MORE THAN A HOME

Financial Strategy

Kingdom GroupCorporate Plan

2019-2024

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Change is not new at Kingdomand over the years we havedemonstrated how we can embracechange, grow the business andmeet a full range of customerneeds. The future will continue tobe challenging, however we havethe plans and people in place toenhance our capacity anddemonstrate resilience.

Nick PollardDirector of Corporate Support Services

KHA 40 Year Financial Plan 4

Future Rent Increases 8

Summary & Risks 10

Loan Finance 10

Covenants 11

Borrowing Capacity 12

Medium Term Funding Strategy 12

Scenario Planning & Sensitivity 12

The Base Case 12

Sensitivities 13

Discontinuance of Activities 14

Major Component Replacement 14

Restrictions on Availability of Loan Finance 14

Lower Subsidy Levels for Development & Higher Interest Rates 15

Higher Subsidy Funds for Development 15

Welfare Reform 15

Pensions 15

Costs 16

Financial Covenants 16

Security for Lenders 16

Annual Rent Increases 16

Sources of Funding 17

Issue Bonds in Own Name 17

Participate Through an Aggregator Issuer 17

Allia Scottish Government Loan Funding 18

Private Placement 18

Kingdom Initiatives Business Plan 19

Kingdom Support & Care Business Plan 20

Contacts 21

Contents Page

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The Group’s business comprises three main activitiesthese are; Housing Management and Maintenance,Development of new properties for rent and sharedequity and Support & Care for people with particularneeds.

Rented properties comprise mainly general needsproperties let at ‘social’ rent levels and a smallerportfolio of properties let at mid market rent (MMR)on short assured tenancies through KingdomInitiatives Ltd (KI). MMR rent levels are around theLocal Authority Local Housing Allowances level. Thelease payment to be made by KI to Kingdom is set at alevel that will allow KI to generate a profit in the longterm and also provide Kingdom with the ability torepay loans associated with the MMR properties’original development, pay insurance premiums andfulfil planned maintenance programmes.

Housing Management and Maintenance - The rentsreceived from tenants are used to pay for the costs of

the management of the properties, the routinerepairs, which arise on a day to day basis, and toservice the private finance that makes up thedifference between the costs of the properties lessthe subsidy received from the Scottish Government orother source (e.g. second homes council tax), andwhich is usually repayable over 25-30 years. Therental income is also required to cover the futurecosts of cyclical maintenance work, mainly painterwork, and planned maintenance, which includes themajor component replacement of windows, kitchens,bathrooms, roofs etc.

Development of new properties – Kingdom’sdevelopment programme has focussedpredominantly on social rented housing, which isfunded by subsidy from the Affordable HousingSupply Programme (AHSP), other subsidy (mainlysecond homes Council Tax funds from the localauthority) and private finance.

The KHA 40 year financial plans cover the activities of the parentorganisation Kingdom Housing Association. Kingdom Initiatives andKingdom Support & Care operate on 40 year financial plans.

The Kingdom Group is shown below:

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1. KHA 40 Year Financial Plan

The subsidy provided for a development does nothave a cost and, consequently, access to subsidyenables Kingdom to provide housing to its tenants ata rent, which reflects the borrowing costs of only theprivate finance element of the development fundingand the expenses associated with managing andmaintaining the properties described above.Therefore, the rent, which the tenant pays toKingdom, is significantly lower than an equivalent‘market’ rent; we call this a social rent.

Financial planning carried out by Kingdom hasconfirmed that its development capacity is sensitiveto changes in subsidy, changes in the cost of financeand the capital costs of properties and their long termrental incomes. Therefore, alternative businessmodels for the provision of ‘affordable’ housingcontinue to be explored in order to deliver affordablehousing within the constraints imposed by pressureon subsidy levels whilst endeavouring to keep rentsaffordable.

During 2016 Kingdom carried out an optionsappraisal for the future provision of Support & CareServices and decided on the creation of a whollyowned trading subsidiary company as the vehicle forthe future delivery of Support & Care services from 1April 2017. The new subsidiary company has takenover the business from KHA and manages it as astandalone business. The company employs staffdirectly in the provision of support and care servicesand where appropriate a service level agreement has

been entered in to for the provision of centralisedadministration services and support to KSC.

Funding for Support & Care services is provided undercontract for hours of service provision and has beenunder pressure for some time arising from the budgetposition of commissioning agents, Local Authorities,funding position.

In respect of private finance then the rental income isused to pay for the costs of the management of theproperties, the routine repairs, planned maintenanceand to service the private finance that makes up thedifference between the costs of the properties lessthe subsidy received. Kingdom has to date drawndown loans from its lenders totalling £101.3 million.This includes traditional secured bank loans withLloyds Banking Group, Santander andNationwide/Dunfermline Building Society totalling£50.5 million. Kingdom has also borrowed funds onan unsecured basis from Allia totalling £16.2 millionand has a private placement with institutionalinvestors where funds have been drawn amounting to£34.6 million.

Kingdom will be making a further draw down on theprivate placement funding in June 2019 for £50million.

