borrower’s capacity to meet its obligations is “extremely strong”. Different levels reflect subtle distinctions in credit quality, so “AA” means the borrower’s ability to meet its debts is “very strong”. “B” indicates increasing levels of concern about the organisation or the market in which it operates. “C” indicates the organisation represents a high risk in respect of non-payment of obligations. A rating of “D” refers to a borrower in default on payments or filing for bankruptcy.

Moody’s equivalent to S&P’s “AAA” is “Aaa”. Its lowest category is “C” and it has a series of numbering levels to reflect risk so “C3” is lowest. Both agencies use + and – to show smaller variations and the rating may also comment on the market the borrower operates in with terms like “stable outlook”.

Agencies and lenders look for a borrower's ability to meet its obligations and withstand internal or external detrimental factors

What do the credit rating agencies look for in a housing association?

Agencies and lenders are looking for the ability of the borrower to meet its obligations and withstand any internal or external detrimental factors. Ratings agencies look to various factors when assessing credit quality. These include the organisation’s financial performance, asset strength and management, including the quality of the executive and the board, the type of social housing provision and the geographic spread of business and likely demand for its services.

What areas should an association try to improve if it gets a bad rating?

An organisation can usually try to improve its rating through better management and financial standing. These improvements would affect its ability to arrange all forms of private finance and not just those reliant on external ratings. The geographical areas of operation and type of social housing mix are fundamental to the organisation. So change is difficult. Change and improvement in these areas, if needed, could be brought about through a merger.

How much does a rating cost?

Initial credit ratings cost about £25,000 and there’s an ongoing fee of between £5,000 and £10,000 a year depending on the complexity of the organisation. Ratings are monitored on an ongoing basis.

An RSL’s performance or circumstances could change at any time and the credit rating would reflect that change. The change could be specific, such as an advantageous merger, or generic, such as a change in the regulatory regime.

For example, if a change to the housing benefit regime made future rent revenues less certain.

When might an association be interested in a bank’s credit rating?

If an RSL has surplus cash it can lend to a bank it can use the bank’s credit rating to assess the risk: a high credit rating means there is low risk the lender will go bankrupt. We recommend Fitch Ratings UK’s Support Rating 1 or 2: this implies central government would intervene to stop the bank’s failure because of its importance to the UK economy.