Implementing Self-Financing for Council Housing. Briefing for Members - February 2011

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1 Introduction The Department for Communities and Local Government (DCLG) has issued a policy document, Implementing Self-Financing for Council Housing, to support the clauses in the Localism Bill which will allow the abolition of the HRA subsidy system and the introduction of a new system of self-financing. The prospectus put on the table by the previous government last March has been replaced by a plan to implement selffinancing on a compulsory basis in April 2012, assuming Royal Assent to the bill in the autumn. The scale of the change is significant and there is much to do at national and local levels in the next year. Further documents are therefore expected to be issued to support the process of implementation in the next few weeks and months. The policy document is an indication of the forthcoming settlement supported by a detailed set of policy proposals as to how the new arrangements will work in practice. A definitive financial determination will be made in draft in the autumn, then a final settlement agreed in January This CIH briefing sets out the key headlines and policy issues for all members. There is a commentary on the main financial and technical issues aimed at senior managers in local authorities and ALMOs together with all those working in HRA finance. It is hoped that they will find it useful in shaping their plans for the coming changes. After the Key Points (below), the CIH position is summarised. The detailed analysis which then follows includes consideration of all the key elements in the settlement. This is then followed by a technical assessment for HRA practitioners, including advice on the action needed in the next few months. Key points of the settlement as it now stands The main headlines are as follows: Confirmation that the HRA subsidy system will be abolished and replaced with a system in which rents will be retained by local authorities following a one-off and final settlement of the current system. A national debt figure of 28.4m allocated across around 160 authorities which will have stock at April 2012, based on assumptions of future rents and costs over 30 years. When compared to the current level of HRA subsidised debt, this gives a cash receipt to the Government of about 6.5bn which represents a share of future net

2 rental receipts up front, with the remainder being retained by local authorities in their 30-year business plans. Withdrawal of the previous proposal to allow right to buy receipts to be retained 100% locally, therefore continuing the current arrangement in which 75% are pooled nationally this was originally proposed for four years in October s Spending Review but seemingly now appears to apply across all 30 years. Confirmation that there will be a cap on debt at the starting level of the settlement; arrangements for setting the cap will take into account borrowing by authorities before and during the transition to self-financing. The following key national assumptions are being made: o Rents to converge with targets/formulae in 2016 with some provision for the 2 limit on annual increases built in there is therefore no assumption of any move towards greater rental flexibility built in to the settlement. o Uplifts in expenditure allowances totalling about 14% including a new allocation for aids and adaptations. o Movement on a range of technical areas lobbied for by the sector including taking account of PFI, property changes and the increased costs of managing debt. There is also a consultation paper from CIPFA on changed accounting and technical arrangements in the new system, relating to debt management and depreciation the key headlines from which are a proposal to split the current debt pool and ring fence debt to the HRA (an approach which has potentially significant consequences for treasury management and for LA finance as a whole), and a requirement to adopt a suitable depreciation approach in line with financial reporting standards and the need to maintain the stock in good condition over the long term. In the DCLG document there is also confirmation that the settlement can be re-opened if a change occurs which would have a substantial, material impact on the value of the landlord s business. There is a great deal to be worked through. Though this is a Policy Document to support the implementation of government policy and therefore not a formal consultation, there will be some expectation of responses or comments from authorities and ALMOs, particularly in notifying key issues to DCLG as soon as possible. There are some areas where information has been specifically requested within short time scales. And whilst we cannot expect detailed regulatory guidance around how authorities should respond and what they should do, there is a general expectation that authorities (and ALMOs) will have modelled their plans and determined the financial implications by Easter at the latest and identified any key issues for DCLG.

