What does it mean to be ‘merger ready’?
Merger may mean different things to different organisations, but there are some clear advantages when it comes to treasury.
2016 was very much the year of the “mega mergers” as L&Q and Affinity Sutton merged with East Thames and Circle respectively to form FTSE 100-sized behemoths. These newly-formed organisations have set the bar that bit higher in terms of scale and influence and like their corporate peers, size matters when it comes to the amount of leverage a borrower can exert over its lenders and investors. But what of the rest of the sector? After a relatively quiet start to the year, we are seeing a noticeable uptick in merger activity across the market and whether or not you buy in to the supposed benefits of merger, we believe that the process of consolidation among housing associations has real momentum and will continue to play out over a number of years. In turn, this process is leading a number of our clients to consider whether their existing financing arrangements are fit for purpose if they see merger and/or acquisition as a key part of their strategy in the short-to-medium-term.
So, what does it mean to be “merger ready”? In truth, it probably means different things to different organisations. Most fundamental perhaps is the mind-set of the board and executive of the business in question. It is often highlighted that the shareholder driver is lacking in the housing association sector – although the evidence of the success that this discipline supposedly brings in the private sector is less than convincing. It is the board who will determine how open or not they are to either receiving approaches positively or pro-actively making approaches to other organisations. There are many organisations which have determined that merger isn’t really for them, either because they don’t believe that scale helps in delivering their social purpose or perhaps because their model or culture is unique and would be lost or damaged, and in a small number of cases, maybe the adage about turkeys and Christmas does indeed hold true. But if we start with the premise of a housing association which is open to mergers (in any form) , are there meaningful steps that they can take to either smooth the process or to make themselves a more attractive merger partner or rescuer of a troubled organisation? We highlight some of the key issues below based upon our considerable experience in housing sector M&A: 1. Existing Treasury Portfolio As readers of Social Housing well know, treasury arrangements in the sector often still feature pre-2008 long-dated, low margin bank debt, generally combined with deeply out of the money hedging plus more recent public bonds, private placements and short-term bank funding. Some bank lenders are active, others are effectively leaving the sector and/or reducing exposures, with a whole range of lender attitudes and objectives in between – including single name borrower limits, as well as a mixed bag of financial covenant definitions and consent requirements around corporate actions. Some lucky borrowers enjoy the dual benefit of legacy facilities with very attractive terms which have few if any corporate constraints – happy days indeed! There are several angles to this but to try and make a general and overarching point, the more consistent the position across lenders, the more “current” the portfolio in pricing and documentation terms. Meanwhile, the less reliant the borrower is on the whim of lenders who would rather be out of the mix, the easier the path through a merger is likely to be (assuming the overall credit proposition is sensible). Of course, in any merger, there will be legacy treasury arrangements on both sides and potentially different consent positions, but it is clear to us that if one side has a ‘cleaner’ position than the other, this will again help to smooth the path to combination. 2. Merger Consents & Corporate Structures Bank (and sometimes PP) consents relating to merger might be non-existent, have consent with a reasonableness test, or a simple (absolute) consent where the lender only as a legal obligation to consider their own interests. Equally, they may or may not apply depending upon the shape of the proposed corporate structure for the merger, whether this be full combination on day one of some form of grouping. This is just one example of the often-tangled picture that exists across the portfolios of two merging entities and the subject is a complicated one in its own right. Generally speaking, because of some obvious loopholes in pre-2008 loan agreements, lenders and their lawyers have tightened up on merger consent language in more recent loan documents. Therefore, although it is possible to introduce materiality and credit linked thresholds into the mix to ease the process around mergers, it is more challenging for most borrowers to completely negotiate such consents away in the bank market. However, the earlier point stands; lenders are unlikely to take issue where they have short-term loans priced “on-market” and no legacy “problem” swaps. The complexity and tension arises where there is a desire to retain attractive legacy facilities and lenders have consent rights. 3. On-Lending Flexibility & Liquidity Having the ability to on lend and sufficient liquidity to be able to do so within a short time-frame undoubtedly puts an acquisitive organisation in a stronger position in situations where a troubled HA is seeking a “white knight”. Given that problem situations in the sector often seem to have a liquidity angle, the regulator and the board of the problem HA may see attraction in being able to access a line of funding in a short period of time which isn’t subject to the provider of that liquidity having to seek lender consent or indeed to go out and raise new funding. Clearly, the two go hand in hand and there is little use in organisations carrying significant additional liquidity for this type of purpose if their ability to deploy that liquidity is constrained and subject to lender consent. Mergers and acquisitions in the housing sector are complex transactions to deliver and the list of issues at play is a lot wider than the relatively narrow treasury lens we have used here. Nonetheless, we are noticing an increasing realisation on the part of some housing associations with a clear appetite for M&A activity that their existing treasury arrangements may present a material stumbling block in pursuit of such a strategy. Addressing these issues is easier said than done but many clients are taking an increasingly pragmatic approach in recognising the need for corporate flexibility versus preservation of value in legacy lending arrangements, much of which can be embedded in long term loans where it is debatable that the value will ultimately be extracted. Rather than seeking re-negotiation of existing terms in a “must have” situation (i.e. at the point of trying to undertake a transaction), some businesses are seeing value in addressing these issues ahead of need. The rewards here of a stronger negotiating position with lenders and a better state of “merger readiness” need to be considered against the risk of giving up value and the hoped for opportunities not transpiring. These considerations as well as different strategies and treasury portfolios will drive a case by case approach, but as the merger bandwagon continues, housing sector treasurers should certainly be kept busy.