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On the basis of the existing development programme and a development programme for 2019/20 through to2023/24 the homes being developed for all parties are as follows;

For each company,including KI theexisting andplanneddevelopmentprogramme for2018/19 through to2023/24 will deliverthe followinghomes;

Developer

KHA

KI

Perth & Kinross Council

Fife Housing Group

Glen HA

Ochilview HA

Ore Valley HA

Grand Total

Mid Market Rent

180

268

448

Off The Shelf Acquisition

88

8

96

Social Rented

2,491

60

69

26

44

195

2,885

Grand Total

2,759

276

60

69

26

44

195

3,429

Company

Fife Housing Group

Glen HA

KHA

KI

Ochil View HA

Ore Valley HA

Perth & Kinross Council

Grand Total

Sum of Total SHIPFunding Grant

£ Million

£5.431

£1.968

£208.628

£13.203

£3.433

£15.099

£4.32

£252.082

Sum of Total PrivateFinance Assumption

£ Million

£4.091

£1.62

£174.339

£22.427

£2.793

£11.811

£3.96

£221.041

Sum of TotalProject Cost

£ Million

£9.522

£3.588

£382.968

£35.63

£6.226

£26.91

£8.28

£473.124

Year

2016/17

2017/18

2018/19

2019/20

2020/21

2021/22

2022/23

2023/24

Grand Total

Sum of Numberof Units

218

409

477

676

517

499

220

413

3,429

Sum of Total SHIPFunding Grant

£ Million

£16.404

£31.449

£36.141

£50.501

£37.396

£34.286

£15.715

£29.19

£252.082

Sum of Total PrivateFinance Assumption

£ Million

£15.756

£25.53

£28.624

£43.30

£32.39

£33.84

£14.357

£27.244

£221.041

Sum of TotalProject Cost

£ Million

£32.16

£56.979

£64.766

£93.801

£70.786

£68.126

£30.072

£56.434

£473.124

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KHA is on lending to KI £8.5 million over the next 12months to support its own stock development whichwill be repayable over a 30 year term. This is inaddition to the £2.62 million already lent to KI which isrepayable in 2026.

KHA projects that it will dispose of up to 10 units ofshared ownership legacy stock each year for a periodof 26 years but the net receipts are not factored in tothe business plan.

A programmed revaluation of all Kingdom’s propertieswas completed in 2016. The existing private finance of£101.3 million is secured at present by 3,486 ofKingdom’s properties meeting the asset cover tests ofloan agreements at a valuation of more than £173.99million although there is some surplus security in thatsum. Kingdom has, as at December 2018unencumbered units of;

Kingdom’s aim is to remain financially secure in thelong term and to achieve this it must be able to coverall costs, both on a day to day basis and in the longterm, when free reserves are used to meet thesubstantial costs of planned maintenanceprogrammes and the requirements of maintaining theScottish Housing Quality Standard. Kingdom projectsthat it will spend more than £176 million, in currentprices, over the 40 year plan on major componentreplacement for its existing stock along withadditional major component replacement costs foreach of the developed units over their life in the plan.

In addition, Kingdom is committed to meeting theEnergy Efficiency Standard in Social Housing (EESSH)by 2020 although the financial cost of implementationof EESSH is estimated at £1.3 million.

Lenders exercise some control over Kingdom byimposing financial covenants, i.e. certain conditionsthat must be met during the term of a loan. Kingdom’sfinances will have to be managed to ensure that

reserves are sufficient to absorb the costs of plannedmaintenance programmes and loans are availablewhen required. The lack of a credible long termfinancial plan could result in major expenditure havingto be delayed due to a lack of cash or a breach oflenders’ financial covenants. Financial planning alsoincludes consideration of alternative business modelsthat would still allow Kingdom to provide ‘affordable’housing, while remaining able to service its debt in thelong term. Kingdom will continue to rely on privatefinance to fund its different development models.Although lenders have increased the margins theycharge to borrowers, this is partly off-set by lower longterm rates. However, the higher cost that arises fromthe increase in lenders’ margins together with lenders’resistance to providing loans for more than 10 years isnow driving a move away from conventional loanfinance to alternatives such as bonds. Kingdom hasdrawn against its Allia facility in late 2015/16, 2016/17and 2017/18 and has drawn against its existingSantander loan during 2017/18. All traditional bankingfacilities are now therefore fully drawn. The privateplacement funding is scheduled to deliver anadditional £50 million in funding in June 2019.

Changes within housing legislation/regulation mayprovide the framework for other financing structures,such as lease and leaseback and sale and leaseback,although this does not look likely in the short term.Financial planning also recognises that rates may risein the medium term. The business plan assumes thatKingdom will be able to borrow at 5.5% based on along term revolving working capital facility withsurpluses seeking to repay that facility as quick aspossible. Kingdom has assumed that any new privateborrowing will be at a fixed rate of 4% for its durationusing a private placement.

The need to ensure long term financial viability alsohas to be considered in the context of theaffordability of Kingdom’s rents. Periodic reviews arecarried out to assess the affordability of its rents.

The most recent review concluded that current rentlevels meet Kingdom’s main measures of affordabilityand that the future rent increases projected in thisplan should ensure that rents remain affordable.However, the higher the level of annual rent increaseapplied, the less affordable Kingdom’s rents are likelyto become.

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Unencumbered Units

Social Rented

Mid Market Rent

Shared Ownership

Total Unencumbered

732

67

243

1,042

2. Future Rent Increases

At 1 April 2018 Kingdom owned 3,581 self-containedgeneral needs houses, 101 supported homes, 266mid market rent properties (managed by KI), leased 7units from KI and a further 258 on a sharedownership basis.

