Sources of finance for housing stock transfers On 5th May 2006 the responsibilities of the Office of the Deputy Prime Minister (ODPM) transferred to the Department for Communities and Local Government. Department for Communities and Local Government Eland House Bressenden Place London SW1E 5DU Telephone: 020 7944 4400 Website: www.communities.gov.uk Documents downloaded from the www.communities.gov.uk website areCrown Copyright unless otherwise stated, in which case copyright is assigned to Queens Printer and Controller of Her Majestys Stationery Office. Copyright in the typographical arrangement rests with the Crown. This publication, excluding logos, may be reproduced free of charge in any format or medium for research, private study or for internal circulation within an organisation. This is subject to it being reproduced accurately and not used in a misleading context. The material must be acknowledged as Crown copyright and the title of the publication specified. 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This publication is only available online via the Communities and Local Government website: www.communities.gov.uk Alternative formats under Disability Discrimination Act (DDA):if you require this publication in an alternative format please email firstname.lastname@example.org Contents Abbreviations Executive summary Part 1 Chapter 1 - Objectives of the study Chapter 2 - Study process Chapter 3 - Assessment of the current LSVT funding market Chapter 4 - Value for money issues Chapter 5 - Barriers to achieving improved value for money and a sustainable programme Part 2 Chapter 6 - Poorer urban and large metropolitan stock transfers the risks faced by recipient landlords Chapter 7 - Full versus partial funding of stock transfers Chapter 8 - Business planning issues and information issues for the vendor local authority and recipient landlord Chapter 9 - Transfer to existing RSLs and a competitive disposal process Chapter 10 - Intermediary body to issue bonds to the capital markets Chapter 11 - Alternative models for stock transfer Appendix I - ODPM Workshop 26th June 2001 Appendix II - Questionnaire to banks and building societies Appendix III - Questionnaire to LSVT borrowers Appendix IV - Organisations contacted to ascertain their views Appendix V - Banks and building societies assessment of return on loans to LSVT RSLs Appendix VI - Funders main observations on funding stock transfers Appendix VII - LSVT generic illustrative risk matrix Appendix VIII - Leaseholder risk to LSVT RSLs in poorer urban and large metropolitan stock transfers Appendix IX - Investment procurement risk to LSVT RSLs in poorer urban and large metropolitan stock transfers Appendix X - Management structures risk to LSVT RSLs in poorer urban and large metropolitan stock transfers Appendix XI - Analysis of replies received from existing RSLs Appendix XII - Calculation of a recipient RSLs risk buffer Appendix XIII - Alternative models for stock transfer Abbreviations ALMO Arms Length Management Organisation B/P Business Plan CAPM Capital Asset Pricing Model CAR Capital at Risk CHA Ceewood Housing Association CHTF Community Housing Task Force CLT Community Land Trust CML Council of Mortgage Lenders DTLR Department for Transport, Local Government and the Regions E&Y Ernst & Young LLP EAD Exposure at Default ERCF Estates Renewal Challenge Fund FSA Financial Services Authority HA Housing Association HAG Housing Association Grant HC Housing Corporation HM Treasury Her Majestys Treasury IRB Internal Ratings Based IT Information Technology LGD Loss Given (the) Default LSVT Large Scale Voluntary Transfer M Maturity NHF National Housing Federation ODPM Office of the Deputy Prime Minister OECD Organisation for Economic Co-ordination and Development PD Possibility of Default PFI Private Finance Initiatives PI Performance Indicators RAROC Risk Adjusted Return on Capital RARORC Risk Adjusted Return on Risk Capital RDA Regional Development Agency RSL Registered Social Landlord RTA Recognised Tenants Association RTB Right to Buy SHG Social Housing Grant SLR Southwark Land Regeneration TMV Tenanted Market Valuation TUPE Transfer of Undertakings (Protection of Employment) Regulations 1981 UK United Kingdom VAT Value Added Tax VFM Value for Money WACC Weighted Average Cost of Capital Executive summary INTRODUCTION The transfer of housing stock from local authorities to Registered Social Landlords (RSLs)has been an important and successful part of successive governments social housing policy.Around 148 housing stock transfers have been completed involving 593,000 properties,raising a total of around £9.5bn in private finance. The programme is expanding and changing to meet new challenges of the decent homesobjective, delivering improved housing services, greater tenant involvement and increasinglyplaying an important role in the regeneration of towns and cities. The Government hasmade clear it will support the transfer of around 200,000 units per year where tenants wantto transfer. This has and will continue to involve potential transfers from some of the largestlocal authority landlords. Future stock transfers are also likely to have a larger share of homeswith high investment needs and in areas facing problems of falling demand. Against this background of change, Ernst and Young were commissioned by the Office ofthe Deputy Prime Minister (ODPM) (previously the Department for Transport, LocalGovernment and the Regions DTLR) to assess how the cost effectiveness of fundingobtained by RSLs to support Large Scale Voluntary Transfers (LSVTs) might be improvedor maintained. The specific requirements of the study were: to assess the current market for funding stock transfers; to identify any barriers to achieving better VFM in financing terms including anassessment of the cause of the barriers and their relative significance in restrictingcost effectiveness; to consider specifically the possible barriers and other issues related to achieving goodVFM for financing transfers of poorer quality urban stock, including stock in lowdemand areas; to consider the implications of the increased size of the stock transfer programme onthe capacity of lenders to provide sufficient finance; and make recommendations about how barriers identified might be overcome to improveor maintain VFM. STUDY APPROACH The study process included extensive consultation amongst existing or potential stakeholders,financial modelling, risk analysis and discussions with external agencies. This includeddiscussion with the ODPM, the Housing Corporation, the Community Housing Task Force,leading LSVT funders, the Council of Mortgage Lenders, the National Housing Federation,HM Treasury and RSLs. ASSESSMENT OF THE CURRENT LSVTFUNDING MARKET The current market was assessed by looking at the profile of recent transactions and activelenders. Vulnerabilities arising from the wider market context in which the lenders operatewere identified, including the potential impact of the New Basel Accord (Basel II). The keypoints arising were: All LSVTs in the programme to date have been funded. There are relatively few financial institutions willing to act as lead arranger for stocktransfer loan facilities. The bond markets have not been widely used. Loan facilities are generally competitively priced. The low returns to lenders to the transfer market, whilst favourable to the LSVTprogramme, may render it vulnerable to withdrawal by key lenders. The implementation of Basel II may lead to greater differentiation in lending termsoffered to LSVT RSLs, with the possibility of higher rates for more risky transfers.However, the impact of Basel II is uncertain and its full implications are not yet known. VALUE FOR MONEY ISSUES An important question for the study to address was whether or not the funding structures usedand the funding rates achieved in transfers to date offered good value for money to the recipientRSL and the public sector more widely. These issues are differentiated for transfers involvingshire, urban and large metropolitan Local Authorities. Some of the key findings were: Shire and other strong transfers. In Ernst & Youngs (E&Y) opinion, the cost of funds to the RSL generally represents good valuefor money. Key value for money issues relate to the sale price received by the local authorityand the local authoritys inability to benefit from gains arising from any subsequent refinancing. Poorer quality urban transfers. Transactions to date represent good value for money, but are still in their infancy. Higher risks relating to management, demand, regeneration and procurement costs,coupled with the implementation of Basel II, may in the future lead to higher pricedloans and therefore poorer VFM. Large metropolitan transfers. Loan facilities raised to date to finance these transfers, which thus far have beencomparatively few in number, have in E&Ys opinion represented good value for money. The scale of transfers of large metropolitan housing stocks, should provide the opportunityfor greater innovation in funding sources and techniques. A key VFM concern is that the level of risk the RSL is required to take should becommensurate with its ability to absorb it. The table below sets out Ernst and Youngs view of the typical loan terms achieved for eachtype of transfer. Shires Poorer urban stock Larger metropolitan  Arrangement fee 1-1.25% 1.25% 1.25-1.35%  Interest margins 10 bp rising 85-100 bp 40-50 bp early years periodically Interest margins 45-50 bp 75-100 bp (within 60-65 bp later years (yrs 7-10 a few years) onwards) Other costs Commitment fees Commitment fees Commitment fees are generally not at around half the at around half the charged interest margin interest margin  % of loan value  Margin above LIBOR. 1,006p = 1 percentage point BARRIERS TO ACHIEVING IMPROVED VALUE FOR MONEYAND A SUSTAINABLE PROGRAMME The study went on to assess the barriers which lenders and borrowers identified as operatingagainst a fully effective transfer funding market providing good value for money to thetransferring local authority and the RSL. The main barriers identified were: In some recipient RSLs, board members and senior executives may not be sufficientlyestablished to act as a well-informed and experienced client during the funding raisingprocess. There is a concern that advisers drive such transactions. The track record of all transfers securing funding, the process and comparatively shorttimetable which to secure funding has produced a commodity approach to funding,which may not produce optimal structures in all cases. All transfers are funded on an individual basis thus losing any potential cost benefits ofaggregated funding. The purchase price/discount rate formulae is mechanical and does not necessarily takeinto account all factors and risks. Under the current clean break system, local authorities can neither benefit frompost-transfer out-performance by the recipient landlord nor support weaker RSLs inmitigating early-year risks. Specific VFM issues and potential means to address them were covered in more detail inthe second phase of the study. URBAN AND LARGE METROPOLITAN STOCK TRANSFERS THE RISKS FACED BY THE RECIPIENT LANDLORDS The study looked at the risk profile of urban and metropolitan transfers. A generic risk matrixwas prepared along with discussion papers in relation to the risk mapping required by therecipient RSL. The main messages from this part of the work were: The purchase price for the stock being acquired should reflect the level of risk absorbedby the recipient landlord. The purchase price should not be unduly influenced by other factors, for example thelocal authoritys need to cover interest breakage costs on its existing Housing RevenueAccount loans. If all risks cannot otherwise be absorbed, the public sector will need to support RSLsthrough dowries, transfer of additional land, subordinated loans or other supportmechanisms if the transfer is to go ahead. Comprehensive regeneration strategies and delivery programmes are imperative if thehousing investment from LSVTs is to lead to long-term sustained improvement. Other key risks faced by transfer RSLs were: those associated with leaseholders; procurement and implementation of the investment programme; and management structures. RSLs considering transfer should develop a comprehensive risk assessment matrix to identifythe risks they are most exposed to and then develop strategies to manage these risks. FULL VERSUS PARTIAL FUNDINGS OF STOCK TRANSFERS This section considers the arguments for and against full funding of peak debt on the day oftransfer, including the perception of LSVTs as start-up businesses, the risks which would beencountered in partial funding and the potential benefits of transfer to existing RSLs giventheir strength as ongoing businesses. Current Housing Corporation policy on registering new transfer RSLs generally supportsup-front full funding of business plans. This reflects the perception of LSVT RSLs as start-up businesses with programmessubject to uncertain costings and external change. For urban and large metropolitan transfers, full funding is a necessary precaution in thelight of the substantially greater risks to the fulfilment of the housing investment programmewhich partial funding would present. For some strong shire transfers, arguments could be made for partial funding, whichwould allow greater flexibility, should reduce costs and may bring additional fundersinto the market. Existing RSLs are more likely to be able to absorb the risks of partial funding and betreated as established businesses for funding purposes. BUSINESS PLANNING AND INFORMATION ISSUES FOR THEVENDER LOCAL AUTHORITY AND RECIPIENT LANDLORD A number of issues relating to the quality of information and business planning offered byRSLs and their advisors were identified in the course of the study. The conclusion was thata more structured allocation of responsibility for information collation, dissemination andbusiness planning would address these issues. Particular points arising were: Much of the information provided by the RSL in its business plan and fundingprospectus is derived from local authority records and accounts. The local authority should provide core data in a Disposal Prospectus and create aDue Diligence Library or data room for inspection by the RSLs and their funders. The RSLs business plan could then focus on its governance and management, its intentionsfor the stock and neighbourhood and all future tenancy matters. Funding advisers should rigorously test business plan assumptions, identify and quantifyrisks to the business plan and consider all the available funding options. TRANSFER TO EXISTING RSLS AND A COMPETITIVE DISPOSAL PROCESS This section considers the extent to which the VFM of funding for stock transfers would beenhanced by the involvement of established RSLs in a competitive bidding process. It analysesthe potential financial value of involving existing RSLs and summarises the results of aquestionnaire designed to judge the appetite of varying sizes of these RSLs for this potentialarea of business. Current ODPM policy is to encourage LAs to involve tenants in the choice of a newlandlord. In some cases this has involved a more formal competition between potentiallandlords, although the policy is still relatively new. Existing RSLs, or group structures involving existing RSLs, should be able to offerpricing benefits through marginal costing of management costs and access to cheaperprivate finance. Virtually all existing RSLs, canvassed as part of a survey, expressed keen interest inparticipating in future LSVTs. A disposal prospectus and data room could create the basis for a properly conductedcompetition for the recipient landlord role. Bidders could include prospective RSLs, existing RSLs and the alternative modelsdescribed below. Competition would need to be carried out prior to ballot against clear criteria and withmeaningful tenant participation in the process. The clear advantages of a more competitive process may be partly offset by the difficultiesof engaging tenants in an extended transfer process. Large metropolitan transfers face additional complexities in introducing competition forthe landlord function because of the policy that generally no more than 12,000 homescan be transferred to a single RSL. INTERMEDIARY BODY TO ISSUE BONDS IN THE CAPITAL MARKETS This section discusses the reasons for the relative under-utilisation of the bond markets andthe potential role of a bond-issuing intermediary, whether this is likely to emerge from themarket or would require public sector support and whether such public sector support couldbe justified. The bond markets have been comparatively under-utilised in providing funding to thetransfer programme to date. The most cost-effective bonds are large, liquid issues which may require the aggregationof a number of smaller transfers. The market has not yet produced a mechanism for aggregating LSVT issues althoughthis has been achieved in the traditional RSL market. There is no current evidence of the poor value for money or market failure which mightjustify public sector intervention to establish a body to issue group bonds for LSVTs. ALTERNATIVE MODELS FOR STOCK TRANSFER A competitive bidding process may open up opportunities for organisations with governanceand funding structures different from those of traditional RSLs. This section considers thepolitical, economic and stakeholder concerns raised by two such models. It also considers lessonswhich can be learnt for the LSVT process from the proponents of such models, in particularthe need to place the social housing investment programme in a wider regeneration context. The current system of transfer to RSLs provides limited capacity to reconfigure estates,maximise for community benefit the value of development land or participate incomprehensive regeneration programmes. Enabling RSLs to carry out wider development and regeneration activities may requirea relaxation of ODPM and Housing Corporation rules and the risks may be too greatfor newly-formed RSLs to absorb. Governance and financing models have been proposed which offer alternative types oflandlord and a wider regeneration capability, but which would need to win the approvalof a wide range of stakeholders, in particular tenants. the structured finance model utilising equity/debt combined funding with returns toequity investors being capped at a level which would allow surpluses to be channelledinto a local regeneration fund. the community land trust model, where transfer of the freehold interest to aCommunity Land Trust would enable a comprehensive masterplan to be developedwith any resulting enhanced value being retained for the benefit of the community. Part 1 Chapter 1 - Objectives of the study Introduction 1.1 The aim of the study as specified by the Office of the Deputy Prime Minister (ODPM) (formerlythe Department for Transport, Local Government and the Regions DTLR) is to identifypotential ways in which the cost effectiveness of funding obtained by Registered SocialLandlords (RSLs) to support Large Scale Voluntary Transfers (LSVTs) might be improved,taking into account the changing nature and increasing size of the stock transfer programme. 1.2 The transfer of housing stock from local authorities to RSLs has been an important andsuccessful part of successive governments social housing policy. Around 148 stock transfershave completed involving 593,000 properties, raising a total of around £9.5bn in private finance. 1.3 The government has expressed a desire to modernise the programme to make it moreeffective in delivering a larger programme of around 200,000 units per year. In particular,the government wants the programme to take account of the changing nature of stock inthe programme as more large urban local authorities pursue stock transfer. 1.4 Cost effective forms of finance are essential in delivering the programme with more transfersinvolving a large number of dwellings, generally in poorer condition, in large metropolitanareas. This expanded programme also raises the issue of the availability of private financeon competitive terms and conditions, from what at present is a relatively small pool ofactive lenders. 1.5 Recipient RSLs taking the housing stock of local authorities have thus far adopted a veryconservative approach in arranging their private finance requirement. Funding packageshave tended to be very similar with comparatively little use of the capital markets, thenatural source of long-term fixed rate funding. 1.6 Some stock transfers recipient landlords have a comparatively small funding requirement,however others, particularly those arising from large metropolitan authorities, can havefunding needs running into several hundred million pounds. These larger loan facilitieshave incurred large arrangement fees, which are, with very few exceptions, netted offagainst the purchase price as part of the recipient landlords set-up costs. 1.7 Loan covenants have become very standardised, generally being a proxy for traditionalproject finance loan life and debt service cover ratios. Whilst these may appear undulyrestrictive for strong stock transfers arising in shire districts, they, along with other financialcovenants and ratios, may be essential in ensuring that lenders to poorer urban and largemetropolitan stock transfers are able to adequately monitor the performance of their borrower. 1.8 However, at transfer, lenders generally consider recipient landlords to be in a start-upsituation. To an extent, this is understandable given the initial catch-up repairs investmentprogramme. However, it could also be argued that stock transfer is the transfer of an existingbusiness with a track record of its operational performance in the ownership of the localauthority, and therefore should be treated as such by lenders. 1.9 Stock transfers arising from shire district authorities have for a number of years become astandardised approach to improve the delivery of social housing. This status has manifesteditself in relatively low fees for advisory services and generally little incentive to innovate interms of new sources and styles of funding. In addition, as the terms and conditions onwhich lenders provide funding has been steadily eroded in recent years, the transfers sectorhas increasingly become unattractive to potential new lenders. The transfer sector has alsoattracted very few new entrants in recent years, presumably a reflection of lenders viewsabout the relative returns from lending to the sector. Given the Governments desire to increasethe size of its annual programme, a continued lack of new lenders coupled with mergersbetween existing lenders could become a cause for concern. 1.10 Given this background of a mature market with relatively few lenders, ODPM wished toreceive a report which: provides an assessment of the financing terms, forms of funding and lender profilespresently involved in funding LSVTs and to assess the extent to which these representgood VFM; identifies any barriers to achieving better VFM in financing terms including an assessmentof the cause of the barriers and their relative significance in restricting cost effectiveness; considers specifically the possible barriers and other issues related to achieving goodVFM for financing transfers of poorer quality urban stock, including stock in lowdemand areas; and considers the implications of the increased size of the stock transfer programme on thecapacity of lenders to provide sufficient finance. 1.11 Implementation of the assignment has been divided into two stages. The first stage was anassessment of the current LSVT funding market. This included canvassing the views ofleading funders, advisors, borrowers, and potential new entrants to the market. An assessmentof the VFM of the current funding arrangements has been made along with the identificationof barriers to achieving greater VFM. This first stage of the project is covered in Part 1 ofthis report, and was required to provide initial views on recommendations for solutions tothe issues identified. 1.12 The second stage of the assignment, as detailed in Part 2 of this report, involved investigatingpossible solutions to the barriers to VFM in the funding of stock transfers, as identified inthe first part of the assignment. In particular, this involved: a) identifying the risks faced by recipient landlords taking the transfer of housing stock inpoorer urban and large metropolitan areas (Section 6); b) investigating the possibility of changing the current norm of all stock transfers arranginga loan facility on the day of transfer, sufficient to cover their expected future peak debtrequirement (full funding). The implications and acceptability of a partial funding approachto the leading interest groups in a stock transfer have been considered (Section 7); c) considering the key business planning and information issues to be addressed in arrangingfunding for a stock transfer (Section 8); d) considering the possibility of increasing the involvement of existing RSLs in futurestock transfers, including their ability to absorb greater risk than a newly formed RSLand to pay a higher purchase price for the stock. In addition, investigating the possibilityof introducing greater competition in the stock transfer process to secure greater VFMin the funding of stock transfers whilst being mindful of the implications for other keystakeholders, particularly tenants (Section 9); e) investigating the possibility of forming an intermediary body to aggregate stock transfersand to issue securities in the capital markets (Section 10); and f) considering alternative structural and funding models to facilitate the transfer ofhousing stock from local authorities (Section 11). Chapter 2 - Study process 2.1 The study commenced with a workshop in June 2001, attended by the project steeringgroup with representatives from ODPM, the Housing Corporation (HC), the CommunityHousing Task Force (CHTF) and the Ernst & Young LLP Project Team. This was used toidentify the concerns and perceptions of all parties and looked at the strengths and weaknessesof the current transfer structures and processes. In particular the workshop looked at demandfor, and supply of, funding for transfers (see Appendix I for a summary of the findings ofthis workshop). 2.2 Following this workshop a questionnaire was compiled for distribution to leading LSVT funders,including banks, building societies, investment banks, funding advisers, mono-line insurersand investors. A copy of this questionnaire is attached at Appendix II. This questionnairewas agreed with ODPM and distributed to a pre-agreed list of funders. 2.3 In addition, it was decided to send a slightly different questionnaire (see Appendix III), toLSVT borrowers to ascertain their perception and experiences of the fund raising process. 2.4 A short presentation of the scope of the project was made to a meeting of the Council ofMortgage Lenders (CML) in June 2001 and a meeting was held with the National HousingFederation (NHF), both members of the projects External Reference Group. 2.5 The next stage of the study consisted of a series of meetings, telephone conversations, e-mailcommunications and written submissions designed to enable the project team to assess thecurrent state of the market and to provide an opportunity for existing funders, non-funders,borrowers, rating agencies, advisors, and trade bodies to comment on their own experience.It was also an opportunity for these stakeholders to provide suggestions for improvements,either to the fundamental funding structures or to the procedures currently adopted (seeAppendix IV for list of contacts). 2.6 These stakeholders were pleased to be given the opportunity to have their views heard andclearly some have taken a significant period of time in preparing their response. 2.7 Following a meeting with the External Reference Group comprising the CML, ODPM, theHousing Corporation, HM Treasury, the CHTF and the NHF, in September 2001, areas forfurther investigation and analysis were agreed. 2.8 The second stage of the project involved further research and analysis of options to achievegreater VFM in the funding of stock transfers and pre-requisites to ensure as far as possiblethe cost-effective funding of ODPMs stock transfer programme with a higher proportion ofpoorer urban and large metropolitan stock transfers. 2.9 In particular, Ernst & Young undertook detailed financial modelling of different fundingstructures to ascertain the potential effect on the purchase price that could be paid for a givenportfolio of properties, of involving equity finance and existing RSLs in future stock transfers. 2.10 We also used our experience of both past Estates Renewal Challenge Fund (ERCF) transfersand current urban and large metropolitan stock transfers, to identify the risks involved insuch transfers, and the extent to which it is reasonable to expect a newly formed RSL, withno reserves, to absorb such risks. 2.11 In the first part of the assignment we clearly identified the possibility of existing RSLs becomingmore involved in all aspects of future stock transfers. We canvassed a large number of ChiefExecutives of existing RSLs to ascertain their appetite to become more involved in stocktransfers. The responses were extremely useful in developing our thinking on the value thatexisting RSLs could bring to stock transfers, and particularly those involving poorer urbanand large metropolitan stock. 2.12 We considered options for greater involvement of the capital markets in funding future stocktransfers. This involved discussions with leading investment banks, credit rating agenciesand mono-line insurers to investigate potential structures. 2.13 The emerging findings from the second stage of the study were discussed at a meeting ofthe External Reference Group in March 2002, as well as being presented at the NHF FinanceConference in the same month. This final report was then prepared. Chapter 3 - Assessment of the current LSVT funding market Summary All LSVTs in the program to date have been funded. There are relatively few financial institutions willing to act as lead arranger for stocktransfer loan facilities. The bond markets have not been widely used. Loan facilities are generally competitively priced. The low returns to lenders to the transfer market, whilst favourable to the LSVTprogramme may render it vulnerable to withdrawal by key lenders. The implementation of Basel II may lead to greater differentiation in lending termsoffered to LSVT RSLs, with the possibility of higher rates for more risky transfers.However, the impact of Basel II is uncertain and its full implications are not yet known. BACKGROUND 3.1 Since stock transfers began in 1988, around £9.5bn of private finance has been raised, ofwhich around £422.7m (4.5%), has been from the capital markets. A number of stock transferRSLs including Beacon HA, Suffolk Heritage HA and Broomleigh HA have raised fundingfrom the capital markets through a partial refinancing exercise. 3.2 The total funding requirement for the 2000/01 transfer programme was the largest ever at£1.8bn. The majority of the funding (around £1.6bn), was provided by banks and buildingsocieties. One transaction, the transfer of 36,356 properties to Sunderland Housing Group,was funded in part (£240m) through the capital markets. No transfer has been unable toraise its required funding. 3.3 This reflects the trend of previous years LSVT funding, in which all transfers have beenfinanced with the majority of funding being provided by a relatively small number of banksand building societies. TRANSACTION PROFILE 3.4 Headline margins were low as a result of competitive pressures for strong and large transactions,where margins begin in the early years of the loan at extremely low levels, for exampleinitially 0.1% points above base rates (typically LIBOR) rising to say 0.45%-0.50% in thelater years of the loan. However, arrangement fees at around 1%-1.25% of the total loanvalues, derivative costs and associated banking services, boosted overall returns to lendersbut not, in Ernst & Youngs opinion, to an excessive level. As in previous years, the vastmajority of transfers for the 2000/01 programme, were completed in the final two monthsof the financial year. 3.5 In two transactions, a single underwriting bank/building society was pre-selected withoutopen competition, but the subsequent syndication of the loan facility was tendered. In generalthis practice was highly unpopular with other funders and some declined to participate inthe subsequent syndication process. Any failure to involve all active lenders in the fundraising process is likely to result in inefficient funding terms and conditions. 3.6 In a further two transactions, only two potential lenders were approached to bid for the fundingmandate. Presumably the funding adviser concerned judged that the potential funders identifiedwere most suited to providing their clients funding requirement on competitive terms. 3.7 A total of 5 (Blackburn, Coventry, Calderdale, Manchester Handforth and Sunderland) ofthe 17 LSVTs funded during 2000/01 could be said to be urban stock. In only one case wasfunding not initially forthcoming (Blackburn) although this ultimately secured funding. Thispractice of accepting a lender of last resort has, since the inception of stock transfers in 1988,ensured that all transfers, including weaker borrowers, have been funded. From the publicsector perspective, this is undoubtedly a strength of the funding market for stock transfers. LENDER PROFILE 3.8 There are currently five high street banks, two building societies, one non-UK bank andtwo or three capital markets underwriters actively pursuing opportunities to lead transactionswith relatively few smaller banks and building societies willing to participate in syndications. 3.9 The merger or take-over of active and inactive bank lenders may have significant implicationsfor the funding market. If the lending or returns criteria of the inactive lender prevail, thenthe lending market may lose an active lender. This may have significant implications for theLSVT funding market. 3.10 A formerly large active lender to LSVTs supplied very little funding to the 2000/01 LSVTprogramme. If this were a portent of a major lender reducing its lending appetite, this wouldalso have a significant and detrimental effect on the LSVT funding market. 3.11 However, should these large funders reduce their appetite, and lending margins increased inresponse, perhaps other relatively inactive lenders (for example Lloyds TSB and HSBC) wouldbecome more aggressive in their appetite for new loans. At the moment these relatively inactivelenders think that the risk:reward equation arising from stock transfers is insufficiently attractive. 3.12 As far as Ernst & Young could determine, no lender had parcelled loans to LSVT RSLs andsecuritised them in the capital markets. This may be because lenders value their relationshipwith their borrowers and being a relatively close sector, securitisation of loans may be perceivedas withdrawing from the sector or reducing commitment. Alternatively, it may be becausethe lenders value assets on their balance sheet and their capital has not been sufficientlyscarce or expensive to necessitate freeing-up capital by using securitisation structures. 3.13 If a funder securitised part or all of its loans to LSVT borrowers, it would be unlikely tomake a significant difference to the future pricing of loans to new LSVT borrowers. Thisis because the lender would be likely to be freeing the capital for use in providing loans tomore profitable sectors, for example Private Finance Initiative (PFI) transactions. However,if the implementation of Basel II (see paras 3.19 to 3.38 below) results in lenders beingrequired to assign more capital to loans to LSVT borrowers, there may be more incentiveto lenders to investigate securitisation structures. STUDY QUESTIONNAIRE TO LENDERS 3.14 All responses to the questionnaire thought returns from lending to LSVT borrowers werevery low. However, all lenders wanted an open competition for the funding mandate. 