The budget that Changed the Social Housing Sector
With the dust now settling on “the Budget” as it may come to be known by future generations of Finance Directors, RPs and other housing sector participants have had a bit more time in which to analyse, cogitate, contemplate and soul search on the new landscape. If not scorched earth, it is certainly feeling slightly crisp and frazzled around the edges. While certain points of detail are subject to change, some big picture themes are emerging fairly consistently in our discussions with clients:
- First up a quote from the Sage of Omaha, Warren Buffett – “It takes 20 years to build a reputation and five minutes to ruin it”, which might well be applied here in relation to a sector which has traditionally enjoyed a reputation amongst lenders and investors for being safe and boring. To rip up the CPI+1% rent settlement after a year sends a message to investors that the sector may not be the predictable safe haven of inflation-linked net revenues it has seemed. Indeed, the very same government influence and support that underpinned the sense of stability and policy certainty has now revealed a rather different face. This, in our view, is a material and negative change to external perceptions of the UK housing sector.
- The main rating agencies have been relatively guarded in their comments thus far at least in terms of individual ratings. Moody’s have placed the whole sector on negative outlook, with the implication that a downgrade may N follow in due course.
- From our discussions, institutional investors are still digesting the news and awaiting feedback from borrowers and issuers as to the likely impact on their businesses. Nonetheless, the government’s actions are hardly likely to result in a positive response. The acid test will be the investor response to the first issuers back into the market. Any volunteers?
- On the banking side there are no doubt some challenging conversations happening between relationship bankers and credit colleagues. Our overriding sense is that the active lenders won’t ‘knee jerk’ and will have continued appetite for the sector. But lenders will want to see business plans which demonstrate that RPs remain robust in the new environment and may call for a sensitivity analysis of previously submitted plans to give some early comfort. Lenders will no doubt view responses from individual RPs as a test of both management strength and resilience. We expect lenders will review their internal credit rating methodologies for the sector and if this results in a ‘downgrading’ it is likely to impact capital charges which in turn could impact pricing; as well as a need to hit internal return on capital requirements, lenders will always be conscious of pricing levels in the market and time will tell how this pans out.
- In the immediate aftermath of the Budget we used the following analysis as an illustration of the broad impact across the sector on interest cover of a 12% fall in rents (the figure suggested by HM Treasury) using the 2013/14 global accounts figures.
- Our initial estimate has been confirmed as broadly right by clients based upon their initial cut of their revised plans. Of course, this is before any mitigating action around costs and development programmes are undertaken and those in a position to do so will cut their cloth accordingly in an attempt to maintain operating margins. But RPs whose plans may have looked challenging prior to the Budget 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.
- In terms of business planning, RPs will need to decide what to put in plans following the four-year period. Perhaps it is reasonable to assume reversion to CPI + 1% in the base case plan, but it illustrates the importance of stress testing and ensuring visibility for boards of modelling assumptions for them to review and comment on.
- As well as impacts on cash flows, there is an impact on security valuations which may be significant for some borrowers. It may be those RPs with the lowest operating surpluses and fewest opportunities to diversify who are hardest hit, since they may also be the RPs where the prospect of a mortgagee or successor RP ever recovering the “shortfall” (compared to the pre-Budget path of future rents) is more limited. There seems likely to be a significant mark-down of EUV-SH accounts valuations but less of an impact on security valuations, reflecting the government’s clear intention that a mortgagee in possession or buyer from same would not be bound by the 1% cuts or at least not to the same extent. The clearer the interplay between the Rent Standard and the government’s legislation, the better for lender confidence.
- An obvious area of cutback for many organisations will be development. This is acknowledged in the OBR papers accompanying the Budget although their figures look optimistic. Some organisations may opt instead for more commercial activity and risk as a means of maintaining their development programme and operating margin or a more aggressive approach to operational efficiencies. Either option points towards large scale development becoming even more concentrated amongst a smaller universe of large RPs.
- Finally and on a more positive note, in financial terms receipts from RTB and higher rents from “pay to stay” may provide mitigating revenues, which will become clearer once the detail can be modelled. Our feeling at this stage is that the government may be over-stating the benefit, that even setting aside the tenant perspective it may “help” most the RPs which need it the least, and that in “credit terms” it is much less reliable an uplift than the 1% rent cut is a negative factor.
9th July 2015