Slow burn: financial resilience under pressure
Taking the long view of the recent regulatory regrades
REGULATION & GOVERNANCE
Image: Istock
Sue Harvey
Director, Campbell Tickell
Catherine Romney
Policy and Research Officer, Campbell Tickell
Issue 64 | February 2023
The housing press and board rooms are buzzing with talk of the English regulator’s latest batch of viability regrades that flowed from its 2022 round of annual stability checks. The recent collection of downgrades from the credit rating agencies is adding to the mood music.
We thought we’d take a step back and look at how this recent flurry of V2s fits within the historical trend in the RSH’s viability judgements.
The shift in regulatory judgements over the past eight years
The chart displays a proportionate breakdown of Regulatory Judgements (RJs) by each governance (G) and financial viability (V) category, at three points over the eight years that the RSH has been publishing them. It’s evident that there has been a very significant shift from G1/V1 to G1/V2, with the proportion of G1/V1s almost halving over that time.
During the time period illustrated the sector has seen two V1 to V2 waves:
- The autumn of 2017 saw around 20 associations regraded as ambitious development programmes and increased reliance on sales for cross-subsidy clashed with the start of four years of rent cuts.
- These last few months have seen around 50 V2 regrades as growing stock investment requirements coincide with the rent cap, inflation, rising interest rates and consequent pressure on financial ratios.
“Driving increased financial risk since well before the current system of regulatory judgements began, is the slow long-term reduction in capital grant.”
Reasons for recent V1 to V2 revisions
We have pulled out the reasons given by the RSH in each of the 51 V2 regrade reports, and unsurprisingly the key drivers are very similar, and indeed are being felt across the sector.
Driving increased financial risk since well before the current system of regulatory judgements began, is the slow long-term reduction in capital grant. The purpose of the central government grant is to support the development of new social housing by providing the subsidy needed to plug the gap between the market-determined costs of land, labour and material, and perpetual sub-market rents.
As grant levels have diminished so each new social home built has required a mix of additional debt (pushing gearing levels inexorably higher), and subsidy from commercial activities (adding a cyclical element to income risk).
For those associations seeking to help meet growing housing need – which is surely most – this weight sits alongside the changing economic and political risks, piling pressure on loan covenants and reducing capacity to absorb further adverse events.
While this picture isn’t really telling us anything we didn’t already know, it does bring home the impact of the slow burn that the sector has been experiencing over decades. The regulator is at pains to point out that V2 is still a compliant grading, but it indicates that RSH considers that an organisation needs to manage material risks to ensure continued compliance.
Stress testing is key
Managing material risks requires best practice governance including very clear statements of board risk appetite, financial plans that embed an appropriate amount of resilience, reporting that supports vigilance, and plans and ambitions that are readily adaptable.
Stress-testing was first introduced as a regulatory requirement at the same time as the G/V RJs. It has become the main tool to support boards in building resilient financial plans by exploring any vulnerabilities to shifts in the underlying assumptions and helping determine appropriate levels of financial headroom.
To support our clients in building sustainable financial plans and demonstrating resilience to their boards and stakeholders, Campbell Tickell will be running two masterclasses on stress testing in early March (see box for registration links).