3 Summary of CIH position CIH has been very supportive of the process of HRA reform and wants to maximise the degree of local financial control for authorities and ALMOs, their tenants, members and officers. The DCLG publication is a significant step on the path to reform, and we are pleased that CIH s detailed engagement with this issue over several years has informed these changes. We have long argued that the current national HRA subsidy system is outdated, no longer fit for purpose and actively works against effective local management of council housing, and we look forward to next April when the system will be replaced by one based on more local choice and more local financial control. Self financing for the HRA is a key aspect of the government s localism agenda. For all of the 160+ authorities with council housing, the new system will mean the opportunity for the first time to develop a long-term and effective business plan for their housing, developed locally with local people. However, given the current financial pressures in the public sector, the government has felt it necessary to confirm that some central controls will continue. We will continue to work with government to maximise the localism within this settlement and continue to raise our concerns around the key macro issues of setting a cap on borrowing, continued pooling of a proportion of right to buy receipts and ensuring that the circumstances in which the settlement can be revisited are limited and clear: Right to buy receipts: the proposal is to retain 75% pooling but to offer a concession on taking account of property losses in the settlement so that all authorities take on less debt instead of keeping all their receipts. There are a number of issues: Retaining any form of pooling runs counter to the principle of localism, and reduces the impact of local asset management on which government wants authorities to focus. Uncertainty around making the right assumptions the RTB market is notoriously volatile and unpredictable what assumptions do you make? The RTB proposals now bring a further layer of risk and uncertainty into the settlement process which we need to see reflected in the assumptions made. Capping debt: we acknowledge the need to control borrowing but will urge the government to consider the consequences for those authorities where decent

4 homes backlogs and other investment needs still exist. Capping borrowing could hurt tenants by preventing investment in properties in the short term and risks stock deterioration until the resources become available which could be many years away. We believe the government should consider offering some headroom for those authorities where their tenants need it the most. Reopening the settlement: this appears to be set in stone in the bill and in some ways is a failsafe for authorities if things do go wrong. We are encouraged that the reasons will be limited and believe that, in time, the risk of reopening might reduce as the new arrangements become the norm. Nonetheless, it is not necessarily appropriate to start a long-term planning process with any threat, imminent or otherwise, of the government coming back for more in the short term. We will continue to press for commitments to be made that the circumstances for reopening will be limited and that the settlement cannot be reopened for the medium term so that each authority s business plan can really bed down. Social housing is a valuable public asset and we want to develop a system that genuinely enables authorities to manage these assets effectively. Properly implemented, self-financing should allow authorities to make much more proactive and long-term decisions about how they use their assets. The settlement will mean more rent retained locally over the long term by all authorities, and the scope for developing longer-term investment plans will be much improved. Nevertheless, some authorities might find that the reductions in public expenditure, particularly in decent homes backlog funding combined with the government s proposals to limit future borrowing, could make their business plans quite challenging, especially in the short term. In summary therefore, CIH welcomes the proposals, as they will provide a better deal all round for councils it would be difficult for it to be otherwise given the problems of the current system. Throughout all the preparations, it will be important to remember what staying in the subsidy system would deliver (or fail to deliver). But it is important that we argue as a sector for all authorities to start the new system without the need to struggle to meet backlogs that have built up for decades and which central government therefore has a responsibility to address.

5 Introduction to detailed analysis We have set out below a discussion of the key areas of detail which authorities will need to think about in developing their plans. We have also noted the key actions throughout some actions are required in the very short term (before the end of March). The publication of a revised and updated detailed model with the policy document is very welcome and an improvement on last year as it contains all the detailed assumptions nationally and for each authority to work through. In terms of the detail, the overall settlement has changed from one where the net debt increase was up to 4.8bn; it is now 6.5bn. The reasons for this change are many and varied (listed at page 33 of the document); some are to the advantage of LAs and others have worsened their position. The areas where the settlement has got better (ie. provides increased financial sustainability for authorities) are: factoring in extra costs of debt management and existing debt refinancing removing the small number of HRA PFI schemes from the settlement and opting to continue to pay separate PFI subsidy to those authorities taking into account stock reductions so that authorities do not take on debt for properties they won t have including an allowance for aids and adaptations (for the first time). The areas which are unchanged (broadly) are around rent convergence and the uplift to M&M and Major Repairs Allowances a position which is to be welcomed in the context of public expenditure reductions elsewhere. There are however significant distributional impacts around the allowances which all authorities will need to work through. For some authorities, the increase in debt from last year is significant (up to 30%) yet some have actually gone down; this is due to the changed pattern of allowances in 2011/12 being used as the basis for the new settlement. If an authority did badly out of the 2011/12 subsidy determination, its debt figure is likely to have gone up further. The areas where the settlement has got worse include: rolling forward one year with increased rents at 7% and increased allowances at 2.5% (nationally) adds significantly to the debt total factoring in RTB disposals in lieu of retaining 100% of receipts appears to be on an assumption of quite low volumes of sales.

