HRS Review No. 76— Strategy, Governance and Regulation — March 2016

EU vote is next major decision point

Editorial 2

The political environment 3

Strategy and Governance 6

The economy 8

Regulation 10

Regulatory Judgements 13

Mergers 16

Greater uncertainties require robust scenario planning

2

In our report of the recent HRS Conference, we said

that we would discuss in more depth the main scenarios that

we had identified for the sector in this edition of the HRS

Review. There are both short‐ and medium‐term factors

affecting which scenarios will develop over the next few

years. The short‐term factor concerns the result of June’s

referendum into the UK’s continued membership of the

European Union. The main medium‐term issue concerns the

extent to which the sector has been able to rebuild a

relationship of trust with the government, while the extent to

which technological innovations are embraced by the sector

will also have an effect.

We will firstly consider the possibility that Britain will

vote to leave the EU. On the basis of William Hill’s odds,

there is a 29% of a vote to leave. Although this makes it

unlikely, this is a significantly higher probability than an

outright Conservative majority in last year’s General Election,

and thus clearly qualifies it as a mainstream scenario.

If we do vote to leave, David Cameron’s position

could become untenable, with a replacement likely to come

from the supporters of Brexit, probably Boris Johnson. On the

plus side, we would be freed of the inefficient, expensive

bureaucracy generated by the EU, for example in relation to

procurement, although it could be argued that these changes

would benefit the private sector to a greater degree. We

could expect a reduction in immigration, which could reduce

the pressure on housing but also reduce the supply of labour

to build new homes.

Economically, Brexit is likely to cause some disruption

to the economy for a few years, although we do not believe

that it should lead to a major shock. There would be changes

to the economy as we sought to become more self‐sufficient

and / or increase trade with other parts of the world,

producing a more volatile economic environment, with the

possibility of an initial recession, followed by shorter periods

of boom and bust.

London would not be seen as such a safe

haven for foreign investors, which could take

some of the heat out of the London market,

exerting downward pressure on house prices

across the country. This could be exacerbated by

higher interest rates brought in to defend the

pound. In this scenario, development for sale is

more risky, although we do not expect a huge

reduction in house prices but rather a small fall,

possibly a bit more in London.

Turning to longer‐term issues, the key factor is

whether the sector can repair its situation with government,

becoming seen as playing an important role in the supply of

new homes, while managing its existing assets more

efficiently. Even if this is the case, we should not expect that

all government policy will necessarily be in our favour. For

example, it may help to reduce the deficit and be politically

popular to extend the period of the rent cut beyond the next

General Election, even though this might be at the expense of

some longer‐term supply from the sector.

It has been suggested by the Policy Exchange that

housing associations should be given the option to repay their

grant in return for new freedoms over the use of their assets.

In an extreme version of the scenario in which the sector has

lost the trust of the government, as occurred a few years ago

in Holland, they could be required to repay the grant in full

over a relatively short period. This would probably result in

a significant level of integration in the sector and possibly

cause a proportion of the assets of housing associations to be

sold into the private sector.

Another possibility is that the government could

differentiate between housing associations that are seen as

meeting the government’s requirements for increases in

supply and efficiency improvements and those that are not.

The members of the latter group could be asked to pay a levy

to fund others to provide the housing that they had failed to

provide, despite having the capacity to do so.

Our future planning needs to consider both the

current forces acting on the sector (politically difficult,

economically benign) and the development of these in

different directions over the medium term. To some extent,

the political situation is in our collective hands. We need to

maintain a sufficient buffer should the economic situation

turns against us, which might be the result of a vote to leave

the EU in June.

Photo: Peter Dutton

Political and economic environment

3

The current dominant factor in

the political environment is the

forthcoming referendum on Britain’s

continued membership of the EU. In

an article for Social Housing, Andrew

Heywood noted that the recent decline

in the value of the pound against the

dollar reflected the view of the

international markets on the

probability and impact of ʺBrexit.ʺ He

warned that, should the UK vote to

leave the EU, inward investment into

the London housing market would

reduce, while interest rates may well

have to rise to protect the pound. This

could create the conditions for a slump

in the wider UK market, with increased

arrears, repossessions and negative

equity, alongside reduced access to

mortgage finance. Housing associations with exposure to the housing market should

consider and prepare for this scenario.

An insight into the current government’s approach to housing policy came in

an article by former Liberal Democrat leader Nick Clegg in The Independent on 25th

February, in which he said that, during the coalition government, David Cameron

and George Osborne had rebuffed repeated calls from his party for money for social

housebuilding on the grounds that ʺAll it does is produce more Labour voters.”

The Labour Party, having recognised that presiding over falling home

ownership levels and not being seen as aspirational had damaged its electoral

performance, has begun review of home ownership to be chaired by Peter Redfern of

Taylor Wimpey. This was launched on 4th February by former housing minister

John Healey, with economist Kate Barker and CIH Chief Executive Terrie Alafat also

involved.

Meanwhile, the Commission chaired by Sir Michael Lyons that had been

established by Ed Miliband to advise on Labour’s housing policy, which originally

reported in 2014, published an update report on 10th February, having reconvened

on an independent basis. The report recommended that the government should:

Broaden the focus of housing strategy beyond home ownership to increase the

supply of homes of all tenures and create lasting capacity in the supply chain

Take a more ambitious approach to direct commissioning

Develop the Starter Homes model, so that public subsidy is retained in

perpetuity and to prevent a reduction in affordable homes for rent

Acknowledge the importance of the contribution of local authorities and housing

associations to tackling the crisis in housing supply, giving housing associations

the certainty they need to plan long term

Put greater emphasis on championing the highest quality of design and

environmental standards for new homes and communities.

Increasing home ownership has

strong support from across the political

spectrum. Housing associations are being

strongly encouraged to support more

people to achieve this aspiration. Selling

homes has a number of advantages for

associations, freeing them up from

repairing liabilities as properties get older,

helping to maintain balanced communities

and providing a cash injection that can be

used to support the development of new

properties.

