In social housing, public and private finance are intertwined, and over-enthusiastic measures to decrease public investment could reduce, rather than boost, the contribution made by private money.
Private lending to housing associations, which underpins the Government's house building programme, has had to develop rapidly. Since 1988, when associations began mixing public and private finance with only the public part counting as public expenditure, pounds 2bn has been raised.
'So far so good' is the verdict of National Westminster Bank, which has led the field in lending to associations. Its corporate banking executive, Fred Goymour, said: 'Nobody has failed to be funded because of lack of capacity but there is a chronic lack of funders.'
NatWest is one of only 12 large bank and building society lenders providing conventional finance for associations. Another 38 have lent on an occasional basis. The capital markets, however, have rapidly been educated to accept housing associations, with pounds 737m from debenture issues currently traded.
According to David Burnett at Midland Global Markets, about 65 per cent of UK bond investors are now buying housing association paper, with each new issue bringing in fresh institutions. 'Almost all the major UK players are now investing,' Charles Arbuthnot, a director of the merchant bank Hambros, said. There were still small UK players to encourage and then overseas markets to look to to keep the sector growing, he said.
The process of convincing the market about associations, with their non-profit-making, voluntary sector roots, is not complete, so the need for care is paramount. 'A stable policy environment is massively important. Government has got to be seen to be strongly behind this sector,' Mr Arbuthnot said.
This year public subsidy to housing associations amounts to an average grant of 65 per cent of the costs of new building. Next year the rate drops to 62 per cent, with the corporation required to allocate grant competitively and the Chief Secretary to the Treasury, Michael Portillo, predicting that the average will be 60 per cent. And things can only get tougher - a 55 per cent grant is expected for 1995/6.
Yet far from getting more for every pound of public subsidy, lowering grant levels too far could stifle lending. Most lenders currently require assets worth one and a half times their loan as security. But with new tenanted association homes being valued at about 60 per cent of their open market price that is a difficult criterion to meet. The necessary level of cover can be reached with grant rates of 60 per cent or more, but if they drop below this limit, additional security will be required.
So cutting grant rates too low would immediately affect associations. The result would be that they would slowly run out of security and so cease to be able to borrow and build.
While reductions in grant aid threaten to stifle development by associations, tampering with housing benefit - another possible Budget move - could cut off the supply of private money at a stroke.
The current gap between rents charged and housing benefit limits provides lenders with the security of knowing that rents could be raised rapidly if anything went wrong. 'If that cushion goes, private investment will stop,' Mr Arbuthnot said. As well as funding new association developments, private finance has a role in the refinancing of council housing.
Local authorities, which are prevented by the Department of the Environment from building and have seen their capital programmes shrink, are queuing to transfer their housing out of the public sector in order to bring in new investment.
So far 23 have done this by selling their whole stock to specially created housing associations. The market financing these large-scale voluntary transfers is 'small but mature' according to UBS. Bruce Mew, a director of the group, says the 13 transfers scheduled for this year, like the previous 23, will be funded.
The problem he anticipates is not supply but timing. A bottleneck is looming between January and March next year when at least 11 new associations will be looking to complete their funding. Council tenants' benefit is in part locally financed so rationing had to be introduced this year after Treasury concern at the growing cost of housing benefit following a transfer.
The DoE approved the list of 13 in April but the transactions must be complete within the year. With only two banks and a handful of building societies lending on stock transfers, compared with the rather larger pool for conventional borrowing, the main constraint is people, according to Mr Mew.
John Gummer, Environment Secretary, is rumoured to be considering changing tack and may begin encouraging stock transfers to bring in receipts from sales. Mr Mew would not say whether finance could be found for an expanded programme but it must be in doubt. 'It is always good to see more lenders,' Mr Mew said.
There are ideas but rarely consensus on ways to ease the supply and particularly the price of private finance, which is still relatively high. The possibilities - still hypothetical - include government guarantees on borrowing, obtaining credit ratings for associations or creating an institution with its own funds to borrow on behalf of associations.
NatWest advocates reform of capital adequacy requirements, which currently put housing association lending on the same footing as private residential mortgages. They should be closer to the local authority standard and the move would cost the Treasury nothing, Mr Goymour said. But he accepts that there is no panacea for unlocking investment. 'Stability and trust between the major parties are the key.'
Douglas Smallwood, policy and marketing manager at Halifax, the UK's largest building society, summed up the issue.
'Private finance is not replacing public subsidy. All we are doing is reducing the amount of capital subsidy required from the public purse in return for higher rents which have an impact on housing benefit.'
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