3.15 The questionnaire to banks and building societies asked how the lender calculated thereturn received from a loan to an LSVT borrower, and whilst a couple declined to respondgiven the commercially sensitive nature of the question, it was interesting to note the widevariety of methodologies employed and the varying degrees of sophistication. Particularlyinteresting were the responses from large banks that are not currently active in lending toLSVT RSLs. A discussion of how lenders might assess the returns arising from loans toLSVT RSLs is contained in Appendix V. 3.16 The role of the Housing Corporation in regulating RSLs and ODPMs methodology used todetermine the purchase price had a tendency to result in a relatively low risk and comparativelyhomogenous sector. Given this low risk perception, loans to LSVT RSLs should be attractiveto a wider population of potential lenders. 3.17 However, lending to LSVT RSLs has to compete with other parts of a banks lendingoperations for the banks capital. Riskier, but higher priced, lending opportunities may bepreferred to low risk: low return loans to LSVT RSLs. Unsophisticated return calculationsthat do not reflect the risk associated with the lending opportunity, would be expected tomake low risk loans to LSVT RSLs seem relatively unattractive. 3.18 Funders responses to the questionnaire are summarised at Appendix VI. THE NEW BASEL ACCORD BASEL II 3.19 The first Basel Accord, launched in 1988, was aimed at strengthening international bankscapital reserves. However, this accord proved not to be sufficiently risk sensitive and flexibleand over time it became necessary to update the agreement in order to achieve its initial goals. 3.20 The New Basel Accord or Basel II was released in 2001 for consultation. This seeks toaddress the issues arising from Basel I by introducing a more risk sensitive framework andthis may lead to more variations in lending pricing from lenders to RSLs. The Accordcomprises three pillars: Minimum capital requirements. Supervisory review. Disclosure and market discipline. 3.21 These pillars link internal risk management and economic capital adequacy with regulatorycapital. The overall intentions of the Accord are that: banks capital levels should be commensurate with risk; risk levels are to be estimated on a conservative basis; and where better data and risk management processes are in place, less capital will be required. 3.22 The timetable for Basel IIs implementation has not been confirmed, but currently it is notexpected to be introduced until early 2007. CAPITAL CALCULATIONS FOR CORPORATE EXPOSURES 3.23 Required capital levels to be maintained by banks are calculated by assigning risk weights todifferent categories of exposure. Two approaches to assigning risk weights are proposed byBasel II. Under the simplest, (the standardised approach, which is similar to existing arrangements)these risk weights are set according to the type of asset and rating. The second approach isthe Internal Ratings Based (IRB) approach, which has two formats either foundation oradvanced. The Financial Services Authority (FSA) will determine whether a lenders internalsystem is of sufficient quality for it to use the advanced system. 3.24 It is expected that given the size of the banks involved in the RSL sector, that either mostwill start using the advanced methodology immediately, or would be permitted to do soshortly thereafter. Some of the smaller lenders, mainly building societies, expect to be on thestandardised approach, although they may move if this produces disadvantageous resultscompared to IRB. 3.25 Under the current methodology arising from the 1988 Accord, an exposure to an RSL isassigned with a 50% weighting. In contrast, most corporate exposures are 100%. The combinedrisk adjusted exposure forms the base against which minimum capital reserve levels arecalculated. The 50% weighting for RSLs is due to the sectors track record of no defaultsto date, its legal status as a non-profit distributing sector supported generally with collateralsecurity and the regulatory framework of a Government agency, the Housing Corporation. 3.26 For the IRB approach, three variables have to be considered in establishing the appropriaterisk weighting: Possibility of Default (PD), Loss Given the Default (LGD) and Maturity(M), these combine to map a schedule of regulatory capital risk weightings. These are then multiplied by the Exposure at Default (EAD) to give the capital requirement. This is thenadjusted for granularity single borrower risk concentrations. 3.27 The quality of the lenders internal credit rating systems will be gauged by the FSA, with thelender either permitted to calculate exposure under the foundation or advanced approach. 3.28 Unlike the standardised approach, where an exposure is assigned one of six risk weightings,of which an RSL is 50%, the proposed IRB approach has a continuous function to providecorresponding risk weightings thereby giving a finer differentiation. The advanced approachallows the lender to provide their own estimates of PD, LGD, M and EAD. This may leadto a less generic sector-wide credit rating, and therefore lower risk weighting. 3.29 Under the foundation approach, the PD is calculated for each group of borrowers. TheBasel Committee recommends that a lender generates an average PD for each categoryover a one year time horizon. In the case of RSLs, who have little or no default history, thisshould mean a low PD. This will need to be benchmarked to publicly available ratings andindustry pool data. 3.30 The LGD is the estimate of each exposures average loss per unit (£) of exposure. Given thealmost impeccable credit record of the RSL sector, most lenders do not have this data in arobust format. Therefore Basel II prescribes a standards based approach at the foundationlevel, which starts with a LGD for Corporate senior debt of 50% and subordinated debt of75%. Some allowance will be given for residential mortgage collateral, but the degree ofpossible mitigation is comparatively low. 3.31 With the advanced approach, the lender is permitted to provide its own internal estimatesfor each category of LGD. This is beneficial as it takes account of lender specific factorssuch as the lenders loss experience and transaction and borrower characteristics. This willalso include a wider recognition of collateral than is available for the foundation approach. 3.32 EAD is calculated as the estimation of the extent to which a bank may be exposed to acounter-party in the event of and at the time of any default. This will also be calculated undera standards-based approach at the foundation level. The total sum is currently expected toequal 100% of the drawn amount plus 75% of any un-drawn amount. The advanced approachwill permit lenders to make their own estimates of EAD. 3.33 Maturity is given as a standard figure for the foundation approach, and will therefore haveno affect on the risk weightings. Under the advanced approach, it is expected that lenderswill explicitly use the effective maturity, which emphasises the contractual maturity. IMPLICATIONS FOR STOCK TRANSFERS 3.34 Most lending institutions have a corporate scorecard system for assessing the risk arisingfrom a stock transfer borrower, which is used generically throughout the business. In orderto convince the FSA that the quality of their internal ratings systems is good enough to usethe advanced approach, the lender must prove that their risk assessments have been suitablyadjusted for the sector specialisation. Given that most lenders have around 13 experiencesof lending to stock transfer RSLs this should not be difficult. 3.35 As highlighted above, the majority of lenders will be large enough to move rapidly towardsan advanced IRB approach. Large lenders, who generally hold significant and diverse portfolios,will be incentivised to develop systems compatible with the advanced approach, as theiroverall capital requirements will be significantly reduced through its use. Basel II requiresthat once a bank uses the IRB approach for one part of its total loan book, it must take stepsto implement the IRB approach across all significant portfolios and business lines. For thesereasons, subject to being able to meet the requisite standards, an IRB approach is likely to beused for all RSLs lenders. Although the IRB approach will initially be the foundation, in thelong run most lenders will move to advanced, and it is therefore expected that RSL exposureswill fall below the current capital weighting of 50% to somewhere between 20% and 40%. 3.36 The whole approach will mean that lenders under Basel II are expected to be more sensitiveto the quality of lending. This is likely to trigger a strategic re-appraisal of sector exposureand may lead to higher variations in pricing. 3.37 The current approach to risk weighting does not discriminate between assets of a differentquality. The proposed IRB approach has a greater focus on asset rating with different weightingsbeing assigned to assets of different quality. This may influence lenders to migrate awayfrom riskier transactions, or to increase pricing so substantially that transactions becomeunattractive to both lender and borrower. 3.38 Ernst & Young is grateful to the FSA and Abbey National Treasury Services in their supportfor drafting parts of this section of the report. Chapter 4 - Value for money issues Summary Shire transfers Key value for money issues relate to the sale price received by the local authorityand the local authoritys inability to benefit from any gain arising from any subsequentrefinancing. In Ernst & Youngs opinion the cost of funds to the RSL generallyrepresents good value for money. Poorer urban transfers Transactions to date represent good value for money, but are still in their infancy. Questions remain about the sustainability of the market, given that some of theEstate Renewal Challenge Funding transactions are still using the initial dowry theyreceived on transfer to finance investment expenditure. Higher risks relating to management, demand, regeneration and procurement costscoupled with the implementation of Basel II, may in the future lead to higher priced loans. Large metropolitan transfers Loan facilities raised to date to finance these transfers, which thus far have beencomparatively few in number, have in Ernst & Youngs opinion, represented goodvalue for money. The scale of transfers of large metropolitan housing stocks should provide theopportunity for greater innovation in funding sources and techniques. The level of risk required to be taken by the RSL should be commensurate with itsability to absorb it. INTRODUCTION 4.1 The purpose of this chapter is to consider the current funding market for stock transfersand the extent to which it represents value for money. Different types of stock transfer willbe considered including: a) transfers of stock in comparatively good condition with demonstrable demand, generallylocated in shire district areas, but also in some suburban and urban areas; b) stock requiring substantial investment, involving issues of uncertain long-term demandand social exclusion often in poorer urban areas; and c) transfers of most or all of the stock of a large metropolitan local authority, demonstratinga variety of issues including a large initial investment requirement and through thelarge number of properties involved, a large private finance requirement. 4.2 Our assessment of whether the current funding market for these different types of transfersrepresents value for money for landlords is based on the following factors: a) whether our assessment of the return on capital to the lender arising from the loan isreasonable given the level of risk involved in providing the loan; b) the implications for the purchase price received by the public sector for the stock arisingfrom the terms and conditions attaching to the loan facility to finance the purchase; and c) whether the nature of the split of the return to the lender between arrangement feesand the profile of interest margin over the life of the loan, represents VFM for therecipient landlord and the vendor local authority. SHIRE DISTRICT TRANSFERS 4.3 Funding for shire district stock transfers has become a standardised product for those whichinvolve good quality stock, in locations generally without social exclusion issues, withrelatively high vacant possession values, a solid business plan embodying reasonable levelsof commercial flexibility and continuing high demand. 4.4 The availability of funding for better quality shire transfers on competitive terms and conditionshas become assured, with considerable competition between potential lenders. Whilst thearrangement fee, payable to the lender on the day of transfer, has remained relatively constantat 1%-1.25% of the loan, interest rate margins have fallen to historically low levels. Interestmargins above base rates begin at or around 10 basis points and rise to around 45 to 50 basispoints from years 7 or 10 onwards. 4.5 E&Y understands that some extremely strong transfers even attract negative interestmargins, but this is generally for loan tranches, which are not used to finance the initialacquisition price. These tranches are often used to finance the major repairs programme.For strong transfers where the need for initial investment in the stock may be limited, theymay or may not be drawn down by the recipient RSL in future years. 4.6 These arrangement fees and interest margins (commitment fees are rarely paid as competitionbetween potential lenders resulted in their removal several years ago) on any measures ofreturn on capital (even with the 50% capital weighting for loans to RSLs) are likely toproduce comparatively low returns to lenders, perhaps in the range 7% to 9%. Indeed, inErnst & Youngs opinion, these loans are unlikely to be making a significant contributionto the lenders shareholder value, given our estimate of a typical lenders cost of capital (seeAppendix V). It may be that lenders returns from derivatives and other services provided toRSLs, for example refinancing, increase lenders expected returns. Other criteria may also beused to determine whether or not to lend. For example, the relatively high arrangement feespaid on day 1 of the transaction may make the proposition attractive if a lender monitorsfee earnings as a performance target. 4.7 Ernst & Young has therefore concluded that VFM questions in these transfers relateprimarily to the price received by the local authority for the sale of its housing stock ratherthan the cost of RSL borrowing. 4.8 The main issues arising in relation to VFM for shire transfers are discussed below. STOCK PRICING 4.9 The system of a single up-front purchase price at transfer may not give the best possible pricefor the stock given the uncertainties surrounding the cost of the repairs and improvementprogramme and the possibility of excessively cautious business plans. ODPMs methodologyof determining the Tenanted Market Value (TMV) for the stock using a 6%-8% real discountrate over a 30 year period, may not generate the maximum price for the stock in everyinstance. There may be a balance however between maximising receipt to the public sectorand establishing a viable business plan for the new RSL with an appropriate level of debt. 4.10 In particular, the involvement of existing RSLs, with experience of private finance mayguarantee a higher price for a given portfolio of properties than a non-competitive disposalprocess to a newly formed RSL. REFINANCING 4.11 The majority of financially strong shire LSVT borrowers refinance their loan facilities withinthe first 2-3 years following transfer. This is because their business plan has stabilised, theyhave more information on the business they have acquired and they have identified efficiencycost savings or generated treasury management savings. The issue is whether the publicsector should participate in the refinancing benefits, and whether any future refinancinggains can be captured at the time of transfer in the transfer contract. FULL v PARTIAL FUNDING 4.12 Some financially strong shire transfers could consider partial funding on the day of transfer.However, this approach to funding would be contrary to the Housing Corporations currentprudent funding requirements. Knowing that they are likely to outperform their initialbusiness plan, the recipient RSL of a strong shire transfer may be able to take a view ontheir funding structure, recognizing that they would refinance and restructure the transactionwithin a relatively short period after transfer. 4.13 Since the beginning of the stock transfer programme in 1988, the terms of loans to stocktransfer RSLs have become more and more competitive, hence the appetite of LSVT RSLborrowers to refinance their loan facilities. This advantageous position of improving loanterms and conditions is not guaranteed to continue indefinitely and any LSVT RSL onlypartially funding their business plan would run the risks of refinancing or raising furtherfacilities on worse terms and conditions. 4.14 The subject of full versus partial funding for different types of transfers (strong shire district,poorer urban and large metropolitan) is considered in more detail in Chapter 7. PRICING OF POLITICAL RISK 4.15 There is a strong perception amongst lenders that the risks involved for lenders and thereforethe rewards sought from new lending propositions are being heightened by post-transfergovernment interventions in RSL rent and tax policies. FEE APPORTIONMENT 4.16 The loading of the return to the lender on to arrangement fees, which are picked up by thetransferring authority, encourages competition on margin but masks the underlying returnsto lenders which may be higher than justified by the risk profile. TIMETABLE AND PROCEDURES 4.17 The timetable and procedures for transfer do not always enable the RSL to act as a properlyprepared and expert client in arranging its initial funding. This is considered in more detailin Section 8 below. POORER URBAN STOCK TRANSFERS Background 4.18 Poorer housing stock can be located anywhere; it does not have to be in urban areas. Suchstock is generally characterized by the need for significant investment, it may be systembuilt, perhaps multi-storey flats and is often unpopular with tenants. Stock located in urbanareas may exhibit some or all of the features of poorer stock, but alternative use values mayvary considerably. Social housing in Oldham may have a low alternative use value; in contrastsocial housing in Hackney may be in a similar poor condition but being close to the City ofLondon, may have a very high alternative use value. Although alternative use values arenot reflected in the TMV, they would be taken into consideration by potential lenders. 4.19 For transfers with poorer quality urban stock, the business plan of the recipient landlord mayinvolve significant risk, including low demand levels, high investment needs and evidenceof social exclusion, the loan facilities struck to date have in Ernst & Youngs view representedgood VFM to the vendor local authority and recipient RSL, when the risk:reward balanceis considered. 4.20 Loans to these LSVT borrowers generally attract a higher arrangement fee of say 1.35%-1.5%,interest margins starting at say 30 basis points to 45 basis points and rising relatively quicklyto around 65 basis points. Occasionally the borrower has only received one funding proposalwith higher arrangement fees and interest margins. 4.21 These transactions have clearly benefited from the reputation of the RSL sector as a wholebeing considered generally as low risk and well regulated. Without these two key strengths,poorer urban stock transfers may have been unfundable. There are VFM questions goingforward relating to the sustainability of this position, as outlined in the following paragraphs. Sustainability of the Market 4.22 There are increasing concerns about how to sustain the level of lender demand for thesetransfers in the light of their perceived higher risk: low reward nature. Strategies to makethese transactions more attractive to potential funders are considered in Chapter 6. 4.23 The wider issue is to ensure that for poorer urban stock transfers the level of risk assumedby the recipient LSVT RSL in relation to such areas as long term demand, social unrest andconstruction and repair contract pricing, is commensurate with its ability to absorb such risk. 4.24 The impact of Basel II is difficult to assess at this stage, but it could have a significantimpact on the pricing for poorer urban stock transfers, which are seen as less credit worthyand would achieve poor internal credit ratings. The possible implications of Basel II arecovered in the later paragraphs of Chapter 3. Pricing for Continued Investment 4.25 Obviously funding of poorer urban stock transfers has to be judged in the long-term. Urbanstock may require substantial further investment even after the implementation of the largeinitial investment programme, (particularly if they include multi-storey flats that may beapproaching the end of their useful life), and the ability of the RSLs business plan toaccommodate that expenditure will be highly important. LARGE METROPOLITAN TRANSFERS Background 4.26 The funding process for these transfers to date has not generally been qualitatively differentfrom that of the shire transfers despite their radically different size and complexity. (The maintransfers completed to date within this category are Tameside (£213m), Coventry (£240m),Calderdale (£111.5m), and Sunderland (£415m)). 4.27 The selection of a lead arranger pre-ballot for the potential transfer of Birminghams CityCouncils housing stock to Birmingham Housing Alliance, was a departure, however thenegative ballot result has meant that the VFM from this approach will not be tested. Analternative approach was taken by Glasgow City Council and following the successful tenantballot it is currently working towards a whole stock transfer to Glasgow Housing Association.It is expected that a lead arranger will be selected in May/June 2002. The VFM of adoptingthis approach will be interesting to observe. 4.28 The size of the funding requirements of these transactions (as indicated above) has made themattractive to potential funders. Arrangement fees are constant at around 1.25%-1.35% withinterest margins beginning at say 40 basis points and climbing to around 60-65 basis points.Because of the size of the borrowers total funding requirement, commitment fees may bepayable, broadly at half the level of the interest margin. This pricing leads Ernst & Youngto the conclusion below given: the size of the funding required; the risks inherent in the transactions; the fact that these are long-term loans; and the borrower has no reserves. These loans represent good VFM for the vendor local authority and recipient RSL. 4.29 These transfers are likely in the future to experience a number of challenges associated withlarge metropolitan communities and the long-term VFM of their funding facilities will needto be kept under review. 4.30 Whilst it may be appropriate to treat smaller shire transfers as a commodity financingoperation, the scale of these transfers and those proposed for Glasgow and Sheffield, shouldprovide an opportunity for: further innovation in funding structures; an exploration of a wider range of funding projects; and funding sourced from a wider variety of funders and markets. 4.31 Both poorer urban and large metropolitan housing stocks generally require the involvementof other agencies to facilitate a joined-up approach to neighbourhood renewal. Investmentin education, health, law and order and other community facilities are generally required toensure long-term sustainable regeneration. The whole area of holistic regeneration is consideredin Part 2 of this report. WHAT FUNDERS LOOK FOR IN LARGE METROPOLITAN LSVTs 4.32 Whilst funders are relatively pragmatic in their credit assessment of shire transfers, they are veryrigorous in their assessment of large metropolitan LSVTs. In particular, they consider whether: all sources of income are deliverable and any grant income or public subsidy iscontractually committed; the purchase price being paid by the recipient RSL is a fair reflection of the conditionof the properties being acquired and their future repairing requirements as well as thesocial and economic well-being of the area; the LSVTs business plan will deliver a demonstrably better service to tenants andsecure regeneration of the area; the LSVTs business plan is viable both in the short and long term; the plan includes robust and prudent assumptions for all key variables, substantiated byindependent research wherever possible, involving a margin of comfort to meet unexpectedcost increases and income reductions; the business plan is fully understood by the Board of the recipient landlord and isdeliverable by the property, staffing and financial resources available to the them; the level of risk assumed by the LSVT RSL is commensurate with its ability to absorbsuch risk; the proposed transfer has widespread political and stakeholder support; the LSVT RSLs business plan cashflows generate a reasonable level of reserves as soonas possible; and the LSVT RSL has undertaken a full risk assessment and has a risk management strategy. 4.33 Given that stock transfers emanating from poorer urban and large metropolitan authoritiesare expected to constitute a larger proportion of ODPMs stock transfer programme, thefundability of these transfers will be considered in more detail later in this report. 4.34 Our estimates of the elements of financing costs of shire, poorer quality urban and largemetropolitan transfers are set out in Section 9. These are indicative only actual terms forany transaction may differ. Chapter 5 - Barriers to achieving improved value for money and a sustainable programme Summary Recipient RSL boards and senior executives are occasionally not sufficientlyestablished to act as a well-informed and experienced client during the fundingraising process. There is a danger that advisers drive such transactions. The track record of all transfers securing funding, the process and comparativelyshort timetable has produced a commodity approach to funding, which may notproduce optimal structures in all cases. All transfers are funded on an individual basis thus losing any potential cost benefitsof aggregated funding. The purchase price/discount rate formulae is mechanical and does not necessarilytake into account all factors and risks. Under the current clean break system, local authorities can neither benefit frompost-transfer out-performance by the recipient landlord nor support weaker RSLsin mitigating early-year risks. 5.1 The responses to the questionnaire, meetings and telephone conversations as summarisedin Appendix IV, clustered into several key themes which begin to address the VFM questionsoutlined in Chapter 4. We describe these themes in this section and then look at a numberof possible options for addressing six key issues in Part 2 of the report. THE LSVT RSL AS BORROWER 5.2 There was broad agreement that the current system is unsatisfactory in that: The RSL has very limited time after the tenants ballot to achieve registration, appointkey personnel, train board members and prepare for the complex handover of propertymanagement. External advisors are often effectively taking key decisions in the absence of anintelligent client. Given the standard nature of LSVTs, and the comparatively low fee levels of fundingadvisers, the incentive for borrowers to innovate new structures and source new funders,is severely restricted. The standard of information distributed by funding advisers is very variable and insome instances inadequate for potential lenders to undertake a full credit assessment ofthe proposal. The implications of this are likely to become more significant when BaselII is implemented and lenders have to undertake a rigorous credit assessment of thepotential borrowing opportunity. Business plans are typically drawn up by advisors, who have no on-going responsibilityfor their delivery. The Finance Director is generally appointed only shortly before transfer and occasionallyeven afterwards. (Indeed, in the proposed Birmingham City Council transfer to BirminghamHousing Alliance the lead arranger was being selected, prior to the unsuccessful ballot,with no Chief Executive or Director of Finance having been appointed.) Boards may be appointed with very little capital financing and treasury management experience. The focus of attention is understandably on the delivery of the transfer and repair/improvementprogramme with the arrangement of a funding facility providing a vital but relativelyunwelcome distraction. 5.3 For shire transfers, which can be fairly homogenous in credit terms, these barriers have hadrelatively limited impact on pricing levels, although they present a perception of a start-uprisk, which is arguably unnecessary. 5.4 However, for poorer urban and large metropolitan transfers they may be serious barriers towell thought out, sustainable business planning as a platform for appropriately structuredfinance achieved on a fully competitive basis. Such deficiencies could lead to a greaterrequirement for post-transfer reappraisal of both the business plan and the funding structurewhich in turn necessitates a more flexible, and therefore possibly costlier, initial fundingstructure than should be necessary. 5.5 Given that recipient landlords for poorer urban and large metropolitan stock transfers facemuch greater risks in implementing their business plan it is crucially important that theserisks are fully investigated and quantified before transfer. Such rigorous assessment wouldenable the recipient landlord to be as comfortable as possible that the purchase price it waspaying, or the dowry it was receiving, and its business plan on the day of transfer was a fairreflection of the risks it was about to assume. 5.6 It may be that in order to undertake the transfer of poorer urban or large metropolitan stock,the recipient landlord is tempted to absorb more risk than is reasonable given its level ofreserves, or to pay a price that is not a fair reflection of the stock being acquired and all theother issues detailed in paragraph 4.32 above. 5.7 Our view is that this is highly inappropriate and could cause the recipient landlordproblems in implementing its business plan post transfer. Indeed, if the recipient landlordpays a purchase price which equates to the breakage costs on the local authoritys HousingRevenue Account loans there is evidence that this is very unlikely to be closely related tothe fair value for the stock particularly in poorer urban and large metropolitan areas. Anygap between purchase price and fair value is likely to be revealed when the selected leadarranger undertakes its detailed due diligence of the transaction. 5.8 Taken to the extreme, if this practise is implemented to any degree, the recipient landlordmay be forced to effectively change its status from a manager of social housing to a residentialproperty manager with a significant development exposure as it tries to realise land valuesand live with an investment programme which is substantially lower than the stock investmentrequirements as identified in the stock condition survey. This would have significantimplications for tenants, funders and the Housing Corporation 5.9 Part 2 of this report will look at the key risks absorbed by recipient landlords in poorerurban and larger metropolitan stock transfers, and strategies to mitigate these risks. COMMODITY OR BESPOKE FUNDING Commodity Status 5.10 The transfer programme particularly for shire transfers has developed many of the characteristicsof commodity funding. Indeed, this characteristic coupled with a small number of assethungry lenders, produces very low priced loans. This serves as a disincentive to potentialmarket entrants, particularly as the funding of LSVTs is a mature market. 5.11 In contrast the interest margins payable by PFI transactions are currently substantiallyhigher, but the arrangement fees are slightly lower than LSVT loans. It could be arguedthat with relatively certain income flow on long-term contracts, senior debt facilities to PFIprivate sector contractors should be lower risk than loans to LSVT RSLs. 5.12 The commodity status of loans to LSVT RSLs is characterised by: Standardised business plans; this is perhaps understandable given that the recipientlandlords initial business plan is often little more than the Tenanted Market Value (TMV)model repriced for inflation with a few other adjustments. This produces a very standarddebt profile, which lends itself to a tried and tested funding structure. A developing track record of performance of past transfers building up a substantialinformation base within funders that probably exceeds the knowledge of most advisersand vastly exceeds the understanding of new LSVT boards and some newly appointedDirectors of Finance. Standardised loan tender documentation. Short timescales for funding responses and from amending the funding mandate toclose. This arises because of the presumption that all but the most risky transfers willsecure funding and the involvement of funding advisers at a relatively late stage. Small number of advisors and funders working on very small profit margins; hence theLSVT market has become unattractive and virtually closed to new entrants. If the poolof funders could be expanded, it may introduce greater innovation and different fundingstructures. Whilst such innovation is unlikely to improve the VFM of funding for shiretransfers (because loan terms and conditions are already extremely fine), it may havea significant impact on the VFM of funding for poorer urban and larger metropolitanstock transfers. The potential for innovation and the forms it may take, are consideredin more detail in Part 2 of the report. Relatively unsophisticated treasury management strategies concentrating on certaintyduring the rent guarantee and catch-up repair periods, and predicated on the potentialof a fairly rapid refinancing with its potential for additional fee income. However theappetite to undertake a refinancing has only existed whilst interest margins have beenreducing and loan covenant requirements have been loosening. Any reversal of thistrend would probably see the number of refinancings decline. Bond Structures 5.13 Bond structures have been used in four stock transfers, raising a total of around £422.7m,developed by the bond underwriting houses, but the primary funding model has beenrelatively straightforward bank and/or building society lending. 5.14 This commodity financing treatment has delivered the ODPM stock transfer programme,but may not deliver optimal funding in the future particularly for the larger metropolitantransfers where a variety of risk profiles may require a range of layered funding structuresand sources. 5.15 Capital market segments, which have not been tapped to date, include: non-UK public bondmarkets; private bond placement markets in both the UK and US; and equity markets. Inaddition the sub-ordinated debt market has not been accessed and this may have a role inhigher risk urban and large metropolitan stock transfers. The Possibility of Aggregating Funding Requirements 5.16 Bond markets specialists in particular raised the question as to the relative efficiency of fundingeach transfer on an individual basis or embarking on some form of centralised procurementprogramme at least for the core acquisition funding of a number of stock transfers. 5.17 Public bond markets prefer issues to have an active secondary market and, in effect, thismeans trying to achieve bond sizes of £150m-£200m at the outset with, preferably, thepossibility of later growth. 5.18 The size of each transfers funding requirement is often a barrier to efficient bond financingbut the overall annual programme of around £2 billion if funded at least partially by bonds,could create a series of liquid benchmark issues. 5.19 The possibility of creating a specific intermediary to facilitate the aggregation of fundingrequirements of different stock transfers and subsequently issuing securities in the capitalmarkets is considered in Chapter 10 of this report. THE ROLE OF THE LOCAL AUTHORITY IN THE STOCKTRANSFER PROCESS AND THE PURCHASE PRICE 5.20 Borrowers and lenders both acknowledged that the system of establishing the transfer priceof the stock does not always result in the best deal either for the local authority or therecipient RSL. Purchase Price 5.21 The methodology used to determine the purchase price, including rents based on theGovernments social rent reform programme and in most cases a large initial catch-up repairsprogramme, results in an escalating debt profile which, it is argued, is often not readily appropriatefor anything other than a fully funded loan facility. The purchase price is determined usingODPMs TMV model. This discounts the projected real cashflows arising from the stockbeing purchased for the next 30 years using a discount rate of between 6% and 8%. 