Governing Risk in Uncertain Times

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Governing Risk in Uncertain Times
NHF Board Members Conference, 4 February 2012

Welfare reform, affordable rent, reduced public subsidy, Supporting People budget cuts, co-regulation, risk transfer. Challenges, opportunities? Risk, risk, risk…. and reward? The new language of 2012.

How the world has changed for housing associations, over the past 25 years, since 1988 and the introduction of private finance. Pre that watershed Housing Act, the environment in which associations operated was benign to say the least.

Pre-1988 we were a cossetted sector, ‘movement’ dare I say. Values driven to deliver social purpose, politically neutral – a third way between public and private; innovative-renewal and regeneration being core tasks given to us then but within a tightly controlled and regulated framework. Competition was limited; there was product scarcity; sub market pricing of that product, free/ cheap capital coming into the sector, and a property asset base that grew. Our governance was focussed on doing ‘the right thing’ for our residents and our wealth grew. Oh happy days.

But since 1988 we have seen many of those key influences, the factors for our success, change. In some instances fall away, in others the relationship becoming different, more complex and harder to understand. As associations grew and in some instances now compare with FTSE 100 companies, we have seen the sector spend time questioning its value system and others asking what those values are. The sector has lost its innocence as a ‘third way’ organisation-not quite public, not quite private. The rows with government about independence and transparency are at the heart a fundamental battle over who controls associations and for what purpose they exist. Are they to help deliver government policy, in alignment with their objectives or, if necessary, in spite of these objectives?

And amidst this struggle over identity, successive governments, of both political persuasions have sought to introduce greater competition within and beyond the sector, including the continued interest in bringing in the private sector and ‘for profit’ organisations to offer ‘better value for money’ for the public purse.

This now comes with the first steps encouraging flexibility on pricing; opportunities for a range of products and very different expectations around how associations use their property assets to lever additional resources, and access new forms of finance. All of these changed circumstances put a new and very different set of pressures and expectations on boards and their governance.

Not just how you will protect and act as guardians of your value system, but also how you will ensure that you survive and hopefully thrive in this new, so much riskier environment. Where are the risks in 2012?

Again a reminder of the past. A housing association undertook activities that delivered a social return and hopefully broke even. In fact once upon a time funding called hostel deficit grant actually paid associations who made a loss on supported housing schemes. Now there is an increasingly stark recognition that many things that we hold as important in delivering social return or social impact do not add to the financial bottom line. Indeed, arguably their benefits are to society as a whole, not individual associations, either in the short or long term. These things include social and economic regeneration, helping communities work, reducing homelessness, reducing worklessness, and building skills and employability of our residents.

To deliver these things when government steps back as it is doing and because boards of associations believe these are important things to do, requires a new approach to financial return and with it, risks. As well as getting the basics right, running an efficient, effective business, associations are increasingly recognising that they need to generate income from other sources to finance the things that have a social return. Some of these things might have an intrinsic good in themselves, for example providing child care services.

Some might be purely about generating profits, for example market sale housing.

Each has risk attached to it. Any reward has an attendant risk. Get it wrong and it could blow a hole in your budgets or worse still in your organisation. And there are lessons to learn from other sectors on getting it wrong, but also on getting right.

The banking sector, the most visible example of a sector getting it wrong, and RBS the most topical. Some of the recommendations from the Vickers report provide good advice for us. Banks should ring-fence riskier operations from high street and less volatile activities ( core business).

Ring-fenced operations should have a ring fenced buffer of at least 10%. There should be increased consumer competition and for example, it should be easier to switch banks.

The care sector- Southern Cross getting it wrong.

The operating model produced low margins even at the best of times. They were locked into leases with landlords who could rapidly increase rents; the squeeze on public finances impacted on income streams that were previously taken for granted; costs increased in other areas, as residents required greater levels of care.

A warning for the affordable housing sector? What impact will welfare reform have on income streams? Associations need to fully assess their risks, exposure to they changing environment and be pro-active in adapting their business.

And on our doorstep are examples of businesses getting their business right- the house building sector.

Look at the environmental context for private sector housebuilding- house prices down 1.3% in 2011; the lowest number of newbuilds since World War2; limited availability of mortgages; first time buyers at an all time low; increasing commodity and other costs.

Yet the operational reality for housebuilders paints a very different story: Barratt 40% increase in operating profit, 8% increase in completions; Persimmon- 50% increase in underlying profit, 8% increase in sales; Bovis- increased profits £31 million, sales, prices up 4.5%; even TaylorWimpey 75% increase in profits.

Why? Because they learnt the lesson from previous recessions, their risks, and focussed on increasing margins and cutting their cost bases. Fundamentally, they understood their own businesses and adapted to the new market environment.

And the regulator’s role in this riskier environment will be increasingly a ‘back stop’ with powers to intervene if and when things go wrong. And for Boards to take full responsibility for control and prevention.

Many have said, given that the time is so uncertain and so risky, the best thing is to do nothing. To wait to see how things settle before making any potentially precipitous decisions.

A perfectly understandable position. However, it would be sensible and sustainable if the world around us wasn’t changing so dramatically and so constantly. Whether you are developing or just delivering housing management services, you will be affected. Welfare reform will have a direct impact on your income and potentially your arrears. The continued economic turmoil will have an impact on the cost and indeed the availability of private finance.

Universal credit will affect your customers, existing and new, will they be the same customers you had in the past? If you are developing, do you know the customers you will be housing over the next five years, how your stock profile may change over that period, and over the longer term.

A sobering calculation is that for those organisations who have a 10% turnover of stock and have offered up 50% of relets for affordable rent, within 10 years, 50% of your stock will be on these higher rents, potentially to a different range of customers, with very different expectations about what an association is about and what its offer is. Within 20 years, that association could be an asset manager with all of its stock on 5 year tenancies, making decisions about who it houses and for how long.

20 years from now until then, that’s less time than now back to 1988. Doing nothing is therefore in my view not an option. A board, if it is operating effectively, must do something. But not just do anything. It must make decisions with a strong eye on the future and an understanding and consideration of the potential consequences. Many boards and their Associations could be heading for a shipwreck, if they don’t take grip now, rather than wait for the dust to settle on the various reforms and policy initiatives that will roll out over the next 18 months or so. It’s all about managing risk, not hiding from it and hoping it will go away.

I think a Board needs to be doing a number of things.

First, trying to understand the risk. Is it to income, to purpose, to client group? Ask the right questions.

Stress test the impact on your business plan of the economic environment and the new opportunities.

What’s your expertise, your knowledge?

What are the potential financial impacts?

For new activity what is the cost of entry? What are the risks and returns? And if it goes wrong, what are the routes and costs of exit?

The board’s key role is to understand and help manage risk. To recast the risk map to ensure that in this most uncertain of times it keeps a focus on the things that matter most – its purpose and its vision.

And don’t let go. Good luck.

Steve Douglas
February 2012