The total budgeted gross annual rental income for2019/20 is around £16.25m (including the James BankHostel). However, the gross annual rental income isnot received in full due to losses arising from voidperiods and bad debts and allowance has to be madefor these items. An allowance of 2.0% of the grossrental income is now being assumed for losses fromvoids (0.75%) and bad debts (1.25%) from the housingstock and 15.0% void and bad debt rental losses forthe hostel for the period of the plan.

Rental increases are necessary to cover increases in theday to day costs of management and repairs, to enableKingdom to repay its loans and to enable it to createreserves to meet the costs of planned maintenancewhen the need for such maintenance arises. Kingdomhas assumed in its plans that in 2018/19 and for2019/20 it will increase its rents by 2.5%.

Kingdom aims to keep rental increases to a minimumover the long term and apply increases evenly overthe period. Such an approach should reduce the needto apply high rates of rental increases in a particularyear or years and should ensure that over the longterm, all tenants contribute on a reasonably equitablebasis to the servicing of the loan portfolio andmanagement and maintenance of the properties.

The likely trend for future rental increases for thisplan is based upon a 30 year cash flow forecast, whichreflects the need to meet financial covenants andvarious other assumptions for Kingdom’s principalactivities.

Based upon a 40 year cash flow forecast incorporatingvarious assumptions, which are noted below, thelikely level of annual rental increases required tomaintain the financial viability of the Association is ofthe order of 2.5% throughout the plan.

This level of rental increase, when applied each yearthroughout the 40 year period, should createsufficient income to meet the various requirementsset out in the assumptions.

The broad assumptions used for the plan are asfollows:

• A five year development programme comprising a mix of ‘social’ rented properties and mid-market rent (MMR) properties. The number of new ‘Social Rented properties that will be brought into management has been assumed to be 1,979 for the period 2019/20 to 2023-24. The number of new MMR properties that will be brought into management has been assumed to be 346 for the same period. The rent for the MMR properties will be based upon the relevant Local Authority Local Housing Allowance (LHA). • As the tenancy agreements for MMR properties are ‘short assured’, the letting of these properties takes place through Kingdom Initiatives Ltd (KI), a subsidiary company. Lease agreements between KHA and its subsidiary are necessary to facilitate these arrangements. The lease makes KI responsible for all aspects of managing and maintaining the properties with the exception of planned maintenance and insurance. KHA is responsible for the insurance, planned maintenance and the servicing of any loans associated with the MMR properties.• The number of shared properties for sale are 10 in 2018-19 and each year thereafter. Whilst unit numbers in the plan are specified they may differ in projected delivery to those stated in the development delivery plan. The financial impact is expected to be consistent regardless of unit numbers and is based on average sale proceeds assumptions.

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• Sales of a small number of MMR rent properties are likely. However, none has been included in the plan. Higher or lower costs of management and repairs than planned or a higher or lower than planned increase in house prices may influence the number of sales.• The assumptions in the plan indicate that there is unlikely to be a breach of the minimum interest cover or maximum gearing covenants during the period of the plan based on the base case assumptions. • The plan also assumes that loan finance will be available for Kingdom to follow through with its planned programme. • Kingdom has assumed annual inflation of 2.0% from 2018 and annual rental increases of 2.5%. Kingdom has around 51% of its tenants on full or partial Housing Benefit, with around 48% of its rental income coming from Housing Benefit. Around 97% of Kingdom’s housing stock comprises two, three or four apartment properties. • The annual inflation rates as measured by the Retail Price Index (RPI) and the Consumer Price Index (CPI) in February 2019 were 2.5% and 1.8% respectively over the previous 12 months. Forecasts of future inflation suggest a rate where RPI and CPI remain benign at around the Government target of 2% to 2.5% level. • The rate of inflation is an important aspect of financial planning as there is some tension between annual increases that do not significantly affect affordability and increases that may have to be greater to ensure financial viability for a developing housing provider, such as Kingdom. An annual rate of 2.0% has been assumed as the link to inflation for future annual rent increases and for costs.

• There is a legislative requirement (Scottish Housing Quality Standard) for housing associations and local authorities to ensure that all houses owned by them. This legislation directly affects Kingdom as the standard must not only be implemented but maintained. • The interest rate for existing variable rate loans and for new variable rate loan finance is assumed to be 1.50% above LIBOR. In the long term this delivers an all in variable borrowing rate of 5.5%. The proportion of fixed and variable rate loans comprising the loan portfolio will be consistent with the Kingdom’s Treasury Management Policy. • Kingdom has closed the defined benefit section of the Scottish Housing Association’s Pension Scheme (SHAPS) to all staff.

Although this addresses the issue of the risk ofliabilities associated with future service, the fundingof the deficit remains an issue and an increase in thepast service pension deficit contribution from £392Kto £606K took effect from 1 April 2014. The higherannual payment will increase by 3.0% each year untilSeptember 2022 when it has been assumed by ThePensions Trust that the payments will cease. This mayor may not eliminate the past service deficitdepending on the valuation of scheme assets andliabilities at that time. This contribution is, in effect, anincrease in overheads that is being borne for theforeseeable future and, together with an annual rateof increase of 3.0%, and has been included in the planto 2022. Kingdom now provides a definedcontribution scheme within SHAPS for the employeeswho were members of the defined benefit section ofSHAPS and this is open to the other employees whohave been auto-enrolled.

