Housing and the Credit Crunch - Communities and Local Government Committee Contents

3  Financial viability of housing associations

Building more affordable homes: the funding model

51.  The Government's targets for building new affordable homes are almost entirely dependent on the ability of housing associations to fund them. Prior to 1988, about 90% of the cost of building new affordable homes was met from the public purse. Since then, through the Housing Corporation, the Government has sought to achieve the greatest value for money possible from Social Housing Grant and average grant rates have decreased to between 30% and 40% of total cost. The resulting funding gap has been met in part by planning gain from private development but mainly by accessing borrowing from the private sector. Associations have also become adept at negotiating viable and profitable developments with a mix of funding, moving gradually first to develop successful shared ownership models which generate cross-subsidy for social rented homes and later to build private homes for sale, thereby generating surpluses for reinvestment. In times of prosperity, there were great opportunities to use the surpluses generated by development to expand. However, housing associations are not immune to the vagaries of the market, and the credit crunch has introduced significant new risks into the business model.

52.  NHF notes that, after public subsidy, "housing associations fund the other 60% of development cost through a combination of private finance (typically providing around 50% of construction costs) and contributions from their reserves (typically around 10% of construction costs)".[100] This breakdown is given in figure 4, below. For most housing associations, the ratio of public subsidy in the form of Social Housing Grant to borrowing has decreased steadily over time. This is illustrated in the Annual Report of London and Quadrant Group, which shows that the ratio of public subsidy to borrowing in that housing association has decreased between 2003-04 and 2007-08 from approximately 3:2 to approximately 1:1.[101]

Figure 4: Source of funding for new affordable homes

Source: Cred 43 (NHF)


53.  The National Affordable Housing Programme, administered by the Homes and Communities Agency, is supported by allocations of Social Housing Grant. This is a capital grant paid upfront in instalments as each building project progresses. There are different rates for social rented and LCHO homes. A formula taking account of the levels of building required on a regional basis determines the levels of Social Housing Grant allocated to each region. Within the regions, housing associations, local authorities and a small number of other developers and Arm's-Length Management Organisations (ALMOs) submit competitive bids for their share of the regional allocation. To facilitate financial planning, organisations are given an indicative allocation for the two following years but, until recently, bids had to be submitted for schemes on a quarterly basis.

54.  Many submissions observe that the decrease in the level of Social Housing Grant, noted above, makes housing associations reliant on cross-subsidy for their development projects. The National Housing Federation, for example, states "grant rates for new development are such now (about 40 per cent) that it is impossible to build social housing at anything but a financial loss, unless associations cross subsidise this building".[102] Much of the evidence we received called for an immediate increase in Social Housing Grant levels in order to reduce the reliance of housing associations on more volatile funding sources. The Housing Forum, for example, told us "housing associations are likely to need increased grant levels if they are to build the same or more properties that they have been up to this point".[103] Ahead of the conclusion to its inquiry into the Mayor's Draft Housing Strategy, the London Assembly Planning and Housing Committee notes that it is considering recommending that "grant rates need to be significantly increased in the short term and that applies to both new schemes in the new financial climate as well as, potentially, those that have already got approval but find themselves now financially unviable".[104]

55.  The Government has responded to the calls for increased Social Housing Grant by changing the way payments are made. Previously, housing associations received 50% of their allocation at the beginning of a project, and 50% upon completion. They will now receive 60% at the start, and 40% upon completion. CLG has also enabled them to bid for Social Housing Grant on a scheme-by-scheme basis instead of in quarterly bidding rounds.[105] Both these changes are intended by the Government to support the cash flow of housing associations and thereby stimulate development. The Homes and Communities Agency (HCA) has recently also demonstrated a willingness to increase grant rates in order to rescue schemes which would otherwise become unviable. Speaking to Inside Housing, the Assistant Director of the National Housing Federation, Bob Wilson, said "we are beginning to get a feel from our members that the HCA is responding positively to the need to negotiate¯on an individual basis¯significantly changed grant rates".[106]