However, as we saw in 2008, the

housing market is vulnerable to external

shocks, and such an effect could be felt if

Britain voted to leave the EU. Strategic,

financial and development plans should

therefore always maintain a sufficient

buffer of both cash and profitability to

enable the association to remain solvent

and continue to comply with its covenant

requirements, even if planned sales do not

take place. If the plan is to build a mixed

development for sale and sub‐market rent,

it may be possible to maintain the overall

profitability of the scheme by converting

some or all of the units to market rent,

with reserve credit lines in place to

maintain liquidity.

Photo: Financial Times

4

Housing associations need to pay

increasing attention to the quality of the

design and construction of their

developments both to meet the demands of

customers, more of whom will be paying

the market rate, and to avoid long‐term

social and maintenance problems.

Given the high level of under‐

occupation in the owner‐occupied sector,

there may be opportunities for housing

associations to bring forward more

products aimed at encouraging people to

downsize. This might include leasehold

properties for older people or helping

people to rent out spare rooms to others.

It is unclear whether the PwC

analysis takes any account of recent

government measures to reverse the

decline in home ownership but these will

depend on the availability of mortgage

finance and sufficient secure, well‐paid

jobs. Housing associations will have to be

flexible in their development plans between

market sale, market rent and intermediate

products, such as shared ownership and

rent‐to‐buy, reacting to changes in the

market over time.

This need for a combination of a mix of tenures and better quality housing

was echoed by a report published by the House of Lords Select Committee on the

Built Environment On 19th February. Building Better Places supported the

governmentʹs focus on increasing supply but argued that this focus should include

quality as well as quantity. It called for the greater provision of long‐term affordable

rented housing, as well as a review of ʺthe impact of financial constraints and

changes to government policyʺ affecting housing associations in their aspirations to

increase supply. The report suggested that the government should reconsider its

proposal to include Starter Homes within the definition of affordable housing and

that local authorities should have the discretion to prioritise long‐term affordable

housing over Starter Homes in the planning system where appropriate. It also called

for clearer guidance on the use of developers’ viability assessments to ensure that

these did not compromise the ability of councils to meet affordable housing need.

The context for these policy proposals is set out in the English Housing

Survey 2014/15, the headline report for which was published on 18th February.

This found that the decline in owner‐occupation had abated, with the proportion of

owner‐occupiers unchanged from 2013/14 at 64%. The proportions of households in

the private rented sector and social rented sector were also unchanged at 19% (4.3

million) and 17% (3.9 million) respectively. The number of households with

dependent children in the private rented sector had increased from 30% to 37% over

the last ten years, during which time the average age of first‐time buyers had

increased from 31 to 33. Average rents in the social rented sector increased from £94

in 2013/14 to £99 in 2014/15, while private rents were unchanged at the national level

at £179 per week. In London, average private rents went up from £281 per week in

2013/14 to £298 per week in 2014/15, compared with average housing association

rents in the capital at £137 per week. Under‐occupation was concentrated in the

owner‐occupied sector, which had 7.3 million under‐occupying households (51%),

compared to 13% in the private rented sector and 9% in the social rented sector.

Only 14% of social rented homes did not meet the Decent Homes Standard,

compared to 19% of owner‐occupied homes and 29% of private rented properties.

Despite the pause in the decline in home ownership detected by the

English Housing Survey, research published on 16th February by PwC, predicted

that home ownership levels in the UK would decline from 61.5% in 2014 to 59.5%

in 2025, with a particularly pronounced fall in London from 45.9% to 39.5%. At

the turn of the millennium, 69.0% of homes in the UK were owner‐occupied,

58.7% in the capital. Meanwhile the proportion of households renting in the

private sector across the UK was predicted to increase from 9.4% in 2000 and

19.9% in 2014 to 23.9% in 2025, with the equivalent figures for London: 15.2% in

2000, 29.5% in 2014 and 39.5% in 2025.

One of the impacts of the increasing unaffordability of housing for market

sale is to widen the wealth gap between older and younger generations. A report

on how to promote intergenerational equity, published by United All Ages on 7th

January, recommended increasing overall supply to 300,000 new homes per

annum; setting up a national task force to produce a national strategy for

increasing the supply of retirement housing; and encouraging old people to share

their homes with younger people, both to make better use of the stock and to

reduce social isolation.

5

Housing associations have been

used to a considerable degree of certainty

in their development planning, with

medium‐term programmes and known

levels of grant. Looking forward, it is

likely that they will have to deal with

greater uncertainty as they are more

exposed to the market. For the time being,

there is also political uncertainty affecting

the rate of increase / decrease in social

housing rents from 2020 onwards, but this

need not necessarily act as a break on

development given the freedoms that the

sector is due to gain through deregulation.

If social rents are cut further, development

capacity could be maintained by disposal of

further void properties or converting some

to market rent.

To succeed in this environment,

associations will need to work in

partnership with each other, with

developers and with local authorities in

order to maximise their impact and share

risk. The areas covered by the new

combined authorities would be a good basis

for a group of housing associations to work

together.

As the dominance of London in the UK economy continues to grow, the

more that the housing issues of different areas of the country diverge, a factor that

is being addressed both by collective action locally and through the devolution

agenda. Looking firstly at London’s issues, on 30th December, the IPPR

published Capital Failure, the interim report of the London Housing Commission.

The reportʹs key points included the following:

The London Plan has a shortfall of 80,000 homes over the next decade

compared to the 500,000 needed to keep up with demand. This could be partly

addressed by increasing the density of well‐connected areas in outer London.

Planning approvals are insufficient to meet demand but many sites with

permission do not necessarily get turned into homes, due both to delays in

providing the necessary infrastructure and to landowners trading land with

permission rather than using it to get new homes built.

Investment is needed to help small and medium‐sized developers to buy and

build on smaller sites. Public grants, loans and guarantees will be required, in

addition to private investment.

Development is being constrained by a lack of capacity on local authorities,

uncertainties affecting the building plans of housing associations and a

shortage of skilled trades.

In the Midlands, Birmingham City Council and Birmingham Social Housing

Partnership, a collective of 35 social landlords based in and around the city, met on

22nd January to discuss how to strengthen existing partnerships to ensure enough

quality homes and support services for Birmingham’s citizens. Providers committed

to support each other to develop a new approach to homes and neighbourhoods and

develop a comprehensive housing offer for Birmingham.