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3. Summary & Risks

SUMMARY• The annual rental increase of 2.5% noted above will allow the Association to manage and maintain its existing properties over the plan period; provide the resources to develop properties (subject to certain assumptions) in the medium term.• It has been assumed that no gift aid will be made between KI, KSC and KHA; however this is considered on an annual basis.

RISKSThe Association recognises risks to its plan, the mostsignificant of which are:

• Inability to achieve the annual rent increases of the level set out in the plan;• Reductions in subsidy - AHSP levels and/or second homes Council Tax;• Increases in interest rates;• The Scottish Housing Associations’ Pension Scheme (SHAPS) has a large deficit as at 30 September 2015 and increased contributions to fund the deficit have been included in the Plan to 2022. It remains to be seen whether this contribution will be sufficient to pay down Kingdom’s share of the deficit. Kingdom is also part of a group of SHAPS employer members that are looking at alternative ways to manage their shares of the SHAPS deficit;• Some limited exposure to the residential property market to achieve sales of a small number of MMR properties in the medium term;• Continuing risks to Support & Care services and lower annual settlements from funders to KSC whilst employment costs continue to rise;• Cost and availability of loan finance;• Costs over which Kingdom has no direct control rise faster than assumed in the plan;• Loss of rental income following the Westminster Government’s welfare reform plans;• Loss of rental income due to low inflation;• Loss of rental income due to rent increase constraints.

4. Loan Finance

The Corporate Plan assumes a continuingdevelopment programme for the period 2019-20 to2023-24 which will bring a total of 1,979 new socialrented units and a total of 346 new MMR units intomanagement for KHA.

Taking account of the costs associated with this levelof development, including the completion of thevarious developments on site in 2016/17, 2017/18 and2018-19 which are on going whilst offsetting free cash(i.e. operating cash, less loan interest and loanrepayments), along with KI on lending then Kingdomwill require additional loan finance of around £80million.

This implies that the loans outstanding will increasefrom £101 million at 1 April 2019 peaking at £220million at 31 March 2025. It has been assumed that KIwill borrow only from its parent organisationthroughout the plan.

In order to support KI’s development plans of its ownstock for MMR it will require to borrow from KHA £8.5million in 2019, and we have assumed that will be fora 30 year term at 4.5% all in rate. This means thattotal on lending to KI will be in excess of £23.9 millionat its peak debt point in 2022.

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Kingdom’s four lenders each have their own financialcovenants. These covenants relate to interest cover,gearing and asset cover (also referred to as loan tovalue ratio).

The interest cover covenants have been calculatedboth without taking account of capitalised majorcomponent replacement costs, plain interest cover andtaking account of major component replacementcosts, interest cover 2.

The interest covers 2 calculations being the moststringent.

Asset cover is concerned with the valuation of thesecurity in relation to the loan amount advanced and issubject to triennial review.

In order to meet the most stringent of the interestcover covenants, Kingdom must generate an operatingsurplus that is 115% of the interest payable, i.e. if theinterest payable is £100K, then the operating surplus,as defined, must be £115K. The financial plans showthat interest cover will not be less than 139% duringthe period 2018/2058, based upon the base caseassumptions.

5. Covenants

Interest Cover

Gearing

Asset Cover/Loan: Value

Security Valuation Basis

DBS/Nationwide

>110%

N/A

100%

Existing Use Value(EUV) - Social

Housing

Lloyds TSB

>115%

<70%

105%

Existing Use Value(EUV) - Social

Housing with Sales

Santander

>110%

<69%

125%

Market ValueSubject to

Tenancies (MV-ST)

Private Placement

>110%

70%

115%

Market ValueSubject to

Tenancies (MV-ST)

In order to meet the most stringent of the gearingcovenants, Kingdom must not borrow more than 69%of the sum of its capital and reserves and grantsreceived. The introduction of Financial ReportingStandard (FRS) 102 in 2016 means that the grantreceived is amortised through the Statement ofComprehensive Income.

The financial plans show that the existing facilities notyet drawn of £50 million will be drawn in 2018/19 andthat net additional lending required in the period2019–2058 amounting does not raise gearing above53% for the period of the plan, Therefore, theassumptions provide some headroom both in termsof interest cover and gearing.

KHA Board ofManagement

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6. Borrowing Capacity

Borrowing capacity is determined by a number offactors. It is also a factor that influences developmentcapacity.

The financial covenants imposed by lenders forinterest cover will set a limit of borrowings that canbe serviced from cash flows and is measured byreference to the interest payable and the operatingsurplus in the income and expenditure account, afteradjusting for the cost of capitalised replacementcomponents. Therefore, the interest cover covenantbecomes a limiting factor when the level of operatingsurplus does not meet the minimum cover multiple ofinterest payable required by the lenders.

The amount of interest that has to be ‘covered’ bysurpluses will vary with the rate of interest thatapplies to the loans. Therefore, for a given level ofborrowing, a higher interest rate results in a higherinterest charge, which, in turn, requires a higher levelof surplus to meet lenders’ covenants.

