Risk reset: what are housing associations stress-testing for this year?

At L&Q, the group continues to conduct a formal stress-testing exercise annually alongside its group financial plan. 

But Ed Farnsworth, the G15 landlord’s deputy group finance director, says that more informal stress-testing is now a “normal part of the business” because of the current economic situation. 

“We’ll always be monitoring headroom against our financial golden rules and we’ll be looking at downside scenarios,” he says. 

Stress-testing involves looking at a “perfect storm” scenario, says Mr Farnsworth. “You test the business to see what will break the business and then you look at what your mitigating measures will be.” 

On the government’s future approach to rent policy, L&Q has stressed for a rent freeze. However, Mr Farnsworth says it is less about an individual stress. “It’s about that combined impact of eroding our headroom and then what mitigation measures we put in place to respond to that.”

“We set our financial golden rules so that we can absorb the removal of sales from our development pipeline and still maintain covenant compliance”

Turning to costs, in its perfect storm scenario, L&Q has stressed for a 10 per cent increase in development costs and a similar rise in its operating cost base, above what it has already factored in for inflation.  

On market sales, for its perfect storm scenario, L&Q has stressed for a 10 per cent reduction in sales values. On a standalone basis it has also modelled for a 10 per cent, 15 per cent and 20 per cent reduction in sales values. “But we wouldn’t entertain a sale beyond a 20 per cent discount,” says Waqar Ahmed, group finance director at the association. 

Mr Farnsworth is also keen to point out that its base plan does not rely on sales. “We set our financial golden rules so that we can absorb the removal of sales from our development pipeline and still maintain covenant compliance,” he says. 

L&Q also does a market volatility stress-test. “We do a six-month complete pause of the market, so no transactions, and we do a 12-month pause as well,” says Mr Farnsworth.

The group is also still grappling with the post-Grenfell building safety crisis. In its base plan, L&Q has put in what it considers to be a “worst-case scenario”.

Mr Farnsworth says: “We’ve allowed for £50m a year over the next five years on fire remediation works. We are and we will be pursuing third parties that are liable for that. But we know that is challenging and takes time.” 

On decarbonisation, in the medium to long term, Mr Farnsworth says it has “significant headroom” in the “latter period” to meet the associated costs. 

“We’re also investing in ensuring we meet the Decent Homes Standard,” he says. “But that will eventually tail off in latter years as well.”

L&Q’s top stresses 

1. Property market crash – 10 per cent, 15 per cent, 20 per cent reduction in sales income
2. Sales delay due to market volatility – six-month and 12-month delay
3. Construction cost increase – 10 per cent and 20 per cent increase in costs
4. Delay in development handovers and associated rental income – six-month and 12-month delay
5. Increase in voids, bad debts and arrears – 2x and 3x multiples
6. Existing undrawn facilities discontinued and 200bp increase in base rate
7. Rent reform; rent freeze on social housing assets for four years
8. Five per cent increase in PRS voids rental losses

At Northumberland-based landlord Bernicia, things are being done “a bit differently” this year, says Janette Longstaff, the group’s executive director of finance.

Due to what was effectively stress-testing last October over the government’s tightening of the rent cap, 15,800-home Bernicia is moving back its usual exercise to this October. However, in March, it still worked with its board on business plan assumptions, risks, stress-testing and recovery priorities. 

Looking at rent policy scenarios, Ms Longstaff says: “We always run with a CPI-only increase from when the current settlement ends,” she says. “The intelligence is saying CPI is going to be around five per cent. But we’re also stress-testing for half of that – so only a 2.5 per cent increase (being allowed). We’re also looking to model a rent cap.”

On another aspect of rent – arrears – Ms Longstaff says it has beaten its year-end target for arrears. But she adds: “Void rent losses are running a little bit higher than we would like. But we already increased our assumptions with regard to rent loss. So we were assuming higher void costs and higher bad debt figures. And we’ve applied a stress-test on top of that.”

The North East, where Bernicia is one of the largest landlords, traditionally has one of the country’s highest unemployment rates. However, Ms Longstaff says the region is partly benefiting from investment under the government’s levelling-up agenda. 

On development, Bernicia has modelled for “significant material costs increases for the next three years”, Ms Longstaff says. “We then stress-test high inflation on top of that,” she adds.

However, the landlord has not scaled backed on its aim to deliver 600 homes over the four years up to March 2026. 

It has no market sales exposure and a small pipeline of shared ownership. 

When it comes to the risk of high interest rates, Bernicia is reasonably well protected. Ms Longstaff says: “98 per cent of our treasury portfolio is fixed. We are hoping it is only drawing on our RCF [revolving credit facility] that would impact us [in terms of interest rate risk], but we’ve also assumed higher interest rate charges for working capital. That’s been incorporated into our base plan, then we stress-test on top of that.”

While Scottish registered providers do not face controls on rent increases like their English counterparts, they are not immune to government intervention.

Last September, Nicola Sturgeon, Scotland’s first minister at the time, announced a six-month rent freeze across all tenures, leaving it unclear whether social housing providers would be able to put through annual increases. 

Ministers subsequently relented, for social landlords at least. “While that had no immediate impact, it set a number of hares running from a business planning perspective,” says Nick Pollard, finance director at Link Group.

“There was a bit of sensitivity-testing and scenario-planning that we had to go through to enable us to inform the SFHA [Scottish Federation of Housing Associations] and also inform the Scottish government what the impact was going to be.”

This had come on top of the Westminster government’s disastrous Mini Budget. “So last year, we had to do extra sensitivity-testing, but this year I don’t think we need to do any scenario-planning and sensitivity-testing beyond the norm,” Mr Pollard says.

Link Group is relatively comfortable with its development situation due to the grant funding it gets from the Scottish government and the fact it does not build homes for market sale. 

Mr Pollard says it faced construction delays due to the pandemic, but does not foresee it being an issue “moving forward”.

On interest rates, he says: “We’ve assumed interest rates at around about 4.5 per cent and we’re assuming that they will rise by 1.25 per cent, as a worst-case scenario.”

Like others, Mr Pollard says he is keen to assess risk-based scenarios, as opposed to just individual factors.

He adds: “We’ve had a relatively benign operating environment for the last 10 years.” But he says the biggest “potential risks to the long-term solvency and viability of the business” are inflation and constrained rents. 

Like many others in the sector, Platform has been feeling the impact of the current economic climate. In February, the 47,000-home group revised its financial golden rule of not falling below a social housing lettings margin of 35 per cent due to the rising costs related to maintenance and retrofitting stock. 

Because of the current climate, Rosemary Farrar, chief financial officer at Platform, says it has “reviewed our risk appetite and tightened the values relating to our risk parameters”.

It has also been “developing and maturing” its approach to stress-testing. 

She adds: “We regularly test individual stresses to review the level of sensitivity and therefore mitigations that might be needed.

Rent levels “continue to be the most sensitive” area, Ms Farrar says. This is followed by “cost pressure and rising investment needs particularly connected to carbon footprint reduction”, she adds. 

Platform is also “actively reviewing” its mitigation plan to “ensure that the actions we take do not affect our level of customer service as far as possible”, Ms Farrar says.