6 Detailed issues and factors Right to buy disposals and receipts Acknowledging the general problems that arise from continuing to pool 75% of receipts, the proposal to reduce the debt settlement to take account of sales is not an insignificant concession. The main issue is: what assumption do you make about sales levels? The assumptions that have been factored in appear to be very low, totalling just 2,400 properties in the first year, and rising over 30 years to over 5,000 per year. In the early years the stock loss represents just 0.15% of the stock total. Whilst this is in line with the experience in the market recently, this is certainly not the experience looking back over the last years. The market is very volatile, and does not conform easily to market drivers. Whilst it might be accepted that rates will never reach the heights of the 1980s or even of 5-8 years ago, what is the likelihood that rates will stay as low as this for 30 years? The financial implications could be significant. Whilst the benefit of lower debt would be limited in the short term, any increase in RTB sales will mean business plans losing resources in the long term. Rates would only need to rise to 1% of stock totals in any year for 75% of the receipts from around 15,000 sales to end up with government whilst rental income to meet HRA debt is reduced. We urge all authorities to work carefully through the assumptions that have been made and develop an analysis which assesses whether sales are likely to be as low as forecast. Operating the cap on debt Whilst the debt cap being set at the opening settlement level has been understood for a while, the administrative arrangements are set out in more detail in the document. In particular, the cap will be set at the higher of the settlement or the amount above the settlement if an authority has undertaken prudential borrowing over the subsidy level of debt. We argued for new build borrowing (under the previous government s Building Britain s Future programme) to be disregarded and DCLG have accepted that case. All new build

7 borrowing backed by HCA grant will be added to the cap although authorities in this position should look at the assumptions that have been made as there is some evidence that not all the borrowing has been included in the modelling. On the other hand, DCLG have moved to control borrowing in advance of the settlement thereby preventing what they perceive as a risk that authorities artificially raise their cap. All borrowing next year would need to be approved with only borrowing for existing capital programmes likely to gain approval. Leaving aside the issue that this perception is hardly born out by the experience of prudential borrowing, which has been very limited, the proposal presents some difficulties: There is no power to control housing borrowing separately in advance of the settlement, so the power will be taken through the debt cap after selffinancing. If you borrow too much in advance you risk breaching the cap on day one. This begs the question about how the government will enforce the cap? Also, and more importantly, there are legitimate reasons why an authority might look to borrow next year. For example, the proposed changes to Feed in Tariffs might mean that it makes sense to finance programmes in 2011/12 in order to generate additional income down the line. Investment of this type is consistent with the government s green agenda. Authorities are advised to carefully consider their options for borrowing next year given this proposal. Rent policy The convergence policy remains to 2016 but there is now a more detailed analysis of the caps and limits assumptions made and authorities will be able to compare closely the outcomes from their own rent models with the assumptions made by government. We urge authorities to make their comparisons between the rent model and the assumptions in the settlement, work out the costs if the assumption is too general and ensure that they fully appreciate the financial implications for their plans. There is no assumed rent flexibility (for example a move to 80% market rents or any other level) in the settlement. This is primarily due to a wish not to cloud the rent assumptions being made. Future policies towards rent flexibility will emerge elsewhere