The financial covenants imposed by lenders forgearing are determined from the structure of thebalance sheet. Gearing is a limiting factor when theborrowings, as a percentage of the sum of grants,capital and reserves exceed the maximum gearinglevel imposed by the lenders.

Also, the number of properties available to use assecurity may prove a limiting factor, as the amount ofloans that can be secured by the properties isdetermined by the asset cover/loan to value covenantand the basis of valuation used for the properties.

7. Medium Term Funding Strategy

The Financial Plans show that Kingdom has thecapacity to continue a development programme, bothin terms of its income and expenditure, which iscapable of meeting typical interest cover covenants atrates of interest that reflect present long term marketrates and lenders’ margins, and its balance sheet,which has sufficient unencumbered housing stock toprovide security and sufficient equity (subsidy, capitaland reserves) to meet typical gearing covenants.

The development programme set out in theCorporate Plan is achievable if finance can be securedon the right terms. Therefore during 2020-21additional borrowing will be sought to provide thebusiness with sufficient cash to continue its planneddevelopment programme.

The plan assumes a need for significant further loanfinance to fund development activity and theborrowing strategy has been developed as part of theoverall Treasury Management strategy.

8. Scenario Planning & Sensitivity

The Financial Plans included in the Corporate Planhave been prepared using a number of centralassumptions and these produce outcomes thatindicate that Kingdom is financially viable in the longterm. However, any variance to the most significantassumptions will have a detrimental impact on thefinancial result for the planning period and this maylead to a breach of a financial covenant or the inabilityto deliver Kingdom’s aims.

9. The Base Case

The base case position is that interest cover will fall toa minimum of 139% in 2023-24 and gearing will reachits maximum of 53% in 2019-20.

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10. Sensitivities

The sensitivities have been applied at a KingdomHousing level because KI will be borrowing from theparent company only and has no covenants withwhich to comply and KSC has no borrowing at all.Operating margins in KI are subject to agreementbetween KHA and KI regarding management fees andlease costs. KSC has no loans to comply with andoperates on very small gross and net profit margins.

The impact of the following changes in the main planassumptions have been quantified:

a) An increase in variable interest rates by 1% for all years throughout the plan;b) Annual rental increases restricted to inflation only throughout the plan;c) Inflation to be reduced from the base case 2% to 1% throughout the plan;d) Voids and bad debts increase by additional 1% throughout the plan;e) b and c above;f) All of the above.

When assessing sensitivity analysis reference hasbeen made in interest cover to the kore stringent testof interest cover 2.

The results of the sensitivity tests are:

• An increase in variable interest rates by 1% for all years throughout the plan: Interest cover is greater than 115% in all years. However this change in interest rates reduces interest cover in all years, with interest cover of 123% in 2023-24 as compared to the base plan. Gearing is broadly consistent with the base plan albeit marginally higher at 54% in 2022-23 and 2024-25.

• Annual rental increases restricted to inflation only throughout the plan: Interest cover is greater than 115% in all years. However, this change in annual rental increases reduces interest cover in all years, as compared to the Base Plan, with interest cover of 132% in 2023/24, as compared to the base plan. Gearing is consistent with the base plan albeit marginally higher at 54% in 2022-23.

• Inflation to be reduced from the base case 2% to 1% throughout the plan: Interest cover is greater than 115% in all years. However this change produces interest cover of 131% in 2022/23, as compared to the base plan. Gearing is consistent with the base plan.

• Voids and bad debts increase by additional 1% – throughout the plan: Interest cover is greater than 115% in all years. However, this change in the voids and bad debts allowance reduces interest cover in all years, as compared to the base plan, with interest cover of 132% in 2022/23, as compared to the base plan. Gearing is consistent compared with the base plan albeit marginally higher at 54% in 2022-23.

• Inflation reduced to 1% and rent increases at RPI only: The cumulative effect of these changes reduces interest cover in all years, as compared to the Base Plan, with interest cover of 125% in 2022/23, as compared to the base plan but interest cover breaches in 2039 at 95% and 2043 at 107%. The breach position is due to a significant component replacement cost in both of those periods. Gearing is consistent compared with the base plan albeit marginally higher at 54% in 2022-23 and 2024-25.

• All of the above changes: The cumulative effect of these changes reduces interest cover in all years, as compared to the Base Plan. Interest cover experiences a period of non compliant performance during the period 2022-23 to 2028-29. In addition there are further periods of interest cover breach which are marginally below the covenant test level due to component replacement costs in future years. Gearing is higher than the base plan and reaches a maximum of 58% in 2024-25.

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A test was made to determine what would occur if alldevelopment stopped from 2020-21 and that debtwould not be required for a further £60 million. Inthat scenario all covenants perform far better thanunder the base plan in the short term. Debt could berepaid far faster and in this scenario although owingto the existing fixes in place debt would not be whollyrepaid until the end of the plan total debt could berepaid from cash. The down side however is that inthe longer term the business overall would generateless net cash as it would not be leveraging its assetsand growth capacity as much overall.

The outcomes of the sensitivity tests indicate thatthere is headroom in the Base Plan even though thereare prudent assumptions in place and that could beexploited to restrict annual rent increases and stillmeet the higher costs or alternatively undertakefurther modest growth.