56.  The Government has taken some welcome steps to improve cash-flow and stimulate building activity by increasing the Social Housing Grant money available to housing associations. The Homes and Communities Agency has also shown a willingness to increase grant rates where necessary in order to ensure the continued viability of developments. It is likely that, as the economic downturn continues, fewer developing housing associations will be able to continue building without such an increase. We urge the Homes and Communities Agency to continue to respond flexibly to the changing economic situation, but there is a limit to what it can do without an overall increase in its budget. We recommend that the Homes and Communities Agency's budget be increased. Without that it will be impossible to meet even the Government's targets for new social homes, let alone the higher targets that we advocate.

Social housing grant and local authorities

57.  We welcome the Government's commitment in principle to allowing local authorities to build new social housing. We also welcome the decision that the Homes and Communities Agency should accept bids for social housing grant from local authorities and Arm's-Length Management Organisations, as well as housing associations. We recommend that local authorities take advantage of this change by coming forward with new initiatives to increase housebuilding, including providing land at nil cost. This approach to increasing house building rates will only bear fruit if all three of these elements come together.


58.  For a typical housing association, approximately 50% of the building cost of new affordable housing is met through borrowing. The market for lending to housing associations consists of about eight or nine major institutions and is worth approximately £40 billion.[107] Housing associations have typically been perceived as sound financial prospects with an implicit government guarantee through the Housing Corporation and have become recognised by lenders as a good triple A investment. As a consequence they have been able to secure loans at very competitive rates. IMLA notes—

over the last five years the strong competition between lenders has driven both the margin on lending to associations very low (0.25 basis points above LIBOR/Base rate) but also the terms of that lending had become less demanding in terms of cover ratios and covenants […] With the onset of the credit crunch in 2007 the number of active lenders to the sector fell […] In recent months there have been only 3 major lenders still active in the sector.[108]

59.  As well as a reduction in the amount of lending, the terms on which banks will lend to housing associations have become more stringent. Housing associations have had little benefit from falling interest rates as loans to them are traditionally linked to the LIBOR inter-bank lending rate, which has fallen much more slowly than the bank base rate. IMLA notes that banks are also "looking more closely at governance and finance and that they have begun to discriminate between [different housing associations] in terms of pricing and terms".[109]

60.  As housing associations find themselves accessing borrowing on less favourable terms, they become exposed to greater financial risk because of their reduced operating margins. Operating surpluses have typically been used to cover the interest payment on loans. The ratio of surpluses to interest costs is usually referred to as "interest cover". Until recently, housing associations have had good interest cover, but some housing associations are now reporting a decrease. G15, a group of the fifteen largest housing associations in London, notes that, in the sector as a whole, "interest cover [is] down from 107% to 92%": by contrast, levels of borrowing are up from 51% to 59%.[110]

61.  Banks are not simply restricting the criteria for new lending, but are seeking to toughen up the terms of existing loans to housing associations. David Orr from the National Housing Federation gave one instance as an example of this practice:

A housing association which had a group structure with three different organisations in its group decided […] that it wanted to collapse that governance structure so that there is one organisation with resident panels, a different model but saving about £300,000 a year and the £300,000 could be invested in better services, neighbourhood support services, new development, whatever. Their core lender said that if they did that, it would regard that as a significant event in the terms of the loan agreement and re-price the entire loan book at a cost to that organisation of £1.9 million a year. The impact of that is that nothing happened; there was no change. So £300,000 of efficiency savings are not being generated, a more rational governance structure has not been put in place and the bank has gained not a single penny piece from its behaviour.[111]