The launch of Homes for the North, an alliance of twenty housing

associations providing homes for almost one million people across the north of

England, but with the ambition to do more, took place a week later. One of the

allianceʹs first activities will be to commission research into building new homes that

will appeal to graduates in an attempt to reduce the flow of graduates away from the

north. This is expected to form part of wider research into the housing market in the

north, to be undertaken in partnership with the ‘N8’ group of universities.

Meanwhile, the process of devolution continues, with widespread support.

On 5th January, the North Midlands Devolution Agreement was published, covering

the counties of Nottinghamshire and Derbyshire. The agreement aims to support an

additional 77,000 homes. Further south, a group of seven boroughs in east and north

London have formed the Local London partnership, seeking the devolution of

powers, including housing, to a sub‐Greater London level.

These powers will require both resources and expertise in order to deliver the

desired outcomes. On 15th December, the Centre for Cities published Beyond

Business Rates, which called for Stamp Duty to be devolved to local authorities in

order to incentivise them to support business growth and the building of new

homes. The report argues that this would increase the national tax take, thus

producing more revenue to be redistributed to poorer areas. On 11th January,

Melanie Dawes, Permanent Secretary at the DCLG told the DCLG Select Committee

that the Department was considering seconding some of its own staff or those of the

HCA to local authorities as part of the devolution agenda.

6

The political environment in

which housing associations are now

operating puts the onus on those

responsible for leadership and governance

to alter the strategy to enable the sector to

recover its reputation with politicians

while retaining sufficient financial

capacity to withstand a much more

difficult economic situation. They will

need to consider:

The volume of planned development,

funding and cross‐subsidy

arrangements, the mix of tenures and

contingency plans for a downturn in

the housing market

The introduction of products whose

subsidy to the tenants varies with

income without causing a disincentive

to work or increase wages

New approaches to tenancy

management to maximise the social

benefit provided by the association,

while maintaining strong

communities

How to work with other organisations

to improve efficiency, including cost‐

sharing groups, strategic partnerships

and full mergers

The approach to the use of new powers

whose use is optional or not specified,

including Right to Buy, fixed‐term

tenancies, selling existing units and

Pay to Stay.

The strategic environment for housing associations is dominated by

government requirements to improve efficiency, increase supply, promote home

ownership and reduce the cost of the welfare bill. In this context, an article in Social

Housing by Terry Frain of Savills Financial Consultants called on housing associations to:

Take more development risk to make a strong contribution to the governmentʹs

stated objective of 1 million additional homes by 2020

Introduce more flexible rents to help reduce the cost of housing benefit

Retain lifetime tenancies but with variable terms to enable rents to be flexed to

respond to changes in circumstances

Commit to reducing the number of associations by 20% by the end of this

parliament to improve efficiency and increase development capacity.

Another Social Housing article, by Fiona McGregor of the HCA, addressed

the need for associations to plan for the extension of the Right to Buy across the

sector. She advised boards “to have a plan for how they will manage the reduction

of stock, the need for increased development and the changed cash flows between

the sale of a property and the construction of its replacement.ʺ Boards would also

need to consider how to ʺdo more to help people with their aspirations for home

ownership.ʺ

While the 1% per annum rent cut is painful from the housing association

perspective, it fulfils the twin objectives for the government of reducing Housing

Benefit costs and forcing social landlords to improve their efficiency. Some

associations have sought to respond to this strategy tactically by seeking to exempt

some or all of their stock from the provisions of the legislation. Partners from both

Trowers & Hamlins and Clarke Willmott told Inside Housing that they had received

enquiries from housing associations about the setting up of sister companies to

whom stock could be sold to avoid the 1% per annum rent cut, since such a sale

would no longer require the consent of the regulator.

A more strategic response is to restructure the business to take out cost and

to manage more effectively the key activities and markets in which the association is

involved. For example, on 1st February, Sanctuary Group announced a new

operational structure in response to the rent cut and the introduction of the National

Living Wage, with operations divided between four areas:

Affordable Housing (social

housing, supported housing and

maintenance)

Care (68 care homes for older

people)

Commercial (student

accommodation, domiciliary

care, telecare and market

renting)

Development (delivery of 24,000

homes over the next ten year,

including the in‐house

construction team).

Strategy and governance

Sanctuary Housing office, Beck Road, Sheffield ‐ Photo: Jonathan Clitheroe

7

The achievement of the association’s objectives,

particularly the efficiency improvements, may well require a

simplification of the management structure, with shorter,

clearer, reporting lines and different divisions focussing on

meeting the needs of different markets. Governance

arrangements may also need to be simplified, minimising the

number of subsidiary companies and only retaining sub‐

committees where these can add real value to the board.

In this context, there will no longer be a place for

large numbers of representatives of particular constituencies

on the board, although some mechanism for ensuring that the

perspective of current tenants is taken into account should be

maintained, perhaps via a tenant‐led sub‐committee as in the

model used by Futures Housing Group. Instead, board

members should be recruited on the basis of their skills,

experience and leadership abilities, along with their capability

to work effectively with other board members and the

executive team.

Associations need to be independent of local

authorities, having the freedom to expand into neighbouring

areas where these can be served efficiently, rather than being

bound by political boundaries. Thus, “golden share” clauses

are no longer appropriate. However, associations must work

constantly at improving relations with local authorities,

being seen as trusted business partners.

The executive team consists of the Group Chief Executive, Chief

Financial Officer and the Directors of each of the new divisions. The

association has a target of £11.8 million efficiency savings in

2016/17.

