• In our view, a shift in U.K.-based social housing provider Local Space's strategy from its growth acquisition phase toward a focus on customer service will strengthen the group's liquidity position on a sustainable basis.
• We continue to think that the group's arrangements with local authorities support very high S&P Global Ratings-adjusted EBITDA margins and modest leverage over the forecast period.
• We have therefore revised our outlook on Local Space to stable from negative. We have affirmed our 'AA-' long-term issuer credit rating.
• The stable outlook reflects our expectation that Local Space will perform in line with our base-case scenario, while maintaining a very strong liquidity position.

LONDON (S&P Global Ratings) June 26, 2020--, S&P Global Ratings today revised its outlook on U.K.-based social housing provider Local Space to stable from negative. At the same time, we affirmed our 'AA-' long-term issuer credit rating.

We are revising our outlook from negative to stable because we expect Local Space's liquidity position to become more stable and remain above 1.75x. The group is in the last year of its 2017-2020 growth strategy, through which it aims to deliver 800 additional units as part of an agreement with the London Borough of Newham (LBN). We expect the group will reach this goal, and that by the end of fiscal year (FY) ending March 31, 2021, it will have acquired about 950 units toward this target. Our previous forecast incorporated uncertainty around when new facilities would be secured and readily available for drawdown to be used toward prefunding capital expenditure (capex), which in our view led to unexpected and relatively significant volatility in the liquidity coverage. We now expect the group's growth plan to finish in FY2021, and the level of capex to greatly reduce afterwards, which will support a stronger and more stable liquidity position.

In our view, the group's new corporate plan for 2020-2025 will drive a shift away from growth, and toward a focus on customer service, digitization, and investment in existing units. We expect management to continue implementing its component-replacement program as part of the renewed focus on customers over the next five years, and will also concentrate on offering improved digital self-services. We forecast that the group will have lower borrowing needs and lower pressure on liquidity as its acquisition plans tail off.

We continue to view Local Space's experienced management and unique long-term arrangements with local authorities as supportive of the very high S&P Global Ratings-adjusted EBITDA margins, through annual rent increases and tight control on operating expenditure. We also consider the very strong demand for the group's properties, its unique operating model, and exceptional asset quality.

With around 2,600 units in FY2020, Local Space is relatively small compared with its peers in the U.K. social housing sector, although the group's property size has steadily increased in recent years. That said, we believe that Local Space's operating model is unique in our rated portfolio. Specifically, Local Space is largely insulated from COVID-19-related increases in arrears and bad debts, and government welfare reforms, as it derives predictable revenue streams through its rent-guarantee agreements with local authorities. The group has little dependency on direct tenant payments, as more than 90% of its rents come directly from local authorities, housing benefit, and universal credit payments.

Furthermore, the housing portfolio is mainly situated in the London boroughs of Newham, Hackney, and Waltham Forest, which remain supported by robust economic fundamentals and high demand for housing. Demand for temporary housing in London remains very high, as more than 67% of the 84,000 English households in temporary accommodation in 2019 are handled by London local authorities. Temporary accommodation in London has risen from 35,000 homes in 2011 to more than 58,000 in 2019. We expect that strong demand for its units will continue to support Local Space's strong operational metrics, with low voids accounting for less than 0.5% of rent and service charges, and low gross arrears averaging 2.4% over the past three years.

We expect that Local Space's profitability will remain very strong, but that adjusted EBITDA margins will drop from 75% in FY2019 to 65% by FY2023. The group's agreement with LBN entails that from FY2022, rents for some of its units will revert from London Housing Allowance (LHA) to London Affordable Rent (LAR), plus service charge. LAR is a rent level set by the Greater London Authority (GLA) annually, and is more affordable than LHA. This change stems from a drive to keep housing affordable for tenants. The GLA will provide £37 million in grants to Local Space in exchange for the reduced rent level, which will reduce borrowings needs for the group. We continue to believe that the group's partnerships and rent guarantee arrangements with local authorities will fuel stable and very strong financial performance, with embedded annual rent increases.

In line with our expectation that the acquisition plan will tail off in FY2021, we forecast that capex will decrease considerably from FY2022. This will reduce the pressure on liquidity that we highlighted in our previous base case. In combination with the receipt of a grant from the GLA, lower capex will also reduce borrowing needs and will allow the group to start to deleverage. We expect debt to peak at the end of the group plan at £392 million in FY2021, and settle at about £330 million by the end of the rating horizon. We anticipate that debt to adjusted EBITDA will average 14.6x for FY2021-FY2023. In parallel, we expect that interest coverage will remain in line with our prior forecasts, at an average of 1.7x in FY2021-FY2023, supporting debt sustainability.

As for other English housing associations, we believe there is a moderately high likelihood that Local Space would receive extraordinary support in case of financial distress. That said, this is neutral for our rating on Local Space, because there is no uplift from the stand-alone credit profile (SACP). Local Space's primary purpose is to provide affordable homes, supporting important policy objectives of the U.K. government. We consider that the Regulator of Social Housing (RSH), a government agency, regulates Local Space to promote a viable, efficient, and well-governed social housing sector, and maintain lender confidence and low funding costs across the sector. It is therefore our view that the RSH would step in to prevent a default in the sector, based on its record of being willing and able to provide extraordinary support on a timely basis.

We assess Local Space's liquidity position as very strong and expect sources of liquidity to exceed planned uses by about 2.1x over the next 12 months. Local Space has a policy of holding a minimum cash balance of £5 million.

We forecast that liquidity sources will comprise:

• Our forecast of cash generated from continuing operations of £25 million;
• Cash and liquid investments of £9 million;
• The undrawn, available portion of committed bank facilities or bank lines maturing beyond the next 12 months of £25 million; and
• Our expectation of ongoing cash injections from the government of £45 million.

We forecast that uses of liquidity will comprise:

• Our expectation of capex of £35 million; and
• Interest payments of £15 million.

The stable outlook indicates that we expect Local Space to perform in line with our base-case scenario. This includes adjusted liquidity structurally above 1.75x and interest coverage of more than 1.5x EBITDA over the forecast period.

We could lower the ratings on Local Space should the fallout from COVID-19 be more severe than we forecast, worsening the economic fundamentals of the areas in which it operates or deteriorating the group's operational metrics. We could also lower the rating if we observed a sustainable weakening in liquidity management, manifesting in volatility in the liquidity coverage ratio.

Conversely, we could raise the ratings if the group's debt burden decreased faster than we expect, such that debt represented less than 10x adjusted EBITDA, all else being equal.

Key Statistics

Related Criteria

• General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
• Criteria | Governments | General: Methodology For Rating Public And Nonprofit Social Housing Providers, Dec. 17, 2014
• General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Related Research

• United Kingdom 'AA/A-1+' Ratings Affirmed; Outlook Stable, April 24, 2020
• U.K. Social Housing Providers Should Remain Largely Resilient To Short-Term Economic Difficulties From COVID-19, April 23, 2020
• COVID-19: Emerging Market Local Governments And Non-Profit Public-Sector Entities Face Rising Financial Strains, April 6, 2020
• U.K. Social Housing Ratings History: February 2020, March 3, 2020
• Why Most Rated U.K. Social Housing Providers Are At Home In The 'A' Category, Dec. 3, 2019
• Global Social Housing Ratings Score Snapshot: December 2019, Dec. 2, 2019
• Global Social Housing Risk Indicators: December 2019, Dec. 2, 2019