Peter Marsh from the Tenant Services Authority told us this type of behaviour was not, in itself, totally unreasonable in a commercial environment. It is the TSA's role to "try to mediate between legitimate commercial pressures, which will be applied by a bank at an opportunity that presents itself, and avoiding banks applying such aggressive commercial pressure that it becomes a disincentive for rational behaviour".[112] It sets out to achieve this aim by facilitating conversations between lenders and housing associations to try to find compromises which enable banks to see a continuing return on their investment and also ensure that housing associations are able to make efficiency savings without penalty. We welcome the proactive approach being taken by the Tenant Services Authority to facilitating dialogue between housing associations and the lenders upon whom they rely so heavily. It is too early to judge what effect this is having on the borrowing conditions faced by housing associations. We intend to revisit this issue later in 2009 to assess what progress has been made.


62.  The Council of Mortgage Lenders argues "the continual reduction of grant rates has created an over reliance on cross subsidy for both the delivery of affordable housing but also the business operating models of associations".[113] The National Housing Federation states that, typically, 10% of the cost of building new affordable housing is met by housing associations through "cross-subsidy". This could take the form of¯

a)  S.106 contributions from the developers of private homes on sites also being used for affordable housing. the Home Builders Federation states "in 2006-07, 58% of all Affordable Housing was delivered through such agreements".[114] As developers reduce their total number of developments, the contribution to affordable housing made by s.106 agreements also decreases. The London Assembly Planning and Housing Committee learnt that "perhaps 50 per cent to 75 per cent of the expected section 106 financed homes [in London] will not now be delivered due to the slowdown in the private market sector".[115]

b)  Funding from the housing association's own reserves. These could be made up of, for example¯

i.  Shared ownership "staircasing" receipts. "Staircasing" refers to the practice of selling further portions of a shared ownership home to the tenant/owner. Until recently, tenants/owners could only "staircase up" by increasing their share of the property but, under one of the terms of the Government's housing rescue package, tenants/owners at risk of repossession will be given the option to "staircase down" by decreasing their share of the property. We were told that the "reduction in mortgage availability, partly as a result of some lenders now classifying shared ownership mortgages as "sub-prime", had resulted in reduced sales for associations.[116] In turn this reduces the level of potential staircasing receipts.

ii.  Proceeds from the market sale of existing properties. The Gentoo Group states "an increasing number of RSLs are balancing their books through property sales with 6 of the top 20 providers of social housing reporting a combined total of £129 million through surplus on the sale of fixed assets in 2007/08".[117] As the housing market declines, it becomes more difficult for housing associations to raise money in this way.

Housing associations may also use money from their "recycled capital grant fund". This is money generated through the sale of affordable housing which was itself funded by Social Housing Grant. This money is not returned to the Homes and Communities Agency but is held by the housing association and accounted for as if it were new Social Housing Grant.

63.  All the different funding streams listed above are exposed to the vagaries of the housing market and are liable to dry up during the credit crunch. This is an issue which was raised repeatedly in both written and oral evidence to our inquiry. G15 told us "the credit crunch has brought to a standstill housing associations' ability to cross-subsidise new homes. This calls into question their ability to meet Government supply targets without increased Government assistance".[118] The Intermediary Mortgage Lenders' Association states "the development model in use in recent years by large and medium sized associations—cross-subsidy—is now broken and must be replaced by one based around higher grant rates and with a focus on social renting".[119] Without being able to make up the funds which would previously have been derived from cross-subsidy, housing associations cannot continue to develop new homes. This is explained by NHF as follows: "overall sector viability remains strong and sound because housing associations are well run and well managed organisations. But it is precisely this astute financial management that means associations will not take unwise development risk and will not continue to develop using a financial model unsuitable for the current economic climate".[120]

64.  The ability of housing associations to build new affordable homes is critical to the attainment of the Government's housing targets. If, because of market failures, they are no longer able to cross-subsidise their development activities at the same high rate as before, we see no alternative but for the Government to replace this funding with a higher average percentage rate of Social Housing Grant. This inevitably means each allocation of Social Housing Grant will produce fewer units than before, but this is a better outcome than funding allocations remaining partially unspent because associations are unable to bring viable schemes forward.

