Board Member Briefing: dealing with a financial crisis
More housing associations are likely to get into financial difficulty. How should board members prepare, and how should they respond if their organisation is struggling? Peter Apps reports. Illustration by Tim Ellis
For reasons that are – at this point – well known, housing associations face perhaps the toughest financial climate in the history of the sector.
Navigating it, while continuing to provide a great service to residents as well as building the social homes the country needs, is going to require extremely good governance.
But even well-run organisations can find themselves in trouble. So what should board members do if things start to get difficult at their organisation? That is the topic of this month’s Board Member Briefing.
Sometimes financial difficulties can be seen coming a long way off, but in the current climate, that is not always the case.
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“There will be some organisations that are already financially weak, where a gradual decline of their financial viability is forecast, and that won’t come as a surprise,” says Nick Atlay, associate director at Savills Affordable Housing Consultancy.
“What can be more difficult is other organisations where a one-off unforeseen issue arises out of nowhere; such as significant unexpected costs relating to fire remediation works, or development costs which threaten the organisation’s financial viability.”
Problems can also arise suddenly if there is a lack of clarity over the specific terms of the various covenants on all the loans a provider holds.
“Another issue can be a lack of understanding of the providers’ covenants, especially if they’ve got historic funding agreements where there’s less visibility over the requirements, they’re not being monitored and all of a sudden someone spots an issue with compliance,” Mr Atlay adds.
Early warning
All experts agree that problems are best dealt with if they are foreseen, so a key job for a board is making sure this sort of event does not arise suddenly.
England’s Regulator of Social Housing (RSH) has been pushing the organisations it regulates to carry out regular stress-testing for years. These models should provide early warning of any problems, especially if there is strong internal audit and oversight in place.
Jonathan Walters, deputy chief executive at the RSH, says that providers should have “golden rules” that set minimum levels around things like liquidity and interest cover.
“If you haven’t got those rules, you ought to be putting them in place now,” he says. “And if you get to the point where the lights are flashing to tell you they might be broken, the answer is not to bend the rules, but to actually look at what the problem is and be really clear-eyed about it.”
Helen Shaw, director of regulation at the Scottish Housing Regulator, adds that being familiar with the regulatory framework is crucial for all board members. “That’s a critical reference point for all board members, when they’re starting to think about how they should be satisfying themselves that their organisation is complying with their regulatory requirements,” she says.
But even with the best preparation in place, the current climate means issues will arise. So what to do when they do?
Crucial, at this stage, is a willingness to admit fault.
“One of the common features of organisations that run into difficulties is a failure to admit there’s a problem, a sort of optimism bias,” Mr Walters adds. “For me, one of the fatal phrases coming from any chief executive is, ‘If we just put more money into this issue, it’ll come good.’
“I think the moment you hear that phrase, it’s telling you something about optimism bias within the executive team, a belief that they can spend their way out of a problem.”
Lucy Grimwood, partner at Winckworth Sherwood, says: “I think being as transparent as you can be with your funders, with your regulator, with your advisors is really key at this point.”
Mr Walters says boards need to be wise enough to distinguish between a major problem and a bump in the road that they can manage their way through.
“Having been involved in a number of rescues over the years, the thing you want most is time,” he says.
“So if a really serious issue does come up, you want to be getting in touch with us early enough that you’ve got choices about what you do and how you get out of that problem.”
Ms Shaw agrees that engaging with the regulator sooner rather than later is better. “We know that in the past, some governing body members have been a little bit nervous about admitting that there’s a problem,” she says. “But if organisations think they have difficulties, they should come and talk to us at an early stage. We would actually welcome that much more than an organisation that didn’t.”
Boards also need to ask whether their internal assurance processes are working properly. This includes the important role of internal audit.
If a difficult situation has arisen, boards need a calm approach that runs through the potential options available.
“Honesty and calmness are the most important things. This is not the time for executive teams to start blaming people, it’s the time for a real focus on how they resolve the problem,” says Mr Walters.
Key briefing points
- The board should ensure there is clarity over all loan covenant agreements, particularly historic ones. If you are going to breach it, you must know as early as possible.
- Put golden rules in place around liquidity and interest cover.
- Avoid optimism bias – do not just hope things will get better with time. If there is a problem, it needs to be acknowledged quickly.
- Speak to lenders and the regulator as soon as possible and be open and clear about what you need.
- If core services can no longer be provided, a rescue merger will be necessary.
- Carry out a lessons learned exercise after the immediate crisis has been averted, with third-party support.
A next step is negotiating with lenders: many will be willing to amend covenant terms, at least temporarily, to help organisations get through a difficult patch without breaching.
“I think if it’s a short-term, one-off blip, it may be that the provider has positive relationships with lenders and the issue can be addressed with one-off carve-outs or a waiver,” Mr Atlay says.
A carve-out is an agreement to change the terms of the covenant temporarily to avoid a breach, while a waiver is the lender excusing a breach that has actually occurred. Both are becoming increasingly common in the sector, as fire safety costs in particular reduce interest cover beyond what loan covenants initially forecasted.
“Currently about a quarter of the sector have some form of covenant carve-out with funders,” says Mr Walters. “Typically that’s where there is a big spend on building safety in a particular year which won’t be repeated. Lenders have been really pragmatic about that and we’re really grateful.”