5.22 The purchase price paid for the local authoritys housing stock needs to reflect the physical,demographic and financial attributes of the stock and the environment of the surroundingarea. It should not be determined (particularly for poorer urban or large metropolitan housingstock), by factors which do not relate to the stock, for example the breakage costs arisingon the vendor local authority housing loans. 5.23 The risk assumed by the LSVT RSL in acquiring the stock needs to be commensurate withits ability to absorb such risk. Any attempt by the vendor local authority to secure a saleprice which does not recognize these criteria, is likely to result in the LSVT RSL receivingvery few offers of funding and the possibility that the recipient landlord experiences difficultiesin implementing its business plan post transfer. Indeed in some stock transfers in urban areas,the purchase price produced will be negative, as experienced in ODPMs ERCF programme. 5.24 The TMV methodology should reflect the potential for negative values, particularly forpoorer stock transfers. Other short-term solutions to supporting what should be negativelyvalued stock, for example structures to mitigate the VAT impact of major repair andimprovement programmes, fail to address the fundamental weaknesses of the stock beingtransferred. Indeed, transfers of negatively valued stock can represent good value to thepublic sector when the full extent of risk transfer is considered. 5.25 Funders generally have developed their lending policies for LSVT RSLs from their mortgageand commercial lending criteria. In these types of loans, a loan to value covenant is important.Generally the loan has to be covered by the property portfolio acting as security to 110-115%.If the purchase price is too high and the valuation for loan security cannot provide therequired level of cover, raising funding can be very difficult. 5.26 In addition, if the purchase price is too high, the degree of risk being absorbed by theLSVT RSL may be excessive and it can take a significant number of years of business planout-performance before any reserves are created. 5.27 The discount rate used in the TMV calculation of 6% real to 8% real includes an implicitrisk buffer, which can be seen as a reflection of the risks to the LSVT RSL of acquiring thestock. The size of this buffer is implicitly included in the discount rate and can be ascertainedby comparing the LSVT RSLs Weighted Average Cost of Capital (WACC) to ODPMs discountrate of 6% to 8%. This calculation is carried out in Appendix XII. It shows the buffer to bebetween 3% and 5% in real terms based on conventional loan funding. In Ernst & Youngs view,it may be questionable as to whether the buffer is sufficiently large to absorb political risk. 5.28 Part 2 of this report looks at the risks in poorer urban and large metropolitan stock transfers,the potential for involving established RSLs in the transfer process, and more competitionin the selection of the recipient landlord and its funders. If more open competition wasintroduced, the public sector would have greater confidence that it was achieving optimumVFM for the stock being transferred at the point of transfer. Post Transfer Involvement for the Vendor Local Authority 5.29 In transfers with a stronger credit, the local authority has very little protection against andgains no benefit from: Over-egged repair/improvement programmes. Over-cautious assumptions about interest rates. Refinancing deals by the recipient landlord within the first few years post transfer. 5.30 Once the transfer price is determined, and the transfer completed, the local authority mayhave no continuing stake in the performance of the RSL. To an extent this clean breakapproach may be attractive to ODPM, however both ODPM and HC have considerableinfluence over the recipient RSLs business plan and viability. This potential political risk,without what some see as commensurate political responsibility, is very unpopular with funders. 5.31 Conversely, in poorer quality transfers, the local authority is currently limited in its abilityto assist by mitigating the early year risk to the lenders funding the new RSL. This results inthe recipient landlord having to adopt very prudent assumptions in its business plan whichmay result in a lower purchase price being received by the vendor local authority. PROCEDURAL BARRIERS TO SECURING VALUE FOR MONEYIN FUNDING FOR STOCK TRANSFERS 5.32 A number of specific points were identified by respondents as creating unnecessarycomplications or barriers to funding efficiency. These can arise from ODPM or HousingCorporation procedures and regulations, or from the LSVT RSL. ODPM and Housing Corporation Requirements 5.33 Notwithstanding ODPMs requirement for local authorities to demonstrate that they haveconsidered options for the recipient landlord, there is limited evidence to suggest that thisis vigorously pursued by all local authorities. It is widely expected that an existing RSL withan experienced management team and board, with expertise in raising private finance loanfacilities, would obtain loans on different terms and conditions than start up landlords. 5.34 The Governments rent restructuring programme has heightened the awareness of thereality of political risk. Where lenders have significant exposure to existing LSVT RSLswhose business plans and covenants have been placed under pressure, they are very vocalin their objection to post-facto alteration in the high level alteration of key assumptions intheir borrowers business plan. 5.35 The provision of warranties by the local authorities to both lenders and RSLs is often amatter of contention and re-negotiation for each transfer. LSVT RSL Procedural Issues 5.36 The quality of demand studies is very variable with no dissemination of best practice. 5.37 There appears to be comparatively little attempt to learn from other sectors with regard tothe long-term fixed price procurement of building, repairs and improvement programmes. THE FUNDRAISING PROCESS 5.38 Competition has not always been in evidence at all stages of the funding process; this isunpopular with the funders not involved in such exclusive arrangements. More importantly,it is highly unlikely to deliver good VFM to the recipient landlord. Part 2 Chapter 6 - Poorer urban and large metropolitan stock transfers the risks faced by recipient landlords Summary The purchase price/dowry for the stock being acquired must reflect the level of riskabsorbed by the recipient landlord. The purchase price should not be influenced by the local authoritys need to coverinterest breakage costs on its existing Housing Revenue Account loans. The public sector will need to support RSLs through dowries, transfer of additionalland, subordinated loans or other mechanisms, if risks cannot otherwise be absorbedby the recipient landlord and the transfer is to go ahead. Other key risks faced by recipient landlords are: those associated with leaseholders; procurement and implementation of the investment programme; and management structures. Transfer RSLs should develop a comprehensive risk assessment matrix to identify therisks that they are most exposed to and then develop strategies to manage these risks. 6.1 The ability to raise private finance for a housing stock transfers in a poorer urban or largemetropolitan area is substantially determined by potential funders perception of the degreeof risk being assumed by the recipient landlord (their potential borrower). 6.2 In Part 1 of this report we highlighted how as these types of transfers are likely assume greaterprominence in ODPMs stock transfer programme. But the implementation of Basel II maycause funding for such transfers to become relatively more expensive or the ultimate riskthat these transfers become unattractive to the small population of funders. This chapterlooks at the risk profile of poorer urban and large metropolitan transfers in more detail. 6.3 For poorer urban and large metropolitan transfers, it is highly important that the purchaseprice paid by the recipient landlord to the vender local authority for the stock should reflect: the condition of the stock to be acquired; the social and economic circumstances of the area and its inhabitants; a level of risk commensurate with the potential landlords ability to assume such risk; and a viable business plan which should secure long term sustainable regeneration of the area. 6.4 If the purchase price (or dowry) does not reflect these issues, it is likely that potential funders(who have considerable experience of analysing risk and the implementation of businessplans by their existing LSVT RSL borrowers) may conclude that the potential borrower isassuming too much risk and therefore decline the funding opportunity. In such circumstances,the recipient landlord may be unable to raise the required private finance, thereby substantiallyeroding one of the key strengths of ODPMs transfer programme since its inception in 1988. 6.5 Funders have considerable experience of both funding stock transfers and monitoring theirborrowers financial and operational performance post transfer and are therefore able to takea view on the price that should be paid or dowry received for the stock. If the purchase pricefor stock is determined by the local authoritys Housing Revenue Account loan interestbreakage costs, rather than the factors and issues detailed in paragraph 6.3 above, thetransaction may be unfundable on that basis. 6.6 The local authoritys housing loan interest breakage cost is a reflection of how much hasbeen spent on capital investment in the past, which has no relevance as to the investmentneeds of the stock into the future. Indeed if a stock condition survey has demonstrated theneed for a substantial initial and on-going investment programme, questions may be raisedin both the minds of the recipient landlord and its potential funders as to the sustainabilityof that past expenditure and the implications of this for future investment. 6.7 The level of interest breakage costs are substantially determined by the prevailing level of grossredemption yields on Government gilts and the local authoritys average loans pool rate appliedto Housing Revenue Account loans at the time of transfer. The recipient landlord and its fundershave no influence over these economic variables and therefore they should not drive thedetermination of the purchase price. Neither of these factors have any relevance to the risks beingassumed by the recipient landlord and the purchase price/dowry that should reflect those risks. 6.8 If the major risks detailed in the following sections are not fully addressed in the recipientlandlords business plan and/or purchase price paid to the vendor local authority, then thetransaction may not be fundable on a stand-alone basis. If that was the case, the publicsector may find it necessary to provide some or all of the following to the recipient landlord: a dowry; valuable land at nil cost with limited clawback arrangements; a non-interest bearing (repayable or non repayable) grant or loan; and grants or other financial support. 6.9 The next section of this chapter looks at the whole area of risk in poorer urban and largemetropolitan stock transfers. We initially outline a generic risk matrix, with columns tostate a judgment of the probability of the risk occurring and the potential financial impacton the recipient landlord if the risk occurs. RISKS TO RSLS ACQUIRING POORER URBAN ANDLARGE METROPOLITAN STOCK 6.10 Each RSL considering the acquisition of housing in poorer urban or large metropolitan areaneeds to undertake a detailed risk assessment exercise. This process involves identifying therisks that the RSL would assume in acquiring the stock and subsequently undertaking anassessment to identify the most significant risks. 6.11 A useful starting point is to use a generic risk matrix and through a rigorous process, to supplementthis with additional risks specific to the property portfolio being acquired. A generic risk matrix isa framework to ensure that all risks are identified and quantified. An illustrative example is shownin Appendix VII. This is not designed to be all inclusive, but a template of a generic matrix. 6.12 Following the process of risk identification and quantification, involving a wide range ofprofessional disciplines, it is possible to identify the most significant risks and to developstrategies to mitigate such risk. 6.13 In the case of newly formed RSLs their ability to absorb the possible consequences of therisk occurring may be severely limited. They may have no option but to secure a reductionin the purchase price, seek insurance to cover the risk or to seek a warranty/indemnity fromthe vendor local authority. In contrast, an established existing RSL with reserves may beable to take a view and effectively absorb some or all of the risk(s) from their reserves. 6.14 This section goes on to investigate in detail four key risk areas identified by the projectsSteering Group. Some of the risks identified appear similar or result from the occurrence ofanother risk. Obviously other significant risks exist in poorer urban and large metropolitanstock transfers, for example demand risk, however the Steering Group thought that thesewere being adequately considered in other assignments or projects. Leaseholder Risk 6.15 Appendix VIII includes a detailed description of the risk to LSVT RSLs of leaseholders inimplementing the investment programme in poorer urban and large metropolitan stock transfers.The purpose of Appendix VIII is to outline the risks to transfer organisations in assumingthe obligation for repairing and improving properties, which contain both leaseholders,(otherwise known as owner occupiers) and tenants. 6.16 The implications for recipient RSLs of decanting both tenants and leaseholders, particularlyin blocks of properties earmarked for demolition, are considered. It also examines potentialmitigation strategies that stock transfer RSLs may be able to pursue in order to reduce therisks associated with properties involving leaseholders. The cost of repairing common (shared)elements of the property will in the case of stock transfer, lie with both the recipient RSLand the leaseholders within the block. 6.17 Recipient landlords will face a number of issues in relation to the leasehold arrangements: the leaseholder may only be responsible for certain types of work and may not be responsiblefor payments relating to improvements to the property, or may only be responsible incertain defined, circumstances; the landlord may be required to provide an estimate of future service charges to tenantsconsidering becoming leaseholders under the Right to Buy (RTB). Leaseholders cannotbe charged more than this amount during the first five years after purchase; and leaseholders will generally have the right to consultation, before contracts with contractorsare placed and work commenced. 6.18 These issues will mean that recipient landlords will have to assess how: they will fund the full cost of improvement works; how they will deal with repairs to properties where some leaseholders have boughtwithin the past five years; and how they will manage the programme to ensure their obligations to tenants during theconsultation phase are met. 6.19 In addition, leaseholders may not be able (or wish) to afford to pay their service charge forthis work. This needs to be fully assessed by the recipient landlord before transfer and strategiesidentified to ensure that the implementation of the investment programme is not delayedand the cost of implementation is not increased. 6.20 Transfer landlords will therefore have to consider in detail the risks associated with propertiescontaining leaseholders and mitigate against them through a thorough assessment of costs,legal requirements, available grant and through robust assumptions in the business plan.Additionally, they may seek to share the risk with the vendor local authority and potentiallycentral government, through the effects on the purchase price and through assistance toleaseholders (probably based on need) with grant and other financial support. Investment Procurement Risk 6.21 Appendix IX considers the procurement and implementation risks for the initial investmentprogramme in poorer urban and large metropolitan stock transfers. 6.22 In these types of transfer, the implementation of the large initial investment programme is of criticalimportance. Not only is it very often the primary reason for the transfer, but is central to deliveringsustainable regeneration of the recipient RSLs housing stock. In addition, the RSLs funderswill be keenly interested to see the efficient and effective implementation of its borrowersinvestment programme, thereby achieving its loan to asset value financial covenant requirements. 6.23 The purpose of this section is to discuss the risks associated with the procurement of investmentworks related to the LSVT of large urban and metropolitan authorities housing stock. 6.24 In this context, procurement describes the methods, systems and processes used by an LSVTlandlord to secure the services required to deliver the investment programme contained inits business plan. The investment programme is likely to be the largest area of cost incurredby the landlord and so funders will be concerned to ensure that: the costs are accurate, ie, that they address the sustainable investment requirements ofthe stock and are not significantly under or over-stated; and the landlord can control the programme, ie, that the risk of cost overruns, slippage anddelays is minimised. 6.25 There are three broad categories of risk which are worth exploring: specification risk: the risk that the wrong work is procured or that the correct work isnot procured; sustainability risk: the risk that the work procured does not maintain or increase thevalue of the stock; and delivery risk: the risk that the landlord cannot implement the investment programmeas planned. 6.26 The following table sets out some specific risks under the three broad risk headings, identifies key issues in the context of urban and metropolitan transfers and suggests mitigation approaches. Further discussion is in Appendix IX. Risk category Specific risk Urban/metropolitan Mitigation LSVT issue Specification Landlord fails to: Stock condition Stock condition survey identify all of the works required Management skills & expertise Regularly update plans Set a standard programme the works appropriately draw up accurate specifications Sustainability Investment does not add Demand Test sustainability sufficient value to the assets pre transfer Stock condition Value added is short lived Develop a management Low Value strategy Tenant profile Ascertain what has Social exclusion worked and failed in the vendor LAs experience Management skills & expertise Delivery Tender price inflation Stock condition Local market analysis Cost overruns during Low Value Use appropriate the contract procurement method Management skills & expertise Delays in letting/starting Put in place appropriate the contract control systems Delays in delivering the contract Management Structures Risk 6.27 Appendix X considers the risks arising from management structures in poorer urban andlarge metropolitan stock transfers. 6.28 One of the key risks associated with stock transfer is that the management structure, skillsand experience of the LSVT landlord might not be adequate to deliver the transfer and thebusiness plan efficiently and effectively. 6.29 Our analysis in Appendix X looks at the risks arising from LSVT landlord structures including: group structure versus a standalone organisation; and a subsidiary of an existing RSL. 6.30 Although registration with the Housing Corporation provides a substantial degree ofassurance about management standards, it does not provide complete assurance that anymanagement weaknesses, which existed before transfer will not endure after transfer. 6.31 In addition to the choice of structure, recipient landlords need to assess a number of otherimportant management issues such as the appointment of senior staff and the risks andrewards of expanding the scope of their activities as a means of mitigating some of the risksof transfer. Investment Coordinated With Regeneration: Delivery ofImproved Housing and Regeneration 6.32 As outlined previously in this report, all parties associated with stock transfer proposalswould benefit from the holistic and sustainable regeneration of the area where the transfertakes place. One potential barrier to attracting suitable investors into stock transfer projectshas been the concern that once initial investment has been made, without other action toimprove economic prosperity, and increase opportunities in education, health, transport andemployment, the area may continue to decline, with increasing anti-social behaviour, voidlevels and other symptoms of social exclusion. Investors wishing to see asset value enhancedare particularly concerned with ensuring that an area is regenerated in a holistic way andthat improvements are maintained in the long term. 6.33 The success of public agencies in securing a joined-up approach to sustainable regenerationis important in delivering stock transfers. This area has been subject to significant governmentreview with new policies introduced over recent years, which should, over time, be reflectedin measurable tangible results. 6.34 The link between low demand for housing and stock quality/condition is mainly evident ineconomically disadvantaged areas, where employment opportunities are limited. This meansthat in areas of high employment, demand exists for all forms of housing good and poor.The simplistic observation therefore is that in order to ensure investor confidence in a LSVTin a poorer urban area, a wider employment generating strategy needs to be developed. 6.35 Structures are now emerging to ensure that holistic regeneration and economic growthtakes place. National policy is now being reflected in Regional Development Agenciesobjectives and in turn more localised strategies are being determined for specific areas andcommunities. However this framework is not complete and in certain poorer urban areas,where stock transfers may be proposed, no true economic regeneration plan may yet exist.Over time it is highly possible, however, that this will alter and as such any proposal forstock transfer could, in theory, be in support of a specific community-wide plan to improvethe local economy. 6.36 Further consideration should be given to the area of regeneration and its relationship withstock transfer. It is important that housing investment is not undertaken in isolation and inlater years shown to have been an inappropriate decision. 6.37 Bricks and mortar investment alone may not be sustainable and required economic measuresshould be identified, which will best ensure that any recipient landlord investment will besustainable and will not have to be repeated in the near term (at present ERCF transfershave not been tested in the long-term). 6.38 A related key concern of lenders in the protection of asset value and sustainable investment,is that active housing management is required. Anti-social behaviour has to be managedand eradicated in order protect the condition of the housing stock and prevent the areafalling back into decline. Chapter 7 - Full versus partial funding of stock transfers Summary Current policy supports up-front full funding of business plans. This reflects the perception of LSVT RSLs as start-up businesses with programmessubject to inaccurate costing and external change. For poorer urban and large metropolitan transfers, full funding is a necessary precautionin the light of the substantially greater risks to the fulfilment of the renovationprogramme which partial funding would present. For some strong shire transfers, arguments could be made for partial funding whichwould allow greater flexibility, should reduce costs and might bring additional fundersinto the market. Partial funding may increase tenants perception of risk associated with transferand could therefore affect ballot results Existing RSLs are more likely to be able to absorb the risks of partial funding andbe treated as established businesses for funding purposes. CURRENT POLICY 7.1 To date it has been standard practice, supported by the HC and ODPM, to ensure thateach LSVT RSL enters into loan facilities which on the day of transfer: cover the projected peak debt including any proposed new development activity as wellas the initial catch-up repairs and improvement programme; are capable of full capital repayment from the projected net rental income arising fromthe RSLs property portfolio within the term of the loan facility; have an amortising structure which in theory achieves full repayment leaving the LSVTRSL debt-free at the end of the loan term; and have a reasonable margin of flexibility to meet unforeseen and detrimental movementsin key cashflows. WHAT ARE FUNDERS FUNDING? 7.2 A key consideration in the full versus partial funding debate is what are funders being askedto fund on the day of transfer. A number of issues need to be considered in determining theanswer to this question. A particularly important issue is the type of transfer that is being funded. 7.3 The risk characteristics of strong shire stock transfers are, notwithstanding the harmonisingeffects of the purchase price by ODPM TMV model, fundamentally different from the risksinherent in poorer urban and large metropolitan stock transfers. The specific risk issuesrelating to the full or partial funding of shire, poorer urban and large metropolitan stocktransfers are discussed later in this chapter. A Start-up or Established Business? 7.4 A key issue is whether potential funders consider the LSVT RSL as a start-up or established business. 7.5 LSVT RSLs are generally treated by most leading stock transfer funders as being akin tostand-alone project financings. On the day of transfer, they may be perceived to have afinite life similar, for instance, to PFI projects, which have initial investment costs financedby injections of equity, sub-ordinated debt and senior debt, which are repaid from incomearising during the life of the loan facility. An LSVT RSLs business plan and funding structureare based on the capacity of the net rental income stream arising from its portfolio to fullyrepay loans within a 25 to 30 year term. 7.6 The LSVT RSL is generally treated as a start-up rather than an established business. Thisis, of course, technically correct, although in many instances the management team, and inall cases the financial cashflows arising from the properties being acquired, have a track-recordwhilst in the ownership of the vendor local authority. 7.7 A LSVT RSLs loan facilities on the day of transfer are set at levels which allow for drawdownover an extended period before peak debt is reached. This occurs typically between 12 and15 years and the loan facilities are set to cover the LSVTs maximum projected borrowingrequirement over that extended period. 7.8 It is, however, anticipated by both funders and their funding advisers, that facilities may berestructured several times during the life of the loan, with a major restructuring once peakdebt has been passed. This is generally because: the RSL undertakes new activities not envisaged at the time of transfer; it has to implement changes in government policy affecting key elements of its business; it out performs its original business plan; it needs to restructure its business plan to reflect new information learned after transfer; and at, or shortly after, peak debt, the LSVT is generally seen to be performing as an establishedbusiness, generating surpluses and reserves and in most cases is able to negotiate a moveto traditional RSL corporate-style financial loan covenants based on an on-going mature and developing business and balance sheet. These traditional covenants are generallyfocused on gearing and annual interest coverage ratios rather than the more restrictivefinancial covenants faced by new LSVT RSLs. IS FULL FUNDING INEFFICIENT? 7.9 It could be argued that the system of full funding stock transfers on the day of transfer isinherently inefficient because: Treatment as a start-up business fails to take account of the continuity of business betweenthe vendor local authority and the LSVT RSL. The properties being transferred mayrequire major investment but they generally provide an immediate and relatively certainincome stream, with documented performance in terms of income and expenditure,arrears and voids. The day-to-day management is likely to be carried out by the samesenior management team under TUPE transfer arrangements from the local authority.In addition, the Board of the LSVT RSL consists partially of local authority representativesand residents who are familiar with the management issues of the stock. Most on-going businesses would expect to run with a level of on-going debt to meettheir investment requirements and this form of funding is generally cheaper than equityfinance. In addition, established businesses would expect to access the debt marketswhen rates are favourable and in a timely manner to meet their funding requirements.In this respect the older LSVT RSLs that have passed peak debt and moved to traditionalRSL financial loan covenants, maintain an on-going level of indebtedness that meetstheir continuing development and investment requirements. The requirements for full repayment during the term of the initial loans ignores thenature of the rental income stream which continues to flow beyond the term of theloan, particularly if the properties have been well maintained. There is no concessionperiod as in housing PFI projects, as the LSVT purchases the freehold interest in theproperty assets in perpetuity. Full repayment leaves a high surplus making potential atthe end of the loan term. The assumption that refinancing will take place possibly several times during the lifeof the initial facility can drive the treasury management policy towards short/mediumterm fixed rate loans. Greater emphasis on the long-term business plan and treatmentof the LSVT as an on-going business rather than a project financing would allow moreconsideration to be given within the treasury management policy for the appropriate useof both short term loans and long-term fixed rate products to balance out the risk profileand to take advantage of specific market conditions (for example, an inverted yield curve,when it is cheaper to borrow long-term fixed rate loans rather than short-term loans). 7.10 The requirement for full funding of anticipated expenditure is potentially more costly thannecessary in that: Lenders may endeavour, subject to the effects of competition, to charge commitmentfees on loan facilities that are not drawn down. They may argue that the fact that theloans are not drawn down is the LSVTs choice, generally assisted by out performanceof their business plan. In stronger shire transfers, the ability to charge commitment feeshas been competed away. Even if specific non-utilisation fees are not charged the banksand building societies may endeavour to seek to recoup their associated costs in committingcapital, whether through arrangement fees or margins. A fully funded approach is likely to be more attractive to a relatively small pool oflenders than partially funded structures, which may attract new lenders more familiarwith corporate style funding structures. Clearly this may have implications for thecompetitive pricing of funding offers. Actual peak debt has typically been lower than projected, at the time of transfer this isachieved through out-performance of the business plan and any funder costs associatedwith providing a fully funded loan facility have therefore been wasted. However, to theextent that the lenders return requirements are substantially met by the ArrangementFee on the total size of the loan, these are included in the set-up costs of the LSVTRSL and are deducted from the purchase price and therefore met by the vendor localauthority. If these arrangement fees were paid by the recipient landlord, the extent towhich they would be borne by the public sector or reduce the return to the lender woulddepend on the degree of competition for the landlord role and whether the recipientlandlord is an established RSL or a newly formed organisation. If the recipient landlord is a large RSL in competition with others for the role, it may, aspart of the competitive selection process, agree to absorb the arrangement fees knowingthat with its financial strength, existing relationships with funders and experience ofraising private finance, it will be able to negotiate these to levels they are able to internallyfinance. This approach has been implemented in a number of past transfers involvingestablished RSLs. In contrast, a newly formed RSL with no reserves will have no option but to requirethat the arrangement fees are deducted from the purchase price. Costly re-financing exercises are virtually built in to the system to take account of thechanging circumstances of the LSVT RSL. The original lender may have a strong incentiveto try and tie in the borrower and reduce the borrowers opportunities to negotiate betterterms and alternative sources of funding for later requirements. However, a number ofLSVT RSLs have changed their lead funders on refinancing and new funders have beenbrought in to provide funding particularly when the LSVT RSL moves to traditionalRSL status, generally after peak debt. 7.11 There is a case for funders to consider some LSVT RSLs as on-going businesses that wereeffectively established prior to the transfer and will continue beyond the term of the transferloan facility. Debt will be required at various times for the original purchase of the housingstock, for the catch-up repairs and improvements programme, to meet the payment ofinterest before peak debt or the reconfiguration of estates including new build programmes.These could, and arguably should, be raised at the time required, not many years in advance. 7.12 This argument, however, takes no account of the risks inherent in leaving likely fundingrequirements unfunded on the day of transfer. Many of these risks may also affect fully fundedtransactions in terms of the ability to drawdown loans, but are mitigated by the existence ofan ongoing banking relationship where it would be expected that the bank would be familiarwith the history of the business plan and the management of the RSL and would want (subjectto a rebalance in the risk:reward equation) to help the RSL through short-term difficulties. PARTIAL FUNDING RISKS 7.13 Clearly if a recipient RSL is facing risks in the portfolio of properties it has purchased from a localauthority, the likelihood of these risks occurring is not affected by whether the RSL is fully orpartially funded. However, the materialisation of some risks may give a partially funded RSLsignificant problems in raising additional finance or securing a refinancing when its existingloan facilities are due for repayment. The occurrence of significant risks would make the RSLa much less attractive lending proposition for potential new lenders and the RSL may be forced,with very little bargaining power, to renegotiate its existing loan facility with its current lender. 7.14 This section proceeds to look at the potential environment of both the funding market andthe RSL, when a partially funded LSVT may be seeking to raise additional finance. 