While many of the recent government policies have posed

additional threats to the housing association sector, others, such as

the Right to Buy, have the potential to provide a boost to the

business plans of some associations. Similarly, plans for

deregulating the sector will give housing associations more

flexibility and enable them to move more quickly. On the other

hand, the removal of the requirement to obtain consents from the

HCA for various activities and the governmentʹs desire for housing

associations to increase their exposure to the housing for sale

market demands more effective leadership and governance. As

Jonathan Walters of the HCA told the NHF Risk Conference: ʺWe

have concerns that the governance that was good enough two to

three years ago is not good enough today.ʺ

Improving governance will require associations to move

away from the traditional governance structures, with large boards

split between residents, local authority representatives and

independent members. On 25th January, Altair published a report,

commissioned by Magenta Living, Incommunities and Bolton at

Home on the governance arrangements for LSVTs. This found that

those that had retained the traditional ʺconstituencyʺ model faced

challenges in gaining access to suitable skills to manage complex

risk, while many others had introduced board pay, streamlined

their arrangements, and reduced the size of their board. Many

associations were moving towards a skills‐based approach to board

recruitment, although steps needed to be taken to ensure that

accountability, customer focus and partnership working with local

authorities were not lost. This required changes to resident

involvement, communication and partnership working

arrangements. The existence of a ʺgolden shareʺ held by the local

authority was seen as a significant barrier to making the necessary

governance changes, with confusion being created when the golden

share applied to the subsidiary in a group structure.

An example of an organisation tackling these issues is

Futures Housing Group, which collapsed its governance structure

into a single 12‐member board at the beginning of the year,

replacing three separate boards covering the parent and two main

subsidiaries: Daventry & District Housing and Futures Homescape

(formerly Amber Valley Housing). The organisation also set up an

Insight Committee with a watching brief over the customer

experience, providing insight into where new homes are needed

and the type of community services need to meet the needs of the

local population. As part of the changes, Daventry District Council

formally ended its membership of Daventry & District Housing

GDP Growth and Inflation

The Second Estimate o f GDP, released by the ONS on 25th February,

reported an increase in UK economic output of 0.5% in the last quarter of 2015,

unchanged from the previous quarter. The economy grew by 2.2% in the year to

December compared with 2.3% in the year to September. Looking forward, the

median of HM Treasury’s comparison of independent forecasts for February predicts

growth of between 2.2% and 2.3% per annum for the next five years, compared with

the 2.4% forecast from the OBR that accompanied November’s Spending Review.

According to Output in the Construction Industry, December and Q4 2015,

released by the ONS on 12th February, construction output decreased by 3.4% in the

year to December (driven by a 6.8% decline in new work and a 2.2% fall in repairs

and maintenance) compared with a decrease of 1.6% in the year to September.

The annual rate of CPI inflation rose from –0.1% in October to +0.1% in

November, +0.2% in December and +0.3% in January. The median prediction for CPI

at the end of 2016 as reported in the HM Treasury document fell from 1.6% in

November to 1.1% in February, close to the OBR prediction of 1.0% for next year.

CPI inflation is predicted to reach 1.8% by the end of 2017 and to remain at around

2% thereafter.

The housing market

All of the five house price indices that we track show a decline in the rate of

growth during the past quarter. According to the standardised indices, which track

the change in the value of a typical home, the increase varied from 4.8% on the

Nationwide House Price Index, up from 3.9% in November, to 9.7% on the Halifax

House Price Index for February, unchanged from October. On a regional basis, the

Land Registry data shows price growth in the year to January varying from 0.2% in

the North East to 13.9% in London compared with ‐0.3% and +9.6% respectively in

the year to September.

The LSL / Acadametrics index of mean house prices, covering England &

Wales in the year to January, shows a 5.5% rise, while the ONS index for England in

the year to December shows a 6.7% increase. On a regional basis, the East of

England was the area of highest house price growth at 9.7% in the year to December,

up from 9.2% in the year to June. The slowest growing area was the North East at

0.9% in the year to December, down from 1.8% in the year to September.

Figures published by the Bank of England on 29th February showed that

there were 74,581 mortgage approvals for house purchase in January, the highest

figure for more than two years.

The medium‐term predictions are

for sluggish growth, at a rate somewhat

lower than the long‐term (post 1948)

average of 2.6%. The economy has not yet

recovered to its level before the Global

Financial Crisis in 2007. Construction

output is being squeezed by a sharp decline

in public sector investment as the

government seeks to eliminate the deficit.

The HCA’s quarterly survey data has also

shown cuts in planned investment of

£1.3ibillion by housing associations

between June and December last year.

Current conditions are relatively

favourable for housing associations to

increase their development output, since

the cost of wages and materials are lower

than they would be in a more booming

economy. Risks include shortages of both

labour, particularly if we decide to leave

the EU, and materials.

Predictions are for inflation to

return gradually to around the target level

of 2%, but more slowly than previously

forecast. In this context, housing

associations should be setting slightly

tougher targets for efficiency savings, since

lower inflation will automatically generate

some savings against the plan.

The latest set of house price data

shows prices continuing to grow much

faster than wages, as well as a return to

growth in all regions, although the gap

between the north and south of the country

continues to widen quite dramatically.

This is further complicated by higher

growth around the big northern cities.

8

The economy Photos: Thinkstock.com

Looking forward, the latest RICS UK Residential Market Survey noted a

second successive month of increases in the supply of properties for sale, mainly

concentrated in London, alongside an increase in demand thought to be driven by

buy‐to‐let investors seeking to beat the increase in Stamp Duty coming in in April.

72% of their respondents expect house prices to rise over the next twelve months.

HM Treasuryʹs latest median forecasts are for house price increases of 5.7% in 2016

(up from 4.8% in November) and 4.3% in 2017 (down from 5.2% three months ago).

The Council of Mortgage Lenders reports that the percentage of mortgages in

arrears by 2.5% or more declined from 0.94% in September to 0.92% in December,

while there were 10,200 repossessions in 2015 compared to 20,900 in 2014. In the last

quarter of 2015, 87,100 loans were made to first‐time buyers (up by 14% on Quarter 4

2014) to a total value of £13.3 billion, with an average loan‐to‐value ratio of 82.9%,

slightly higher than the previous year. Gross mortgage lending was estimated at

£17.9 billion in the January, up by 21% on the same month in 2015.

Business viability

There were 3,495 company insolvencies in England and Wales in the fourth

quarter of 2015 (on a seasonally adjusted basis), compared with 3,593 in the previous

quarter and 3,904 in the fourth quarter of 2014. In the construction sector, there were

2,547 company liquidations in the year to September 2015, down from 2,603 the year

to June.

