Red alert

As finance directors sit down for their annual conference in Warwick, talk in the bar is bound to turn to one of the toughest years that housing associations have ever had.

At the end of 2008, six associations were under the close watch of the Tenant Services Authority, and three associations had lined up to provide loans or take over those in need of major help. Loans are much more expensive and lenders take every opportunity to squeeze out more money on financial products. Housing association liquidity is being hit by the falling value of their land banks and unsold properties.

So what are these new risks that have got the sector into this parlous situation?

Until the credit crunch began to bite, housing associations had enjoyed relatively cheap loans from banks because of competition between lenders. The sector had access to cheap money because of the perception that they were very unlikely to default on their repayments - and would be bailed out by merging with another organisation if they came close. But those conditions started to disappear rapidly in mid-2008.

Banks’ own funding costs rose and they found that cheap, long-term loans were costing them money, so they started to raise the rates. Whereas before they might have overlooked minor breaches of loan terms, such as filing information late, some began to use these infractions to renegotiate deals.

Associations that needed to re-finance and those mulling mergers or restructures also saw attempts to renegotiate their deals at a new, higher price. Competition between lenders for business, which had helped to push down prices, also dropped back as the sector’s main lenders drew in their horns, leaving about three active ones. Where associations might once have paid a 0.2 to 0.4 per cent margin to their banks on top of the going interest rate, they could now expect to pay anything between 1 and 3 per cent. ‘We are trying to look at each one on its merits and not take a dogmatic approach,’ says Clive Barnett, head of housing finance at Royal Bank of Scotland.

So far, says London & Quadrant Group chief executive David Montague, only a small number of associations have seen their loans repriced, but he predicts that eventually the banks will want to have such discussions with almost every association. ‘We have ambitions to grow. I expect we will be going back to the bank for more money at some point, so I expect to have the conversation with them,’ he says.

Mark Washer, group finance director of Affinity Sutton, says the possibility of loan repricing has put his association off making structural changes and was one reason why they did not bid to take over struggling association Presentation. ‘Repricing has the potential to wipe out any savings we could make from rationalising the group,’ he explains.

Double whammy

At the end of last year, the sector reeled from another blow, as some housing associations were hit by short notice calls from banks for millions of pounds of cash or property, to use as collateral on financial agreements.

The associations affected were using financial products called ‘stand-alone swaps’ which are designed to protect them against interest rate rises. Under the deals, associations take out a loan at a variable rate with one bank. They then pay a fixed rate to a second lender. In return, the second lender will pay them a variable rate to cover the original loan. This allows the housing association to put the fixed rate in its business plan and remove risk.

That deal usually turns out favourably for the housing association, although they agree to put up more security on the deal should the rate the housing association pays to the second lender drop more than an agreed level below the amount it receives from them. That situation happened, after sudden shifts in long-term interest rates at the end of 2008.

The result? Thirty-two housing associations had to raise £396 million in collateral.

Richard Williams, a director of consultants Enterprise BWNL, thinks most associations knew what they were getting into when they signed up for swaps.

‘I think most housing associations understood the swaps but I don’t think anyone in the market anticipated that scale of rate fall,’ he says.

But Alex Pilato, chief executive of Traderisks, which advised on the management of such derivatives, says associations should have been advised to allocate extra security. ‘They should have talked about increasing the amount of security on an annual basis,’ he says.

A few of the larger housing associations have set up landbanks - a store of sites that they can develop later. Some of these purchases are now worth much less than the price paid for them. Last year, Metropolitan Housing Partnership wrote down £8.1 million of land in the Midlands, while Paddington Churches wrote down £3.7 million. Fifty housing associations are expected to do the same at the end of this financial year, says the Tenant Services Authority.

Some associations are said to have continued buying sites for top prices several months after the commercial house builders stopped bidding.
‘They paid what was a fair market price at the time but now looks expensive,’ says Richard Petty, head of residential property consultants Drivers Jonas.

But many could defend their acquisitions on the basis that they managed to buy a site they could never have got before, he adds.

Long term, it will work as social housing - but it will cause some short-term balance sheet pain first.

Worst case scenario

Some associations may have to declare the drops in value of these sites in their accounts as impairments. In the worst cases, this could push their income and expenditure into the red, potentially triggering a breach of their loan covenants and opening the door for their lender to reprice deals.

But if associations were planning to build on the sites and are able to prove they can raise the money to build the scheme - perhaps by securing extra grant from the Homes and Communities Agency - then the site’s value may not have to be impaired. The consensus in the sector is that this extra funding may reduce the scale of impairments.

The slowdown in the housing market has inevitably hit associations with properties for outright sale and shared ownership. Figures from the Tenant Services Authority gathered in January say there were 10,060 homes unsold, with 4,560 unsold for more than six months.

Several associations based in the south east said homes in London were still selling well but some more marginal locations in the south east and West had slowed. There was still demand for houses, but town centre apartments were less popular, they added. The Homes and Communities Agency is offering extra grant to turn some schemes into homes for social or intermediate rent. So far, 3,996 have been converted.

No money, no confidence

Lack of mortgage finance for buyers of low cost homes is proving a major headache, in addition to the impact of low confidence in the economy.
‘Demand is strong but the number of people withdrawing is increasing because of concerns about job security,’ says Graeme Moran, managing director of Metropolitan Home Ownership. Valuers are also tending to price homes anything from 10 to 30 per cent lower than the value assumed by the association, which can scupper sales.

‘They are sometimes disregarding comparative evidence within the scheme and simply taking a bit off for the sake of caution,’ says Mr Petty, although a lack of sales means it is sometimes hard to compare prices.

Nobody seems in a hurry to blame the Housing Corporation as regulator, now the Tenant Services Authority, for their problems - rather they believe the speed and size of the downturn could not have been foreseen. The only voices of dissent - and they are mild - are over whether the Corporation pushed housing associations to take on too much debt when they published their Unlocking the door report in February 2007. ‘There are probably RSLs that did what the Housing Corporation said, unlocked the door and fell out the other side,’ says Mr Washer. ‘But nobody predicted anything on this scale.’

Peter Marsh, chief executive of the TSA, defends Unlocking the door, which he said helped to bring more investment into the sector. ‘Housing associations are not there to generate piles of cash, they are there to need housing need,’ he says. But with regard to the cash calls on swaps, the TSA will review its treasury management guidance in the summer. ‘We will be trying to learn lessons about what happens in this recession,’ he says. ‘Nobody was forecasting two or three years ago that long-term rates could get as low as they did in December.’

Coping mechanisms

He predicts the number of unsold homes will now drop, as associations work with the HCA to convert some to rent. This will also reduce potential write-downs, although there will still be ‘one or two’.

Mr Marsh did not want to comment on the number of associations now under the TSA’s close watch, but the TSA’s quarterly figures for January did predict some more mergers, while adding it did not foresee any failures or insolvencies.

Overall, though, he feels the sector has coped very well with the financial maelstrom of the last year.

‘The evidence is of a sector that can cope with those four big hits in the last year,’ says Mr Marsh. ‘That demonstrates a degree of robustness and resilience that should place it well to continue with building homes in next five years to meet England’s housing needs.’

In Warwick, finance directors contemplating the hangover from housing’s boom years will be hoping that he is right.

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