7.15 If the LSVT RSL assumes a future funding risk by only partly funding its peak debt requirementon the day of transfer, it may need to raise further funds at a time when: there is a general credit squeeze and bank and building society lending may be difficult to achieveeither at all or at margins that can be accommodated within the LSVT RSLs business plan; the existing funder may have undergone a change in lending policy through merger orreaching sector limits leading the LSVT RSL to rely on attracting funds from new lenders.Such new lending would result in new arrangement fees (which would not be paid bythe vendor local authority), perhaps legal costs in effecting the new lenders securityrequirements, if a security trustee has not been put in place at the time of the initialtransfer funding, and any interest rate breakage costs; and the impact of Basel II may be more apparent and require lenders to revise their riskweighting requirements, particularly for high risk poorer urban and large metropolitanstock transfers, which may result in higher margins and arrangement fees. Management and Performance Risks 7.16 There are a number of risks associated with the management and performance of the RSL: Catch-up repairs programme may have been delayed and/or the costs underestimatedleading to a higher than anticipated funding requirement and lower lender confidencein the managements ability to efficiently and effectively implement its business plan. Underperformance on rent collection and voids turn-around may have adversely affectedcash-flow and, again, lender confidence. The performance of the board and senior management team may not have metexpectations leading to the risk of non-availability of finance or finance at higher costsand with tougher covenants and ratios. There have been a relatively small number ofLSVT RSLs where the Housing Corporation has found it necessary to make appointmentsto the RSLs board. If these LSVT RSLs had been seeking additional funding at any timeafter the identification of deficiencies in the organisational or financial position, theywould have found this a challenging exercise. Indeed there is evidence that the RSLs thathave had HC nominations to their boards, have found it difficult to effect refinancings. External Risks 7.17 The following risks may be particularly important for poorer urban and large metropolitanstock transfers: The local economy may have suffered a severe blow through the closing down of a majorindustry leading to a migration of tenants to other areas so reducing demand from tenantsin paid employment and leading to: increased reliance on housing benefit; higher managementcosts; and a tougher environment for loan negotiation. The local authority or other regeneration agencies may have failed to meet theircommitments to invest in ancillary regeneration projects in the area leading to reduceddemand, increased fear of crime, low educational achievement, inadequate infrastructurefacilities and consequential lower demand for social housing. Alternatively the investmentmay have failed to produce sustainable regeneration and neighbourhood renewal, withthe result that further investment is required. Political Risks 7.18 Lender confidence may have been undermined by changes in government policy pastexamples would include the withdrawal of Section 54 grants to cover Corporation Taxliabilities; rent restructuring proposals; and the imposition of RPI linked rent controls. Thefinancial consequences arising from changes in Government policy may result in the LSVTRSL having to: revise their business plan; seek additional loan facilities, generally from their existing funder as they will oftenhave a first fixed charge over all of the LSVT RSLs property portfolio; seek the extension of both the profile of loan repayments and the final repayment dateof the loan. STAKEHOLDER PERSPECTIVES ON PARTIAL OR FULL FUNDING The Housing Corporation 7.19 In registering any new LSVT RSL, the Housing Corporation requires that there is a fullappreciation by the organisations Board of the nature of the business, the financing structuresbeing entered into and the risks being assumed. The Housing Corporation takes the viewthat unless a Board can demonstrate that it has taken into account future financing orrefinancing risk and has strategies in place to deal with those risks, it will not normallyapprove registration where full funding is not ensured. A very small number of exceptionshave been made to this policy. 7.20 The Housing Corporation would expect the LSVT Board to be prepared to acknowledgepublicly any consequential risks to the programme as promised to the tenants at ballot. 7.21 However, there may be instances, particularly where a large established RSL is part of agroup structure involving an LSVT RSL, where a partly funded loan facility would notrepresent an unreasonable risk. This may also apply to some strong shire transfers and,perhaps more unlikely, some urban transfers. The LSVT RSL Board 7.22 The Board will need to be sure that it has a business plan and funding facilities which: enable it to fully meet its commitments to tenants as outlined in the consultationdocuments sent to tenants; enable it to fully meet its obligations to its lenders; do not contain any excess risks at any point in time, for example particularly during theperiod of the relatively high risk initial development/regeneration programme; contain risk management strategies for those risks which cannot be assigned to other parties; provide for the generation of reserves as soon as possible; and contain a margin of flexibility within its loan facilities over and above the basic requirementsof the business plan. 7.23 A newly formed board of LSVT RSL is likely to take the advice of its Director of Finance(assuming this person is in place) and/or its funding advisor as to the relative risks and rewardsof a full versus partially funded loan facility. If the arrangement fee associated with the loanfacility is to be paid by the vendor local authority (by a reduction from the purchase price),the LSVT RSL may be ambivalent as to its level. In such circumstances there would needto be clear benefits in the other terms and conditions of a partially funded loan facility forits selection in priority over a fully funded loan facility. FUNDERS 7.24 A number of existing bank and building society funders have expressed their very strongpreference for initial loan facilities to fully fund the LSVT RSLs peak debt requirements.This is particularly so in the more risky poorer urban and large metropolitan stock transferswhich going forward may constitute the bulk of ODPMs annual stock transfer programme.It is arguable that this may partly be because of the additional returns achieved by fundersthrough arrangement fees on larger loan facilities some of which may never be drawn.However, lenders would contend that they are able to adapt more flexibly to the changingfunding needs of the LSVT RSL when they know they have a long-term commitment toprovide the peak financings and can work with the LSVT towards mutually satisfactoryrestructurings on the back of a developed relationship. 7.25 During our consultation of potential lenders not currently active in the LSVT funding arena,a number indicated that the length of loan facility requested, and the current market termsand conditions, are a disincentive to becoming involved in the sector. This barrier to entrymay be reduced if partially funded loan facilities were more widely used. 7.26 Capital markets funders, who thus far have only provided around 5% of the total loan facilitiesto LSVT RSLs, may find it generally easier to sell bonds to investors if they were on a bulletrepayment basis. However, the credit rating agencies generally require full amortisation ofthe capital market issue to assign the necessary rating level to attract investors, which willachieve optimal pricing advantage for a capital markets issue for the LSVT RSL. 7.27 Rating agencies, in order to retain their credibility and market standing with investors, arenaturally very prudent and cautious in the structures to which they are prepared to assignstrong credit ratings. The most prudent funding structure for a LSVT is fully funded andfully repaid, based on robust assumptions by the end of the period of capital markets issue.Hence full repayment of the loan facility within the period of the bond issue has been thestructure adopted in the bond markets for LSVTs to date. Otherwise the rating assigned bythe credit rating agencies would command a margin over gilts which would make capitalmarket issues unattractive to LSVT borrowers. FULL VERSUS PARTIAL FUNDING FOR DIFFERENT TYPESOF TRANSFERS Shire Transfers 7.28 Shire transfers may have characteristics which could enable their boards to make the casethat partial funding was an appropriate and realistic possibility without undue risk. Thefollowing characteristics of shire transfers may support the boards case: The property assets, though requiring some repair and improvement generally haverelatively high alternative use values in the wider housing market and will typically notconstitute a major proportion of the housing stock in the district. The stocks average rent levels are not excessive and are a reasonable margin belowopen market rents. Rent collection performance will probably have been strong, witha reasonable proportion of tenants in receipt of housing benefit and relatively minimalvoid losses. Evidence of strong sustainable demand for the RSLs properties for the foreseeable future. Local economies will typically be vibrant, with below average unemployment levels, witha wide variety of robust employment opportunities for relatively low paid employment. Repairs and improvement programmes may be relatively modest, with little or no demolition. A strong management team, including people with private sector or RSL experiencealong with the detailed knowledge of former council officers of the stock to be acquired,and the resources to efficiently and effectively implement the LSVT RSLs business planmay be able to out-perform the business plan. 7.29 If such criteria are met, the transfer could be argued to be the transfer of an on-going businessrather than a start-up business, primarily because of the lack of a large initial investmentprogramme. The board will still need to take account for the future financing risks detailedabove but could argue that certain risks are no more than a well-founded business would beexpected to manage. 7.30 The advantages of such an approach, if accepted by both the Housing Corporation andfunders, would be that: the LSVT RSL may be subject to traditional RSL financial covenants and balance sheettests and may not be subject to annual business plan approval by funders; the range of funders willing to provide short-term finance to established businesses iswider than those providing long-term project-style finance to start up RSLs; the facilities would be negotiated to match the realities of a well managed, relativelymature business and with lower arrangement fees; and the LSVT RSL would have more flexibility to utilise a variety of financing sources andinstruments as its business develops in the private sector. Poorer Urban and Large Metropolitan Transfers 7.31 It is difficult to envisage the Board of a newly formed RSL to take the transfer of poorerurban stock, being able to satisfy itself or the Housing Corporation that it had the necessaryongoing business strength to warrant taking on the additional risk of partial funding. Indeedpotential funders are likely to stipulate that a key term of them providing funding for suchtransfers is that it is for a fully funded loan facility. The following issues may in aggregaterepresent too much risk to facilitate a partially funded loan facility: the scale, duration and cost of the initial investment programme; a lack of confidence in demand levels into the future; the alternative use value of the stock in the wider housing market may be low, and insome instances negative; the performance of other agencies in providing the regeneration context for the housingstock may be uncertain; the weakness of the local economy; and the local area may have many of the features of a poorer urban area, including socialexclusion, low academic achievement, low expectations, high unemployment levels,and high crime levels. 7.32 Shire transfers generally have the benefit of being able to source financing on the back of theirasset strength as and when required, but poorer urban and large metropolitan stock transfersmay need to benefit from the security of knowing that they have a committed funder in placefor their full requirements and for the full term. In the event that the RSL fails to perform toits business plan, the business plan is revised to ensure full repayment of the loan within theloan period. Clearly this is easier if the loan period is 25-30 years rather than say only 10 years.If the re-costing of the business plan fails to deliver an acceptable repayment profile, theinvolvement of the Housing Corporation in its regulatory role is quickly sought by funders.This position may change when the LSVT RSLs initial investment programme has beencompleted and has been demonstrated to have produced long-term sustainable regeneration. 7.33 If, however, some of the risks identified in Chapter 6 of this report were not transferredwith the stock then the need for a fully funded loan facility may be reduced. Transfers to an Existing RSL 7.34 Funders might be prepared to advance a partially funded initial loan facility if the LSVT RSLwas a financially strong existing RSL or part of a Group Structure involving a financiallystrong existing RSL, with a reasonable level of reserves and unencumbered assets. Lendersattitudes towards such a funding proposition, might depend on: the strength of the existing RSLs balance sheet including its gearing and annual interestcoverage levels; its past performance in relation to both major repairs, project control and housingmanagement; and if the transferee RSL was only a subsidiary of an existing RSL, the level of managementand financial support to be provided by the parent, or other asset owning subsidiaries inthe group. 7.35 Subject to these caveats, existing RSLs taking LSVTs are more likely to be capable of beingtreated as ongoing businesses for transfer funding and may have significantly greaterexperience of treasury management and risk appraisal than newly formed LSVT RSL. 7.36 To an extent, this demonstrates the difference between a project funding loan facilitysecured on the cashflows arising from the assets being financed and a corporate loan facility,secured on the financial strength of the borrowers balance sheet. FULL AND PARTIAL FUNDING CONCLUSION 7.37 Thus far, LSVTs have with virtually no exceptions been fully funded on the day of transfer.This is extremely prudent, but is strongly preferred by funders, and particularly their creditcommittees, and has served the sector well since the stock transfer programme began in 1988. 7.38 Some strong shire transfers have been fully funded on the day of transfer but due to thestrength of their cashflows, have not had to draw down much in the form of additional loansin the years following transfer. Clearly these and similarly strong transfers in the future couldadopt a partial funding approach with no significant increase in the risk assumed. This alsoapplies to LSVTs that take place to a RSL which is part of a group structure including alarge strong existing RSL which would be able to provide additional finance in the future. 7.39 Given the inherent additional risks, LSVT RSLs (unless they are part of a financially stronggroup structure) taking the transfer of poorer urban or large metropolitan stock, should befully funded on the day of transfer. This is a prudent approach, but is fully justified by thechallenges these transfers face from the day of transfer onwards. Chapter 8 - Business planning issues and information issues for the vendor local authority and recipient landlord Summary Much of the information provided by the RSL in its business plan and fundingprospectus is derived from local authority records and accounts. The local authority should provide core data in a Disposal Prospectus and create aDue Diligence Library or data room for inspection by the RSLs and their funders. The RSL business plan could then focus on its governance and management, itsintentions for the stock and neighbourhood and all future tenancy matters. Funding advisers should rigorously test business plan assumptions, identify andquantify risks to the business plan and consider all the available funding options. INTRODUCTION 8.1 The terms and conditions of the loan facilities received by the recipient landlord should bedetermined by the strength of their business plan, the level of risk being absorbed, the purchaseprice, the experience and expertise of management (including the Board) and the standardof information supplied to potential funders to enable them to undertake their creditassessment and due diligence. 8.2 For the reasons outlined in Part 1 of this report, the standard of information supplied topotential lenders will become increasingly important following the expected implementationof Basel II. Under the IRB approach of Basel II, the level of capital that a lender has toassign to a loan more accurately reflects the level of risk involved in providing the loan, thepotential for default and the loss arising to the lender if default occurs. However, Basel IIwill not be implemented prior to 2007, albeit many banks will begin to implement earlierthan this. At this stage, it is not clear what the effects will be. 8.3 Given this background it is important that stock transfers landlords adopt best practicein the provision of information to potential lenders. This chapter considers how recipientlandlords can ensure that the information supplied to potential lenders generates maximumcompetition in the tendering of the funding mandate. CURRENT POSITION 8.4 The business plans of the transfer RSLs which are circulated to funders as the basis for theirfunding bids are at present an uncomfortable hybrid including elements which could moreproperly be seen as the vendor local authoritys Disposal Prospectus as well as elementswhich are more genuinely the purchasers forward business plan and funding prospectus. 8.5 The RSL is currently responsible for producing the business plan and running the fundingcompetition. However, the results of the funding process may have a material affect on thepurchase price and so the local authority, which in any case holds much of the base informationabout the stock, has a strong interest in ensuring that the information received by the fundersis comprehensive and accurate. Under present arrangements, as was particularly highlightedby existing funders in the survey of views conducted in Part 1 of the assignment, key RSLappointments (including the Finance Director) have sometimes been delayed to the extentthat the business plan is effectively put together by the RSLs financial advisers. 8.6 The Community Housing Task Force is well positioned to give advice to local authoritieson the extent and quality of the information which they should be providing to form aDisposal Prospectus. DUE DILIGENCE LIBRARY 8.7 To enable the RSL, whether new or existing, and its funders to carry out due diligenceeffectively and quickly, and to avoid duplication of effort by the local authority and theRSL, a Due Diligence Library could be established by the local authority and its advisers.The provision of such a library is standard practice in PFI projects and was used effectivelyby the Housing Corporation in the disposal of its own loans portfolio. It should enhance thearguments for a reduction in arrangement fees and places the responsibility for core dataprovision where it best belongs. CONTENTS OF A DISPOSAL PROSPECTUS 8.8 The local authority disposal prospectus could include the following information: stock analysis age, type, size, location, built form etc; recent stock condition survey; description of the local economy employment levels, concentration of employersin any one industry, retail buoyancy, land price trends, inward investment levels,regeneration strategies; description of the local housing market tenure split in area covered by transfer or inwider district, house price trends, private rented market, any special features, for examplelarge student population; demographic analysis of existing tenants, waiting list, local population; demand expectations covering short, medium, long term. A full independent DemandSurvey could cover this and the preceding 3 points; local authority Management Performance with 3 year minimum record to demonstratetrends and the reasons for them: void levels average length of tenancy by demographic group rent collection history bad debts write offs; warranties being offered preferably on a standardised basis and/or backed byinsurance; and for urban areas/large metropolitan transfers, the regeneration strategies for the area includingcommitments by the local authority and other partners in the fields of neighbourhoodmanagement, education and health improvement, local transport, retail and leisure facilities: how well developed are programmes is the necessary funding committed who is responsible for efficient and effective delivery. BUSINESS PLAN AND FUNDING PROSPECTUS 8.9 With the aid of the Disposal Prospectus and Due Diligence Library the new or existing RSLwould be in a better position to develop its business plan for the future and its fundingprospectus, based on adequate information about the stock and the broader context of thetransfer. The Business Plan would focus on: details of the new landlord and relationship with any existing RSL group; financial projections for the stock and organisation; details of assumptions used; rental, voids and bad debts policies to be adopted; rent and other guarantees; management costs; planned repairs and improvement programmes; new development plans; diversification plans if any; housing management and services provision; and proposed role of RSL in local housing market. THE ROLE OF THE FUNDING ADVISOR 8.10 Armed with data from the local authority and the business plan the RSLs funding advisorshould be expected to: identify and analyse the risks inherent in the business plan; stress test the assumptions in the business plan and their impact on cash-flows; devise a funding structure and tendering strategy which as far as possible: allows for adequate flexibility to meet changing conditions mitigates the identified risks minimises lender control over the business plan; explore the full range of market opportunities to allow the management and Board toinformed choices; and explain the consequences of the funding strategy for future treasury management. Chapter 9 - Transfer to existing RSLs and a competitive disposal process Summary Current ODPM policy is to encourage local authorities to involve tenants in the choiceof a new landlord. In some cases this has involved a more formal competition betweenpotential landlords, although this policy is still relatively new. Existing RSLs, or group structures involving existing RSLs, should be able to offerpricing benefits through marginal costing of management costs and access to cheaperprivate finance. Virtually all existing RSLs canvassed as part of a survey, expressed keen interest inparticipating in future LSVTs. A disposal prospectus and data room could create the basis for a properly conductedcompetition for the recipient landlord role. Bidders could include newly formed RSLs, existing RSLs and the alternative modelsdescribed in Chapter 11. Competition would need to be carried out prior to ballot against clear criteria andwith meaningful tenant participation in the process. The clear advantages of a more competitive process may be partly offset by thedifficulties of engaging tenants in an extended transfer process. Large metropolitan transfers face additional complexities in introducing competitionfor the landlord function because of the policy that generally no more than 12,000homes can be transferred to a single RSL. INTRODUCTION 9.1 This chapter considers the extent to which VFM of funding for stock transfers would beenhanced by the involvement of established RSLs. In addition, it considers whether theinvolvement of one or more established RSLs in poorer urban or large metropolitan stocktransfers would enhance their fundability and the terms and conditions on which they couldsecure private finance. COMPETITIVE DISPOSAL PROCESS 9.2 Government policy is to encourage local authorities to consider a range of potential landlordswhen planning the transfer process, but competition for the recipient landlord remainscomparatively rare. A Disposal Prospectus and Due Diligence Library, as described in theprevious chapter, would be a useful tool in providing the information base for a competitivedisposal process for stock transfers, introducing competition for the landlord function amongstexisting RSLs and other forms of landlord. 9.3 The advantages of running a competitive transfer process would include: The local authority runs the competitive process and stands to gain maximum valuefrom the competition. Tenants would have a high degree of certainty of achieving a base level of commitmentsbut would also gain from added value commitments by bidders. It would bring the management and financial strengths of existing RSLs into the system. Funders would have the opportunity to work with RSLs as partners to develop attractive,flexible and innovative funding packages. Using the information supplied by the vendor local authority, the RSLs could run apre-competition for funding partners and would be able to decide for instance betweenbond and bank finance on the basis of knowledge and experience This competitionwould ask funders what the maximum price was they would be prepared to fund andon what terms and conditions. It might be more possible for funders and the RSLs to defend the position that in theparticular structures and circumstances the risks of not signing up for full funding andfull loan repayment during the loan period had been analysed and adequately mitigated. 9.4 The disadvantages of undertaking a competitive process could include: Tenants may not feel integral to the process and therefore vote against transferring tothe selected landlord. The whole transfer process may become protracted leaving tenants to become disenchantedwith progress to transfer. Existing RSLs may be prepared to pay too high a price for the stock purely to increasetheir property portfolio thereby jeopardising their long term financial strength. 9.5 The report now considers the findings of a financial analysis between newly formed RSLsand established RSLs undertaking stock transfers. It seeks, in particular, to examine the priorsuspicion that an existing RSL will achieve better loan terms and conditions and will generallybe able to pay a higher purchase price or receive a lower dowry, at the point of transfer. FINANCIAL ANALYSIS 9.6 The analysis focuses on management and funding costs since these elements in the determinationof the purchase price have the propensity to differ most significantly dependent upon thestructure of the recipient RSL. Other items of income and expenditure are not consideredas part of this exercise, as they tend to be more stock specific and less sensitive to the typeof recipient landlord. 9.7 Management costs have a direct impact on the determination of ODPMs TMV for thestock and hence the transfer price. Funding costs could have an impact on the TMV if theyenable the discount rate used to determine the TMV purchase price to be at the lower endof ODPMs 6% to 8% range. They may also influence the final transfer price indirectly ifthe recipient landlord is able to achieve cheaper funding and therefore bid a higher purchaseprice for the stock. This reflects the ability of an established RSL to take a view as to whatpurchase price it is prepared to pay for a portfolio. In the only real competitive bidding for aportfolio of around 1,024 social housing properties sold by the Ceewood Housing Association(CHA) to Shaftsbury Housing Group, the results of a competitive process were seen. Theprocess resulted in an attractive sales price to the vendor Smith Industries, with no detrimentto the rent levels and services provided to CHAs tenants. MANAGEMENT COSTS 9.8 The management cost structure of an existing RSL will differ from that of a new RSL vehicleestablished for the purpose of undertaking a stock transfer. Differences arise for a variety ofreasons, but primarily because an existing RSL will have an asset base and so can incorporatemanagement costs on a marginal cost basis into its business plan for the transfer stock. 9.9 A new RSL on the other hand will be obliged to incorporate management costs on a fullcost basis as it has no other assets over which to spread its costs base. Economies of scaleavailable to the existing RSL may not be available to newly formed organisations. Specificsavings can be expected in terms of central overheads, the Chief Executive function, thefinance department, IT systems and other central support services, as the support serviceinfrastructure already exists. 9.10 Table 1 provides the results of a present value calculation which reveals the potential impacton the TMV purchase price and hence additional purchase price that an existing RSL couldpay in comparison to a newly formed landlord from various levels of management cost savings. 9.11 Table 1 highlights that comparatively modest cost savings can have a significant impact on the TMV purchase price of a transferring stock. A relatively small saving of £25 per unit per annum for 30 years in management costs equates to a present value of around £1.0m for 3000 units transferring. This increases to £3.9m for 12000 units. Table 1 Present value of management cost savings Annual saving Impact on TMV (£m) in management cost per unit: 3,000 units 6,000 units 9,000 units 12,000 units £25 1.0 2.0 2.9 3.9 £50 2.0 3.9 5.9 7.8 £75 2.9 5.9 8.8 11.7 £100 3.9 7.8 11.7 15.6 9.12 The Housing Corporation Performance Indicators (PIs) for 00/01 report that the sectoraverage management cost equated to £536 per unit. Therefore, a saving of £25 per unitwould equate to around 4.5% of the average management cost. 9.13 Obviously the management cost structure of individual stock transfers is contingent uponthe specific characteristics of the stock being transferred. The Housing Corporations 00/01PIs detail that the unit management costs of individual RSLs range from £44 per unit to£2,729, thereby reflecting the diversity of the sector. However, the above analysis, althoughextremely generalised, appears to support the prior suspicion that existing RSLs have thepotential to offer a higher purchase price or sustain a lower dowry for a property portfoliopurely on the basis of management costs. FUNDING COSTS 9.14 Of the 146 stock transfers undertaken to the end of the 2000/01 programme fewer than 30have been to existing RSLs, or subsidiaries of existing RSLs. Of these, a great majority havebeen comparatively small estate based or ERCF stock transfers. Given this limited history oftransfers to existing RSLs, there is a relatively small population of evidence with which tocheck the comparative funding costs of funding transfers to existing and newly established RSLs. 9.15 From discussions with various lenders, existing RSLs are able to attract more keenly pricedlending facilities than newly formed RSLs. This arises for a number of reasons, but is directlyrelated to the lenders perception of the risk inherent in their financial strength and in thetransaction they are proposing to undertake. 9.16 Table 2 highlights that existing RSLs are generally able to achieve lower arrangement fees,interest margins and commitment fees than newly formed RSLs particularly for poorer urbanand large metropolitan transfers. It also demonstrates that lenders will price the facilitydependent upon the perception of the risks inherent in the lending proportion. That is, ashire transfer is perceived as comparatively less risky by the lenders and is priced accordingly. 9.17 Clearly with the lower arrangement fees detailed above, existing RSLs or newly formed subsidiaries in a group would be able to pay a higher purchase price for a portfolio of properties than a newly formed standalone RSL. With regard to interest margin this analysis needs to be broken down into shire transfers and poorer urban/large metropolitan stocks. Table 2 Funding terms new and existing RSLs New RSL Existing RSL Shires Poorer Metropolitan Shires Poorer Metropolitan urban stock urban stock Arrangement fee % 1-1.25 1.25 1.25-1.35 0.25 0.25 0.25 Interest Margin % Early years 0.10 0.85-1 0.4-0.5 0.4-0.5 0.4-0.5 0.4-0.5 Late years, say 0.4-0.5 0.75-1 0.6-0.65 0.4-0.5 0.4-0.5 0.4-05 year 10 onwards Commitment fee Nil 50% of interest margin Nil in early years then 50% interest margin SHIRE TRANSFERS 9.18 At first sight it may appear that the extremely low initial margins (reflecting a subsidy fromthe higher arrangement fee) would enable a newly formed RSL to pay a higher price for thestock than an established RSL. In E&Ys view this is unlikely to be the case. EstablishedRSLs with treasury management experience, would be less reliant on funding advisers andtake a wider loan portfolio view and build less margin of comfort into their real interest rateassumptions. This would enable them to undercut the 6%-8% ODPM real discount ratein the determination of the purchase price, and thereby pay a higher purchase within thecontext of a viable 30 year business plan. POORER URBAN / LARGE METROPOLITAN STOCK TRANSFERS 9.19 In the case of these transfers, the interest margins payable by a newly formed RSL are higherthan for an established RSL. This lower interest cost and the factors outlined in the previousparagraph of being able to undercut the 6%-8% real discount rate, mean that establishedRLSs would, if they chose to, be able to pay a higher purchase price than newly formedRSLs for poorer urban and large metropolitan housing stocks formed RSLs. COMPETITIVE BIDDING PROCESS 9.20 Invitations to bid for a portfolio of stock would need to be made prior to the tenants ballotand perhaps under OJEC rules. They could be directed towards: Existing RSLs wishing to take the stock direct into their own ownership, with or without,local management arrangements. Existing RSLs which were prepared to commit to the creation of a community basedRSL within their group structure utilising local authority and resident board membersand consulting fully with residents about the nature of the new organisation. A newly formed RSL if it felt sufficiently strongly established to bid independently. Private sector companies subject to other policy considerations considered elsewherein this report. Community Land Trusts or similar organisations where surpluses are directed to communitybased projects, possibly in conjunction with either private sector companies or RSLs. 9.21 Bidders would select funding partners, construct business plans and funding models, andestablish the price which they could afford to pay for the stock. Bids would be judged on anumber of criteria which would have to be pre-established and transparent. The selectionprocess would potentially have much in common with PFI selection methodologies. Involvingtenants would also be very important in establishing ownership of the process and supportfor the preferred landlord. 