Employment

According to the UK Labour Market Bulletin issued by the ONS on 17th

February, in the three months to December unemployment fell by 60,000 compared

with the previous quarter to 1.69 million (5.1% of the people who could work). In

January, the claimant count, incorporating both Job Seekers Allowance and

Universal Credit, was 760,200, the lowest figure since May 1975. Average total pay

including bonuses rose by 2.0% in the year to December to £496 per week, up from

£492 in September. This was again well above the rate of CPI inflation in December,

which was 0.2%.

Using the median figures from HM Treasury’s latest range of independent

forecasts, average earnings are predicted to rise by 3.0% in 2016 (November: 3.3%)

and 3.5% in 2017. According to the same source, the unemployment rate is predicted

to be 5.0% at the end of 2016 (November: 5.1%), falling to 4.9% next year.

9

The high rates of growth in and

around London have a number of effects.

Firstly, the cost of land is much higher, so

the subsidy required to provide housing at

social rents (as opposed to Affordable

Rents) is much higher. Secondly, there is

a greater probability and / or impact of the

bursting of a house price bubble, which

could leave associations with a cash and

revenue deficit from homes unsold.

Thirdly, homes in the high value areas are

becoming even less affordable to people on

typical incomes, increasing the need for

more sub‐market housing. Perhaps the

best way for housing associations to

respond to this is to increase the density of

new developments in high‐value areas to

make better use of the land.

Happily, the rates of arrears and

repossessions among home owners are

extremely low, although this will change at

some point in the future when interest

rates rise, with a much sharper

deterioration possible if an economic shock

occurs. Such a shock would also affect the

rate of insolvencies and associations

should continue to monitor the financial

health of their main contractors.

Prospects for the labour market

appear relatively positive, both from the

perspective of an employer and in relation

to the financial circumstances of tenants.

However, although unemployment is

falling, many of the jobs created are part‐

time, poorly paid and unstable, so support

will be required to help tenants manage a

volatile income stream while staying out of

arrears.

Spring

10

Boards need to give some careful

thought as to whether their objective is to

maintain a V1 grade for Viability, or to

take on further exposures that could

result in a V2 grade in return for the

greater rewards of faster growth and a

greater contribution to housing supply.

We would encourage the latter but only if

systems, skilled personnel and

monitoring arrangements are in place to

manage the risks involved and avoid a

further deterioration to V3.

Drawing on the post‐IDA advice

given by Simon Hatchman, the financial

position of the association can be

improved through efficiency savings, a

withdrawal from activities whose poor

financial performance cannot be justified

on social value grounds and by making

better use of their assets. Provided that

the land is available, selling an old home

and replacing it with a new one with

higher environmental standards should

reduce costs for both the tenant and the

landlord. The higher risk strategies that

you may be considering will require more

robust governance arrangements, with

executives and non‐executives working

more closely together to agree the

objectives and manage the risks.

As associations take on more market risk and reduce the headroom in their

financial plans in response to the rent cut, there is likely to be an increase in the

proportion of associations with a lower Viability grade. Writing in Inside Housing,

Julian Ashby of the HCA observed that ʺin responding to the changes in 2015 and

the proposed reduction in income, some providers will have lost some capacity to

deal with further changes or risks which ariseʺ and we could therefore expect to see

more associations graded V2 rather than V1. He also noted that many associations

were predicting a significant reduction in management costs as a response to the rent

cut, which could affect the quality of services or the condition of the stock.

While housing associations are generally subject to less intensive regulation

than previously, they will from time to time, with the frequency depending on their

risk profile, be subject to an In Depth Assessment (IDA). In a Social Housing article,

Simon Hatchman of the Acis Group said that the most important element of

preparing for an IDA, was ʺthe drawing up and delivery of a detailed project planʺ

to test the organisationʹs governance arrangements, identify areas of weakness and

put in place measures to address them.” This gave the organisation confidence that

its governance framework ʺwould stand up to scrutiny from every angle.ʺ Simon

noted that the areas in which the HCA were most interested were:

The approach to value for money

Stress testing and the links to the broader risk framework

The rationale for the organisationʹs diverse activities

The management of development and sales risk

Strategic asset management

The blend of skills among board members and executives.

The ongoing regulation of associations of different sizes may also be

changing. On 14th December, Fiona McGregor, the HCAʹs Director of Regulation,

told the DCLG Select Committee that the regulator was considering introducing a

more nuanced system in which the level of regulatory engagement would be based

more on risk and less on the size of the association, possibly removing the current

distinction between associations with more than 1,000 units and those with fewer.

Meanwhile, with some of its functions expected to be devolved to combined

authorities, there is a now a question mark over the future of the HCA itself. On

10th February, Brandon Lewis issued a Written Ministerial Statement,

announcing the launch of a review of the Agency. This would examine:

The continuing need for a non‐departmental public body

The capacity of the HCA to deliver more efficiently and effectively

Whether corporate governance and management arrangements are

sufficiently robust and transparent and ensure that agency is operating in line

with recognised principles of good corporate governance.

The regulator is clearly under pressure both to improve its own efficiency

and that of its regulated bodies. Speaking at a Capita regulation conference in

January, Fiona McGregor said that she was considering undertaking a regression

analysis on housing associations’ operating costs, repeating the exercise carried

out in 2012, which found ʺclear differencesʺ between the costs of associations that

could not be explained by the control variables used in the analysis.

Regulation

11

Whether or not the HCA is

replaced by another body, regulation will

continue to evolve to meet the

government’s policy objectives, which

currently include having the sector

reclassified as private, increasing

efficiency and increasing the supply of

new homes. Associations should push

themselves very hard on costs, both on

development and on ongoing operations,

while putting in place measures to ensure

that the use of the new freedoms from the

need to obtain regulatory approval do not

result in strategic errors. These might

include merging with the wrong partner,

setting up complex and inefficient

governance structures and entering into

onerous financing deals.

The government’s deregulation

agenda is bound to cause some concern

for lenders, whose credit assessments for

the sector are adjusted upwards on the

basis of the likelihood of government

support. You should maintain a close

relationship with your lenders and

investors, with a strong narrative as to

how you will manage the risks in your

strategy, while ensuring robust financial

management to ensure that the forecast

results continue to be achieved, giving

lenders confidence in your abilities.

