Fitch Ratings has affirmed Civitas Social Housing Limited's Long-Term Issuer Default Rating (IDR) at 'A-' with a Stable Outlook, and its senior secured rating at 'A'.

The ratings reflect Civitas' GBP1.9 billion UK property portfolio of predominantly specialised supported housing (SSH), which provides stable government-sourced rental income. The group benefits from these properties' long-dated, inflation-linked, full repairing and insuring (FRI) leases with registered providers (RPs), and incurs no direct void risk.

Within one of its main subsidiaries, CIM Healthcare Properties LP (CHP), Civitas has a growing exposure to special needs schools, adult residential care and children's homes, accounting for 23% of the group's investment portfolio at end-June 2024. Fitch views these non-SSH assets as having a higher risk profile than SSH and has allocated them a lower debt capacity. Fitch regards the existing group structure and leverage as transitional and expects net debt/EBITDA to increase to a still healthy 6x while maintaining loan-to-value (LTV) around 35%.

Key Rating Drivers

State-Sourced SSH Rents: We expect SSH to remain the group's main contributor at 65%-75% of total rents. Civitas indirectly receives government-sourced SSH rental income, at levels pre-agreed with local authorities. RPs leasing SSH properties receive housing benefit on behalf of tenants, which is then paid as rent to Civitas. SSH rents are exempt from social housing rent increase caps. Sustained demand for SSH is underpinned by the UK government's legal obligation to provide housing and care for adults with special needs.

Non-SSH Lower Debt Capacity: Fitch allocates a lower debt capacity to Civitas' non-SSH assets when setting a blended net debt/EBITDA rating sensitivity for the group's current portfolio mix. Fitch believes these assets have a higher risk profile due to exposure to care providers' operations, and also because the concept of market rent is less established than for SSH. CHP's assets have a higher net initial yield (NIY) of 6.26% versus Civitas' SSH's NIY of 5.84%.

Expanding CHP Schools Portfolio: Since merging with Social Healthcare Properties LP (SHP) and CHP in January 2024, Civitas acquired around GBP220 million of mainly CHP-type non-SSH assets, funded with cash from CK Asset Holdings Ltd (CK Asset). By June 2024, non-SSH assets constituted 23% of the group's investment portfolio and 24% of its annual contracted rent, up from 14% at end-January 2024.

Non-SSH has Less Market Rental Evidence: Although CHP's rents for special education and registered care assets are state-sourced, there is no pre-agreed rent with state funders. Local authorities pay a care package for each user to care providers who then pay the facility's separately negotiated rent to Civitas. Civitas sets these buildings' rents based on a minimum expected EBITDARM (EBITDA before rents and management costs) rent cover of 2x (June 2024: 2.1x).

Long-Term Lease Structures: The group's weighted average unexpired lease term (WAULT) of 23 years (of which Civitas, SHP and CHP are 20, 24 and 28 years, respectively) highlights the specialist and long-term nature of the group's assets. Civitas does not assume void risk in the leases and maintenance costs are covered by lessees under FRI leases. However, exposure to the conduits, RPs and care providers including specialist school operators, can result in rent disruption to Civitas.

SSH Rent Arrears: Arrears from three RPs - My Space, Falcon and Auckland - have led to a bad debt provision and rent concession representing 5% of Civitas' FY24 (financial year-end March) rental income. Fitch expects arrears and concessions to reduce by FY26, due to lease transfers and improving rent collection, areas where Civitas uses its expertise to assist the RPs. Exposure to these RPs fell to 18.9% of annual contracted rent at end-June 2024 from 30.4% in January 2024. Two of Civitas' major RPs in arrears are still paying 60%-80% of their rents and rent collection is improving.

Lease Transfers Ensure Rent Stability: Civitas' ability to reassign leases reduces RP failure risk and minimises tenant disruption, although potential rental loss or lease transfer costs may not be fully recovered. Leases were transferred to Qualitas from RPs that were in arrears with no rent reduction in FY24 and 2Q24. Pro-actively, Civitas had transferred many of its My Space leases to Qualitas ahead of this RP's proposed company voluntary arrangement announcement on 3 February 2025.

RSH Regulatory Judgements: The Regulator of Social Housing's (RSH) regulatory judgements on some of Civitas' RPs do not affect their ability to receive housing benefit; these RPs continue to pay rent to Civitas. Most regulatory judgements in 2018 and 2019 addressed these RPs' past governance and financial viability, some of which have since improved. In June 2024, Civitas had 11 RPs under regulatory judgements, which accounted for 44% of its annual contracted rent, down from 59% in January 2024.