9.22 The criteria used in the selection process could include: commitment to fulfilling the aspirations of tenants for local management involvementeither through the RSL or by other means; management support offered to a subsidiary or locally based management structure; evidence of general commitment to resident empowerment; track record of delivering major development or improvement programmes on timeand to budget; track record of day to day management and maintenance including peer groupperformance indicator ranking; deliverability of business plan; funding availability and flexibility; evidence of wider regeneration success; and purchase price offered. CIRCUMSTANCES FOR COMPETITIVE BIDDING 9.23 Competitive bidding could only take place where there were sufficient numbers of RSLsinterested in expanding their operations in this way and with the capacity to handle thelong-term results. Transfers of over 10,000 units may struggle to find sufficient interest asthere are relatively few existing RSLs with the management capacity to handle such a large transfer and even fewer who could sustain a programme of such large transfers. Smaller townbased transfers or partial city transfers could, however benefit. Where stock can be splitinto manageable groupings even the larger metropolitan transfers could reap the benefits,although there may be over-riding policy and practical considerations which preclude splittingthe stock. These include: the complexity for large metropolitan authorities of having multiple competitions orthe need to have a number of competitors every year over a number of years to achievefull transfer; the implications for the balloting process; the number of RSLs with the capacity to handle several thousand units of possibly poor stock; the problems of attracting bidders for the poorest areas; and the desire to mix poorer and better areas into larger groupings to maximise sale proceeds. Other issues in transfers to existing RSLs 9.24 Whilst the review of management costs and funding costs appears to support the suggestionthat promoting competition in stock transfers could lead to higher purchase prices, a numberof other issues must be considered. These include: The impact of TUPE. RSLs may be slightly restricted in how competitively they can pricemanagement costs if they are required to accept a full transfer list of former local authority staff. The costs associated with integrating stock into an existing RSL will mitigate, to someextent the level of savings achievable. In addition, the transferring stock will be expectedto make a contribution towards central overheads which will also lower potential savings. The impact on the objectives of community ownership. It could be perceived asdetracting from community ownership unless a local community based RSL subsidiaryis formed as part of a large group structure. The impact on the success rate of ballots. Tenants perception is extremely important inthis regard. The perception of staff and in particular senior management is important. Often theimpetus for stock transfer comes from senior officers. The perception of members is also important and ties into community ownership.Members may be less supportive of stock transfer if they feel that there is a loss ofcontrol or influence over a key local service. The principles of competition are well established in local government. Compete,challenge and compare are 3 of the fundamental principles of the Best Value regime.Therefore, extending competition to the selection of the recipient landlord process isin line with best value. RSLS QUESTIONNAIRE 9.25 In order to gauge their interest in participating in future LSVTs, E&Y wrote to the ChiefExecutives of 109 existing RSLs. These included the largest RSLs in England and thoseformed by previous LSVTs. The main questions asked and a summary of the responsesgiven is set out below. More detail is given in Appendix XI. We received replies from 67RSLs, of which 40 were from established RSLs and 27 from RSLs created by an earlierLSVT, an overall response rate of 61%. The replies are summarised below. More detail isgiven in Appendix XI. 1. What extent would your organisation, or an organisation linked to your organisationwant to increase its stockholding/size through stock transfers from local authorities? Of those questioned, all but two would like to increase the size of their holding throughstock transfers. 2. If the answer to 1. is no, what factors would need to change for your organisationto consider becoming involved as a recipient landlord? One of the nos gave no reason, the other had only recently completed a stock transfer andwas not looking for another for the next five years. 3. Do you have a view on how many properties your organisation would be interestedin acquiring, recognising ODPMs guidance that the maximum number of propertiesto be transferred to any one new RSL should generally be no more than 12,000? A wide variety of replies were received for this question as can be seen in Appendix XI.Established RSLs were more ambitious overall in their target number, however, invariablythey were already larger on average. Some RSLs had no view on the amount whilst 8 statedit depended on the circumstances. For those wishing to have more than 12,000 transferred,either a group structure was already in place, or this was planned in the near future. 4. Would you target a particular type of transfer ie, shire district councils, poorerurban stock, large metropolitan transfers etc? A majority of respondents wished to remain geographically local to their current housingportfolio. 25 respondents did not target a particular type of transaction, but would considereach opportunity on its merits. RSLs tended to opt for the opportunity most likely to occurin their existing geographical region or where they had expertise, ie, Shire RSLs indicated acontinued preference. Finally, six respondents with specialist skills such as regeneration orsheltered accommodation specified that these were the areas they would target. 5. Would you wish to pursue partial or whole stock transfers? Most RSLs would go for either partial or whole stock transfer. A number indicated that in theirarea, either a partial (metropolitan/urban) or a whole (shire) transfer would be most likely. CONCLUSIONS ON RSL QUESTIONNAIRE 9.28 The conclusion is that there is a strong appetite within established RSLs to undertakeLSVTs whether through partial or whole stock transfer. The replies indicated strong localgeographical preference, with 50% of respondees indicating that they would wish to staywithin their current area of operation. Established RSLs also indicated an overall desire tocontinue to work with property types in which the RSL already had expertise. 9.29 A number of London based established RSLs already have expertise in poorer urban andmetropolitan stock and so wished to remain in this field of activity. Other established RSLsexpressed a preference to continue working with shire transfers based in areas where theyalready have a presence. Several established RSLs expressed concern about the financialviability of poorer urban stock. 9.30 The number of properties that a RSL would be interested in acquiring generally related toits current size, area of operation and group structure. Smaller RSLs were generally unwillingto take on housing in excess of their current size. A number of the medium and larger sizedRSLs either specified that they could take up to the 12,000 home general limit or wouldexamine each potential project as the opportunity arose. 9.31 A minority of respondents were willing to take on any locality or number of properties. MostRSLs indicated that they would examine potential transfers on a case-by-case basis to ensurethat its management arrangements for its current stock would not be jeopardised. Chapter 10 - Intermediary body to issue bonds to the capital markets Summary The bond markets have been comparatively under-utilised in providing funding tothe transfer programme to date. The most cost-effective bonds are large, liquid issues, which may require the aggregationof a number of smaller transfers. The market has not yet produced a mechanism for aggregating LSVT issues althoughthis has been achieved in the traditional RSL market. There is no current evidence of the poor value for money or market failure, whichmight justify public sector intervention to establish a body to issue group bonds. TRANSFERS AND THE BOND MARKETS TO DATE 10.1 Long term fixed rate debt is an important option for transfers to have available in determiningtheir treasury management strategies as it can provide a core level of certainty to the fundingof their business plan. The bond markets are the traditional source of fixed-rate debt withlong-dated loan stock being issued by both government and corporate borrowers. 10.2 However in recent years the swaps markets have extended out to 30 years enabling banksto offer significant competition in this market. The traditional RSL sector has used bothbanks and bonds extensively with increasing levels of sophisticated decision making basedon their relative covenant and pricing packages. Bonds have been issued by individual RSLs(primarily to finance Housing Association Grant (HAG) and Social Housing Grant (SHG)supported development), groups of RSLs organised by lead underwriters, and by the independentintermediary The Housing Finance Corporation on behalf of aggregated groups of RSLs. 10.3 The bond markets are under-represented in the financing of housing stock transfers althoughto date their relative unpopularity has not proved to be a problem in funding ODPMs annualtransfers programme because of the active participation of sufficient banks and building societiesto ensure the successful funding of the full programme. If the banking/building society marketdeclines, or the size of the total annual funding requirement substantially increases, theimportance of a well-developed bond market would become increasingly significant. THE BORROWERS PERSPECTIVE 10.4 Bonds have not been the preferred mode of financing for a number of reasons primarily asthey are seen by RSL boards and by most of the funding advisers as inflexible, expensive torepay early and complicated to launch. Against this it is argued that banks flexibility mayalter with market circumstances and the covenant structures required by the banks allowfor very significant intervention and control if business plan performance deteriorates; bondholders have a far more hands off approach with Trustees only taking action when minimumlevel performance covenants are actually breached. 10.5 Underwriters would also argue that there should be no need for, or expectation of, earlyrepayment for the core debt of the transfer and that breakage costs will also be significantfor bank-funded fixed rate debt. The complications of launch depend on the timing of theissue and can largely be handled by the underwriter. THE INVESTORS PERSPECTIVE 10.6 A key factor inhibiting the wider development of suitable bond structures from the investorspoint of view is the volume of individual transactions. Until 3 to 4 years ago, the acceptedwisdom was that a liquid issue (which by definition would attract active secondary markettrading and therefore the keenest pricing) would need to be in the order of £75 -£100 million. 10.7 This size of issue would now be regarded as illiquid and require an additional margin premiumof probably upwards of 25 basis points (0.25%) to meet investors appetite. Liquidity in thesecondary market is generally agreed to commence at an issue of over £200 million withamounts below that being treated effectively as private placements with little anticipationof future trading. THE NEED FOR AGGREGATION 10.8 Very few of the largest transfers require core fixed rate funding of over £200 million andso active use of the bond market for smaller transfers would require the use of potentiallymore expensive private placements rather than liquid public issues or the aggregation of anumber of transfer transactions into a single bond issuance programme. The latter in turnwould require the establishment of an intermediary vehicle to act as the bond issuer. Suchan intermediary could be a shell vehicle set up by the lead underwriting bank with thebank structuring the bonds and dealing with the issuing process. Alternatively, it could bean independent organisation carrying out its own financial structuring and seeking competitiverelationships with underwriters. 10.9 Neither form of intermediary vehicle has yet emerged in the funding market for stocktransfer despite both forms having been used extensively by non-transfer RSLs. This wouldappear to be because: Banks have, to date, been prepared to offer full, flexible funding packages for alltransfers at margins which were very competitive with what the bond markets couldhave offered. Bond underwriters have found it difficult to break into the market even for the largertransfers (with a few notable exceptions) and there are limits to the extent to whichthey will invest in innovative products when the potential rewards are so tenuous. The bond markets need to be used in conjunction with more traditional banking productsin order to add the flexibility and variety which a total transfer funding package requires.Bond underwriters therefore either need to have a banking division within their ownorganisation prepared to work closely to provide the full package in-house or they needto establish partnerships with other banks or building societies. This may prove difficult when the same banks and building societies are both hungryfor loan assets at relatively low margins and are capable of providing a fixed rate productthemselves (albeit in some market circumstances at higher cost to the borrower). The timing of transfers is such that any attempt to co-ordinate an aggregated approachto the bond market at or around the time of transfer is fraught with difficulty. WhichRSL would be prepared, or indeed well-advised, to enter into a funding deal whichdepended for its ultimate success on a number of similar RSLs agreeing to participate atthe same time? Warehousing of transactions until the size of the first issue was adequatewould require the interim (or bridging) banking facilities referred to above and thecapital markets out-take would be hard to guarantee within a defined period. An independent intermediary issuing in its own name would overcome some of thecomplexities of the aggregation process but unless it was adequately capitalised fromthe outset it would face questions about its own creditworthiness which would be at themercy of its weakest borrower until it had built sufficient track record and reserves tooffer a genuine spread of risk to investors. The rating agencies have not to date been prepared to rate an open-ended bond whichallowed for the addition of later transfers. Transfer RSLs are seen as having a muchbroader spectrum of credit characteristics than traditional RSLs which have significantbalance sheets, experienced management teams and do not generally require majorinitial investment programme in their stock. 10.10 The lack of progress in establishing a structured bond financing which could be used on anaggregated basis has not been for the want of trying. The two leading underwriters active inthe field have considered this possibility and continue to investigate further. 10.11 The Housing Finance Corporation has indicated its willingness to establish new vehicles forthe purpose and work with the underwriters to find a way through the problems. However,despite its position as a successful independent issuer it does not have sufficient balancesheet strength to capitalise such a vehicle and gain the credit rating in its own name whichwould overcome the perceived weakness of the underlying credit position of a number ofdisparate transfer RSLs. A ROLE FOR GOVERNMENT? 10.12 ODPM is thus faced with a policy dilemma as to whether it feels that the benefits of acentralised and capitalised intermediary are sufficiently substantial to warrant public sectorintervention in the market. These benefits can be summarised as: providing access to a wider range of markets for all transfers and thus protecting theprogramme from any potential narrowing of the current limited lender base; the generation of a comparatively untapped source of funding, thereby stimulating theexisting funding market which whilst delivering funding for all transfers thus far, isclearly showing signs of contraction and stagnation; and gaining the economies of scale and process efficiency which a unified bond issuanceprogramme can provide. 10.13 If it was thought to be justifiable, public sector involvement could take a number of forms including: Investment in the capitalisation of an independent intermediary to provide it withsufficient strength to attract a high investment-grade rating in its own name. Purchase of bonds issued by an intermediary until such time as the bond size wassufficient to trade in the public markets. Entering into a partnership with an existing public/private organisation such asPartnershipsUK (PUK) to develop a bundling approach to smaller stock transferswhich would necessarily involve individual transfers being encouraged or required tobuy into a centralised funding solution. 10.14 The difficulties of government intervention in an established funding market are significant borrowers will not wish their freedom to select their preferred funding solution to be diminishedand lenders will complain, with some justification, that such intervention is anti-competitiveand provides one element of the market with advantages not available to the rest. 10.15 In addition, a key justification for Government intervention is market failure. Given that allstock transfers since the inception of the LSVT programme in 1988 have been funded andthere is still strong funding appetite for new transfers, (albeit from a limited pool of funders),it is extremely difficult to justify Government intervention in such circumstances. 10.16 E&Y does not therefore recommend that the establishment of a centralised vehicle withgovernment assistance should be contemplated at this time. It could, however, be useful forODPM to acknowledge publicly the desirability of aggregation, to indicate that it wouldwelcome proposals emerging from the market, and to be prepared either now or in the futureto offer to work with the private sector to try to overcome some of the process problemswhich have been a contributory factor to date in deterring such initiatives. CONCLUSION 10.17 We conclude therefore that the market may eventually produce a new bond and vehiclestructure which will meet the varied requirements of transfer RSLs, investors and ratingagencies. This is most likely to happen if the available banking/building society financeweakens or more large transactions with a core funding requirement of over £200m occuror returns improve. Until then it is difficult to envisage there being sufficient incentive forthe major investment in time and money which such an exercise would require. Chapter 11 - Alternative models for stock transfer Summary The current system of transfer to RSLs provides limited capacity to reconfigureestates, exploit, for community benefit, the value of development land or participatein comprehensive regeneration programmes. Enabling RSLs to carry out these wider activities may require a relaxation of ODPMand Housing Corporation rules and the risks may be too great for newly-formedRSLs to absorb. Governance and financing models have been proposed which offer alternative typesof landlord and a wider regeneration capability but which would need to win theapproval of a wide range of stakeholders, in particular tenants: the structured finance model utilising equity/debt combined funding with thereturns to equity investors capped at a level which would allow surpluses to bechannelled into a local regeneration fund. the community land trust model, where transfer of the freehold interest to aCommunity Land Trust would enable a comprehensive master plan to be developedwith any resulting enhanced value being retained for the benefit of the community. 11.1 Private sector equity investors seek investment opportunities secured by strong income streams.The delivery of social housing services, with tenant rental flows supported to a substantialdegree by housing benefit payments, is seen as a potential future investment area, subject tochanges in RSL governance rules. There is also a second reason for private sector interestin stock transfers, namely inherent land values. In certain areas of England and Wales theland transferred or that created via demolitions, has redevelopment potential assuming thatthe tenanted units can be re-provided by site reconfiguration and density changes. 11.2 Recently Ernst & Young has seen a number of private sector led proposals to bring a newapproach to the area of stock transfers and as part of this project we were asked by ODPMto examine the Regent Integrated Housing Model in particular. The Regent proposal couldbe described as a structured finance RSL with a limited or capped return to equity investors.Surpluses would be retained in the community through a form of trust. 11.3 A second model is also examined in this section, which is the Community Land Trust,where transfer of the freehold to such a body would facilitate the preparation of acomprehensive master-plan resulting in benefits being retained for the community. REGENT INTEGRATED HOUSING MODEL 11.4 Regent Integrated Housing is owned by Charlemagne Capital and has been set up to developinnovative social housing finance solutions. Regents proposals are aimed at reducing thecost of financing stock transfers and hence increasing the opportunities for successful transfersand increasing the level of payments to local authorities for their assets. Their proposals areoutlined in more detail in Appendix XIII. 11.5 The Regent Model utilises structured finance to improve financial terms available for stocktransfers, with the financial partners (particularly equity) controlling the management ofthe Housing Company to which the housing stock is transferred. The Regent Model involvesusing competitive mortgage and capital markets for procuring the majority of the finance.The Housing Company is to be an RSL. Changes to current policy may be needed as themodel proposes that funders gain ultimate control over key management appointments. 11.6 Under the proposals the total return paid to investors would be capped and any excessprofits covenanted to the public sector via a Trust for which it is envisaged that tenants andthe Council will make up the board. The transferred surpluses would enable the Trust toundertake wider social, economic and physical regeneration works in the area. 11.7 The Housing Company would be able to use and develop the assets to provide, undercontract, a flexible housing service to accommodate social housing tenants in propertiesthat matches their changing needs. Regents model goes further than other proposals wehave previously seen in that it might involve substantial flexibility in the management ofthe stock, to allow appropriate remodelling and redevelopment of assets. 11.8 As a form of security Regent has proposed that a golden share be retained by the publicsector and that a Bond could be taken out to insure the public sector position in the eventof the Housing Company getting into financial difficulty. These measures are designed tohelp protect the interest of tenants as well as the public sector investment in the stock. COMMUNITY LAND TRUSTS 11.9 A Community Land Trust (CLT) is a model for the mutual ownership of land. The landowned by the local authority and the community is pooled together with either the communityor the local authority retaining the assets freehold interest. Depending on the exact structure,the CLT will invariably have a board containing much the same composition as that proposedfor an Arms Length Management Organisation a third tenants, a third independents anda third local authority representatives. 11.10 The CLT would enable a comprehensive master plan to be developed with any resultingenhanced value solely being retained for the benefit of the community. Proposals to datehave centred on the CLT leasing the housing units to an RSL, which will manage andrepair the stock, with the ground lease rents enabling community projects. If it is necessaryand possible to tackle major regeneration projects, it is likely that the CLT would prepare amasterplan and then seek a commercial development partner to undertake the project. 11.11 The Council of Mortgage Lenders (CML) has stated its concerns regarding CLT optionswhere stock is leased to RSLs, arguing that it will be more expensive for borrowers toapproach lenders without the benefit of security of freehold land. 11.12 The approaches above both focus on creating profits to enable regeneration but simplyhave different primary objectives. The private sector models such as Regent must createprofits to maintain investor confidence. The CLT model is centred more on communitywide requirements but without a commercial partner it is unlikely that major regenerationprojects would be possible. We envisage that proposals for CLTs will become further developedas more regeneration opportunities are implemented and following this, methods for financingand managing the Trusts may become more innovative. STAKEHOLDER KEY ISSUES 11.13 From a general economic perspective, it is desirable to make the most efficient use of thefinancial markets and also maximise the value derived from the underlying land assets.However, balancing the financial requirements of debt investors, equity investors with thesocial and service provision requirements of the public sector is not straightforward. Thereare several sets of key stakeholders whose interests must be balanced. These are: Tenants. Council Members. Public Sector ODPM and the Housing Corporation. RSLs, Housing Company or Community Land Trust. Debt and Equity Investors. The interests and concerns of each of the above are considered below. TENANTS 11.14 Tenants require appropriate accommodation provided by a landlord they trust at an affordablerent. Tenants are often wary of change and the benefits of any change of landlord have tobe acceptable to the residents affected. Tenants currently have the right to veto transfer byway of their ballot and as has been recently seen, if tenants are not convinced of the benefitsassociated with transfer then the ballot result will be against transfer. 11.15 In any transfer, and perhaps particularly in any new approaches, tenants first concern will bethe prospect of rising rents and security of tenure, but to many a further concern will be thepotential movement of communities as residents are re-housed to enable regeneration activity. 11.16 Tenants will need to see significant benefits in order to allow this and improved homes willonly be one part. Total community-wide regeneration with financial assistance to also targeteducation, employment, crime and health will be needed. Communities will require sympatheticre-housing and additionally there may be a need to allow tenants to participate directly inthe benefits from development. 11.17 It cannot be overestimated how vital the tenants support of any new approach would be.In particular, proposals involving equity or other private investors are likely to be highlysensitive and potentially an easy target for groups opposing stock transfer. Tenants wouldneed to be provided with the full facts and allowed choice. 11.18 It needs to be remembered however, that any reconfiguration of estates is likely to offertenants considerably more choice, not only in the provision of new homes but also increasedopportunities for mixed tenure accommodation. This combined with a commitment todeliver sustainable regeneration through health, education and employment improvementscould secure tenant support, if communication and consultation is clear and inclusive. Council Members 11.19 Council Members currently hold the political responsibility for ensuring housing servicesare provided appropriately and demonstrate that Best Value is obtained by the public pursein the procurement of these services. Additionally, if the Housing Company, CLT or otherlandlord were to actively work the land assets and generate development value then CouncilMembers also have responsibilities to achieve best consideration on the initial sale of thoseassets. That means that at the time of transfer if the portfolio has development potentialthen the Council must achieve a sale price which reflects the potential or alternativelymakes appropriate initial claw-back arrangements. A claw-back arrangement would protectthe Council and wider public sector from excessive asset and value leakage to the privatesector over and above the pre-agreed returns. 11.20 From a wider community perspective Council Members do not only require housing improvementsbut in line with national regeneration policy, require a holistic approach to improving thelives of residents in more deprived areas. Improvements in education, employment, crimeprevention and health are now seen as essential bricks and mortar regeneration is knownnot to work in isolation. The roles of the Housing Company, Trust, CLT, RSLs and otherorganisations in undertaking wider regeneration activities would need to be clearly understoodand agreed. 11.21 A local authority also holds municipal powers for planning and compulsory purchase.Compulsory purchase powers in particular mean that a local authority is uniquely placedto assist a housing organisation to instigate major development activity. 11.22 Being responsible for housing service procurement Council Members in particular will wantconfidence in the managing organisations ability to meet the changing needs of tenantsgoing forward. Councillors and Tenants on the board of the Housing Company or CLTwould help achieve this. PUBLIC SECTOR (ODPM/Housing Corporation) 11.23 The wider public sector may have similar concerns regarding stock transfer to CouncilMembers in that appropriate housing services are to be provided at a reasonable cost tothe state. The ODPM has stated national policies to provide Decent Homes for all and thatno one should be disadvantaged because of where they live or who their landlord is. TheGovernments joined up approach to regeneration is now pivotal to neighbourhood renewaland stock transfers, in that improvements simply to housing is seen as insufficient. 11.24 Raising money by redeveloping key areas may be currently encouraged, where funds raisedcan be targeted at education, employment, crime, health as well as physical developmentworks. What is of political concern would be the leakage of valuable sites from the publicsector without true value being derived from the transfer. Currently potential value is notrealisable because RSLs are substantially restricted to maintaining existing estates. 11.25 A number of innovative regeneration schemes have been approved by ODPM, some underthe auspices of the Estate Renewal Challenge Funding programme. In particular OptimaCommunity Housing Association, formed specifically to take the transfer of around 2,800properties in Birmingham, undertook wider commercial development activity, which isbeing used to support neighbourhood renewal in Optimas business plan. 11.26 The Government is likely to require complete assurance that the proposals meet therequirements and aspirations of local tenants. Disputes with tenants not wishing to move orfailing to see the benefit of the regeneration proposals would need to be avoided to ensurestakeholder and lender confidence. 11.27 There are also wider housing related issues for the public sector stakeholders to considersuch as the need for key worker accommodation. For example, land values in GreaterLondon are high and hence it is attractive to consider regeneration proposals. However,these must be implemented with appropriate regard not only for the needs of tenants butalso nurses, teachers etc who require affordable housing in their area of work. The need foraffordable housing may be greater than the need for a local authority to unlock proceedsvia purely private sector development and should be reflected in overall policies. RSLS/ Housing Company/Community Land Trust 11.28 In any new approach the in-house management team must have the experience and resourcesto meet tenant expectations, provide appropriate housing services (to meet current andfuture needs) and also have the ability and freedom to work the underlying land assets toidentify and exploit potential opportunities. In E&Ys opinion, it is not essential that theorganisation has direct development resources as it is possible that such experience can begained indirectly by joint ventures with developers. 11.29 Experienced, professional board members are required, who have the capability and knowledgeto identify opportunities and negotiate with developer(s). Retaining staff of appropriateexperience may be dependent on the ability of the organisation to provide remunerationin line with comparable private sector positions. Investors 11.30 Investors prime concern is the security of their investment/loans and achieving an appropriatereturn on that investment. The key to this will be having complete confidence and in thecase of more investor-driven approaches, some degree of control over the management ofthe housing organisation. 11.31 Although it has been argued that there is a significant market for structured finance in propertymanagement firms, it is our belief that equity investors in particular will only achieve appropriatereturns if the management is able to take on some development related activity and henceneed higher risk capital from equity investors. If this is the case then maintaining investorconfidence in the board and senior management is paramount. 11.32 Investors will also want to see value in the underlying assets protected and discussions withfinance providers has indicated a growing recognition that holistic regeneration of an areais the key way to ensure the success rather than decline of a housing area. 11.33 Investors are likely to seek some degree of political reassurances with regard to stock transfer.The tenants rental income stream underpins the managements core Business Plan. Policystability would be desirable to investors especially in the area of rental levels and housingbenefit regulations, obviously this also applies to the present tried and tested existing stocktransfer regime. Summary 11.34 As a summary the table below highlights key issues and requirements of each stakeholder: Tenants Council members Public Sector RSL/Housing Investors (ODPM/HC) Company/CLT Decent homes Best consideration Best consideration Robust Degree of control for land including achieved and Best management over RSL board and coverage for Value for services board Management value uplift Communities Best Value for Financial regulation Freedom to asset Access to improved maintained provision of of the RSL sweat portfolio returns from RSL housing services (directly/indirectly ability to asset sweat via developer involvement) Rent rises in line No leakage of No leakage of Appropriate Political stability with Government assets to private assets to private remuneration for limited policy change, policy and sector sector key posts for example re rent protected tenure levels Holistic Holistic regeneration Holistic regeneration Holistic regeneration Holistic regeneration regeneration: meet national in order to maintain/ in order to maintain/ employment policy objectives enhance underlying enhance underlying health asset values asset values crime education HOW DO THESE ALTERNATIVE APPROACHES DIFFERFROM THE PRESENT RSL APPROACH? 11.35 As identified above, two key differences between the new approaches and the present RSLsystem are the involvement of equity capital and the greater importance placed on theunderlying assets in the transaction the land. Some of the new proposals (such as Regent)also seek to bring commercial property management experience to increase the level offlexibility in managing housing assets and meeting tenant needs. This may be acceptableto tenants if it results in them receiving a wider choice of better accommodation. Equity Capital 11.36 In present models, where development activity is generally restricted to social housing, theneed for high-risk equity capital does not arise. The current arrangements are low riskwith tenant rentals effectively guaranteed to ensure business plan projections are achieved.Structured finance arrangements are appropriate for higher risk activities and the highercost reflects the risk incurred. 11.37 Only if ODPM and Housing Corporation rules are relaxed to allow increased developmentactivity and give funders greater control over key management appointments will structuredfinance really be appropriate. This is likely to have implications for the way in which theHousing Corporation assesses and regulates RSLs exposure to risk. 11.38 In this regard, the HC would need to review its guidelines for regulating the non-coreactivities of RSLs, as embodied in Regulating a Diverse Sector. Land Asset Value Leakage/Local Authority Asset Valuation 11.39 Asset value leakage is a particular issue due to the present approach to determining thestock transfer price. Assets are currently transferred at a value (Tenanted Market Valueover 30 years), which has no regard for redevelopment potential. Local authorities shouldnot enter into transfer arrangements before undertaking a comprehensive review of theirportfolio to identify future development potential and ensuring that this is appropriatelyreflected in the stock transfer price and any claw-back arrangements. Claw-Back Arrangements to the Public Sector 11.40 Given a local authoritys requirement to obtain best consideration for the sale of its assets,even if the management is giving surplus returns to the community, there may be the needfor the local authority to have claw-back arrangements. Claw-back arrangements come intoplay if proceeds generated on sales are beyond the expectations assumed in determining theoriginal transfer price from the local authority. These arrangements often run for a set periodof time say 5-10 years perhaps on a sliding scale and would allow the authority to recoup apre-agreed percentage of the additional proceeds after reasonable costs. Regional Variance 11.41 The new approaches may have a significant regional variance in their application. Thepossibilities to relocate, for example city-centre tenants to create redevelopment sites withvalues of significant magnitude are far greater than those available in less affluent or ruralareas. It could be argued that in the areas where there is sufficient demand from equityinvestors to enter into stock transfer arrangements, the local authorities concerned wouldbe best identifying potential sites and examining all other available options to secure fullvalue for the sites. The resulting proceeds could be allocated to regeneration activities. 