Contingency planning

65.  Given the high levels of exposure to financial risk being experienced by housing associations as a result of the credit crunch, it is of fundamental importance that they undertake robust contingency planning. Some of the written evidence we received suggested that this was not happening. Unison, for example, reports "a third of social landlords contacted in a survey by Baker Tilly […] have not made contingencies for dealing with the crisis".[121] We heard in oral evidence, however, that over 80% of housing associations already had strategies in place.[122] Similarly, the Housing Corporation states in written evidence that a "significant number" of housing associations have begun to review their business models since the onset of the credit crunch. It details a number of the measures being taken, including¯

  • "reviewing all uncommitted development and in particular scaling back on shared ownership assumptions;
  • reviewing their operating cost base;
  • looking at sales dependence and how the exposure can be mitigated; and
  • ensuring treasury management strategies are appropriate for the current situation".[123]

66.  As the new independent regulator, the Tenant Services Authority has oversight of the contingency planning process. Oral evidence from Peter Marsh, its Chief Executive, suggested that it is already being very proactive in this role. He told us that, of the 250 housing associations in development partnerships with the Homes and Communities Agency, approximately one in three has tended to be heavily reliant on cross-subsidy. Of that number, there are "half a dozen which have risks which need to be addressed and managed in the next six months". The TSA is managing these six housing associations by asking "to see cash flows on a weekly basis and we want to talk to the boards and we want to and are engaging with both their chairs and their lenders to ensure we understand their response to the threats posed to them".[124] The authority is also generating "a cab rank, if you like, of organisations that would be ready and willing to step in" should a housing association fail and require takeover by another housing association.[125] On 9 January 2009 three large housing associations, Affinity Sutton, Circle Anglia, and L&Q Group, told the TSA that they would be willing to lend to housing associations facing financial difficulties.[126] The TSA has been scenario-testing to ensure it is able to respond quickly in the event of such a takeover.[127] A detailed guide to its contingency plans is set out in Annex C to the Government's response to supplementary written questions posed by us following the oral evidence session on 16 December 2008.[128] We welcome the proactive approach being taken by the Tenant Services Authority to managing the contingency planning of housing associations and look forward to an update on its effectiveness later in 2009.

100   Cred 43 Back

101   The L & Q Group, Financial Statements 2008 (2008), p 7. Back

102   Cred 43 Back

103   Cred 39 Back

104   Cred 59 Back

105   Cred 60 Back

106   Crispin Dowler, "Grant rates rise for associations", Inside Housing (16 January 2009). Back

107   Cred 08 (Intermediary Mortgage Lenders' Association) Back

108   Cred 08 Back

109   Cred 08 Back

110   Cred 06  Back

111   Q 23 Back

112   Q 78 Back

113   Cred 30 Back

114   Cred 42 Back

115   Cred 59 Back

116   Cred 25 (Unison). Back

117   Cred 26 Back

118   Cred 05 Back

119   Cred 08 Back

120   Cred 43 Back

121   Cred 25 Back

122   Q 76 Peter Marsh (TSA) Back

123   Cred 61 Back

124   Q 76 Back

125   Communities and Local Government Committee, oral evidence session with the Tenant Services Authority, 21 October 2008, Q 7, Peter Marsh (http://www.publications.parliament.uk/pa/cm200708/cmselect/cmcomloc/uc1123-i/uc112301.htm). Back

126   Crispin Dowler, "Cash-rich landlords agree to bail out peers", Inside Housing (9 January 2009). Back

127   Communities and Local Government Committee, oral evidence session with the Tenant Services Authority, 21 October 2008, Q 7, Peter Marsh (http://www.publications.parliament.uk/pa/cm200708/cmselect/cmcomloc/uc1123-i/uc112301.htm). Back

128   Cred 60A Back

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