8 from consideration of the Localism Bill. However, taking a lead from the housing association sector, any future rent flexibility, even if it is encouraged, will almost certainly come with a requirement to develop more properties. Expenditure allowances The overall uplifts for M&M allowances are 5.5% and MRA 28% as before and following the research undertaken in the HRA Review. The major changes are in the distribution of uplifts where the 2011/12 subsidy determination appears significant, and in the withdrawal of the previous proposal to get all authorities to a minimum level of uplift overall. The vast majority of authorities have seen an increase in their indicative settlement of between 0-10%. For some, the increase in debt allocation is up to 30% and above. For others, the debt settlement has gone down. In some ways, the distributional impacts highlight the inadequacies of having the current system of redistribution at all. Necessarily, as this will be the last determination, the effects of getting the distribution out of kilter will last into the long term for all authorities. Authorities are therefore encouraged to work through the detailed supporting document on how the assumptions have been made in order to identify whether the outcome on allowances is appropriate for them. Aids and adaptations Government has acknowledged that its previous position of failing to finance future needs on aids and adaptations is unsustainable, particularly given the re-pooling of RTB receipts. The original research indicated a significant cost over time. Allowance has now been made in the revenue allowances equivalent to approximately 60 per unit annually across the sector. The distribution assumption has been made on a simple per unit basis, although to an extent this appears to be as a result of there being no other suitable and uncontroversial way of doing it. Authorities might therefore want to make a case as to an alternative mechanism for distribution particularly if there evidence of significant additional relative demand arising from stock or demographic pressures. The evidence base must be sound and it must be remembered that any additional allowance would come from a fixed national sum.

9 Debt management and refinancing The settlement factors in both existing premiums on debt refinancing (currently financed in the subsidy system) and an increase in debt management expenses arising from the net national increase in debt. These are to be welcomed although the actual premiums/discounts payable might change in the run up to the settlement. Authorities will need to watch this carefully in the context of their own treasury management decisions. Property numbers Government has accepted the argument that where there are definitive plans to demolish and/or dispose of properties, authorities should not take on debt relating to the rental stream from those properties. The arrangements are important and authorities have been asked to let DCLG officials know of plans to demolish up to three years after the settlement. Only approved demolitions will be provided for. Our experience suggests that virtually all authorities will be thinking about plans for disposal or demolition of stock in some form, be it for major regeneration schemes or for smaller-scale redevelopment of (for example) sheltered schemes. We would urge all authorities to get those plans discussed and approved in the context of self-financing and to ensure that where you do have plans for stock reduction, these get taken into account. The average national debt allocation is around 15k/unit the last thing authorities need is to be paying debt of this level on properties they no longer have. Transaction, borrowing and Treasury Management issues There is a significant amount of detail in the document around preparations for the transfer of funds on the day that the settlement is implemented. For authorities having debt written down, the proposal is to top slice PWLB (Public Works Loan Board) loans from the existing portfolio, take them over and pay them off. The key issue remains as for previous consultations: how to take account of higher interest loans in authorities with high debts currently. Those small number of authorities affected will need to engage DCLG directly in the run-up to implementation.