In the meantime, a number of the HCA’s regulatory powers

are to be removed as part of the process of returning the classification

of housing associations in England to the private sector for statistical

purposes. On 15th December, Brandon Lewis told the DCLG Select

Committee that the government would be introducing a series of

amendments to the Housing and Planning Bill to deregulate the

housing association sector in order for it to be reclassified by the ONS

as private, while also maintaining a proportionate regulatory system to

give comfort to tenants. The measures included:

Removing the requirement for housing associations to obtain the

permission of the regulator to make constitutional changes, such as

mergers, restructuring, winding up and dissolution.

Removing the requirement for housing associations to obtain the

permission of the regulator to sell property or use their assets for

loan security

Restricting the power to appoint managers of an association to

where there has been a breach of legal requirements

Removing restrictions over the spending of the proceeds of Right to Buy / Right

to Acquire sales

Introducing a special administration regime to be used in the ʺunlikely eventʺ of

an association becoming insolvent.

These amendments were published on 4th January and introduced to the

Commons by Local Government Minister Marcus Jones the following day. They

provide for the special administration scheme for charities and registered societies to

be set out in future regulations by the Secretary of State, while the scheme for

companies involves importing, amending or omitting some parts of schedule B1 of

the Insolvency Act 1986. Under the proposed arrangements, an organisation could

remain in housing administration indefinitely and could only exit with the consent

of the communities secretary.

Social Housing subsequently reported concerns that this could lead to lenders

experiencing a delay before they could enforce their security, possibly leading to the

repricing of existing loans and / or reduction in the valuations of security. It also

reported that valuers were meeting with lenders and housing associations to

consider the impact of the deregulatory changes on valuations and loan agreements.

Eleanor James of Trowers and Hamlins told Social Housing that the amendments

included the option of extending ordinary administration procedures to housing

associations and, if this option was chosen, ʺfloating charges would need to be

written into the loan agreements of the majority of associations to enable lenders to

block the appointment of an administrator if necessary.ʺ

While most housing associations will benefit from the removal of the

requirement to obtain consent for property disposals, it has been reported that those

registered with the Charity Commission will need to apply for permission from the

Commission for such disposals once this is no longer undertaken by the HCA on

their behalf. Although most of those affected would be small alms‐house

organisations, this does include a number of stock transfer landlords.

Brandon Lewis MP ‐ Photo: Policy Exchange

12

The need for accuracy in

information provided to third parties

applies both to funders and regulators.

We have seen examples of data provided

to both parties with some of the figures

given in pounds rather than thousands of

pounds. Checking systems should be

beefed up; we can run a check on your

Financial Forecast Return that will

highlight such errors, among other

things, before you submit it to the HCA.

As the government continues to

rein in departmental expenditure and

taking into account the financial benefit

that the sector derives from the existence

of the regulator, there is a strong case for

some of the HCA’s costs to be met from

its regulated bodies, provided that the

charges are reasonable. Some estimate of

these charges should be included in

future financial plans, while we await

more detail in the consultation.

As organisations that exist for the

public good, housing associations should

be transparent about the complaints that

they receive and report on the changes

and improvements they have made in

response to them, possibly within their

annual report.

Associations providing financial

services to their customers should take

particular care, and obtain third party

assurance, that their procedures are in

line with legislation. Take note of the

cost to the banks of the mis‐selling of PPI

for example.

Although the HCA’s regulatory powers are to be reduced, it will still hold

significant influence that could be brought to bear in situations where it is concerned

at an association’s plans. In December, Jonathan Walters of the HCA told Inside

Housing that, while the HCA would no longer be able to stop mergers it considered

inappropriate from taking place under the proposed regulatory changes, it would

still be able to downgrade the associations involved, which could suggest to lenders

that they should not agree to the merger.

In relation to its current activities, the HCA has expressed disquiet regarding

the quality of some regulatory returns provided by Registered Providers. Writing in

an NHF Finance Update, David McCormick of the HCA highlighted that ʺpoor

returns may be considered by the regulator as an indication of failings of governance

and internal controls.ʺ Errors detected by the regulator include the transposition of

figures, figures given for years rather than months and misplaced decimal points. He

encouraged providers who are uncertain of data requirements to seek clarification

from the regulator and to ensure consistency between different returns.

In the future, in the context of reduced funding from the Treasury and the

benefit that associations receive in terms of lower interest rates, it is expected that the

HCA will introduce fees for the bodies within their ambit. Speaking at the NHF Risk

Conference on 14th January, Jonathan Walters of the HCA said that he wouldn’t be

surprised if regulatory fees came back on the agenda in the course of this year or the

next. With communities secretary Greg Clark reportedly in favour of the HCA

bringing in fees for regulated bodies, it is now expected that the HCA will publish a

consultation on charging such fees once the Housing and Planning Bill had become

law. Fees could become chargeable from April 2017.

A further regulatory function in relation to the activities of housing

associations is fulfilled by the Housing Ombudsman, whose role has been the subject

of a recent review. On 18th December, the Cabinet Office announced that, for the

time being, the Housing Ombudsman would remain separate from the combined

Public Service Ombudsman, which covers parliament, the health service and local

government, although the two organisations could be merged at some point in the

future. It is likely that this decision was influenced by the governmentʹs desire to

have housing associations reclassified into the private sector as soon as possible.

In terms of the role of this service, Home Improvements, a report published

by the Centre for Social Justice on 17th February, recommended that the

Ombudsman should be given powers to publish data on the number and nature of

complaints against each social landlord.

Away from sector specific regulation, housing

associations also need to comply with a raft of other

legislative requirements, including those relating to the

financial services functions fulfilled by some of them. In

December, Aldwyck Housing Group wrote to customers who

had taken out HomeBuy equity loans between 2008 and 2010,

saying that, because documentation had not been compliant

with consumer credit legislation, the organisation would be

refunding all of the interest charged on these loans to date,

while issuing new loan documents that are compliant with

legislative requirements. The number of customers affected

and the amount of the repayments was not disclosed.