11.42 It would only be after a review of all available options that the public sector could be assuredof receiving Best Consideration for the assets. Alternatively, local authorities could producea masterplan for the area and then use the Housing Company, CLT or RSL to implementthe plans and hence trap rising value in the area for the local authority/community. ALTERNATIVE APPROACH AND ECONOMIC DOWNTURN 11.43 Existing RSLs are generally counter-cyclical businesses, as the economy constricts and unemploymentincreases, social housing demand generally rises. However, if RSLs have undertaken commercialdevelopment activity the business may be exposed to risk of falling property markets. Given thelong term nature of many regeneration projects, markets may fluctuate. This, added to risksassociated with securing planning consents for projects, may mean that the price paid to thelocal authority at the time of transfer undervalues the future development potential and thereforethe public sector bears the cost of those risks by failing to secure an appropriate developmentvalue. This is a key reason why rigorous claw-back arrangements would be required. 11.44 In addition the financial track record of RSLs is exemplary with no private lender havinglost money as a result of lending to an RSL. If RSLs attract equity capital and start toundertake riskier investment and development activities, the risk profile of the sector maysubstantially change. This is fully recognised in the Housing Corporation guidelines onRegulating Diversity by RSLs. In an economic downturn the risk profile of an RSL undertakingdevelopment activities would change substantially. 11.45 In fact no RSLs have ever gone bankrupt. However, many property developers have. A keyconsideration in examining the possible changes necessary to the structure of RSLs to permitdevelopment activity therefore would be how the provision of housing services can bemaintained and tenants protected if financial problems were encountered. Proposals such asRegent have suggested the retention by the local authority of a golden share the protectiontruly offered by such a proposal or any bond guarantee would have to be examined in detailand shown to offer true protection to the public sector, as well as tenants, so it does notbecome the ultimate risk taker. CONCLUSION 11.46 New approaches have to demonstrate value for money and need to ensure that ultimately,risks do not simply remain with the public sector, through reduced land sale proceeds withuncertain claw-back arrangements for enhanced values. In situations where there is developmentvalue, the local authorities may be best placed to develop planning frameworks and analysedisposal options to ensure optimum receipts are secured by the public sector. It is possiblethat local authorities and RSLs could initiate not-for-profit regeneration schemes throughwhich community trusts could have a more significant role. 11.47 However, we believe that proposals such as the Regent Model and CLT do raise importantissues for further consideration and where perhaps ideas could be transferred to existingmodels of stock transfer landlords. These include: RSL management boards must be robust and gain and maintain the confidence ofinvestors (lenders). Value from the national housing portfolio should be further utilised for the benefit oftenants and local communities. Local authorities could review their housing propertyand land portfolios to identify redevelopment value and identify options to secure BestConsideration for key sites. Holistic regeneration is necessary and required by all key stakeholders in the stocktransfer process. 11.48 The discussion above has identified a number of potential difficulties with the alternativemodels. But notwithstanding these, we believe that there may be merit in some of the newproposals to improve social housing in deprived areas. However, we could envisage localauthorities being more proactive in identifying regeneration options and then seeking privatesector partners to take on appropriate development risk, either in partnership with a localauthority or as part of an RSL consortia on transfer. 11.49 A further option is to allow landlords based on new models such as Regents to compete openlywith other RSLs to become the recipient landlord and so allow communities to expresstheir preference. If this occurred then it would be the potential new landlords challenge toconvince local authorities and tenants regarding the value of their proposals and demonstratewhether their proposals can provide greater benefit than RSL organisations. Appendix I - ODPM Workshop 26th June 2001 IN ATTENDANCE Simon Llewellyn ODPM Tom Oscroft ODPM Richard Clarkson ODPM Gill Rowley The Housing Corporation Mary Marshall Community Housing Task Force Ms Barbara Ainger Ernst & Young Dougald Middleton Ernst & Young Bruce Mew Ernst & Young The purpose of the workshop was to draw on the wide range of experience of the processfor, and funding of, stock transfers and to identify the strengths and weaknesses of thedemand and supply for funding. SUPPLY OF FUNDING Strengths All stock transfers have been funded raising a total of around £9.3bn for approximately117 stock transfers since 1988. The suppliers of funding have shown the ability and willingness to absorb the adverserisks that have arisen since 1988 including falling Right to Buys, low inflation, highinterest rates, the removal of Section 54 grant, and rent restructuring. Loan covenants are generally reset each year reflecting the development of their borrowersbusiness plan. Loans are relatively finely priced. No loan defaults have been called by lenders, although they will certainly have hadgrounds to do so. Funders have shown a willingness to adapt to new transactions and structures, includingfunding negative value transfers. Weaknesses A limited number of funders exist and bank mergers may reduce this number further. Relatively little innovation has taken place since 1988, with a noticeable underrepresentation of the capital markets. Transactions with a weak credit status often only receive one consortium offer of funding. Arrangement fees are relatively high, and have shown considerable resistance toany reduction. The returns received by funders are not transparent, particularly for swaps, fixedinterest breakage costs and refinancing costs. DEMAND FOR FUNDING (LSVT BORROWERS) Strengths Loans to LSVT Registered Social Landlords secured on residential property have acapital weighting of 50%. The discount rate used to determine the purchase price. The borrowers belong to a Government regulated sector. Borrowers generally require a large initial drawdown to fund the purchase price, this isvery attractive to lenders. The treasury management requirements of LSVT borrowers are attractive to lenders. Negligible default history and a growing performance track record. Considerable flexibility exists within a 30 year business plan and loan term to rectifyany financial underperformance. Weaknesses NaÃ¯ve borrowers, every deal is funded individually with inexperienced boards. Appears to be little mechanism for disseminating funding lessons learnt. Poor financial and funding advisers in some cases, low fees do not allow top qualitystructuring and funding advice. Finance Director often not appointed early enough in the process. Little incentive to innovate. LSVT transactions are not readily appropriate for partial funding. LSVT RSLs have escalating debt profiles, requiring undrawn loan facilities for anumber of years. Subject to political risk. Basel II may create wider credit differentiation, with a commensurate effect on price. Once transfer complete sponsoring local authority has no residual stake (other thanboard members) and currently does not participate in the benefits of refinancing. Appendix II - Questionnaire to banks and building societies 1. Name of organisation 2. Name and position 3. Exposure to LSVTs Commitments outstanding. Drawn balances. Other products offered, for example derivatives. What determines your level of exposure to the sector? 4. Appetite to advance further funding to LSVTs Shire District transfers. Poorer Urban Stock transfers. What market factors would lead you to increase your exposure to LSVTs? 5. What credit assessment criteria do you use in reviewing LSVT funding proposals? Do you consider LSVTs to be primarily a 1) Property risk or, 2) A project cash flow risk. What Credit Risk Assessment Methodology do you use? 6. What returns calculation methodology do you use? Risk Adjusted Return On Capital (RAROC). Risk Adjusted Return On Risk Capital (RARORC). Other. 7. What are you thoughts on the potential implications of Basel 2 on your returns from LSVTs? 8. What are your thoughts on the implications of consolidation of leading LSVT funders? Halifax/BoS. RBS/Natwest. 9. Please let us have your views on the current LSVT process Timescales. Standards of advisers. Degree of innovation. Timing of funders involvement. Competition for funding. Quality and quantity of information provided by funding advisers. 10. Do you have any suggestions as to improvements that would encourage you to increaseyour exposure? Procedural. Structural: Price calculation Cash flow, for example involvement of sub-debt Precedents from PFI/Scottish system for stock transfers. Do you have any radical suggestions/proposals to improve the attractiveness of LSVTs to funders? 11. Do you have any other views/observations on poorer urban stock transfers to encourage youto increase your exposure to them? Risk allocation. Demand studies. Procurement and implementation of investment programmes. Size of funding requirement. Other. 12. How do you think the market will develop in the absence of changes to the process? Implications of recent transfers experience, for example Coventry, Sunderland. Changes to covenants/ratios. Full v partial funding at transfer. Other potential developments. Appendix III - Questionnaire to LSVT borrowers 1. Name of Organisation 2. Name and position of interviewee 3. Size of original loan facility, size of expected loan facility, size of loan facility now 4. Strategy in fund raising process Debt. Other styles of funding. 5. Number of funding offers received/expected Types of funding offers received/expected. Form of competition. 6. Satisfaction with original loan package Pricing. Flexibility. Covenants. Any trade-offs accepted. Post completion relationship with funders. 7. Views on role of ODPM/Housing Corporation/local authority in fund raising process 8. Views on fund raising process generally 9. Standard of funding advice received How selected. Value for money. 10. Views on full or partial funding at time of transfer 11. Understanding of funding package at time of transfer Timing of appointment of Finance Director. 12. Post transfer experience Out-performance of business plan. Risks encountered: Demand issues. Procurement and implementation of investment programme. Number of refinancings undertaken. Benefits of refinancing(s) and options considered at the time. 13. Any other views/experiences Appendix IV - Organisations contacted to ascertain their views Royal Bank of Scotland Halifax plc Bank of Scotland Nationwide Building Society Abbey National Treasury Services Bradford & Bingley Plc Barclays Bank Plc Lloyds TSB Bank Plc Britannia Building Society HSBC Helaba Hypo Vereinsbank BN Paribas Dexia KBC Bank Nomura Royal Bank of Canada ABN AMRO Dresdner Kleinwort Wasserstein Morgan Stanley NM Rothschilds & Sons Ltd PUK Standard & Poors Freud Lemos Regent Pacific Group Sector Treasury Services Hacas Exchequer Services AMBAC International Beacon Housing Association Sheffield City Council Burnley & Padiham Community Housing National Housing Federation Council of Mortgage Lenders Trowers & Hamlins Jenkins & Hand Appendix V - Banks and building societies assessment of return on loans to LSVT RSLs INTRODUCTION Banks and building societies receive a significant number of lending proposals every year.Each lending proposition has to compete with other lending opportunities for the lendersscarce and theoretically expensive capital. The purpose of this appendix is to outline how leading lenders to the LSVT sector wouldassess the potential returns arising from the lending proposition. It begins by consideringthe requirements of the lenders regulators for the maintenance of adequate levels of capitalto meet the potential loses arising from the loan. The appendix then considers how returns would be measured against the capital set asideto meet the potential losses. Finally, it looks at the lenders cost of funding loans to LSVT RSLs and how a hurdle ratemight be established to identify transactions that add to the lenders shareholder value. This Appendix should be read in conjunction with the sections earlier in the report discussingBasel II, which when implemented, is likely to codify a number of existing capital adequacy practices. CAPITAL ADEQUACY Capital adequacy aims at setting a minimum level for a lenders capital base as a function ofrisks. A bank and building societys capital base is not limited to equity plus retained earnings;it includes any debt, which is subordinated to its other commitments. The Cooke ratio is an industry measure which is used to assess the minimum requiredcapital as a fixed percentage of assets weighted according to their nature and is designed tocater for credit risk. In the calculation of this ratio, assets are weighted according to theirquality in terms of credit standing. The rating scale starts at zero, for commitments with public counter parties up to 100% forcorporates. Other weights are 20% for banks and municipalities within OECD countries,and 50% for mortgage backed loans, including loans to Registered Social Landlords (RSLs)secured by a fixed charge over residential property let to a tenant. The Bank of England stipulates that a banks capital base should be at least 8% of weightedassets. For building societies this was set by the Building Societies Commission, and now bythe Securities and Futures Authority, at around 10%. Without capital, banks and building societies would fail at the first loss not covered by baddebt provisions. RISK: RETURN EQUATION Each new proposition brings risk and the risk:return equation arising from the lendingproposition, should subject to other strategic priorities, meet the lenders targets. If the lender only considers the potential returns arising from a lending proposition, and theassociated risks part of the equation is ignored, a number of important issues cannot beaddressed. These include: the performance of individual transactions and business units, may not be fullycompared without adjustment for their inherent risks; the assessment and pricing of the risks of lending to counter parties is uncertain; and the optimal allocation of the banks total risk exposure to business units or transactions. RISK-ADJUSTED PROFITABILITY Risk-adjusted profitability measures seek to address the issues raised in the previous paragraph. The main functions of such measures are: the reporting and comparison of profitability and risk across business units, productsand customers; measurement of transactions and portfolios against profitability targets; aid pricing of risks; and the allocation of the lenders capital across business units, products and customers,based on the risk reward profile. This allocation of risk and capital is firstly at the strategic level of lending to different sectors,for example corporates, public authorities, Private Finance Initiative transactions, RegisteredSocial Landlords and other types of borrowers. Through the allocation of risk and capital,a bank is able to establish exposure limits and target returns for each sector. Secondly there may be a balancing between different loan portfolios within a business unit,for example between portfolios of loans within the banks corporate lending division. Allocation of risk within a lenders portfolio of loans to a particular sector, for examplea lenders loan portfolio to RSLs may be sub-divided into traditional associations andLSVT landlords. Risk should be allocated to individual borrowers to ascertain target returns and exposurelimits for each borrower. However, there may be some lending propositions where, whateverthe potential returns, the lender is not prepared to accept the inherent risks. This has beenseen where some high risk, negative value, poorer urban stock transfers received very fewfunding proposals. REGULATORY AND ECONOMIC CAPITAL There are two measures used by lenders to assess the amount of capital that has to beassigned to support their lending activities, regulatory and economic capital. Regulatory capital Some lenders use relatively simple methods to measure the risk: return equation. They maycompare total interest and fees, net of costs and expenses, with the level of regulatorycapital that has to be set aside in accordance with the Bank of England/FSAs requirements,to cover the possible losses arising from the potential loan. Using this approach, the calculation to determine the amount of regulatory capital requiredto support a loan to an RSL would be: Amount of Loan x Capital Adequacy requirement x Risk Weighting of Asset. For a loan of £1m to an RSL assuming an 8% Capital Adequacy requirement, thiswould be: £1m x 8% x 50% = £40,000. Economic capital The methodology of adjusting a banks capital for the risks inherent in a funding propositionis based on determining the level of Economic Capital or Capital at Risk (CAR) from thepotential losses arising from individual lending propositions, business units or the banksentire portfolio. Funding propositions with strong counterparties (for example large, financially strong,established RSLs, with unencumbered reserves) will appear more attractive based on riskadjusted returns than based on regulatory capital, because they will be deemed to require lesseconomic capital. In contrast, riskier propositions with poorer counterparties (for examplenew RSLs with no reserves or track record) are advantaged when regulatory capital is used,because under an economic capital methodology they would require more capital. Economic capital is intended to correct such distortions and is defined as the amount ofcapital that the bank needs to set aside for the potential loses (expected and unexpected)arising from its loan facilities, (including derivatives) to borrowers. The calculation to determine the amount of Economic Capital required to support a loanto an RSL would be: Amount of Loan x Capital Adequacy requirement x Economic Capital requirement. For a loan of £1m to a weak RSL taking the transfer of stock in a poorer urban area,assuming an 8% Capital Adequacy requirement, this might be: £1m x 8% x 75% = £60,000. Regulatory v economic capital a comparison The simplest way of defining CAR is to use the regulatory capital requirements of the Bankof England for banks or the Securities and Futures Authority for building societies. Simplistically, there would appear to be no need to be more accurate than the regulatorsrequirements. However, using regulatory capital as a substitute for economic capital resultsin important distortions because of the divergence between the real risks arising from lendingpropositions and the forfeited risks of regulatory capital. For regulation purposes, the amountof capital to be set aside is dependent on outstanding balances (amounts at risk), and on asmall number of categories of counter parties, including loans to RSLs. With regulatory capital, credit risk is identical for short-term and long-term loans, in spiteof the obviously higher risk in the case of long-term loans. Most loans to LSVT RSLs arefor 25 to 30 years and should carry a higher capital requirement than say 5-year loans tothe same borrower. The regulatory capital requirement for LSVT RSLs is the same for all loans to RSLs securedon residential property, regardless of whether they are LSVTs and their individual creditstanding. In the case of an LSVT for a poorer urban stock, a loan to a financially strong,well established existing RSL, with substantial unencumbered reserves, has the same regulatorycapital requirement as lending to a newly formed RSL with no track record and no reserves.Thus regulatory capital fails to reflect the real risks to the lender of two very differentstrength potential borrowers. Whilst LSVT RSLs are members of a regulated sector, and therefore one could argue thatthe credit standing of the two RSLs described in the previous sentence should have relativelysimilar credit standing, this clearly fails to recognise the significant gap in potential defaultrates between the two borrowers. Finally, the regulatory capital requirement measures risk over a portfolio of loans, by simplyadding together the individual credit risks ie, the sum of the 50% Cooke ratio requirementsfor drawn balances to RSLs in the portfolio. This ignores the diversification effects and resultsin the same measure of risk for all loans in a widely diversified portfolio, such as loans toLSVT RSLs. RAROC MEASURES The ratios used to calculate risk-adjusted returns are known as RAROC or RARORC. Theyare very similar, but either use regulatory capital or economic capital (Capital at Risk). Theyare normally calculated on a before tax basis. This is on the premise that a banks lendingoperations has little or no influence over its tax policy and liability. RAROC or Risk-Adjusted Return On Capital adjusts the returns for risks, for instance bycalculating returns net of statistically expected defaults. The RARORC or Risk-Adjusted Return On Risk Capital is profitability arising from theproposition, loan or portfolio of loans, calculated on Capital at Risk. These measures are designed to contribute to a banks shareholder value, by steering theoverall credit portfolio towards a more optimal risk/return balance. However, a fundingproposition that meets risk adjusted return requirements does not necessarily make it agood deal. Risk Adjusted Return On Capital (RAROC) The RAROC ratio adjusts the earnings to the bank over the expected life of the loan tothe LSVT RSL and uses regulatory capital as a measure of the banks capital required tosupport the loan. The RAROC calculation becomes: Present Value of Risk Adjusted Net Earnings less Losses arising from statistically expecteddefaults/Regulatory Capital. Calculation of risk-adjusted net returns A banks earnings for a loan to an LSVT RSL would include Arrangement Fees, CommitmentFees (if payable by the LSVT RSL), Interest Margin, Renewal Fees, and Annual MonitoringFees etc. These would be calculated for each year of the loan period using the loans expecteddraw down and repayment profile. Where a relatively large Arrangement Fee is received with commensurately lower initialinterest margins, the model may amortise the Arrangement Fee over an appropriate numberof years. The financial model may use either nominal (projected outturn) prices or real cash flows.For positive value LSVTs the loan profile is relatively standard, with a peak debt in years12-15 and repayment between years 25 and 30. From the annual net interest and fee income, is deducted the lenders costs, including: Servicing the loan. Marketing costs. Loan administration cost. Client relationship management. Back office costs. An allocation of central overheads to cover credit department and other costs. All of these costs will be projected forward for the entire period of the loan, along withassumptions for annual increases. Credit grading of LSVT RSLs In order to risk-adjust annual returns, the bank has to risk assess or grade the potentialLSVT RSL. This may be done in a variety of ways, including subjective judgement or ananalytical methodology. In this respect Basel II accepts the principle of Internal RatingBased (IRB) approaches. One approach may be to compare a new LSVT proposition with industry performancestandards (including those published by the Housing Corporation) or the banks internalexperience of LSVT borrowers, to ascertain a comparative measure of risk. Alternatively, a relatively sophisticated credit rating method may be used to compare thepotential LSVT borrower and its funding proposition against a number of factors to determinea weighted average rating. Each factor may have a weighting to reflect its importance ordegree of risk. The factors that may be considered include: constitution; political and tenant support for the transaction; experience, expertise and composition of the board; recourse to unencumbered assets and reserves of a large, financially strong RSL; executive management skills and experience; management understanding and ownership of the organisations business plan; standard of advisers; size of organisation; secured or unsecured facility; number and type of properties being given as security (proportion of flats, shelteredaccommodation etc); demand for the recipient landlords properties; construction programme and risk; social inclusion challenges facing the potential borrower; degree of intended diversification into non-core activities; rent levels; purchase price being paid; perceived margin of comfort/flexibility in potential borrowers business plan; and valuation for loan security headroom. Once the weighted rating of the potential borrower is established (and perhaps agreed withthe banks internal and independent credit function) this can be used to ascertain a shadowcredit rating. This would be achieved by comparing the internal weighted rating to a tableof shadow ratings from a recognised credit rating agency. Given the role of the HousingCorporation and its strict regulation and monitoring criteria, one might expect these shadowratings to fall in a relatively narrow range. When a shadow rating for a funding proposition is ascertained, the bank is able to add anappropriate interest margin to a risk free rate to derive a risk-adjusted interest rate. Thisappropriate interest margin is such as to increase the risk free rate to a level reflecting therisk attaching to a transaction with the risk profile of the funding proposition. The risk free rate may be the Gross Redemption Yield on UK Government gilts with asimilar maturity to the average life of the loan. The average life of the loan will be less thanthe final repayment date of the loan because of the loans amortising profile. This risk-adjusted interest rate is used to discount the cash flow of the banks future netearnings to a present value. Loss severity Given this potential default guideline, the severity of the banks loss that would result froma default scenario, needs to be ascertained. This is generally a matter of the judgement ofthe lending officers and the independent credit function. In the case of LSVT RSLs, degreesof severity would be determined by the location, standard and quality of properties beingacquired by the borrower and charged to the lender as security. Properties (particularlymulti storey flats) in poorer urban areas are unlikely to score highly in contrast to 3 bedroomsemi-detached houses in market towns. The severity loss rating would normally be the percentage of the total loan facility outstandingthat would be lost by the lender at the time of default. Independent valuers would have animportant role in determining the open market vacant possession value of a phased disposalof void sales. The lending bank would determine the amount of capital arising from the LSVT lendingproposition that it has to earmark for unexpected losses. Statistically expected defaults arising from the funding proposition are derived from theshadow credit rating and historic data of losses arising from borrowers with that grade overthe life of the proposed loan facility. In the case of LSVT RSLs losses arising from statisticallyexpected defaults might be relatively small given the performance track record of the sectorand the role of the Housing Corporation in arranging transfers of engagements of ailingRSLs. In this respect the losses experienced by the lenders to LSVT RSLs, might provideuseful background. The risk-adjusted present value of the banks future net returns less the losses arising fromstatistically expected defaults, is divided by the amount of regulatory capital required tosupport the loan to determine the RAROC of the funding proposition. Risk Adjusted Return On Risk Capital (RARORC) The RARORC calculation is: Present Value of Risk Adjusted Net Earnings less Losses arising from statistically expecteddefaults/Risk Adjusted Capital (CAR) The shadow ratings outlined in the previous section, would enable the bank to refer to arating agencys table of potential default risk. It should be recognised that the potential ofborrower default increases with the period of the loan facility. So in this respect, notwithstandingthe role of the Housing Corporation in arranging transfers of engagements, LSVT RSLswith 25 to 30 year facilities may have a relatively high default risk potential. Given that banks do not publicise their default history for borrowers, nor have they creditgraded all borrowers in the past, the reference table will probably relate to public capitalmarket issues, particularly debt issues. These public issues are often rated by a recognisedrating agency and as they are listed instruments on a recognised Stock Exchange, theredefault history is readily available. Hurdle rates and the lenders cost of funding Simplistically, each lender has a rate of return (generally in terms of a percentage) whichmarks the watershed between a lending proposition being worth undertaking and not. Thepercentage may be on a risk-adjusted basis as discussed above. If the lending propositionsreturn were higher than the hurdle rate then the lender would be creating shareholdervalue by providing the loan. If the return from the lending proposition is less than the hurdlerate it would (absent of other profitable transactions with the borrower) be destroyingshareholder value if it undertakes the transaction. Hurdle rates may be set at artificially low levels where the lending proposition is seen asbeing of strategic importance for the lender. Loans to LSVT RSLs are unlikely to be seen asstrategic for lenders as the market for these loans is mature having been developed since1988 with around £9.3bn of loans outstanding. Capital asset pricing model The Capital Asset Pricing Model (CAPM) provides a useful guide as to the return a lenderhas to earn on a lending proposition in order to justify the assignment of capital to the loan. Using the CAPM, the cost of equity for a lender may be defined as: R = rf + Brm Where, rf is the risk free rate of return, rm represents the market risk premium and B(beta) is the systematic risk of investing in that share. The risk free rate of return is generally taken as the return that an investor can achieve byinvesting in UK government securities (gilts). Loans to LSVT RSLs are looking at futurecashflows, so we look at returns on gilts over the length of the lending proposition. For loansto LSVT RSLs where the loans are generally for 25 to 30 years, returns on gilts of this maturitymay be used. However, if the loan were expected to be refinanced in say 5 or 10 years, returnson gilts of this maturity would be used. Given the relatively flat shape of the current yieldcurve, the difference between yields on short and long dated gilts, is not significant. The beta of a share measures the relationship between changes in an individual share priceand the changes in the underlying share index. It measures the systematic risk taken whenan investor buys that share and identifies to what extent the share price of that share willmove in line with the market. The higher a shares beta, the riskier the share. A share havinga beta greater than one will generally move more than the market and is sometimes describedas a volatile share. A share having a beta of less than one generally moves less than the marketand is sometimes thought of as a defensive share. Betas are generally calculated using historicdata over a 60 month moving average. This time horizon is often used as it generally containsa full business cycle. The market risk premium represents the additional return an investor can obtain frominvesting in equities as compared with risk-free alternatives such as government gilts. Estimatesof market risk premium can be either forward or backward looking. This reflects what an institutional investor needs to give up for the relative security of the bond market for themore uncertain equity market. Leading equity market commentators (including Ernst & Young), and the London BusinessSchool prepare estimates of the market risk premium. Looking backwards, ABN Amro andthe London Business School calculate that over the last 100 years the nominal market riskpremium has been 5.8% and 5.3% on a real basis. Barclays Capital calculate that real market risk premia have been as follows: 10 years 2.4% 20 years 4.1% 50 years 6.5% 101 years 4.4% Credit Suisse First Boston calculates that the nominal market risk premium during theperiod 1918 to 2000 was 5.9% and 5.7% on a real basis. Ernst & Young currently uses a nominal market risk premium of 6%, and being close to therange of views outlined above, this figure will be used in the calculation below. In order to determine whether a lending proposition adds to shareholder value, the cost ofthe lenders debt needs to be included in the calculation of the lenders overall WeightedAverage Cost of Capital (WACC). This is because a lenders capital base is not composedpurely of equity. The calculation can be represented as follows: Lenders WACC Risk free cost of debt + (market risk premium x Beta factor) = Cost of Equity Risk free cost of debt + premium over risk free rate = Cost of Debt Lenders Weighted Average Cost of Capital equals: Cost of Equity x Equity as a % of market value of total capital + Cost of Debt x (1 Tax rate) x Debt as a % of market value of total capital Debt raised by the lender as part of its capital base to support its lending operations carriesa tax shield because the interest payable on such debt is deductible before the lenderstaxable profits for Corporation Tax purposes are calculated. WORKED EXAMPLE (AS AT 28TH FEBRUARY 2002) Cost of equity Risk free cost of debt = Gross Redemption Yield (GRY) on long gilt = 4.8% Market Risk Premium = 6% see above Beta for leading LSVT lenders (From London Business School) ranges between 0.80 and 1.11,so for the purposes of this worked example we will use 1.0 Cost of Equity = 4.8% +(6.0% x 1.0) = 10.8% Cost of debt Risk free cost of debt = 4.8% Premium over gilts for long dated sub-ordinated debt for a leading LSVT lender(for example HBOS or Abbey National)= 1.0% Cost of debt = 5.9% WACC WACC for a leading LSVT lender assuming a capital structure of 66% equity/34% debt: Cost of equity x 66% = 7.13% Cost of debt x (1 Corporation Tax rate) x 34% = 5.9% x (1 30%) x 34% = 1.40% WACC = 7.13% + 1.40%= 8.53% From WACC to hurdle rate If the LSVT RSL lending proposition is not risk adjusted, this WACC would need to beincreased by the credit risk attaching to the LSVT RSL. The extent of this credit spreadwould need to be estimated, perhaps using the spread over gilt yields for structured andunstructured capital markets issues for LSVT RSLs. Appendix VI - Funders main observations on funding stock transfers BANKS/BUILDING SOCIETIES 1. Margins and pricing generally declined to levels that make loans to LSVT RSLs ofmarginal or insufficient attraction given the long-term nature of the funding requirement. 2. Government support (housing benefit) and role of Housing Corporation as regulator isvery important. 