Housing Treasury – Financing Risk

Plenary three: Regulating social housing providers

Speakers: Jonathan WaltersDeputy Director, Strategy and Performance

Homes and Communities Agency

Gareth HallPartner, Banking, Governance and Corporate

Devonshires

Successful places with homes and jobs

A NATIONAL AGENCYWORKING LOCALLY

The Regulator’s Perspective

Jonathan Walters, Deputy Director Strategy and Performance

23 October 2013

The SHR’s objectives, duties and general approach

The economic regulation objective The consumer regulation objective

Ensuring that social housing assets are not put at risk Protecting the public value in the assets Helping to ensure that the social housing sector can continue to

attract the necessary finance to build new homes

Minimise interference Proportionate, consistent, transparent and accountable

Co-regulatory principles underpin the regulatory approach

Diversification in the sector

Involvement in a greater range of activities

More complex financing arrangements and organisational structures

Wider range of business models involved in social housing

Different business models emerging

What is the function of a social housing business?

Diversification – the case for

A rational response to changes in the operating environment

Cross-subsidisation (ish) of social housing activities

Facilitates development of new homes

Contributes to wider economic and social benefits

Diversification – the issues

Legal ability to undertake an activity

The full range of implications and legal obligations

The links between social and non-social activities and within groups

Cross-subsidisation of non-social housing activities?

Impact of capital outlays on cash balances

Current regulatory approach to diversification

In line with the Regulatory Framework and Regulating the Standards

Boards sighted on risks and have effective strategic planning and control frameworks in place

Understanding the links between social and non-social activities and within groups

Understanding the mechanisms for ensuring that social housing assets are not put at risk

Using the same sources of assurance that Boards use where possible

What is the regulator looking for? Liquidity

Interest cover

Gearing

Security

Headroom against covenants and stress tested, for example:

– Delay in sales / drop in values

– Increases in interest rates

– Reduction in rental income (e.g. owing to welfare reform)

Board engagement and quality of advice

Fit with business plan

Some more challenging issues Non-social housing: level of recourse to the social housing assets?

– On balance sheet

– On-lending

– Guarantees

Technical covenants – e.g. around on-lending

Complexity and byzantine structures

Manage future exposures – e.g. index-linked finance; derivatives

How do the new finance structures play out in an insolvency?

– Capital markets – public bonds / non-UK private placements

– Sale/lease and leaseback

– Unsecured creditors (including retail investors)

Diversification Where are we?

– Responses to the discussion document are due to be published this week

– Series of external stakeholder events in the autumn

– Working towards publication of discussion document early next year

What was in the discussion document responses?

Recognition that there was a problem that needed addressing

Many providers concerned about ring fencing, although many lenders were keen on the concept

General support for resolution and recovery planning, but concerns over practical implementation

Jury divided on the disposal of properties to for profit entities

What will be in the consultation document?

Revisions to G&V standard

Disposal of Assets

Registrations Guidance

Rents – following direction from DCLG

Protecting the social housing assets

The regulator is looking for a 5 pronged approach:

– Understand you assets and liabilities– Understand your contingent liabilities – not just on a legal basis– Understand how they perform through an economic cycle– Understand what combination of factors can derail the business and

what mitigations can be put in place– Have a plan for protecting the social housing assets in the event of a

business failure

This will be set out in the revised G&V standard and the associated code of practice

Issues to be resolved The regulator’s thinking is still developing, but issues to be dealt

with include:

– What is the role of boards and executives?– Is there a place for third party assurance?– How does the regulator judge a good plan?– What happens if the regulator has concerns?

This will be a step change for many providers and there will be greater scrutiny of the business models of providers

The fundamental issue remains – how do we protect social housing assets, whilst funding new development, in a more challenging operating environment

Regulating Social Housing Providers

Gareth HallPartner

Devonshires Solicitors23 October 2013

What I will be talking about

• What’s it like out there for RPs?• Conclusions from consultation paper• HCA: investment and regulatory roles• Permitted activities: legal constraints• New business, new ways of doing business• Risks and how to manage them• Recovery planning

What’s it like out there for RPs?

• Rising delivery targets, falling grant• Need to cross subsidise: diversification• Diversification brings risks – need to accept and

manage them• RPs need freedom to deliver their development

programmes• There’s no going back

Conclusions from Consultation Paper

• Full ring fencing not achievable• Some trade-off risk and reward is inevitable• “One size doesn’t fit all”

capacity; capability; size; history; geography; appetite for risk

• Regulatory focus on outcome: maximise output, manage risk

• …and robust measures to prevent business failure

HCA: investment and regulation

• Investment arm: more than social housing: objects relate to, in England (H&RA, s2) Improve supply and quality of housing; regeneration and

development of land and infrastructure; creation, regeneration, development and wellbeing of communities; sustainable development and good design.

• Initiatives have included Help to buy; Build to Rent; Get Britain Building; PRSI

• Regulatory focus: protect social housing and associated funding (section 92K)

RPs’ permitted activities

• Provider of (at least some) social housing: low cost rent, LCHO (s80, 112)

• Registered (or small) charity or (s115):• Non profit; purposes are provision or management of

housing, and matters connected with or incidental to provision of housing

• Complies with regulation: financial, constitution (governance) and management (s112)

Charity law

• Primary purpose activities: low income (affordability), elderly, disabled

• On-balance sheet non-primary purpose trade: “no significant risk”

• Financial investment: market rent; loans/equity for subsidiaries

• Investment policy: issues similar to HCA’s i.e. identify and manage types of risk and return

• Mixed motive investment• Tax/gift aid

Diversification: non-social housing business

• Sale• Market rent• Key worker, student?• Care (stand-alone)

Commercialisation: how you do business

Could be social, non-social or mixed• Group structures• Joint ventures and consortia• Cost share groups• Buying businesses and companies• Agency and Franchising• Leasebacks• Bond issues? Use of proceeds

Legal risks to core business

• Equity/loan investment• Who contracts for mixed developments• Guarantees, indemnities, step-in• Cross collateral• Comfort letters• Leasebacks: forfeiture risk• Loan covenants: repricing, intra group cross default

Legal protection

• It’s all about risk; so manage it• Identify your limits: mission-creep, support-creep• Play the vires and regulation card• RPs are not banks• Internal processes; training

Recovery planning

• Stress test business plans to ensure they can withstand most serious challenges

• Can social housing assets be protected?• Not just the usual sensitivity analysis• Will the HCA sign them off? Capacity/expertise• External validation?• What if things change? Monitoring/review• Tendency to down play risks? Implications for rating

agencies

Where should the focus be?

• Effective risk management and monitoring• Exit strategy/risk management plan• Vires may prevent bringing activity on balance sheet• Board composition– capacity to understand and

manage risk• Don’t lose sight of core social housing business• Value for money