10 For authorities paying money to government, this will be all on the day and therefore they may take on debt: there is an outline procedure set out, principally focused on ensuring that the funds are available from PWLB in good time. Whilst it is positive that DCLG are thinking through the logistics at this stage, and despite the obvious technicalities, there are some concerns that the procedures might restrict the freedom of treasury managers to fund buy-out payments according to local needs in the run-up to April For example, some might want to bring investment back in to pay towards the settlement rather than take out PWLB loans directly. Some might want to forward borrow (from a treasury management perspective). Loans and investments are changing hands on a minute-by-minute basis between authorities, PWLB and market lenders and government needs to ensure that there is the maximum opportunity for authorities to exercise local freedom in the way they approach the transaction. Other options There is a short passage on the implications of self-financing for stock transfer proposals with a commitment to recommence a programme of stock transfer after April The current interruption to the process appears to be more related to planning for a single settlement rather than an unwillingness to look at transfer. At the same time, the implementation of self-financing will make stock transfer much more difficult to deliver. The policy towards valuation is effectively to adopt the same assumptions as for self-financing and varying from these would be subject to a rigorously reviewed case based on value for money for the public purse. There is a reference to acceptance that taxation implications could be taken into account. So what does this mean in practical financial terms? Effectively, the main issue is that stock transfers could only be pursued at the level of the self-financing debt possibly adjusted in some way for VAT on expenditure allowances. There would be no factor included for up front or backlog investment and no allowance for increased costs over the 30 years arising from being a separate organisation. Both of these have been an essential component of stock transfer proposals for 20 years. Partial transfers might remain on the table for some, particularly where challenging stock can be disposed of (perhaps for nil value) and the remaining debt costs met by the remaining (better-placed) stock. Put simply, the plan might not stack up for 10,000 properties at 200m debt but if you transferred out 1,000 of the highest-cost properties, the plan might stack up for the 9,000 left behind, even at 200m. It is likely however to be a difficult financial equation and authorities might be expected to proceed with care in developing their plans and options. But there may be restricted choices in many

11 areas and investment by purchasing housing associations might be a key way of getting backlogs cleared and stock redeveloped. Technical commentary There is a link to the CIPFA consultation paper on debt pooling and depreciation. Responses are required by 28 th February the timescales are shorter than the usual DCLG consultations as these relate to accounting and technical frameworks (as opposed to government policy). More detail will emerge over time, but at this stage, the key headlines for housing and housing finance people can be summarised as follows. Debt pooling The proposal is to split the debt between General Fund and HRA. If there is pre-existing debt, this will require a physical split of the loan portfolio. There are a series of worked examples setting out how the split could be effected. The splitting of the debt pool is important financially and (to an extent) psychologically. Ring-fenced and unsubsidised debt will be directly attributable to the HRA and therefore against rent income. The implications for the HRA ring fence are significant and positive, in the sense that this makes the case for a definite policy around the use of rent income toward meeting loans payments as a first call. It should also assist members and tenants appreciation of the links between income and debt costs in a transparent and business-like way. There will be some pitfalls, particularly for some debt-free authorities where borrowing for General Fund purposes has been undertaken. Those authorities are likely to be covered by a commitment from CIPFA (and DCLG) to seek specific measures to ensure that the General Fund is not adversely affected by the debt-split. Depreciation DCLG want to ensure that sufficient resources are set aside for long-term maintenance the second call on rent income after debt payments. This is entirely consistent with International Financial Reporting Standards. The main proposals are to be welcomed: Ensuring a depreciation charge is made equivalent to the long-term maintenance costs of the elements within the stock, split into large components if they have varying useful economic lives.

12 Ensuring that the charge made to the HRA is credited to a reserve specifically ring-fenced for future capital investment purposes (currently we use the Major Repairs Reserve and this or a new form will continue); this provides DCLG with the comfort they need that the assets will be maintained. It is important that authorities link their charges for depreciation to the long-term renewal costs of the stock as identified in their stock condition survey/asset databases. There may be some cases where the costs go up compared to now a useful benchmark would be the uplifted level of MRA calculated in the settlement assumptions. It might be expected that amounts being moved into major repairs will go up compared to the current amounts. Authorities will need to manage the transition with care to ensure that the amount being put aside for capital replacements is sustainable in both the short and long term. Too much, too early might cause problems for revenue expenditure; not enough and there could be problems financing capital expenditure when it becomes due. Other Work from CIPFA is outstanding on the format for the HRA balance sheet and we look forward to that being published in due course. Towards a realistic HRA Business Plan The priority actions for local authorities and ALMOs are likely to focus around the development of an initial analysis of the financial implications of the revised figures followed by a more detailed need to prepare a suitable business plan ready for next April. Key to the future will be adopting and refining the approach to risk management. All authorities (and where in place ALMOs) have risk management strategies in a range of formats. The taking on of unsubsidised debt will have big implications for the balance of risks in these strategies. For example: What is currently the annual risk of not being in control of expenditure allowances will be replaced with risks over exposure to inflation. The risks of resource fluctuations outside of your control are replaced by interest rate risk.

