Going over the numbers

The Housing Corporation’s new regulatory code, The way forward, published in January, marks the end of a long period of discussion about its expectations of housing associations.

We have shared with associations how we intend to carry out inspection and our expectations of the way in which lead regulators will work – but we have yet to set out in detail how we will regulate that part of the code covering financial viability. A good practice note will be published shortly.

But first, where have we come from? Over the past few years we have collected financial information, including annual accounts, from associations and carried out an assessment using standard ratios and benchmarks. Any signs of short-term viability problems were followed up by investigation or correspondence.

At the same time – but as a separate process – we looked at association financial management and prudence. By and large this approach worked in an era where a complex group was only a parent and a registered subsidiary, and diversification was still a minority sport.

Pressure for change has come from a number of sources. First, housing associations are now more complex – they include organisations set up as group borrowing vehicles, they engage in joint ventures, they are diversifying their activities and in general they are much larger – therefore more is at stake.

Secondly, associations are facing greater financial pressure, for example, in managing low demand, rent restructuring and asset management. As a result, the gap between actual performance and the minimum expectations specified in funding covenants has narrowed for many associations, leaving them more vulnerable to financial shock.

Thirdly, we have recognised that good management and good risk management are key to financial viability, and this needs more explicit recognition in our approach.

Many of these themes were echoed in the National Audit Office report on regulating housing associations’ management of financial risk.

So what will our new approach look like? We intend to look at both short and long-term viability. It can take a number of years for an association to turn around structural issues, such as low demand, which affect future viability, and where the assets (houses) and funding (largely debt) require long-term commitments.

This means looking forward rather than back, so we will give equal weighting to associations’ business plans and financial projections in our regulatory assessment.

We need to understand what these projections are telling us. We expect plans to demonstrate that stock will be kept in good condition and will meet lenders’ covenants and our expectations on rent restructuring.

We want to understand just how vulnerable an association is to financial shock. All things being equal, an association projecting interest cover of 180 per cent is less vulnerable than one projecting interest cover of 112 per cent.

Our experience shows this is not an academic exercise: associations from time to time face financial difficulties. To understand these, we need to understand the context in which the associations operate.

Finally, where we have identified concerns, we want to ensure the board and senior management of associations recognise the issues and are actively engaged in addressing them.

The key elements of our new approach are:

> an annual appraisal for each lead regulated association – based on the five-year forecast, business plan and annual accounts – confirming a rounded assessment of our views on the association’s viability (this will be sent to all associations)

> quarterly returns used to assess short-term viability

> an extended range of ratios calculated automatically by our system, made available to associations

> for the more robust associations, fewer quarterly returns required

> individually tailored ratios and hurdles for each LSVT

> focused follow-up work where necessary.

To support our annual appraisal we have developed a framework for financial analysis, which will be published as part of the good practice note.

In applying this we will:

> look at the management of the association, the markets in which it works, and the risks it faces

> undertake a more detailed analysis of the environment in which the association operates and the influences, particularly in its turnover

> analyse the association’s profitability, in looking in particular at operating margins and financial efficiency

> review the cash flow dynamics and capital structure of the association.

We intend to work with associations, in tandem with lead regulation. We will, after all, be concentrating on things that have not yet happened.

We will pilot this approach shortly, beginning in earnest this summer.

The benefits for associations will be a more transparent process and a more effective way of working together. For our part, it will bring about a greater understanding of the position and likely financial direction of the associations we regulate.