Aldwyck Housing head office, Haughton Hall, Bedfordshire

Regulatory Judgements

13

As noted above, associations

should not fall into V2 in an unplanned

way but should be clear that being given

this rating is the acceptable result of

pursuing a strategy of growth that meets

broader policy objectives. Equally,

boards should be wary of approving

financial plans that remain in deficit for

any significant period. Clear plans and

robust monitoring arrangements are

needed to ensure that efficiency savings

are delivered, while associations

developing without grant have the option

to use new units for market rent if the

government extends the period of

negative or below‐inflation rent rises.

While risk management needs to

improve in the higher risk environment,

some associations are failing to meet

current standards on risk and assurance.

The Audit Committee should meet

frequently to hold the officers to account

and to obtain assurance on the risks and

controls just below the highest level that

is reported to the Board. Risk definitions,

assessments, controls and assurance

requirements should be reviewed at a

frequency in proportion to the size of the

risk and ahead of any strategic change

that would alter this balance.

Since our last report in December, 163 Regulatory Judgements have been

issued, of which 150 contained unchanged assessments for both Governance and

Viability. Of the remainder, seven associations were upgraded for Governance, of

which one was also upgraded for Viability, while three associations were

downgraded for Governance and one for Viability. Two associations received their

first Regulatory Judgements, one as a new stock transfer and the other following a

merger. None of the Judgements published in the last quarter had a non‐compliant

grade on either measure.

The one association downgraded for Viability was Christian Action (Enfield)

Housing Association, which was given a V2 rating on 11th February. This was due

to a ʺrelatively weakʺ financial profile, with ʺdeclining headroom in the business

plan in relation to funders’ covenants, as a result of forecasting diminishing

surpluses over the next few years and deficits in the long term.ʺ Risks to achieving

the planned financial outturn include the failure to achieve efficiency savings and not

achieving the planned rental growth from new developments. Following the

publication of the Judgment, the association’s Chief Executive, Mark Hayes,

complained that the regulator was disincentivising associations from increasing their

contribution to new housing supply.

The three associations downgraded to G2 for Governance were Flagship

Housing Group, Magna Housing Group and Bolton at Home. The revised RJ for

Flagship Housing Group was issued on 16th December, following an In Depth

Assessment, which identified problems with the organisation’s new approach to

assurance. This did not provide sufficient assurance ʺon the adequacy of the controls

in place, and whether the level of residual risk is in line with the organisation’s risk

appetite.ʺ Instead, assurance plans were linked to managersʹ views of the potential

for efficiency gains, with the internal audit programme being replaced by a series of

lean systems reviews. In addition, the Audit Committee met infrequently with

limited terms of reference. The Group had accepted that this approach left a gap in

its assurance framework and had committed to a review in the near future.

The downgrade for Magna Housing Group, issued on 11th February, also

followed an In‐Depth Assessment. The regulator concluded that the association had

ʺnot published a robust self‐assessment which sets out in a way that is transparent

and accessible to stakeholders how it is achieving value for money in delivering its

purpose and objectives.ʺ In addition, there were deficiencies in risk management,

including the lack of a strategic review of key risks, controls and assurance by the

Board, the failure to regularly review key risks such as welfare reform and the lack of

clear prioritisation of risks within the risk matrix.

The downgrade for Bolton At Home was published on 24th February,

following the discovery by Internal Audit of ʺa significant number of out‐of‐date gas

safety certificates,ʺ including some that had been expired for many years, which had

arisen due to ʺa lack of accountability for property data within the organisation.ʺ

Bolton at Home had avoided a further downgrade because it had self‐reported the

issue to the regulator and had taken action to improve performance. On Viability,

the association has the weak financial profile of an early‐years LSVT, with particular

exposures relating to the delivery of efficiency savings in response to the rent cut; the

potential for an increase in major repairs costs; possible increases in pension costs;

and the treatment of a number of poorly performing assets.

Housing Association Gov. Viab.

Acis G1 V1

Aldwyck G2 V2

Bolton At Home G2 V2

Christian Action (Enfield) G1 V2

Flagship G2 V1

Gloucester City Homes G1 V2

Knightstone G1 V1

Local Space G1 V1

Magna G2 V1

Saffron G1 V1

Soha G1 V1

14

Having accurate data is essential

to the running of any business; where

this data covers matters such as gas

servicing or fire risk assessment actions,

this could be a matter of life and death.

Clear responsibility should be allocated

for ensuring that key business and safety

data remains accurate and up‐to‐date ,

with third‐party assurance being

obtained on a frequent basis.

Our experience in reviewing the

financial plans of associations over a long

period of time is that economic

assumptions were often very

conservative. This is no doubt changing

in response to the rent cut, which calls

for more thorough stress testing to assess

the impact of adverse scenarios on the

cash position and loan covenants, with

contingency plans and trigger points

agreed to respond to such scenarios.

The experience of Knightstone

shows the importance of maintaining a

sufficient cash in addition to that which

is required in the plan to guard against

delays in refinancing or the receipt of

sales income. Liquidity and cash

forecasts should be regularly reviewed by

members with relevant skills.

The initial Regulatory Judgement for Gloucester

City Homes, published on 24th February, also cited a

relatively weak financial profile as the basis for its

Viability Rating of V2. This took account of an

inherently tight loan covenant position due to the need

to obtain annual business plan approval; the delivery of

cost savings in the light of relatively tight economic

assumptions; and limitations on the stress testing

undertaken to date.

Of those associations benefitting from an

upgrade, that relating to Aldwyck Housing Group

represented a change from a non‐compliant G3 rating

for Governance. Aldwyck had been downgraded to G3

in November 2014 due to failings relating to probity, risk

management and internal control. Since then it had:

Fully implemented all the recommendations from

the audit of its internal control and probity

frameworks that was carried out in 2014 through its

governance action plan

Strengthened its board through co‐optees

Completed an audit of the organisation’s culture and

implemented its recommendations

Undertaken reviews of its governance structure of

the skills of its board and committee members recommendations

Introduced a board and committee member and staff learning and development

plan

Implemented the recommendations of a review of its finance department,

strengthening those areas identified as weaknesses

Commissioned additional audits to validate the effectiveness of its governance

action plan including a design audit and an operational effectiveness audit.

