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The budget that changed the social housing sector

So there we have it. It was clear from the chatter around the much anticipated (dreaded?) post election budget that something fairly major was coming down the pipes, but “bad” in the minds of most sector observers would have been a housing benefit freeze or at worst a direct real reduction on housing association rents, applied in the guise of an adjustment from CPI+1% to CPI-1%. However, while the rabbit pulled out of Mr Osborne’s hat on the National Living Wage left Iain Duncan Smith in a bout of football style fist pumping ecstasy, his assault on the housing association sector left the away end unable to watch, barely believing what they were witnessing.

Our understanding is that some of these matters will be the subject of primary legislation in short order. Like everyone else, we are still digesting the potentially far reaching implications of a 1% nominal reduction in rents for four years starting in April 2016, but have set out some high level and early thoughts as to some of the fall out from this below. It is worth of course emphasising that while this must be the headline item for housing association finance directors, there are a number of other moving parts in the budget including others with significant impacts on RP finances and those of their customers:

  1. In 2014, and after consultation, a ten year CPI+1% rent settlement was announced, starting from 2015. In part, this was designed to offer RPs medium term visibility for business planning and investment decisions and by extension, similar certainty to investors and lenders putting money to work in and around the sector. To rip this up only a year later in favour of a 1% nominal four year rent reduction sends a message to investors and rating agencies that a) the sector may not be the stable safe haven that has been presented to them in the past and b) the previously understood credit fundamental of safely underpinned and inflation linked rental streams can no longer be relied upon as such. We expect to see both rating agency actions (whether at the individual RP or a sector-wide level) and investor reaction on the back of this news.
  2. There will now be a scramble to re-visit RP business plans in the coming days and weeks. The following figure indicates the broad impact across the sector of a 12% fall in rents, 12% being the figure suggested by HM Treasury which assumes that inflation would have been low for a couple more years anyway. We have used the 2013/14 global accounts figures rather than sought to project forward the counterfactual 2020/21 position.
  3. There may be all sorts of reasons to come up with a slightly different figure and probably a bigger headline fall once all the benefits changes are worked through but this is just an average – those RPs with already tight business plans may now be forecasting covenant breaches. A number will face significant additional pressure and regulatory scrutiny and may be forced to consider their independence. Indeed, we believe that a recent uptick in merger activity may be the start of a much bigger trend – perhaps one of the “efficiencies” that Mr Osborne alluded to, both as a means of accessing cost savings and as more financially robust organisations present a compelling story to those facing viability issues.
  4. As well as impacts on cash flows and business plans, there is an impact on security valuations which may be significant for some borrowers with limited capacity. For associations still in the process of raising their game on liquidity management it just got slightly harder.
  5. On a treasury related note, short-to-medium term hedging will potentially become more attractive as RPs look to close off possible risks in relation to the tighter interest cover levels outlined above.
  6. Unknown impact of introduction of a National Living Wage. We speculate here, but if this ripples through to wider wage inflation, then RPs may face a double whammy of increased cost pressures and significant falls in revenue.
  7. The obvious area of cutback will be development for schemes not already committed to. This is acknowledged in the OBR papers accompanying the budget although their figures look potentially optimistic. Some organisations may opt instead for more commercial activity and risk as a means of maintaining their development programme. Either points towards large scale development becoming perhaps even more concentrated amongst a smaller universe of large scale RPs.
  8. Finally and on a more positive note, and no one has previously thought of right to buy as a possible bright spot, but in financial terms, receipts from RTB as well as any increased revenue arising out of changes to rent levels for households with higher incomes may provide welcome mitigating factors, which will become clearer once the detail can be modelled. The Budget here refers to “up to hundreds of millions of pounds in additional rental income for Housing Associations” from the “pay to stay” change which is less than the impact of the rent change which will likely top £1bn p.a., but at least it’s something. Our feeling at this stage is that the government may be over-stating the benefit – the ‘benefit’ is not predictable nor spread evenly on a geographical basis.

We have frequently commented on the ability of the housing sector to “cry wolf” in response to policy changes but are in no doubt that this one is a game changer in a number of ways and that the sector as we have known it faces far reaching changes, so hold on to your hats.