“I’d be surprised if it wasn’t more than a quarter in that position [needing a carve-out from lenders]. It’s perhaps still at the beginning – we may see more,” Ms Grimwood adds.
“The lenders are going to ask some pretty obvious questions: what kind of carve-out do you need, does this impact your other loan agreements, how long do you need it for?
“The board needs to make sure the organisation has been very robust and have tested those numbers and the nature of the carve-out needed because you don’t want to get a carve-out and then find you haven’t carved out enough.”
Mr Walters adds: “I think where it becomes more difficult is when you’re suddenly starting a conversation with a lender and needing something quickly. At that point, they start asking why executives didn’t know about the issue sooner and alert them about it. Is it a control failure or have they failed to be open and transparent?”
“If a really serious issue does come up, you want to be getting in touch with [the regulator] early enough that you’ve got choices about what you do”
What if the issue is so serious that a temporary carve-out is not enough to fix it? Mr Atlay says that the provider should look at mitigations that are in its control first of all.
“Mitigations can include efficiency savings, stopping development or deferring stock investments – although that is becoming less of an option due to the requirements around quality,” he says.
Mr Walters agrees that this latter option – reducing investment – may not be desirable.
“Again, this comes back to being really honest. Is it simply that this year we were going to have a major roof replacement programme and we simply haven’t got the money, but we will next year?” he says.
“That’s a different conversation to saying, ‘Actually we’re never really going to have enough money.’”
And at a certain point, cutting investment is simply not an option. “There are some non-negotiables that you cannot push back. Health and safety is non-negotiable. Gas servicing is non-negotiable. If you’re in a position where you’re having to say ‘we cannot afford gas servicing this year’, then that really is game over and you need to find a stronger partner to help you,” he says.
Selling vacant homes can help raise cash, but this may not help for an interest cover breach.
“Sometimes, within the definitions of interest cover, fixed-asset sales aren’t included,” Mr Atlay explains. “So even selling a lot of stock wouldn’t repair the business plan because you’d only have a very minor impact by being able to pay down debts and reduce your interest costs, but it wouldn’t have a direct impact on the top half of the ratio.”
If options run out, then the next step is merger. Mr Walters says there are actually many providers willing to act as rescuers, because of the boost they will get to their own balance sheets from the additional stock, once the problems have been resolved.
Learning lessons
Mergers can be complex and difficult for organisations to navigate, and require clear leadership from the board. This means they need time to complete and plan, which is why – once more – the organisation will benefit from early decision-making. Unifying housing management systems and finance systems will take time to set up and there needs to be scrutiny from both sides.
But once more, moving quickly is crucial for the best outcomes. “If you’ve got a year or two before the situation really bites, you’ve got time to find a partner who is the right cultural fit, and who will buy into the things you want to deliver as an organisation,” Mr Walters says.
“But the less time you have, the more the board is simply going to have to ask who has got a balance sheet strong enough and a risk appetite large enough to take on whatever risk has crystallised for you.”
If an organisation does make it through a difficult patch and out the other side, the final critical step is to learn the lessons to ensure it is not repeated. This can be difficult, but needs to be approached honestly.
“I think once the imminent financial issues have been averted, the board should carry out a lessons learned exercise, to understand how the provider came so close to the cliff edge and what changes may be needed,” Mr Atlay says.
“I think some sort of external process is often really helpful,” says Mr Walters. “For example, bringing someone in who’s not involved but can look at the issue with clear eyes and make sure you’re not repeating the same mistakes again.”
A key point is that no organisation should think it is immune.
“The subtext of this story is really that this may become more common,” Ms Grimwood says. “In the past, it was sometimes a result of poor financial planning, but now even the best financial planning in the world can’t always cope with spiralling costs, and if retrofit becomes mandatory that will increase. So every board needs to make sure its organisation gets their house in order to be ready.”
Inside Housing’s Board Member Briefing series
The Inside Housing Board Member Briefing series aims to help board members at housing providers get up to speed with their role in a fast-changing world, but are also for everyone else engaged in the running of social housing businesses who want to stay on top of the key issues of the day. Click below to read other briefings in the series.
What is the board’s role in monitoring tenant engagement?
Hannah Fearn explores how the boards of housing providers can best assure themselves that their organisations are truly engaging with their tenants
Lessons from the Grenfell Tower Inquiry report
The inquiry into the Grenfell Tower fire has concluded. Peter Apps distils what board members at social landlords should take away from it
Preparing for a cyberattack
Cyber security is one of the sector’s biggest strategic risks but is often overlooked by boards focused on service delivery and financial stability. Peter Apps explores what boards need to know and how mitigating the risk of attack can improve performance more generally
Dealing with a financial crisis
More housing associations are likely to get into financial difficulty. How should board members prepare, and how should they respond if their organisation is struggling? Peter Apps reports
High rises and building safety regulation
The next stage in England’s new building safety regime is set to begin, with the Building Safety Regulator able to call in “safety cases” for high rises from April. Peter Apps explains how boards should prepare
Mergers
Peter Apps looks at housing association mergers and the process behind them
Tenant board members
Peter Apps looks at how tenant board members can add value to the governance of an organisation
Development risk
Peter Apps looks at how the boards of housing providers can manage development risk in a difficult operating climate for the housing sector
Consumer regulation
Peter Apps, looks at the forthcoming consumer regulation regime
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