The key risk issues in terms of existing covenantcompliance are the sensitivities d) and f) which relateto voids and bad debts changes throughout the planand the combination sensitivity of low inflation andlow rental costs as they affect income far more thancosts.

In the event of a catastrophic set of circumstancesthen development beyond 2020/21 could be “turnedoff” as it is not contractually committed therebyrestoring Kingdoms financial viability in all scenariosrapidly with full repayment being achieved but overalldelivering fewer affordable housing units and lowernet cash.

11. Discontinuance of Activities

In the event that external economic, political orlegislative impacts affected Kingdom’s viability thenrisk mitigation would be undertaken by contracting orreducing the development programme beyond itscurrent committed two year profile. The modellingcarried out indicates that Kingdom could continue asan independent entity focussed on solely themanagement and maintenance of its own housingstock.

12. Major Component Replacement

The interest cover covenant performance is affectedby the projected major component replacementprofiles which are based on current information. It isexpected that re-engineering of work packages basedaround delivery rather than estimated componentfailure points along with advancement and deferral ofsome component replacements due to actual lifecycle experience will mean that a “smoothing” oftheses costs may be achieved in the future ironing outsome of the potential for significant financial impactof those costs on covenants.

13. Restrictions on Availability of Loan Finance

Due to the significant amount of around £90m ofadditional new loan finance required to deliver thefive year development programme, there is a risk tothe development programme if KHA is unable tosecure loan finance on acceptable terms.

In order to minimise the significant risk associatedwith loan facilities that are inadequate to meetcontractual obligations, Kingdom will ensure that thevalue of contractual obligations do not exceedundrawn loan facilities, less excess cash.

The borrowing strategy has been proposed on thebasis of securing revolving facilities to support shortterm cash flow fluctuations with planned committedfunding for the future from 2021.

14. Lower Subsidy Levels for Development & Higher Interest Rates

The Development programme set out in the Planassumes certain levels of subsidy and interest rates,which make these developments financially viable.

Reductions in these subsidy levels and/or increases ininterest rates would be likely to make some of thedevelopments set out in the Plan unviable. As eachpotential development is subject to an InternalFinancial Appraisal, financially unviable developmentscan be identified before contracts are awarded.

15. Higher Subsidy Funds for Development

The plan assumes an average subsidy of 53%(approximately 56% for ‘social’ rented developmentsand 36% for MMR developments). Any increase inthis level of subsidy would have a positive impact forKingdom through a reduction in fundingrequirements and a consequent reduction in interestcosts, or the possibility to increase the proportion of‘social’ rented properties within the Developmentprogramme.

16. Welfare Reform

The introduction of Welfare Reform and theimplementation of Universal Credit in April 2017 mayresult in a higher level of arrears and bad debts.Although Kingdom will seek to ensure that the risksarising from these changes are properly mitigated,some modelling has been carried out to determinethe impact of higher levels of bad debts. At this timeKingdom is not forecasting a deteriorating arrears andbad debts position as its experience to date does notsupport such an approach. Recent experiences arethat the Scottish Government has sought to mitigatebenefit welfare reforms for the most vulnerable.

17. Pensions

The Scottish Housing Associations’ Pension Scheme(SHAPS) has reported a significant deficit based uponthe triennial valuation as at 30 September 2015 albeitlower than in 2012. There is a 2018 triennial valuationdue for reporting in the 2019 period. As noted this willnecessitate past service deficit contributions in futureto pay off this deficit and it has been confirmed thatthe Past Service Pension Deficit contribution willremain at £640K per year but the payment period isonly to September 2022, with annual increases of3.0%. The Plan includes the cost of £640K with annualincreases of 3.0% to September 2022 as a liability onthe statement of financial position.

Kingdom closed the Defined Benefit Section of SHAPS(Final Salary 60ths and CARE 60ths) on 31 March 2014thereby preventing the accrual of further liabilities forfuture service in the defined benefit schemes.

From 1 April 2015 a defined contribution scheme wasintroduced with an employer’s contribution rate of8.0%. This also provided an auto-enrolment vehicle toenable Kingdom to meet its statutory obligations forpension provision.

Kingdom also operates an auto enrolment pension viaSHAPS, the risk based change in costs of £65k perannum from 2019-20 has been assumed where staffmay transfer from the auto enrolment pension to theSHAPS defined contribution scheme due to thebeneficial costs to them of such a move compared toincreasing auto enrolment costs.

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18. Costs

Kingdom will continue to monitor costs to identifyareas where savings can be captured without anadverse effect on service delivery and customersatisfaction.

19. Financial Covenants

Management of Financial Covenants is critical toensure continuity of the business. Therefore, the Planhas been prepared on the basis that there isheadroom between the planned outcomes and theminimum interest cover and maximum gearingcovenants set out in Kingdom’s various loan facilities.

20. Security for Lenders

Although three of Kingdom’s lenders allow security tobe valued on the basis of Market Value Subject toTenancies (MV-ST), Kingdom has tested its borrowingcapacity on the basis of MV-ST and Existing Use Value– Social Housing (EUV-SH). Kingdom currently has3,486 properties secured to various lenders. Kingdomholds 744 social rented properties, 67 MMR and 243shared ownership properties unencumbered.In addition Kingdoms three office locations areunencumbered as are the 25 garages.