Leverage in Transition: We expect Civitas to increase its LTV to around 35% and its net debt/EBITDA to about 6x by FY28. We anticipate the group to increase its borrowings to fund its acquisition plans, particularly in the UK special education sector. At FYE24, following CK Asset's equity investments, the group's debt was GBP316 million, with a low net debt/EBITDA ratio of 5.4x and LTV of 16%. Civitas' EBITDA net interest cover is expected to remain robust at above 3.5x, unchanged from FYE24.

Standalone Rating: Civitas is rated on a standalone basis. Using Fitch's Parent and Subsidiary Linkage Criteria, Fitch views CK Asset as a stronger parent and the legal, strategic and operational incentives for support as 'Low'. Civitas provides a small financial contribution to CK Asset and we see limited operational overlap. Although 46% of Civitas' debt is currently guaranteed by CK Asset, we believe the permanence of the guarantee for future funding is uncertain. CK Asset is not involved in Civitas' operations, but is engaged in its investment decisions and has representatives on its board of directors.

Derivation Summary

Civitas' closest UK peer is Social Housing REIT PLC (A-/Negative, previously Triple Point Housing REIT Plc) that holds only SSH assets whereas Civitas' portfolio includes SSH, special schools and residential care assets. Another peer, Assura plc (A-/Negative), receives indirect state-funded rental income for its UK GP surgeries. Assura has recently expanded to include private hospitals.

For the majority of their assets, these entities agree on rents with state authorities when commissioning long-term assets and benefit from long leases with their tenants. Civitas and Social Housing have similar WAULTs of 23 years and 24 years, respectively, while Assura's is shorter at 13 years.

All three benefit from upward-only rent reviews. SSH REITs have CPI- or RPI-linked rents while Assura's rents include inflation indexation, fixed uplifts, and open-market reviews. Maintenance risk remains with the lease counterparty for all three entities. Only Assura has void risk.

Fitch believes rental income would continue during lessee failure for Civitas, Social Housing and Assura, as rents are agreed with government entities. Further, local authorities prefer not to capitalise assets on their balance sheets. For the SSH providers, local authorities would want to avoid moving the tenants and maintain continuous provision of care and housing for them.

Civitas, Social Housing and Assura have net debt/EBITDA of under 9.0x and NIYs of 5.2%-6%. The SSH REITs' NIYs are at the higher end of this range.

Civitas, as a commercial for-profit private sector entity, is not rated under Fitch's Government-Related Entities Rating Criteria or Fitch's Public Policy Revenue-Supported Entities Rating Criteria.

Key Assumptions

Fitch's Key Assumptions Within our Rating Case for the Issuer

Civitas has changed its year-end to December from March but Fitch has retained the March year-end for its forecasting

Annual rental uplift of 2%-3%, in line with the CPI inflation forecasts in Fitch's December 2024 Global Economic Outlook

Rent arrears to reduce to 3% of gross rental income in FY26

Acquisitions of GBP185 million in FY25 mainly funded with CK Asset's equity injection

Acquisitions of GBP600 million during FY26-FY28 funded with debt

Policy rate in line with Fitch's December 2024 Global Economic Outlook for variable-rate debt and any new debt

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Adverse effects from the finalised group structure

Net debt/EBITDA above 8.0x on a sustained basis, reflecting the current years' portfolio mix

Significant financial losses to Civitas resulting from poorly managed SSH RPs

EBITDA net interest coverage below 2.0x

Consolidated LTV above management's target of 40%

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Civitas's rating is currently capped by the group's overall risk profile, including target LTV, and its sector's ecosystem

Liquidity and Debt Structure

Civitas refinanced GBP144.6 million of debt with a new GBP145 million three-year term loan with a lender that has a relationship with CK Asset. A further GBP100 million of debt matures in November 2025 with the same lender and discussions for refinancing are ongoing. We expect Civitas to refinance this maturity by utilising its own and its parent's banking relationships. The group had GBP24 million of cash at end-March 2024 and significant unencumbered assets of GBP1.4 billion as alternative sources of liquidity.

Of Civitas' debt, 56% is secured in two segregated non-recourse financings, each with their own asset pools. Fitch has not differentiated these entities' secured instrument rating as the investment-grade IDR is well above default, and cash circulates within the group to support different divisions. Each SPV up-streams its post-interest cash to the parent, which it may use to correct any LTV breach or meet interest cover shortfall at any SPV. The remaining debt is unsecured under two separate financing vehicles that hold their own asset pools.

The Civitas group may aggregate its assets, which are currently held in separate group entities, and fund itself with unsecured bonds in the future.

Issuer Profile

Civitas is a private-sector REIT that provides SSH for tenants with special needs in the UK. The REIT had an investment portfolio valued at GBP1.95 billion at end-June 2024 with 1,251 properties spread across the UK. It is 100% owned by CK Asset, which took Civitas private in May 2023. Two UK funds owned by CK Asset, CHP and SHP, were transferred to Civitas in January 2024.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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