On the edge

But, given the dire forecasts for the economy next year, this could just be the beginning. The banks’ attitude has hardened considerably since the collapse of Lehman Brothers in September and lenders are seizing any opportunity to renegotiate existing loans and demand repayment at higher rates.

A Housing Corporation survey in November revealed that associations have almost 10,000 unsold low-cost home ownership homes on their books – the equivalent of 45 per cent of last year’s programme.

Speculation continues about the viability of some associations – with between five and ten on a watch list drawn up by the new regulator, the Tenant Services Authority.

Writedowns and loan covenant defaults are very real prospects if the situation does not improve. And the dramatic cuts in interest rates could have negative consequences for associations that have used derivatives as a hedge against higher rates.

Output of new homes is already suffering as a result of the standstill in the private market and cutbacks forced on the associations. One of the most likely moves designed to help associations, an increase in the grant rate by the HCA, will mean even fewer new homes.

‘It’s worse than things seemed even in September – there’s been a mood change,’ says Jonathan Pryor, a director at accountant Smith & Williamson. ‘The collapse of Lehman Brothers was the catalyst. Forecasts of sales have had to be revised down and the attitude of the banks has become pessimistic.’

Tom Dacey, chief executive of Southern Housing Group and chair of the G15 group of the largest associations in London, says: ‘The prospects look gloomy. We’re entering the bleakest period in housing association history.’

A survey by ROOF of the accounts of 24 of the 25 largest associations for 2017/08 shows how reliant they were on property sales to finance borrowings. Superficially they seemed to be doing well.

Their combined turnover was up 12 per cent at £4 billion and the post-tax surplus was up 29 per cent at £345 million.

However, the accounts show that 14 of the 24 large associations had an operating surplus below the level of interest payments. The combined operating surplus was £783 million, but interest amounted to £790 million. This deficit would not matter in a rising market. But a falling market places several associations at risk. And the accounts understate their present position – they only cover the period to the end of March, when the annual rate of house price inflation had yet to turn negative.

Last year saw Places for People report sales income down from £127 million to just £32 million and a loss on development for sale of £3 million. And Metropolitan made a provision of £8.1 million to cover falls in the value of homes under construction and its land bank in the Midlands.

However, the real question is how associations will fare over the next two years. The Halifax index shows that the average house price has fallen 14.6 per cent in the first seven months of 2018/09 and mortgage data shows that new loans are running at half the levels of this time last year.

‘The prospects look gloomy. We’re entering the bleakest period in housing association history’

All associations agree that the market is difficult, but some are faring better than others. Graeme Moran, managing director of Metropolitan Home Ownership, says its equity loan programme is ‘going great guns’ with completions running at up to 130 a month. It still has sales running at about 26 a month on a 280-unit new build programme.

‘Sales are going well on some schemes but we have more straggler units than we have traditionally had,’ he says. ‘We’ve done a lot of work with mortgage lenders to make sure we can package deals for customers. It’s not that people are wary of home ownership because of fears about price falls but that they simply can’t get mortgage finance.’

But Metropolitan has seen big differences between regions. ‘We have some properties in the Midlands where we’ve seen falls in value of 25 per cent during the past 12 to 18 months, whereas we’ve seen no falls in London and perhaps a 5–6 per cent fall across our schemes overall.’

Even so, Metropolitan is making a provision to write off £8.1 million because of a fall in the value of stock and land holding. ‘We thought it was prudent,’ says Moran. ‘I’m surprised we haven’t seen others do the same.’

For David Montague, group chief executive of London & Quadrant (L&Q;), the next 18 months are about not increasing sales risk. L&Q; has 9,000 homes in its development pipeline. It has modelled a worst-case scenario in which it builds all 9,000 but is forced to put all of the outright sale element for market rent and all of the shared ownership for intermediate rent. Even then, he says, L&Q; will still come out of the next five years in profit.

‘Our first priority must be the protection of existing business. We’re using our balance sheet capacity for that. Our ambitions for the next five years remain the same but the terms on which we grow will be different.’

Worst-case scenarios are very much on the mind of Tom Dacey. ‘We’re trying like fury to sell unsold Southern Housing Group stock and work out what is to be handed over by the financial year end,’ he says. ‘We’re finding that there is still demand, but all the banks are looking for 10 per cent deposits, even for shared ownership.’

As head of the G15 group, Dacey was one of the first to sound the alarm about the impact of the credit crunch on the sector. ‘Associations are not going to be sitting down with their external auditors just yet, but that will probably start happening early in the new year. The really big issue is the extent of impairment in their accounts.’