21. Annual Rent Increases

The base case Plan assumes annual rental increasesof around 2.5%. However, changes to the amount ofinterest payable compared to plan are likely toinfluence annual rent increases due to the need tomeet the minimum interest cover covenant set bylenders. The interest payable will be affected byhigher or lower interest rates and/or higher or lowerlevels of loan finance, as compared to the Plan.

Kingdom is able to exercise some control over interestrates, and hence interest payable, by using fixed ratearrangements, as set out in its Treasury ManagementPolicy. Kingdom’s planned borrowings have beencalculated assuming certain levels of capital costs andsubsidy for its development programme. However,differences in either the cost of new properties or thesubsidy levels may result in higher or lower financingrequirements associated with the planned level ofdevelopment, which in turn will affect the interestpayable to lenders. Therefore, where an increase ininterest payable requires additional surpluses to begenerated to meet the required minimum interestcover, Kingdom will seek to balance this need with itsaim of keeping rents affordable.

This may have to be achieved by amendments to thedevelopment programme.

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22. Sources of Funding

There are a number of routes for Kingdom to raiseadditional finance:

• Traditional bilateral Bank Lending. This route provides loans on a fixed or variable rate basis with repayment periods of 10-15 years, significantly shorter than the 25-30 year repayment periods offered before the financial crisis that occurred in 2008. The continuing introduction of new banking regulations since the financial crisis makes it more difficult for banks to lend long-term finance to the housing sector. Therefore, bank lending provides short to medium term loans, rather than the long term loans previously made available. Consequently, this type of borrowing exposes Kingdom to a minimum of one and potentially up to three repricing and a refinance risks at the end of each loan period. The banks set various covenants that have to be met during the life of the loan.• Loans from managed funds. The investment business of Prudential, through M&G, has developed a product that is similar to traditional bank lending, but without the margin reviews that are now incorporated into banks’ loan facilities. This type of lending is attractive to investors who need inflation-linked returns and is an alternative to index-linked gilts (Government bonds), which are in short supply for investors that have to meet inflation-linked liabilities. • Bond finance. A bond is an IOU from the borrower (issuer) to repay money to a lender (investor or bondholder) with interest at a pre-determined time (maturity date). There are three routes to obtain bond finance: - Issue bonds in own name; - Participate through an aggregate issuer; or - Private Placement.

23. Issue Bonds in Own Name

An own name issue will be issued into the publicmarkets and listed on one of the major stockexchanges.

The minimum size of an issue is around £150m toeconomise the large up-front costs of arranging,underwriting and documenting such a bond issue.

As a result, the majority of RSLs are not sufficientlylarge to participate directly in the bond market.Housing providers such as A2Dominion Group,Sanctuary, Places for People, Hyde Housing andPeabody have issued bonds in their own names.

24. Participate Through an Aggregator Issuer

The alternative for the majority of RSLs is toparticipate through an aggregator issue. The bestknown vehicle is The Housing Finance Corporation(“THFC”) or GB Social Housing.

THFC was established at the end of the 1980s whenprivate finance was being introduced to the socialhousing sector and GB Social Housing is a morerecent addition to the sector.

To date it has raised several billion pounds across arange of issues for a significant number of RSLs. As agroup vehicle, THFC has enabled even very small RSLsto raise private finance (loans of less than £1 millionin some cases). The spread paid by THFC is around180 basis points (1.8% per annum) over thebenchmark gilt.

THFC is rated “A+” by Standard & Poor’s but is notrated by any other agency. GB Social Housingoperates along similar lines as THFC with its currentbond being a maturity of 2038.

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25. Allia Scottish Government Loan Funding

Kingdom took advantage of funds offered by the AlliaScottish Government bond amounting to £5.222million in 2016, £5.014 million in 2017 and hasrecently taken a further £5 million in March 2018.

This is unsecured borrowing at competitive marketrates which has simple loan agreements, terms andconditions. The 2016 and 2017 loans were covered bya different master facility agreement which is nolonger valid. The new Master Facility Agreement is for£35m in funding although only the above £5 millionhas been drawn. Kingdom may seek to further drawagainst the Master Facility Agreement if it suits itsoverall loan portfolio approach.

26. Private Placement

The source of the funding is typically InsuranceCompanies and Pension Funds (who also participatein the public bond issues). Those companies include,Canada Life, Standard Life, M&G and BritishAerospace. However, it is distinguished from the otherissues by documentation that is more akin to abanking loan agreement, with most of the termsbeing similar to those within the bankingdocumentation. It is called a Private Placement as thefunding agreement is a private arrangement betweenthe borrower and the institutional investor – it is nottraded on the public markets and hence is notregarded as a liquid instrument.

However, the terms of any Private Placement fundingcan be as flexible as the banking market with issuesbeing for a range of maturities (5 years through to 30years and in some cases longer) and either on a fixedrate or floating rate basis. The sums that can beraised via a Private Placement range from £25 millionup to £200 million.

The Private Placement market does share onecharacteristic with the other Capital Market productsin that the funds are usually drawn within a relativelyshort period after the agreement has been signed.

The maximum period is likely to be 12 months but amore typical time frame is 3-6 months once theagreement has been executed. This results in a “carrycost” to the borrower, KHA which can be significantgiven margins between borrowing and deposit funds.Recent deals have seen long stepped profiles ofdrawdown arranged with some providers.

