As the financial plan is made up of a large number of assumptions over a lengthy period, it is important for the impact of these assumptions to be understood. Sensitivity analysis demonstrates the impact of different assumptions on the plan (and in particular on the annual surplus/deficit, cash generated and loans borrowed). It should test both income and expenditure.
Each association must determine the areas it needs to see analysed and this will depend on the nature of its own business. It is particularly useful to use the five key risks which have been identified as areas for modelling. For example a housing association involved in shared ownership or outright sale may need to see the impact of delays to sales or reduced valuations, while an association with a significant proportion of variable rate debt will need to assess the impact of changes in LIBOR or bank base rate.
An organisation should evaluate the dependency of its rent income on housing benefits and the impact universal credit changes may have. An organisation with significant amounts of supported housing may want to model reduced grant income.
Other areas to model could include increases in staff or maintenance costs, changes in inflation (CPI and RPI), reductions in rent levels, reduced grant or increased maintenance requirements. In addition, the impact of no further development (beyond that already committed) is often asked for by funders and the regulator.
It is considered good practice, and a regulatory expectation, to carry out multi-variant stress testing on financial plans. Ideally, this should be group variables which are likely to be effected by a movement in external factors, such as inflation or house price demand. While altering a single variable gives the best indication of risk for that variable, altering interrelated issues perhaps gives the best and most likely outcomes.
As organisations evolve and increase their mix of tenure, it is important to test the assumptions used: growth may differ between markets, as will the life cycle and maintenance of a product. Scenarios can be built to include exit strategies from shorter term markets or to reflect longer term strategy.
It is useful to know which assumption has the smallest change with the greatest impact and which change in assumption can ‘break’ a plan (ie make a plan break its covenants). Funders often ask for sensitivity tests with higher assumptions than the ordinary to check the solidity of a plan. Through such inputs, it is also possible to identify if a plan is behaving as expected and test for potential errors in setting up the plan or inputs.
In addition to understanding the effect of changes to the assumptions, it is also worth modelling the ‘unexpected loss of income, or higher expenditure’. What level of ‘loss’ can occur before the association is in breach of its covenants?
However, understanding the financial impact of the sensitivity testing is only part of the testing. What becomes more important to board members, funders and the regulator is the corrective action the association would undertake to mitigate any negative effects of ‘lost income or extra expenditure’. Mitigation actions should be realistic and costed. They should also be tested against a housing associations ability to meet its, loan, regulatory, legal, and importantly customer safety obligations whilst maintaining its stock to a lettable standard. Having these mitigating measures approved by the board, in advance of problems arising, gives the regulator confidence that boards are in control.