Introduced a new risk and internal controls framework and associated approach

to probity.

Aldwyckʹs Viability judgement of V2 was affected by significant exposure to the

housing market and relatively little headroom against its tightest financial covenant.

The association that received an upgrade on both its Governance and

Viability ratings was Knightstone Housing Group. According to Governance section

of the RJ published on 11th February, the regulator now has ʺassurance that

Knightstone has an effective risk, controls and assurance framework, in particular in

relation to monitoring the group’s liquidity.ʺ The Group had enhanced its financial

framework, with clearly defined parameters that form the basis for performance

reporting to the Board. The Board had reduced in size, to between eight and ten

members, taking ʺmore active ownership of the risk register and the risk

management process.ʺ On Viability, it had financial plans that were consistent with

its strategy, sufficient funding and security to deliver the business plan and

headroom against its loan covenants ʺunder a wide range of scenarios,ʺ having

ʺsignificantly rationalised its development plans.ʺ

15

Aldwyck has now put in place a

governance and internal control

framework that is fit for purpose, but it

will have experienced significant costs

and management disruption as a result

of the events that led to its downgrade. It

experienced a failure of probity in

awarding contracts to a company

controlled by a board member and then

failed to co‐operate with the review being

undertaken in response to these events.

Board members should receive regular

reminders of the need to declare any

interests, with an annual signed

declaration. Where any issues arise that

require communication with the

regulator, they should be informed at the

earliest opportunity, kept up to date and

any agreed actions undertaken in full

and within the agreed timescales.

The problems experienced by RBH

give a reminder that the landlord retains

overall responsibility for the safety of a

home, even if the management and

maintenance is delegated to another

organisation. Associations with such

agreements should obtain positive

assurance that safety critical tasks have

been performed as required or take back

the responsibility and charge the third

party for undertaking the work. This

may be more cost effective than the

alternative arrangements in any case.

The remaining Governance upgrades reflected the implementation of

additional controls to ensure compliance with the Rent Standard by Soha Housing

and improvements in the Value for Money self‐assessments from Acis Group, Local

Space and Saffron Housing Trust, with the latter having also having introduced a

new governance model, refreshed the board with appropriately skilled members and

obtained external assurance on improvements to the internal control framework.

In addition to the large number of Regulatory Judgements issued in the last

quarter, the HCA has also announced that the grading of one association is under

review and issued five Regulatory Notices. On 2nd February, the HCA announced

that it was ʺcurrently investigating a matter which may impact on Tower Hamlets

Community Housing’s published compliant governance grading.ʺ A statement from

the association said: ʺThis follows various historical reviews that THCH has

commissioned into aspects of our operations. We are working closely with the HCA

to ensure that any areas of concern are dealt with effectively.ʺ

On 13th January, the HCA issued regulatory notices to three small providers

for breaches of the Governance and Viability Standard. Mulberry Housing Co‐

operative had breached the Rent Standard by imposing a rent increase of 10% in

January 2015 to support a programme of repairs. The Charity of Annie Kew and

Drayton Parochial Charities had failed to submit their accounts within six months of

the end of their financial years.

The two remaining Regulatory Notices both relate to failures in gas servicing

leading to a breach of the Home Standard with the potential to cause serious

detriment. One was issued on 27th January to Bolton At Home for the reasons set

out in the RJ. The other was issued on 24th February to Rochdale Boroughwide

Housing (RBH), which had discovered, on terminating a management agreement

with a tenant management organisation that had been responsible for providing a

full landlord service on 45 of its homes, that a number of gas safety certificates were

out of date, in some cases for up to two years. Although responsibility for

undertaking the checks was with the tenant management organisation under the

terms of the agreement, RBH retained ultimate responsibility for ensuring that they

were undertaken. RBH had since completed all of the outstanding checks and its

Audit Committee had approved the findings of an internal review. The regulator

had therefore decided not to downgrade RBHʹs governance rating at this point.

Hargreaves Risk and Strategy 48 Broomfield Avenue London N13 4JN Tel: 020 8245 0737

Email: John Hargreaves: j.hargreaves@HargreavesRS.co.uk Chris Mansfield: c.mansfield@HargreavesRS.co.uk Sharron Preston: s.preston@HargreavesRS.co.uk Website: www.HargreavesRS.co.uk

Mergers Planned mergers

On 11th December, Affinity Sutton and Circle Housing Group announced that both of their Boards had approved the business case for the two organisations to merge and that they would now "move forward with the merger process, including consultation with residents and key partners. On 19th February, it was announced that Keith Exford of Affinity Sutton as the Chief Executive Designate of the new entity, with Sir Robin Young of Circle Housing becoming the Chair Designate. The merger is expected to be completed this year, subject to consultation with residents, final approval of the two boards and the consent of the regulator. Ahead of the merger, Circle is undertaking a governance review with a view to simplifying its group structure, which currently includes 9 Registered Providers.

On 21st January, AmicusHorizon announced that it had been selected, after a competitive process involving eleven

associations, to take over 277‐home Southwark and London Diocesan Housing Association. The merger will enable the

smaller associationʹs residents to be offered a wider range of services, as well as giving scope for more new homes to be built.

On 25th January, Octavia Housing Group announced that Ducane Housing Association would, subject to final approvals, join

the Group on 1st April. The merger will enable Ducane to significantly increase its development output.

On 2nd February, Sovereign Housing Group and Spectrum Housing Group announced that they were in merger talks with

the objectives of improving efficiency through economies of scale and helping to deliver more new homes.

In February, the Boards of Genesis and Thames Valley both accepted the initial business case for the proposed merger and

would now finalise the last of the due diligence and consider how to integrate the two organisations, which is being driven

by the need to build more homes to address the housing crisis.

NHF Merger Code

43% of 107 chief executives replying to an anonymous survey by Inside Housing, said that they were unlikely or very unlikely to adopt the NHF merger code (for details, see HRS Review 74, page 16), with rates of opposition higher among smaller associations. Some feel that its requirements are too onerous or biased in favour of predatory bids, although, in the words of Fiona McGregor of the HCA, “The sector has got some serious questions ask itself about just dismissing mergers out of hand.”