KHA has already borrowed in this space £85 millionfrom a private placement arrangement from multipleinternational investors. That private placement asalmost six times over subscribed and there remainssignificant market interest as well as market capacityto support Kingdom as a credit proposal.

Properties are held in a security trust and futurecompleted properties will be placed in the trust tosupport a further borrowing proposal.

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27. Kingdom Initiatives Business Plan

Kingdom Initiatives Ltd operates as a non charitablewholly owned trading subsidiary company of KHA. It’sprimary focus is the management of Mid Market Rent(MMR) stock which KHA is not allowed to managethrough a leasing arrangement.

KI’s financial assumptions in its business plan are thesame as those of KHA. In addition KI is subject tocorporation tax on its profits and at this time it isassumed that all profits will be retained and thatcorporation tax charged is paid. KSC may however giftaid profits to its charitable parent organisationreducing the corporation tax liability. This assumptionis under annual review each year.

The margin between the lease cost that KI pays toKHA and the rent charged by KI to its tenantsgenerates an operating surplus.

KI employs no staff directly at this time and thereforepays a unit management fee for each property let byKI. KI remains responsible for day to day repairs andmaintenance and pays a management fee perproperty to KHA for the management of all propertiesleased from KHA. KI owns 51 properties of its ownwhich its lets but it also pays KHA a management feeto manage them on its behalf.

In future years there are planned furtherdevelopments of MMR stock by KHA under the existingmodel of KHA development and leasing to KI for lettingpurposes. In the short term however the plan is for KIto develop the homes for its ownership and notthrough a leasing model. This will require borrowingand it has been determined that currently KHA will onlend a further £8.5 million to KI in addition to itsexisting £2.62 million inter company borrowing onsimilar rates albeit repayable at 30 years not 10 years.

The financial plans show that KI is viable in the longterm as it is forecast to generate operating surpluses.KI’s balance sheet grows through the revenue reservegrowth after the current developments are completed.

KI’s individual plans have not been subject tosensitivity analysis as the company has no financialcovenants to meet and operates on thin margins. Anyborrowing is assumed to be through intercompanyloans and therefore the overall financial plans of KHAGroup are what has been sensitised. KI is highlysensitive to rental income changes whilst costs aredependent on agreements between parent companyand subsidiary. Whilst KI’s tenants will not beimmune to external economic impacts they are lesslikely to be benefit dependent. Voids, bad debts andarrears are much lower in KI than in KHA althoughassumptions are the same for both organisations.

KI is also looking at other activities such as theprovision of market rent and property for outrightsale as well as a joint venture with St AndrewsUniversity in an effort to diversify some of the Grouprisk exposure to grant funded affordable rent and theprovision of other services such as propertymaintenance for other organisations and privateindividuals.

Financial viability will be maintained through the leaseagreements’ margin and suspending developmentactivity in later years if required. Assets created by KImay be utilised by KHA to raise funds on KI’s behalf infuture years.

28. Kingdom Support & Care Business Plan

Kingdom Support & Care Community InterestCompany (KSC) operates as a non charitable whollyowned trading subsidiary company of KHA. It’sprimary focus is the provision of support and careactivities for approximately 250 service users acrossFife and Falkirk. KSC receives funding under contractfrom the commissioning organisations and throughpersonal support packages requested by serviceusers.

KSC employs its own staff but also receivescentralised support services under an OperationalLevel Agreement and Schedule of services.

KSC employs significant numbers of staff in theprovision of support and care services many of whomare paid at the Scottish living wage.

KSC is subject to corporation tax on its profits and atthis time it is assumed that all profits will be retainedand that corporation tax charged is paid. KSC mayhowever gift aid profits to its charitable parentorganisation reducing the corporation tax liability.

This assumption is under annual review each year.

It is important to note that KSC commenced its firstyear of operations in 2017/18 with an equityinvestment by KHA of £427,000. That equityinvestment is non interest bearing and there is noobligation to repay at a future date. If however KSCmakes supernormal profits then repayment of theequity investment instead of a dividend is possible byKSC.

KSC assumes that contract values will grow by 1% ateach contract renewal which is every 3 years. Inaddition KSC assumes that it will grow its provisionunder contract by approximately 3% per annum.KSC’s business plan assumes that costs arising fromthe SHAPS DC and SHAPS auto enrolment schemethat may accrue in 2019-20 of £85k per annum areincluded. KSC is also committed to future efficienciesforecasting that the implementation of Telecaresolutions will deliver future cost savings. In additionKSC expects that it will deliver operational processefficiencies.

The financial plans show that KSC is viable in themedium to long term as it is forecast to generateoperating surpluses.

KSC’s individual plans have not been subject tosensitivity analysis as the company is highly sensitiveto income changes from contracting clients. KSC hasno covenant requirements to meet and operates onthin margins.

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29. Contacts

Bill Banks: Kingdom Group Chief ExecutiveScott Kirkpatrick: Director of Development Nick Pollard: Director of Corporate Support Services Alan Simpson: Director of Housing & Asset ManagementNorah Smith: Director, Kingdom Support & Care

Kingdom Housing Association LtdSaltire Centre I Pentland Court I Glenrothes I Fife I KY6 2DA

Tel: 01592 631661Email: kingdom@kingdomhousing.org.uk

www.kingdomhousing.org.uk

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