13 The risk of policy changes by government affecting your plans are enhanced but over the longer term rather than the short term. A key aspect of the planning process will relate to how authorities choose to allocate their resources for every new rent raised from tenants, there will now be a realistic choice (with tenants) as to how this gets spent on services, maintenance or other investment. This is a significant change but must be seen in the light of the shape of HRA business plan in the future characterised as follows: Rent and other income are the only long-term income resources for the HRA business plan. The first call must be to cover existing debt (just like a household mortgage). The second call must be to ensure that properties are maintained so that they continue to raise rent income so that they can continue to cover the debt. The third call is for service delivery and other priorities. This has significant implications for the operation of the HRA ring fence there can be no free-for-all on resources when there are millions of unsubsidised debt on the books. Developing plans, in conjunction with tenants, to balance the use of resources between these priorities will be an interesting new direction for many particularly given the way the current system determines what amounts authorities should spend on what. Summary of key actions The key priorities for action are scheduled below. 1. Review your plans for borrowing next year and ensure that DCLG are aware of your plans to borrow in advance of the settlement. 2. Develop plans for taking out the money to pay the settlement now, in conjunction with corporate finance colleagues, and to maximise value in the settlement transaction.

14 3. Complete or update the initial model to assess the impact of the new figures given your 2011/12 budget base and known capital plans. 4. Run scenarios and identify the key factors: for some this might be repairs backlogs, for others this might be the starting position on debt, for yet others, rents might be above or below targets with implications for financing. 5. Assess the impact on the General Fund of the change to self-financing and alert DCLG to any unintended consequences: they are open to proposals to mitigate adverse GF effects. 6. Developing a new approach to risk management, fit for the new world. 7. Think now about planning to establish the HRA business plan for April 2012: this will involve consultation, the involvement of the rest of the council, and ideally putting something in place for the start of self-financing. Put another way, since it was introduced in 2000/2001, the HRA business plan has always rather been a bit of a plaything for housing finance practitioners. There will now be an extra 28bn of unsubsidised debt out there, and whilst the risks are important they are containable and the rewards are potentially significant and begin to arise quickly in many areas. The time is rapidly approaching for HRA business planning to be become real! Steve Partridge CIH February 2011

15 CIH is offering support for business planning through a series of offers to councils and ALMOs. We are working with a number of high-performing councils on best practice and new approaches to business planning and we will continue to have close engagement with government through regular update meetings with DCLG, LGA and CIPFA. We will also continue to work closely with many organisations around the country. To see how we can support you in your modelling, preparing your business plan in conjunction with tenants and members, and working towards a longer-term approach to asset management for your stock, please contact our team as follows: Steve Partridge, Director of Financial Policy and Development Steve.Partridge@consultcih.co.uk Simon Smith, Finance Consultant Simon.Smith@consultcih.co.uk Hilary Vaughan, Associate We are also working closely with Savills to offer wide ranging services around asset management strategy in the HRA business plan for more information, contact us or Robert Grundy at rgrundy@savills.com or on The Chartered Institute of Housing (CIH) is the professional body for people involved in housing and communities. We are a registered charity and not-for-profit organisation. We have a diverse and growing membership of over 22,000 people both in the public and private sectors living and working in over 20 countries on five continents across the world. We exist to maximise the contribution that housing professionals make to the wellbeing of communities. CIH provides a wide range of services available to members, non-members, organisations, the housing sector and other sectors involved in the creation of communities. Many of our services are only available to CIH Members, including discounts. Our products and services include: Training

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