3. The consolidation of leading funders could be beneficial if it reduces the number offunders and causes interest margins and pricing to rise. 4. Timescales are too short and funders are involved too late in the transfer process. 5. The standard of advisers and information is very variable. 6. PFI style repairs and maintenance contracts may be useful in poorer urban stocks giventhe risk attaching to construction cost inflation. 7. Exclusive underwritten Banks/building societies deals are unpopular with funders whoare not involved. 8. Political risk is significant and perhaps the largest risk to the sector. 9. The number of syndication participants has declined to a negligible number and thosethat exist have relatively small capacity. 10. Minimal innovation has occurred apart from that promoted by funders. 11. There is a need to learn from the lessons of problem LSVTs. 12. Whilst LSVT transactions are seen primarily as cash flow transactions with residentialproperty backing, asset cover is becoming an increasing problem. 13. The views on the potential implications of Basel II are variable. 14. Tenant controlled boards are unpopular. 15. Some funders would like a larger LSVT programme to increase funding requirementsand interest margins receivable. 16. Land sale risk would be unacceptable to some funders. 17. The long-term financial viability of LSVT borrowers particularly in poorer urban areasneeds to receive more emphasis in developing business plans. INVESTMENT BANKS 1. Public sector could take more initial risk in return for further consideration later. 2. Creation of a central securitisation vehicle could be useful perhaps sponsored by PUK,with other funders providing different layers of debt. 3. Partially funded transactions on the day of transfer are seen as too risky particularly in amarket with a limited number of funders. 4. Bonds could be held by the public sector sponsor of the transfer and sold off later by atender process. 5. Monitoring of guaranteed loans to LSVT RSLs taking more time than anticipated bymono-line insurers. 6. Securitisation of bank/building society loans to LSVT RSLs should be looked at to freeup capital. 7. As in health PFI schemes, LSVT RSLs with a funding requirement above a certainlevel (say £150m) could be required to review the efficacy of bond finance. 8. A private bond market may be developing for sizes of £30m to £100m. Appendix VII - LSVT generic illustrative risk matrix RISK TYPE RISK LIKELIHOOD OF THE RISK IMPACT OF RISK OCCUR OCCURING HIGHMEDIUMLOWPROBABILITYHIGHMEDIUMLOWINCRE % COS REDU INCO INVESTMENT Stock Condition STRATEGY information may be inaccurate. Investment strategies may not be coordinated with other strategies in the area such as urban renewal, education, crime prevention. Investment expenditure may not be sustainable ie, need to be repeated before the end of the expected useful life of building components. The investment strategy may not have sufficient flexibility to meet changing needs, for example in levels of demand, tender prices, tenant requirements. It may focus too closely on the short term and a static model of the housing stock. Delays may occur at preliminary and tendering stages which hold up the implementation of the investment programme. Investment strategy may not recognise the revenue implications of investment proposals. Full decant requirements may not be built into the business plan and/or investment costs, including buying out leaseholders. Leaseholders may share common areas with tenants and may not be willing to pay their share of repair costs. Investment strategy may not be appropriately linked to demand patterns thereby resulting in investment being undertaken on properties for which there is not long term sustainable demand. PROCUREMENT Capital programme may not be delivered within time and budget therefore failing to meet the undertakings to tenants and funders asset value requirements. This may be caused by one or more of the following risks. There may not be enough contractors in the area with the experience to deliver the large scale contracts required by the transfer, this could result in the investment being delayed or more costly than the business plan assumptions. There may be insufficient project management capacity available to the recipient RSL, to ensure that the required large scale contracts are let and operated efficiently. Funders conditions precedent to drawdown may not be met by recipient RSL, causing cash flow problems for RSL. The receiving landlord may be tied to contracts with direct service organisations if these organisations under perform they may expose the RSL to financial risks. The large number of contracts involved may result in tender price inflation above the levels assumed in stock condition surveys/investment programmes. Poor market intelligence may result in contracts being poorly packaged and let at prices which are higher than necessary. Contractors may experience financial failure resulting in an inability to deliver the full investment programme. DEMAND The demand analysis on which the business plan is based may be over optimistic, this may be caused by one or more of the following risks. Certain areas of stock may experience collapsing demand, for example as a result of changes in the economy or as a result of popularity/reputation issues, thereby reducing the income available to the recipient landlord. The contracts may not build in sufficient quality and commitment to continuous improvement, for example Egan principles. FINANCIAL Interest rate risk MARKET AND and counter party OPERATIONAL risk may result in increased costs for the RSL. Inflation risk may cause income to increase less than expected in the business plan. POLICY RISK Business Plans may be exposed to future changes in the VAT regime. Changes in Right to Buy (RTB) legislation could reduce income or reduce stock. MARKET Loan conditions imposed by funders are onerous in relation to delivering tenant guarantees and expected commitments to the local authority. MANAGEMENT Local authorities are likely to self insure many risks RSLs will not have the capacity to do this to the same extent. Any delays in excess of that assumed in the RSLs business plan in processing housing benefit by the local authority will impact on the RSLs income. Void levels and/or arrears may increase above the levels assumed in the business plan. Rents may not be set at an appropriate level to ensure continued demand and affordability. Receiving landlord may fail to meet the priorities of the local authority, resulting in lack of commitment from the local authority. Management structures established (including subsidiaries) may fail to meet the balance with economies of scale and governance requirements. The receiving landlord may not be able deliver on regulatory standards, for example in relation to energy efficiency, health and safety, and meeting decent home targets. The receiving landlord may be required to take on existing contracts which it has not negotiated, the terms of which may not be advantageous, for example in relation to asylum seekers. CHANGE-OVER Handover data in relation to rents, stock and costs may be inaccurate, any split of stock may introduce additional risks. Staff skills may not match the profile required by the receiving landlord. Receiving landlord may fail to meet registration requirements. The board of the receiving landlord may not have sufficient skills to efficiently and effectively manage the organisation. Pre transfer settlements with the local authority may be onerous, for example on RTB receipts or arrears resulting in too high a purchase price being paid by the recipient landlord. Information on additional property forming part of the transfer may be inadequate (for example commercial property, garages, roads and footpaths), causing the RSLs business plan to underestimate the costs of future maintenance. Funders due diligence may uncover further liabilities for the recipient landlord. Title to the stock may not be clean leading to delays and additional costs and also potential difficulties with implementing the investment programme. Receiving landlord may fail to develop a package which balances an attractive tenant package and prudent business planning. ENVIRONMENTALLand contamination may be discovered beneath or close to transferring stock or development land. This can be a significant risk which the recipient landlord is unable to absorb. These are generally covered by a warranty from the vendor local authority who may arrange specialist insurance to cover its liability under such warranty. Appendix VIII - Leaseholder risk to LSVT RSLs in poorer urban and large metropolitan stock transfers INTRODUCTION The purpose of this appendix is to outline the risks to transfer organisations in assuming theobligation for repairing and improving properties, which contain both leaseholders (otherwiseknown as owner occupiers) and tenants. The implications for recipient RSLs of decantingboth tenants and leaseholders, particularly in blocks of properties earmarked for demolition,are considered. It also examines potential mitigation strategies that stock transfer RSLs maybe able to pursue in order to reduce the risks associated with properties involving leaseholders. BACKGROUND Tenants in Council property have the right to purchase their property at a discount to the openmarket value, related to the number of years of residence. There are now around 200,000properties throughout England where a local authority or transfer RSL is the freeholder(included in this number is a significant number in urban and large metropolitan areas).This means that responsibility for the cost of repairing common (shared) elements of theproperty lies with both the Council (or RSL in the case of a stock transfer) and the leaseholderswithin the block. Most owners of flats, which were formerly Council property, will be leaseholders. The Councilwould retain the freehold, which would be transferred to the recipient RSL in transfer of thehousing stock. Ownership of the freehold will provide certain rights to the landlord. Thesewill normally include the ability to levy reasonable service charges to cover costs related torepair, maintenance and communal services such as landscaping and stair cleaning. Thefreeholder will then be responsible for the provision of these services. The lease with eachleaseholder will determine the rights and responsibilities of each party. If the freehold istransferred to the RSL as part of the housing transfer it is highly likely that these rightswill also transfer. Whilst elements of the repair and improvement of the property subject to service chargesto leaseholders depend on the terms of individual leases, but can include roof repair orreplacement, insulation, works to the common stairs and similar works. Recipient landlords will face a number of issues in relation to the leasehold arrangements: The leaseholder may only be responsible for certain types of work and may not be responsiblefor payments relating to improvements to the property, or may only be responsible incertain defined, circumstances. The landlord may be required to provide an estimate of future service charges to tenantsconsidering becoming leaseholders under the Right to Buy. Leaseholders cannot becharged more than this amount during the first five years after purchase. Leaseholders will generally have the right to consultation, before contracts with contractorsare placed and work commenced. These issues will mean that recipient landlords will have to assess how: They will fund the full cost of improvement works. They will deal with repairs to properties where some leaseholders have bought withinthe past five years. They will manage the programme to ensure their obligations to tenants during theconsultation phase are met. LEGISLATIVE BACKGROUND Section 20 of the Landlord and Tenant Act 1985 currently requires landlords to consultleaseholders before carrying out works costing more than a prescribed amount, where thecosts of the works would be met by leaseholders through service charges. The prescribedamount is currently the greater of £1,000 or £50 times the number of leaseholders who arerequired to pay service charges. These amounts can be varied by secondary legislation, butthe formula cannot. The above legislation sets out detailed requirements for the consultation process. Differentrequirements apply where there is a recognised tenants association (RTA). In all cases atleast two estimates must be obtained by the landlord for the proposed works, and at leastone of these must be from a contractor who is wholly unconnected with the landlord. Wherethere is a RTA, the landlord must supply a full specification of the proposed works and theRTA has the right to ask the landlord to invite alternative contractors to provide estimates.The landlord is required to have regard to observations put forward by leaseholders or a RTA. If a landlord fails to comply with the requirements of Section 20, any costs in excess of theprescribed amount cannot be recovered through service charges, although a county court mayoverride this restriction if it is satisfied the landlord had acted reasonably in a particular case. The formula for determining the prescribed amount relates to the total cost of the job ratherthan the amount payable by individual leaseholders. The requirements only apply to specific works and would not catch contracts for the provisionof ongoing repair and maintenance contracts. Landlords are currently free to enter intolong-term contracts for the provision of works which could cost leaseholders considerablymore than the prescribed amount over a period of time, without giving the leaseholders anyopportunity to comment. For RSLs taking stock transfers of poorer urban and large metropolitan housing stock, theremay be risk mitigation advantages to be gained from long-term repair and maintenancecontracts, particularly for large estates including tower blocks. LEASEHOLDER CONSULTATION Following the report Rethinking Construction by Sir John Egan, there has been a growingtrend towards long-term partnering approaches. The requirement to consult leaseholders on particular works under Section 20 can causeproblems with long-term maintenance contracts, which as a means of reducing the risk oflong-term maintenance costs, can be useful to RSLs undertaking transfers of poorer urbanand large metropolitan stock. If the RSL has entered into a contract with a private sectorcontractor to carry out future maintenance costs, it would not be able to accept anyalternative estimate to satisfy the observations of leaseholders. However, it is important that leaseholders concerns about matters which may involve themin significant costs are properly taken into account before decisions are made. Leaseholdersmay wish to question whether the works are necessary or whether there is an alternativeand less costly way of resolving a particular repair requirement. Given that long-term repair contracts may be attractive to RSLs acquiring poorer urbanand large metropolitan housing stocks, it is therefore important to ensure that the concernsand rights of leaseholders can be met. ODPM is introducing revised leaseholder consultationarrangements primarily designed to address issues identified in the housing PFI pathfinders. Section 151 of the Commonhold and Leasehold Reform Act 2002 would replace the existingdetailed requirements of Section 20 of the Landlord and Tenant Act 1985. New Sections20 and 202A of the 1985 Act envisage two stages at which consultation with leaseholderswould be required. Firstly, where a landlord was proposing to enter into an agreement ofmore than 12 months which would lead to costs being recovered from leaseholders throughservice charges. Secondly, consultation would be required when a landlord was proposing tocarry out specific works which would result in costs of more than a prescribed amount beingrecovered from any leaseholder through service charges. Detailed requirements would beset out in regulations. ODPM plan to consult on draft regulations in August/September 2002.It is expected that the final regulations will be published around February 2003 and will comeinto force three months after that. Consultation of leaseholders on long-term agreements Long-term contracts for the repair and maintenance of poorer urban and large metropolitanhousing stock are in their infancy and could cover a wide range of risks from the simple tothe complex. Section 151 of the 2002 Act enables regulations to make provision generallyor only in specific cases and to make different provisions for different purposes. For contracts primarily intended to cover arrangements where all management and maintenancefunctions relating to leasehold property are to be carried out by a third party, the third partywill either carry out all the functions themselves or act as a main contractor with particulartasks being subject-contracted. The key features of this type of arrangement are that the contractor will carry out all theworks and services as and when required, and that details of the works and services forindividual properties together with the precise cost will not be ascertained in advance. Thelandlord would be required to inform leaseholders of the proposed scope of the contract(ie, the nature of the works and services that are expected to take place during the periodof the contract). The landlord would be required to obtain bids from at least two contractors(at least one of which to be wholly unconnected with the landlord). Details of the bidders would be supplied to the leaseholders together with an indicativeestimate of the costs applicable to their property over the period of the contract. Leaseholderswould be able to make representations on these matters and the landlord would be requiredto have regard to those representations. Where leaseholders specifically request, the landlordwould be required to make available copies of the tender documents. To avoid the need to consult on relatively trivial contracts where the cost to leaseholderswould be minimal, consultation will not be required where the cost recoverable from anyleaseholder during a 12 month period does not exceed a prescribed amount. ODPM areproposing this amount should be £25. Consultation of leaseholders on specific works The ODPM proposes to adopt a common procedure regardless of whether or not there isa RTA. The rights of leaseholders, individually or as members of a RTA, should follow thecurrent arrangements for consulting RTAs in Section 20(5) of the 1985 Act, subject to anumber of changes. The requirement to produce at least two estimates and the right to nominate other contractorswould not apply where the works were to be carried out by a contractor (who carries outthe works or acts as main contractor) under an agreement of more than 12 months andwhere leaseholders had been consulted on the award of that contract. Leaseholders wouldbe able to make representations about the detail of the proposed works and suggest alternatives.It is thought that this should avoid many of the difficulties experienced with partneringarrangements for the refurbishment and maintenance of housing stock. The trigger for leaseholder consultation should be the amount payable by any leaseholderrather than the cost of the job, as at present. Where the proportion of costs payable byindividual leaseholders varies, the threshold may only be exceeded for some of the leaseholders.In such cases, all leaseholders should be included in the consultation process. ODPMproposes to adopt the figure of £250 as the threshold for leaseholder consultation under thenew arrangements unless there is a clear consensus in support of a higher or lower amount.It is the intention that the amount would be raised from time to time to reflect inflation. Compliance with the consultation requirements would not, in itself, affect the requirementfor service charges to be reasonable, or leaseholders rights to challenge the reasonablenessof service charges at a Leasehold Valuation Tribunal. Although ODPMs proposals for leaseholder consultation should address most of the existingissues, leaseholders may still be able to frustrate the implementation of the investmentprogramme by: some may not giving consent and this may delay or prevent the RSL from implementingits crucially important repairs and improvement programme management time involved; some may be unable to afford their proportion of the works and/or service charges ormay need assistance in order to fund them; and investment programmes may have to be rescheduled to suit the pattern of ownership inindividual blocks. IMPLICATIONS OF REDUCTION OR A DELAY TO THE RSLSINVESTMENT PROGRAMME If the transfer RSLs is unable to invest in properties where there is mixed ownership inaccordance with its Business Plan (B/P), a number of issues may arise. While initial investmentcosts may remain unspent thereby reducing loan draw down requirements, there may be anumber of very significant short, medium and long-term implications. Limiting investment to internal works for tenants within mixed tenure blocks is likely to becontrary to some of the primary objectives set for poorer urban and large metropolitan stocktransfers and may impact on the ability to provide guarantees to tenants prior to transfer orto fulfil guarantees post transfer. Since most structural repairs relate to common elements ofproperty, such as roofs and walls, the condition of the property will continue to decline. Inthis situation the long-term cost/benefit of internal repairs and improvements may also haveto be questioned. The deteriorating condition of some blocks may blight neighbourhoods and prevent holisticand sustainable community regeneration which the RSL, government and sponsoring localauthorities are seeking to achieve. The value of these properties may decline creating anissue for the neighbourhood, the receiving RSL and for the owners themselves. This cycleof deterioration would inhibit the creation of long-term sustainable communities andhousing markets. It is likely that the long-term effect for both the receiving landlord and the neighbourhoodin general would be increased difficult-to-let properties; rising voids; anti-social behaviour;and increased future repair and maintenance costs. If true regeneration is to take place, and if tenant guarantees are to be met, these leaseholderswill have to be involved in investment and maintenance programmes in the initial stagesfollowing transfer and in future maintenance. ISSUES RSLs proposing to undertake investment in blocks (including demolition) where there areboth leaseholders and tenants will have to consider: whether they have the legal right to repair or improve leaseholders properties inaccordance with the lease and relevant legislation; how to secure vacant possession of the leaseholders property in the case of demolition; how agreement to works must be obtained (for example through a majority vote byleaseholders); whether leaseholders can be charged their share of the cost of works, through servicecharges or through other means; and how such charges will be charged and collected. The issues for a landlord receiving stock following a transfer will be to: Ensure that it can carry out the proposed investment programme across all properties,particularly in relation to any guarantees which have been provided during the ballot period. Avoid leaving owners with levels of debt which make it difficult or impossible for themto sustain home ownership. DEMOLITION OF LEASEHOLDERS PROPERTIES Some recipient RSLs will have identified properties, including those with leaseholdersproperties, which do not justify substantial investment. This may be due to a number offactors, including: The level of investment required is so large as to not represent good value for money. The block has already reached, or is approaching, the end of its expected useful life andwould require further investment in the relatively near future. The site of the block is strategically important and has a high alternative use value,which is important to the long-term viability of the recipient RSL. In such circumstances the RSL will be seeking to decant its tenants and buy-out the interestsof leaseholders. Compulsory Purchase Powers (CPO) may be required to secure the interestsof leaseholders. During the pre-ballot tenant consultation process, potential demolitions may be identified.This may prompt some tenants to submit an application to exercise their Right to Buy in theexpectation of making a sizeable profit in the prospective RSL seeks to secure vacant possession. In order to secure the vacant possession of leaseholders properties, they may need to be offeredacceptable alternative accommodation. In addition, they may need, along with tenants, tobe offered disturbance and removal assistance, particularly if they are of retirement age. The recipient RSL needs to ensure that: these costs which may be significant for properties in urban areas are fully reflected intheir business plan and in the Tenanted Market Value determination of the purchaseprice payable to the vendor local authority; the programme included in its business plan for securing vacant possession of unitspending demolition, is reasonable and deliverable with a reasonable margin of comfortfor slippage; it has the necessary resources to efficiently and effectively manage the labour intensiveprocess of the decanting and demolishing such properties; and if the alternative use value of the site is important in ensuring that the RSL will meetits asset cover requirements to lenders, then sufficient time is included in the businessplan to achieve demolition, site clearance, site rectification for any contaminated landand securing any necessary planning permission for change of use. LEASEHOLDER PROFILE In general, leaseholders of former local authority property tend to be at the lower end ofthe income spectrum. Leaseholders tend to fall into four main groups: Leaseholders who bought at a significant discount and are now of pensionable age. Leaseholders of pensionable age where near relatives have provided financial support tothe leaseholder to enable them to fund the purchase. Leaseholders who bought at a significant discount and continue to have an incomefrom employment. Leaseholders who bought the property on the resale market at full value, most of whowill have low to moderate income from employment perhaps with little equity. PROPERTY PROFILE In addition to leaseholder profile, which is relatively low income, property values amongstformer Council properties also tend to be lower than those in the privately built market andto show lower year on year increases in value. This will present a significant issue where owners are required to fund the proportion ofrepair costs, which may represent a significant proportion of the total value of the property.This may also be an issue where, due to the ongoing investment requirements of the property(particularly aging flats), service charges are expected to be significant for a number of yearsinto the future. This problem will be exacerbated where the repairs do not add significantlyto the open market value of the property. FINANCIAL ASSISTANCE TO LEASEHOLDERS Currently, the majority of assistance to owner-occupiers is provided by local authorities.The Housing Green Paper, Quality and choice A decent home for all published in 2000estimated that £250 million was provided per annum to approximately 70,000 households.This funding is used for a variety of support mechanisms to owners, not just for those in formerCouncil property. It includes grants for renovation, repairs to common areas and home repairassistance, which provides assistance for small-scale repairs. It is unlikely that the amountof assistance currently will be sufficient to meet the additional requirements created by thelarge post transfer investment programmes needed in poorer urban and large metropolitanareas, unless a significant proportion of total funding is ring-fenced for that purpose. RISK MITIGATION The costs to the transferring landlord of not dealing with leaseholders will be significant. Itmay mean a failure to meet the guarantees provided to the tenants in adjoining properties,along with rising voids, unpopular properties, neighbourhood decline and increased managementcosts. In addition, a failure to recoup costs from owners will reduce income. Receiving landlords will wish to ensure that they have sufficient mitigation against this risk.This could be done in a number of ways as set out below. Clearly establishing potential costs and sources of funding The stock condition survey and investment programme must clearly identify the costs toleaseholders of work, which will be carried out on common elements. The transferring local authority should then establish the level of local authority grantwhich owners can expect to obtain in order to assist with costs. This is likely to involvenegotiation with the local authority to ensure that an appropriate proportion of the grantbudget can be directed to matching the RSL investment programme. The RSL should examine the extent to which other grants (for example in relation toinsulation) can be obtained by leaseholders to assist with their service charge obligations. Establish legal framework The legal documentation for each lease may be different and may differ between differentblocks currently owned by the same local authority. The receiving RSL will need to ensurethe extent to which: it can undertake repair and maintenance work to common areas; it can undertake improvement to property; charges can be made to relevant leaseholders for such works; and the level of consultation with leaseholder is required. The answers to these questions will determine the extent to which this issue will affect thepost transfer business plan and the extent to which further mitigation is required. Additional financial assistance The RSL, on its own or in partnership with the local authority, may wish to explore schemeswhich would assist owners with raising the capital required to meet their proportion of thecosts involved. These may include equity release arrangements including second mortgages,easier access to low cost and low start loans, or savings funds. These may be run either by existing organisations or on an agency basis. The mechanismsto be used should be developed and agreed as far as possible prior to transfer. In additionany assistance available may affect the interest programme implementation and rate ofservice charge recovery. Rate of recovery Within the business plan the receiving landlord will wish to estimate an appropriate level ofrecovery of service charges from leaseholders. This is required since the works to the propertywill need to be undertaken whether or not leaseholders agree to pay so that landlordcommitments can be met. The assumptions in the RSLs B/P should take into account the level of grant and otherassistance available and also any available information on existing levels of recovery forsimilar work. Where a large number of leaseholders exist, the effect of any loss of futureservice charge recovery may be so significant as to require a reduction to the initial purchaseprice paid to the vendor local authority, thereby removing some of the risk from the RSL.The assumptions for recovery should reflect a pessimistic rather than optimistic view. In addition, the assumptions should also reflect the level of grant, which the local authority isable to commit. Rates of recovery may be improved to some extent by requiring a proportionof total cost to be paid prior to commencement of works. Sharing the risk If the number of leaseholders is significant as a proportion of the total number of propertiesto be transferred, it may be appropriate for the vendor local authority to share in the riskgiven the catch up nature of much of the early investment work. This may be done partlythrough sharing agreements and through the assumptions contained within the businessplan. If the problems are of a sufficiently large scale it may also be appropriate for some riskto be taken by other parties such as central government, for example through increasedgrants or through support to other schemes to assist owner occupiers. CONCLUSIONS Leaseholders will form an important stakeholder group in many poorer urban and largemetropolitan housing stock transfers and in the ability of the recipient landlord to efficientlyand effectively implement the investment programmes, which follow. Without leaseholdersparticipation, investment programmes may be seriously hampered; guarantees to tenantsnot met and holistic regeneration will not take place. It may also cause the RSL to defaulton some of its financial covenants and ratios with its lenders. The number of leaseholders in urban areas is likely to be more concentrated in flatted propertywith shared common elements with tenanted property. Transfer landlords will therefore haveto consider in detail the risks associated with properties containing leaseholders and militateagainst them through thorough assessment of costs, legal requirements, available grant andthrough robust assumptions in the business plan. Additionally, they may seek to share therisk with the vendor local authority and potentially central government, through the effectson the purchase price and through assistance with grant and other financial support. Appendix IX - Investment procurement risk to LSVT RSLs in poorer urban and large metropolitan stock transfers In poorer urban and large metropolitan stock transfers, the implementation of the large initialinvestment programme is of critical importance. Not only is it very often the primary reasonfor the transfer but it is central to delivering sustainable regeneration of the recipient RSLshousing stock. In addition, the RSLs funders will be keenly interested to see the efficientand effective implementation of its borrowers investment programme, thereby achieving itsloan to asset value financial covenant requirements. INTRODUCTION The purpose of this appendix is to discuss the risks associated with the procurement of investmentworks related to the large scale voluntary transfer (LSVT) of large urban and metropolitanauthorities housing stock. The first section covers the risks and how they may be mitigated.The next section gives a definition of procurement and identifies the broad areas of risk.Before discussing the risks in detail, the particular features of large urban and metropolitanLSVTs are discussed in order to set the context for the discussion of risks and mitigations. PROCUREMENT In this context, procurement describes the methods, systems and processes used by an LSVTlandlord to secure the services required to deliver the investment programme contained inits business plan. The investment programme is likely to be the largest area of cost incurredby the landlord and so, funders will be concerned to ensure that: The costs are accurate ie, that they address the sustainable investment requirements ofthe stock and are not significantly under or over-stated. The landlord can control the programme ie, that the risk of cost overruns, slippage anddelays is minimised. There are three broad categories of risk which are worth exploring: Specification risk: the risk that the wrong work is procured or that the correct work isnot procured. Sustainability risk: the risk that the work procured does not maintain or increase thevalue of the stock. Delivery risk: the risk that the landlord cannot implement the investment programmeas planned. These risks are described in greater detail below, but first of all the context for these risks isdiscussed by looking at the large urban and metropolitan authority dimension. THE POORER URBAN AND LARGE METROPOLITAN AUTHORITY DIMENSION Procurement risks apply to all LSVTs, but the scale and/or complexity of urban and metropolitantransfers influence the likelihood of the risks occurring as well as the relevance and utilityof the mitigation strategies which can be used. The particular characteristics of these transfers which impact on risk are: 1. Demand: low or decreasing demand will manifest itself in higher turnover, longer reletperiods and possibly even unlettable stock. The main financial impact will be on rents andtherefore on the landlords ability to meet its financial commitments and funding ratios. The impact of changes in the labour market as well as the availability of alternativeaccommodation can have a significant effect on demand. For example, the trendtowards the relocation of major employers of low-paid workers to business parksand sites out of