The danger is that impairment could pass a threshold where it triggers a loan covenant default – a breach of the detailed terms of agreement with the borrower, such as cover for interest payments. ‘Default with one lender could trigger default with all lenders, at which point technically loans are repayable in full,’ says Dacey. ‘In practice what usually happens is that lenders reprice loans and want to see the organisation address the factors that triggered the default. What’s impossible to say is how many associations will be affected – will it be the large ones with big development programmes or the small ones that are more vulnerable?’

The problem for associations is compounded by the attitude of lenders, according to Jonathan Pryor. ‘If you talked to most banks a year ago, the possibility of a covenant breach was there but they were blasé about it. Now we’re starting to see that the first sniff of a covenant breach is an opportunity to increase loan charges.’

David Mairs of consultant Tribal says: ‘Opinion among lenders is that problems that will emerge soon. I know this is also a concern for the Tenant Services Authority. Lenders have concerns about specific RSLs and the TSA has a number on its horizon.’

David Montague argues that associations are still in a strong position relative to other sectors. But he adds: ‘It’s inevitable that there will be some fall-out. It wouldn’t surprise me to see a few more red lights.’

The TSA has prepared the ground for possible problems by lining up a ‘cab rank’ of large, financially strong associations that can step in to merge with organisations that run into problems. This is what happened at the start of the year when the collapse of Ujima was averted by a merger with L&Q.;

However, there is mounting concern that lenders could see a rescue merger as a material change to the loan portfolio and reprice the entire loan book. And, as Jonathan Pryor points out: ‘Ujima came perilously close to collapse. Maybe the sector can absorb one Ujima but can it absorb ten of them?’

On the plus side for associations, the reduction in VAT will reduce pressure on interest cover by reducing maintenance costs. Jonathan Pryor estimates that VAT savings could be worth up to £1 million a year to a large association.

Deep cuts in interest rates should also help. But not if you are one of the associations that used derivatives to hedge against rising rates and now face margin calls on those contracts.

The housing market could still improve. Peter Hammond of Tribal says the crucial period could be the summer of 2019. ‘If there are some green shoots of recovery appearing by June, July or August, perhaps associations won’t need to impair.’

There is also the prospect of help from the new HCA. ‘The HCA is being very supportive in the development of a more flexible model that doesn’t have home ownership at its core,’ says David Montague.

Tom Dacey agrees. ‘There is a strong likelihood of unsold low-cost home ownership stock being converted to intermediate rent and the possibility of a deal with a grant to support that and reduce the risk of impairment and reduce the calls on our development capital.’

However, there could be further problems to come. Peter Hammond of Tribal points out that associations with land banks face greater risks of impairment because the value of land fluctuates by more than the market as a whole. Associations that have set up subsidiaries and joint ventures to handle their development for sale could also face problems. At worst, the subsidiary may run into major problems and need bailing out.’

‘The risk is intense that no affordable housing will be produced in the next two to three years’

Dacey’s overall assessment is a sobering one. ‘This year I would put the likelihood of loan covenant defaults at 5 per cent. If nothing changes that risk increases next year and if things haven’t improved by 2010/11 it’s going to be dreadful.’

He says the only real solution is government support for an increase in mortgage lending: ‘It would cost peanuts to help people at the entry level. Instead, house builders are at risk of going under and housing associations are at risk of being unable to develop. If this continues, the risk is intense that no affordable housing will be produced in the next two to three years.’

ROOF surveyed the accounts of 24 of the 25 largest housing association groups to estimate their vulnerability to the downturn. The total amount they were paying in interest was higher than the joint operating surplus, leaving them reliant on property sales to fill the funding gap.

We excluded five large transfer associations from the survey because their need to finance improvements to their stock means borrowings are higher. But others have stock transfer subsidiaries.

Accounting methods vary considerably between associations, with differences in the way they calculate turnover, the value of assets and the extent of capitalisation of major repairs, interest and development administration.

The picture that emerges is of some associations with strong finances and others in a more vulnerable position. Overall, 14 of the 24 had interest payments greater than their operating surplus.

There may be good reasons for this in individual cases. For example, the borrowings of transfer associations tend to be much higher in the early years of their business plan because they have to invest heavily to meet promises made to tenants on home improvements. ROOF excluded pure stock transfer landlords from the survey to eliminate this impact but some of the other large groups have expanded by taking over transfer associations.