Accounting for change

In science, the ‘observer effect’ is the name given to the phenomenon whereby the act of looking can change what is being looked at.

Strange as it may seem, something akin to this is set to take place on the financial statements of every housing association in the UK in the coming months. New reporting standards for the sector - known as FRS (Financial Reporting Standard) 102 - have been in place since the start of last year, meaning this year’s set of accounts will be the first to reflect them universally.

If the sector’s bean counters are to be believed, FRS 102 will not affect the financial state of housing associations so much as how their financial statements look. Or, as one treasury director tells Inside Housing: “This is just about accounts.”

The question is whether the act of looking in a different way at housing associations’ accounts changes anything at all for the sector.

Despite the assurances of a number of finance directors, the answer is anything but clear. The changes to reporting standards - designed to make housing associations’ finances more transparent - are myriad (see comment). But the impact of such a flurry of changes could mean confusion for anyone less versed in the language of the balance sheet.

In broad terms, the requirement for landlords to include a range of items on the statement of comprehensive income (the part of the financial report previously known as the profit and loss account, or P&L) that could previously be hidden elsewhere will result in far greater volatility when it comes to surpluses. The items which will now be listed include complex financial instruments, such as swaps and derivatives, liabilities associated with the Social Housing Pension Scheme, and historic grant.

The potential jump one way or another in any given organisation’s surplus could have two potentially damaging consequences: for one, what may appear to be a dramatic change on the bottom line could spook housing association boards; meanwhile, that same movement risks breaches of covenants attached to landlords’ bank loans.

“The volatility will make it difficult for the sector,” warns Jonathan Pryor, a partner at auditor Smith & Williamson. “The implications are potentially great because of the pressure from government for value for money, the sense that the sector is inefficient, and the natural requirement for boards to consider risk carefully. 

“FRS 102 financial statements will not necessarily help as it may lead to confusing or misleading messages being presented to stakeholders.”

Mr Pryor is also a key member of a working group looking at the new Statement of Recognised Practice (SORP) for housing, triggered by the introduction of FRS 102.

Potential headaches

The impact of the new standards on loan covenants is one of the areas that has been most exercising the group. Mr Pryor, who is working with banks and borrowers to help broker new agreements, admits that there could be headaches for borrowers who have not previously agreed clauses which allow them to calculate covenants based on old standards - known as UK GAAP.

“That clause is in most loan agreements but not all,” says Mr Pryor. “From the point of view of the borrower, even if they have lots of loans that do have that clause, if they have even one that does not, it could be very problematic.”

While the noises coming from members of the SORP working group suggest negotiations with banks have been largely positive, others believe the sector has taken too long to respond to a change that has been in the pipeline for more than two years.

“They should have been having conversations with their respective lenders earlier,” says Clydesdale Bank’s head of social housing Elaine Reed. In a warning that a quick-fix solution might not solve the covenant problem, Ms Reed adds that “every covenant is different so it will depend on what is in each individual loan agreement”.

With the new regulations designed to make finances less opaque, Ms Reed says they could open lenders’ eyes to parts of their borrowers’ debt profile that were previously hidden.

“We’re not always aware of what financial instruments or other loans have been entered into,” she explains. “Now, any liabilities or exposure will show up, so it should be clearer.”

None of this necessarily means banks will see an opportunity to go after housing associations.

Neil Waller, a banking partner at Trowers & Hamlins, says that he has seen “no evidence that lenders are looking to use this [the new standards] as an excuse to reprice or renegotiate”, but he admits that housing associations have not necessarily been quick to respond to the change.

“It’s been a slow burn when it comes to implementation,” he adds. “What we would have expected is that if you have a lot of loan covenants, you’d have revised most of them by 31 March. But I only know of one housing association that was insistent that they have the revised covenants in place.”

Changing covenants

Places for People is one landlord that has been reporting its finances under international rules similar to FRS 102 since it issued a listed bond in 2011. Its financial director Simran Soin shares the view that loan covenants won’t be a problem for the sector more widely.

“The underlying credit of the sector is the same as it was… [so] I wouldn’t have thought these changes will result in significant changes from a covenant point of view.”

However, it’s not only banks that finance directors have to worry about.

“The biggest risk is internal,” says Mr Pryor, who predicts boards may become “more reticent about the scale of development”.

He continues: “The likely outcome is that, for some boards, they will be confused by the messages given by FRS 102 financial statements.”

Rob Griffiths, finance director at Longhurst Group, and another member of the SORP working group, admits that the change to the status of pension liabilities will add £2.8m to the 19,000-home landlord’s management costs, which will now appear on its balance sheet.

Nevertheless, Mr Griffiths calls the change “long overdue”, and accepts he and his colleagues have a big job ahead in smoothing the transition to the new standards.

“For the user of the accounts there will have to be more analysis done and we need to think about how we will explain the financial performance better,” he says.

FRS 102 may well be just an accounting change. But with some big numbers likely to appear on balance sheets for the first time, the short-term task for finance is to put both their lenders’ and their boards’ minds at ease.