the city centre, could effectively exclude the tenants of certainareas from employment because of transport costs and/or difficulties. This couldlead to a decline in demand for these areas. Research has shown that most households prefer to buy rather than rent. This findingis supported by the success of many low cost homeownership initiatives. It is likelythat large urban or metropolitan authorities have a greater range of housing optionsthan other authorities and this could suppress demand for social rented housing. Where the reasons for low demand are to do with the property type or condition,this might be difficult for the landlord to address due to a lack of resourcesincluding developable land. The issue of demand will affect sustainability risk. 2. Scale and complexity: the greater the number of properties, tenants and staff involvedin a transfer, the greater the scope for unforeseen issues to emerge which may have anadverse financial effect. For example, a property defect that was not identified until afterthe transfer, might exist in all similar properties and might be costly to remedy. On theother hand, the scale of the transfer may mean that problems which would be major ina smaller transfer are less serious. To take the previous example, 1,000 properties with acostly defect to remedy would have a greater impact on the business plan of a smalllandlord compared to that of a larger landlord. The issue of scale and complexity will impact investment programme on delivery risk. 3. Stock condition: poor and defective housing tends to be more prevalent in urban andmetropolitan stock than in shire districts. This creates particular issues for landlords ofurban and metropolitan stock in that the stock requires greater investment and in somecases, the investment cannot be certain to extend the useful life of the properties. The issue of stock condition will impact upon all three broad areas of risk. 4. Low value: the tenanted market value of the housing stock is related to the conditionof the stock. In urban and metropolitan areas, the value of the stock is likely to belower than that of shire districts and might indeed be negative in value. This mightcause difficulties in raising private finance and might also have implications for the longterm viability and sustainability of the housing stock. The issue of low value will impact upon investment sustainability risk. 5. Tenant profile: the profile of tenants has changed significantly over the past twodecades. There are several main reasons for the changing profile: The right to buy and the improved availability of home ownership has removedrelatively higher income households from the social rented sector. Demographic and social changes have led to an increase in the proportion ofsmaller households, elderly households and households who require some form ofsupport to live independently. This means that the nature of the housing management service that is required has alsochanged. The impact of these changes is particularly marked in urban and metropolitanareas where there are large concentrations of tenanted housing properties. The issue of tenant profile will impact upon sustainability risk. 6. Social exclusion: in many urban and metropolitan areas, problems of social exclusionhave emerged, requiring intensive management as well as cooperation with otheragencies such as the police. The issue of social exclusion will impact upon investment sustainability risk. 7. Management skills and expertise: most authorities who are seeking to transfer all oftheir properties through LSVT do so to a new landlord, specially created for that purpose.Most of the staff of the new landlord will transfer from the authority in accordance withTUPE legislation, including the senior staff. Furthermore, the board of management iscomprised of unpaid volunteers who might not have any relevant qualifications or experience. There is a risk that the organisation lacks the competence to deliver the business planbecause of skill gaps and weak or poor management. There is also the risk that problemsmight be more difficult to detect because of scale and complexity. In small transfers, thesafeguards of regulation are likely to be more effective than for large organisations, whereit might be more difficult to detect problems at an early stage. The issue of management skills and experience will impact upon all three areas of risk. Summary of risk effects The following table summarises the issues applying to large urban and metropolitan transfers and the areas of risk which they affect. It shows that stock condition and management skills and expertise have the widest potential impact. Issue Specification risk Sustainability risk Delivery risk Demand Scale & complexity Stock condition Low value Tenant profile Social exclusion Management skills & expertise Taking the urban and metropolitan dimension into account, the remainder of thisdocument explores the three categories of procurement risks identified earlier. SPECIFICATION RISK This is the risk that the landlord fails: to identify all of the works required; to programme the works for the appropriate time period; and to draw up accurate specifications for the work required for contractual purposes. In areas where the stock is in particularly poor condition, or where there is a significantproportion of non-traditional housing stock, this risk is increased. Both of these conditionsis likely to apply in poorer urban and larger metropolitan stock transfers. Mitigation i) Stock condition survey The main method of mitigating this risk is for the landlord to commission a stock conditionsurvey. The survey is typically sample-based at the 95% confidence level and may includespecialist engineering surveys. The survey serves two purposes: it provides the new landlordwith reliable information about the current condition and future investment needs of thehousing stock and it also passes on some of the risk to a third party ie, the surveyors whowill warrant the survey against errors. The survey should be sufficient for planning purposes, but because it is sample based thelandlord should be aware that the actual investment programme is likely to vary. Manysurveys provide annual investment figures for the first ten years and then group figures infive year bands thereafter because of the variations that will inevitably occur. ii) Pre inspections In practice, the landlord will find that some elements might need replaced later than thelifecycle schedules assume and conversely, some elements might need replaced sooner. Theactual requirement will be determined through pre-inspection by suitably qualified individualsbefore the investment works are specified and procured. This will help to ensure that worksare not done in advance of need and that they are properly specified. iii) Update business plan The business plan projections need to be constantly updated to take account of actual spend:if the landlord does not need to replace a particular item in the year originally programmed,this might allow earlier investment on other items or it simply mean that total spend in thatyear is reduced. iv) Develop a standard Drawing on the developing experience of housing PFI schemes, some landlords are examiningthe option of developing a standard ie, an output based specification which defines thequality and functional requirements of the physical property. This standard can be used asthe basis of developing a whole life approach to asset management by linking capital investmentto the quality of the revenue repairs service. Because the standard is output based and does not specify how these outputs are delivered,it allows scope for innovation and competition in the delivery method. This creates thepotential for efficiency gains. SUSTAINABILITY RISK This is the risk that the investment does not add sufficient value to the housing assets orthat the value is short lived. It also covers resources being spent on the wrong things. For example, for some housing in low demand, investment will not improve its lettability andso the landlord has to question the worth of investing in these properties at all. There are manyexamples of substantial public investment in housing failing to make an area more desirablebecause the factors affecting demand are more complex than stock condition alone. This is a major area of risk for low value transfers of urban and metropolitan housing stock.Properties which have problems of sustainability and demand in public ownership will notautomatically have their problems solved by transfer, even if it is accompanied by majorinvestment in the physical fabric of the housing stock. A new landlord organisation is highlyunlikely to have the capacity or resources to cope with stock which has a limited life, unlessthe transfer business plan has an effective strategy to deal with these issues in the first place.Therefore, it is important that the business plan can demonstrate long term sustainabilityto funders. Funders are concerned to ensure that especially in the early years where debt is increasing,investment improves the value of the asset by a greater amount, or at least, by a matchingamount. Funders are likely to be keen to ensure that investment which does not result inan increase in value is minimised. This may apply to non-essential or discretionary investment. Mitigation i) Test sustainability pre transfer One way of mitigating this risk could be to test sustainability before transfer proposals areapproved by ODPM. The Housing Corporation provides guidance on assessing sustainability,which can be used by landlords. Armed with demand information and projected investmentcosts from the stock condition survey, the transferring authority and/or the new landlord isin a position to rank areas or even property archetypes according to cost and demand. Thiscan be represented in a sustainability matrix as follows: Demand Cost High cost/low demand High cost/high demand Low cost/low demand Low cost/high demand Using this approach: low cost/high demand stock should be retained; and the other categories of stock should be subject to an option appraisal to determine theirfuture: retain in current use; refurbishment; demolition and new build; demolition andsite clearance. The option appraisal would take into account the potential for increasingthe sustainability of the area and property type through investment. This is just one example of how to approach a sustainability analysis, but the important pointis that the risk that the new landlord might fail to be a going concern because of fundamentalissues of sustainability should be addressed before the transfer business plan is produced. ii) Develop a management strategy The previous paragraphs describe how demand, stock condition and low values can beaddressed in order to mitigate sustainability risks. In areas where sustainability is a concerndue to one or more of the other issues previously discussed (tenant profile, social exclusion,management skills and expertise), the new landlords business plan should address howthese will be addressed in a management strategy, for example through developing locallettings plans to avoid having concentrations of particular types of tenants in locationswhere this would cause problems for all concerned. DELIVERY RISK This is the risk that the new landlord is unable to carry out the investment programme asplanned because of: tender price inflation; cost overruns during the contract; delays in letting the contacts/starting the works; and delays in delivering the contract. Tender price inflation Tender price inflation may occur because of a general or local increase in the cost of labourand/or materials. This may occur for economic reasons out of the control of the new landlord,or it may occur because of an increase in the amount of work being offered to the market asa result of the stock transfer. In urban or metropolitan areas, labour is mobile and contractorswill compete for suitably qualified workers. This may have the effect of pushing costs up becauselabour rates increase and because contractors can command a higher price for their work. Cost overruns during the contract Cost overruns can occur for many reasons: labour and or materials inflation; unforeseen circumstances, for example the discovery of asbestos or rot once intrusivework commences; poor or mismanagement of the contract by the landlord and/or the contractor; or profit maximisation on behalf of the contractor, for example a contractor may bid lowto win a job and then seek additional fees to achieve the target profit level. Delays in letting the contracts/starting the works There may be delays in letting the contracts/starting the works due to a lack of managementcapacity on behalf of the landlord or due to a lack of contractor capacity. Delays in delivering the contract There may be delays in delivering the contract due to: poor or mismanagement of the contract by the landlord and/or the contractor; unforeseen circumstances, for example the discovery of old mine workings; optimistic planning; disputes with the contractor about the contract; and major problems with the contractor organisation, for example liquidation. Mitigation i) Local market analysis One way of mitigating this risk is for the new landlord to investigate the local market whenthe investment programme is being prepared. The new landlord can assess the capacity ofthe local contracting market by reference to information about turnover and other statisticsheld by enterprise companies. It will be important to take into account any other majorworks which is being planned by other bodies so that a suitable amount for price inflationcan be added onto the costs. Also, the new landlord could meet with contractors (individually or collectively) to discusstheir capacity and to discuss procurement issues with a view to packaging the work in acost effective manner. ii) Use an appropriate procurement method The procurement method will affect risk. In essence, there are three main methods ofprocuring works. a) Term contracts These are contracts for more than one financial year (usually for three to five years) for smalland recurring types of work. They can be expensive to administer and are typically used forhigh volume, low individual value works such as responsive maintenance. Works costs areusually based on a schedule of rates which helps to simplify the administrative process. b) Traditional lump sum contracts These are contracts for specific works, which deal with the repair and or replacement ofproperty elements. They are usually of less than a year in duration and are let on a competitivetender basis. They can be let on a fixed price or variable price basis. Although cost risks can be passed on through fixing the price and through appropriateinsurances and indemnities, a new LSVT landlord would have to devote considerableresources to managing a programme based on this form of procurement. c) Design and build These are contracts for new build or major refurbishment works and last for more than oneyear. They typically involve lump sum tenders based on the clients output specification. Although the risk of cost inflation is passed on to the contractor, experience has shownthat this type of contract can become adversarial as contractors seek to recover unforeseencosts, resulting in disputes and delays. iii) Partnering First introduced to the social rented sector by the Egan Report in 1998, and now promotedby the Housing Corporation for RSLs, partnering involves: Entering into a long term arrangement with a number of contractors for the provisionof repairs and replacements. Focusing on the tenant rather than the process by emphasising outputs rather thantraditional input based specifications. Introducing performance targets for improvements: reducing costs, improving productivityand efficiency and reducing defects. Integrating the design and construction process by involving the constructor duringdesign stages thereby increasing the scope for innovation. Replacing the lowest initial cost culture with a best value approach. Ensuring that resources are available when they are required by giving the contractorthe scope for resource planning. Capturing scale economies and maximising buying power. Partnering is particularly suited to large urban and metropolitan LSVTs because: the volume of work in large transfers creates potentially complex logistics and difficult planning; the repetitive nature and common features of some of the work lends itself to setting upprocesses to streamline and improve efficiency; large labour resources are required to deliver the whole programme and a coordinatedapproach allows labour planning; multi-site contracting is a major management and programming task and the contractorsas well as the new landlord might have difficulty dealing with this individually; and it provides greater control and certainty to the new landlord than any other method. In practice, the new landlord may use a combination of these methods to deliver itsinvestment programme. iv) Put in place appropriate control systems As previously discussed, the scale and complexity of large urban and metropolitan LSVTs aswell as potential weaknesses in management skills and expertise can impact upon deliveryrisk. Therefore, it will be important for the new landlord to ensure that appropriately qualifiedstaff are in place to manage all aspects of the delivery of the investment strategy and thatthere are effective systems of control in place. CONCLUSIONS This Appendix has sought to identify procurement risks and the particular issues which relate to large urban and metropolitan LSVTs along with appropriate mitigation strategies. Three broad areas of risk have been identified. The following table summarises for each risk, the particular issues and the possible mitigations. Risk category Specific risk Urban/metropolitan Mitigation LSVT issue Specification Landlord fails to: Stock condition Stock condition survey identify all of the works required Management skills & expertise Regularly update plans Set a standard programme the works appropriately draw up accurate specifications Sustainability Investment does not add Demand Test sustainability sufficient value to the assets pre transfer Stock condition Value added is short lived Develop a management Low Value strategy Tenant profile Social exclusion Management skills & expertise Delivery Tender price inflation Stock condition Local market analysis Cost overruns during Low Value Use appropriate the contract procurement method Management skills & expertise Delays in letting/starting Put in place appropriate the contract control systems Delays in delivering the contract Appendix X - Management structures risk to LSVT RSLs in poorer urban and large metropolitan stock transfers INTRODUCTION This section of the report considers the risks to RSLs taking the transfer of poorer urbanand large metropolitan stock arising from management structures. The case for transfer is not simply an investment case; it is a whole business case, whichinvolves the management of the housing stock. Therefore, one of the risks associated withtransfer is that the management structure, skills and experience of the LSVT landlord mightnot be adequate to deliver the transfer and the business plan efficiently and effectively. This analysis looks at the risks arising from LSVT landlord structures including: group structure versus a standalone organisation; and a subsidiary of an existing RSL. Before the advantages and disadvantages of these structures are considered, the particularissues facing urban and metropolitan transfers are discussed. URBAN AND METROPOLITAN TRANSFERS In any large scale voluntary transfer it is important that the LSVT landlord has the necessaryskills to deliver the transfer business plan and to deal effectively with any risks that mayemerge during the transfer process and beyond. This may be particularly challenging forlandlords who acquire housing stock from large urban and metropolitan authorities. Many urban and metropolitan authorities face problems of: low or declining demand; social exclusion; changing client groups and expectations giving rise to changing managementrequirements; and poor stock condition including significant proportions of non-traditional properties. Internally, they face the issues of adapting to modern service standards, with an increase inthe use of technology to make services more efficient at the same time as trying to respondeffectively to the problems listed above. For some authorities, this is made more difficult bythe presence of outdated working practices, as well as a reluctance to reduce staff numberseven where the stock has reduced significantly due to the right to buy. Although registration with the Housing Corporation provides a degree of assurance aboutmanagement standards, it does not provide complete assurance that management weaknesseswhich existed before transfer will not endure after transfer. GROUP STRUCTURE VERSUS A STANDALONE STRUCTURE Some transfers have involved setting up a group structure rather than transferring to asingle landlord body. Usually this has been done to comply with the ODPM requirementthat no more than 12,000 units may transfer to a single body. However, compared to astandalone structure, group structures have the potential to offer additional benefits: cost pooling and economies of scale; cross-collateralisation for loan security purposes: the assets of the group may have thepotential to support a larger loan than the loans which could be raised by thesubsidiaries individually; tax efficient sharing of resources: the subsidiaries and parent can provide each otherwith services without having to charge VAT; synergy of ideas and performance: opportunities exist for the subsidiaries to benefit fromthe experience and innovations of the other members of the group; and devolution to a local level to involve communities: the subsidiaries can have a localidentity with its membership and directors drawn from the communities it serves flexibility:there is scope for the individual members of the group to specialise, for example theparent might provide corporate services to all of the subsidiaries or each subsidiarycould specialise in a particular corporate specialism on behalf of the group, such ashuman resources or IT. The possible disadvantages of a group structure are: poor performance of one member of the group could have an adverse financial effect onthe other members; it might be difficult to find enough good candidates for all of the boards; and tenants and others might perceive the parent as having too much control over thesubsidiaries. These potential advantages and disadvantages apply to group structures in general, but thereare other issues to consider if an existing RSL sets up a group structure with a new subsidiarydesigned to take over the management of an authoritys housing stock. In these circumstances,the financial strength, existing management expertise and experience of implementingmajor investment programmes of an existing RSL, can be hitched to the greater politicalacceptance of a new landlord. OTHER ISSUES There are a number of other issues related to management structures which are worthconsidering. These are discussed below. Appointment of senior staff It is important that the Chief Executive and Finance Director are appointed as early aspossible, preferably pre ballot, to direct and influence the RSLs business plan and thepurchase price to be paid to the local authority. The appointment of these senior executivesis generally undertaken post ballot. Given that the chances of securing a positive ballot maybe lower than for shire transfers, appropriately qualified candidates may need to be givenincentives to leave existing employment to join an organisation where its long-term futureis uncertain. Expanding the scope of the new landlord Diversification could assist the new landlord to spread risk in such a way that the risksassociated with the transferred stock are mitigated. This greater activity would obviouslyneed to comply with the Housing Corporations regulation of RSLs diversification intonon-core activities. For example, the RSL could have greater freedom to act as a not-for-profit housing business,with responsibilities to tenants and accountability to the local community for social housingprovision, but with greater scope to manage assets, create value and diversify into widerhousing markets. This could enhance the viability of the organisation as a whole. Also, thenew organisation would have greater relevance to the whole community, rather than justsocial housing tenants, and should be more attractive to potential board members. Another example would be to set up the RSL as the primary regeneration vehicle for itsarea, with freedom to undertake selective demolition, redevelopment for mixed-use andmixed-tenure. This should make the RSL a much more relevant and interesting propositionfor board members and senior staff. Using the skills and expertise of established RSLs Where the authority has decided to set up a new RSL for the transfer, it could consider thesecondment of existing RSL Chief Executives and Finance Directors to the recipient RSLfor the period from pre-ballot to say 6 to 9 months post-transfer. For challenging poorer urban and large metropolitan stock transfers where the need forspecialist skills at board level (for example project management, corporate finance, andlegal skills) is particularly acute, the possibility of paying specialist board members, may beattractive. This may be a useful mitigation strategy, particularly during the higher risk initialinvestment programme. This is part of a much wider debate and is far from being universallyacceptable within the RSL movement. Appendix XI - Analysis of replies received from existing RSLs E&Y received replies from 67 existing RSLs, of which 40 were from established RSLs and 27 from RSLs created by LSVTs, an overall response rate of 61%. Established RSLs LSVTs Total Number of replies 40 (60%) 27 (40%) 67 (61%) Do you wish to Yes 40 Yes 25 Yes 65 increase the size of your holding through No 0 No 2 No 2 stock transfers? Partial or whole Partial 2 Partial 2 Partial 4 stock transfer? (not all replies specified) Whole 1 Whole 1 Whole 2 Either 33 Either 19 Either 52 Would you target Geographically local 19 Geographically local 18 Geographically local 37 particular types of transfer? (replies Urban/Metropolitan 7 Urban/Metropolitan 2 Urban/Metropolitan 9 may include more than one of the Shire 5 Shire 9 Shire 14 answers) Any 21 Any 3 Any 25 Specialist area Specialist area Specialist area 6 (sheltered (sheltered accommodation/ accommodation/ regeneration) is regeneration) is important 3 important 3 What is your view on the amount of properties your organisation would be interestedin acquiring? ESTABLISHED RSLs Numbers of properties Number of RSLs Wish to own a further currently managed in this category 0-4,999 8 0-4,999: 5 Depends on circumstances: 2 No answer: 1 5,000-10,000 11 0-4,999: 4 5,000-6,000: 2 12,000: 1 No view: 2 No answer: 2 10,000-14,999 11 0-4,999: 6 10,000: 1 14,000: 2 No answer: 1 Depends on specialist market: 1 15,000-19,999 7 3,000+: 1 6,000: 1 10,000: 2 12,000: 1 15,800: 1 1 or 2 per annum: 1 20,000+ 3 5,000+: 1 7,000: 1 Depends on circumstances: 1 TOTAL 40 LSVT RSLs Number of properties Number of LSVT RSLs Wish to own a further currently managed in this category 0-5000 11 0-4,999: 4 5,000-10,000: 4 Depends on circumstances: 2 No more: 1 0-4,999: 3 5,000-10,000 11 5,000-9,999: 2 10,000-14,999: 3 No view: 2 Depends on circumstances: 1 10,000-14,999 5 12,000: 1 14,000: 1 Depends on circumstances: 1 No more: 1 No view: 1 TOTAL 27 Appendix XII - Calculation of a recipient RSLs risk buffer LSVT RSLS WACC On the day of transfer most LSVT RSLs undertake a range of treasury management activitiesto provide a degree of certainty in its future interest cost, particularly during the period ofthe rent guarantee and the initial catch up repairs programme. On the assumption that the LSVT RSL hedges 80% of its interest risk by undertaking aseries of interest rate swaps for 3, 5, 7, and 10 years and the remaining 20% being left on afloating rate basis, it is possible to calculate the recipient RSLs initial WACC. If we assumethat the LSVT RSLs interest margin is a blended 40 basis points, we can use interest rateswap rates to calculate the LSVT RSLs initial WACC. As at 28th February 2002, interest rate swaps of the above duration were as follows: Swap Margin RSLs cost of funds rate 3 years 5.25% + 0.40% = 5.65% 5 years 5.40% + 0.40% = 5.80% 7 years 5.40% + 0.40% = 5.80% 10 years 5.45% + 0.40% = 5.85% 3M Libor 4.10% + 0.40% = 4.50% LSVT RSL Initial WACC = (5.65%+5.80%+5.80%+5.85%+4.50%)/5= 5.52% An alternative approach is to assume that on the day of transfer the LSVT RSL undertakesa 30-year interest rate fixture, by undertaking an interest rate swap. As at 28th February2002, a 30 year swap had a strike rate of around 5.1%, plus the long term interest margin ofsay 0.4%, giving a long-term fixed rate of 5.5%. Alternatively on the day of transfer, the LSVT RSL could undertake a structured and unguaranteedcapital markets issue. From capital market sources, E&Y consider that as at28th February 2002 an LSVT RSL could undertake a capital markets issue at a margin overthe gross redemption yield on the reference gilt of say 1.40% and with 30 year gilt yields of4.75%, this gives an initial WACC for the LSVT RSL of 6.15%. Clearly, a new LSVT RSL, (particularly large metropolitan stock transfers with a largepurchase price) could undertake a blend of several of these treasury management scenarios.However, given the current shape of the interest rate environment, such an approach wouldnot significantly alter the analysis and conclusions. LSVT RSLS REAL WACC If the real WACC of the recipient RSL is compared with the real discount rate used by ODPM to determine the purchase price of the stock being acquired, it is possible to get an approximation of the level of recipient landlords risk buffer. To compare the LSVT RSLs initial WACC to the REAL discount rates used by ODPM, one has to move the RSLs WACC to a real WACC by taking account of inflation. Market projections for long-term inflation can be derived from long-term gilt yields. Yield on 30 year gilt (6% Treasury 2028) = 4.79% Real yield on index linked gilt (2.5% Treasury 2024) = 2.32% Market projection for long-term inflation = (1.0479)/(1.0232) = 1.024 ie, 2.4% The calculation to move from the RSLs initial WACC to a real WACC is: RSLs WACC/Projection for long-term inflation. The results of this calculation for the three treasury management scenarios outlined above, are shown in the following table (assuming 2.4% inflation and using 6% and 8% as real discount rates used to calculate the TMV): RSLs WACC RSLs real WACC Risk buffer Blend of interest 5.52% 3.04% 2.96% to 4.96% rate fixtures Long-dated swap 5.5% 3.02% 2.98% to 4.98% Structured capital 6.15% 3.66% 2.34% to 4.34% markets issue THE RISK BUFFER To accurately reflect the LSVT RSLs long term WACC, requires estimates of interest rateswhen the swaps mature. This requires detailed analysis of the forward curve for interestrates, and is beyond the scope of this assignment. Notwithstanding the RSLs exposure to interest rates after the period of the interest ratefixtures in the three calculations above, in each case the LSVT RSLs real WACC as at theday transfer is substantially below ODPMs current TMV real discount rate of 6% to 8%.However, this calculation does not take account of the annual loan management fees payableto lenders, annual commitment fees (if payable) and any security management fees. It is difficult to say whether the level of risk buffer is too high or too low. In some strongshire district transfers it may be too high and the public sector could secure a higher pricefor the stock by a more competitive process for the selection of the recipient landlord(including new with limited profit models and structures). This is investigated in moredetail in Part 2 of this report. In the case of poorer urban and large metropolitan stock transfers the buffer may be toolow in that it produces a purchase price which is unsustainable by the recipient landlord,particularly if this landlord is newly formed with no reserves. The extent of the risk bufferwill also be irrelevant if the purchase price is strongly influenced by the interest breakagecosts on the vendor local authoritys housing loans. The level of the risk buffer is not a simple issue particularly for poorer urban and largemetropolitan stock transfers where the large initial catch-up repairs and improvementsprogramme often creates negative cashflows in the early years of the TMV calculation.Where negative cashflows exist the TMV methodology should use real investment ratesduring those periods rather than real borrowing rates. Appendix XIII - Alternative models for stock transfer REGENT INTEGRATED HOUSING MODEL THE PROPOSALS Regent Integrated Housing (Regent) is owned by Charlemagne Capital and has been set upto develop innovative social housing finance solutions. Regent has worked with Miller Construction,Depfa, Nationwide Building Society and Bank of Scotland in developing its proposals. The following points summarise Regents proposals, which are aimed at reducing the cost offinancing stock transfers and hence increasing the opportunities for successful transfers andfor increasing the purchase price received by local authorities for their assets: 1. The acquiring Housing Company would utilise structured finance to improve financialterms available for stock transfers, with the financial partners (particularly equity)controlling the management of the Housing Company to which the housing stock istransferred. The Regent Model involves using competitive mortgage and capital marketsfor procuring the majority of the debt finance. Regent sees risks being allocated to thoseparties who are best able to competitively price the risk and positioned to bring gains tothe Housing Company namely equity investors and motivated management. Regenthas stressed that the management team must be incentivised. This is something that isnot overly permitted with current RSLs. 2. The Housing Company is to be an RSL (accepted by the HC on the condition thatit complies with all registration requirements). Regent has indicated that to attractcompetitive finance the providers would need maximum confidence in the HousingCompany management. Regents proposed Housing Company would give the financeproviders ultimate control over the appointment of key managers. 3. The total return paid to investors would be capped on any excess profits covenantedto the public sector via a Trust for which it is envisaged that the tenants and the localauthority would make up the board of. As an indication of how this arrangement couldwork, Regent indicated that once investors had secured an agreed rate of return, anyremaining profits would be covenanted to the Trust. The agreed return would be determinedby competitive bidding and so would vary between transfers reflecting market perceptionsof risk. Any surplus generated by the Housing Company would be transferred to theTrust to enable it to undertake wider social, economic and physical regeneration worksin the area. 4. The Housing Company would be able to use and develop the assets to provide, undercontract, a flexible housing service to accommodate social housing tenants in propertiesthat matched their changing needs. Regents model goes further than other proposalswe have previously seen in that it might involve substantial flexibility in the managementof the stock. Subject to their agreement, tenants could be decanted and rehoused tofacilitate development opportunities : ie, the Housing Company would not have toretain existing estates in the format in which it acquired them on transfer, if alternativeacceptable accommodation was provided. 5. Regent also propose that a golden share be retained by the public sector and that aBond could be taken out to ensure a smooth transfer of ownership to another landlordin the event of the Housing Company getting into financial difficulty. These measuresare designed to help protect the interests of tenants as well as the public sector investmentin the stock. The research examines the extent to whichfinancing for housing stock transfers offer valuefor money, and identifies ways in which this couldbe maintained or improved in the future.
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