Balance Sheet Capacity - Gearing and Leverage

Ratio 49. Total Debt per Unit (£000's)

Total of short and long-term debt dividend by total number of units.
Needs to be compared, implicitly at least, with the value per unit and weekly rent and operating surplus per unit. In this sense it is a relative measure which can be expected to vary by type of property and by region. For example a rent of £60 per week might generate a surplus per unit of £15 per week. Allowing for cover of 1.1 this would service interest of £709 per annum. At 7% interest this implies debt of £10,130 per unit. Debt would then be 3.25 times gross rental income or 169 times weekly rent.

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Ratio 50. Gearing (Net Debt % Net Worth plus SHG)

Total of short and long-term debt less cash, as a percentage of total capital and reserves plus grants. The traditional ratio of debt to equity capital including grants.
One of the most popular balance sheet measures of borrowing capacity among lenders, but unfortunately based on historical cost accounting 'values', rather than existing use or alternative use market values.

For RSLs a ratio of 50 debt to 50 of capital, reserves and grants gives a ratio of 100% which might be regarded as the normal upper limit. But if surplus and cash flow are strong and asset values very old you might see 150% based on debt of 60, reserves of 40 (a loan to "value" of 60%)!

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Ratio 51. Leverage % (Net Debt % Net Assets)

Net debt as a percentage of the total assets net of grants.
Gearing and leverage are different ways of looking at the same issue - the amount of borrowing. Leverage is used here instead of the traditional gearing because it is similar to the "loan to value" concept used by property lenders. Shows what proportion of the balance sheet value of assets (net of grants) is funded by debt. It is important because it has a direct effect on the cash cost of capital and hence interest cover and debt repayment ability.

It can be argued that reducing the asset value by deducting capital grants brings the measure more into line with the reduced income from the assets that characterises social housing rents as compared to commercial property. It therefore is arguably closer to a view of borrowing against existing social housing use valuation. From a lending perspective this ratio can probably be as high as 65%.

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Ratio 52. Adjusted Leverage % (Net Debt % Gross Assets)

Net debt expressed as a percentage of total assets but with capital grants added back.
This ratio is calculated in addition to the net leverage (Ratio 51) ratio since the asset value funded by SHG and written out of the balance sheet is significant. This ratio measures debt against assets at full cost, which arguably might be closer to an alternative use valuation. 50% is probably a comfortable maximum for lenders considering the downside scenario of having to realise the asset value. For traditional RSL housing this ratio will probably be less than 35% but for non grant funded activities 65% might well be acceptable.

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Ratio 53. Net Debt % EUV (SH) Asset Value

Net debt expressed as a percentage of an estimated EUV(SH) Asset Value based on a multiple of total rents receivable. The multiple value is an input based on the valuation experience of the particular association in its different business streams.
Arguably a more relevant measure of Loan to Value than 'book' leverage since the value is based on gross rents and therefore on the means of servicing interest. It should be closer to the lender's viewpoint. Ideally the value should be based on rents net of direct costs times a higher multiple. A maximum of 70% for this ratio would seem appropriate.

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Ratio 54. Net Debt % NPV (30 years constant)

Net debt is expressed as a percentage of the net present value (NPV) of the next thirty years' cash flows before interest but after capex. Cash flows after the forecast period are assumed to grow in line with inflation and then discounted at the average cost of borrowing.
A cash flow-based loan to value calculation, arguably superior to that based on estimated EUV(SH) asset value because the cash flow incorporates critical issues such as repairs and maintenance outflows to remedy stock condition problems. If this ratio has a value of 100% all of the next 30 years' cash flows are need to service and repay existing loans.

Allowing for all the risk and uncertainty factors over the next 30 years plus the low margin aspects of social housing, 100% is probably the absolute maximum to plan for. A value of 150% means, approximately, that interest could be serviced but no repayments made, in the absence of future addition of value through developments.

This situation might arguably be sustainable and appropriate for maximising development potential, ie that all maturing debt is refinanced, but ideally the ratio should reduce towards 100% over time.

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NB. For all multi-period discounted ratios (54, 55, 57, 58 and 59) the following notation is used:
where
r = average cost of debt
t = time period
c = cash flow (CFS21 - CFS11)
g = inflation (growth) = RPI assumption

r and g must be expressed as decimals ie 0.3 not 3%

Ratio 55. Net Debt % NPV (30 years plus TV)

Net debt is expressed as a percentage of forecast cash flows before interest, extrapolated to infinity! Cash flows, for the next thirty years plus a terminal value (a "growing perpetuity"), are discounted at the average cost of debt.
This ratio compares existing debt to the maximum cash flow value of the business, since it is based on cash flows extrapolated "to infinity." The absolute maximum for this ratio must be 100% since this implies mortgaging the future cash flows 100%, allowing no margin for risk and uncertainty factors which can affect the cash flows forecast. It implies perpetual debt, which is arguably acceptable if the assets and cash flows can also be maintained indefinitely.

A prudent maximum might be 80%. A value-adding development programme could reduce the ratio from 100% to 80% over time

=BS 13 + B 20 - BS 11

divided by NPV of (CFS21 - CFS 11) for years 1 to 30, discounted at FP 25

plus NPV of

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Ratio 56. Current Assets/Current Liabilities (Times)

The rate of current assets to current liabilities.
A simple and very approximate measure to compute the association's ability to meet short-term liabilities from short-term assets. This is a very "static" balance sheet ratio that ignores cash generated from operations and undrawn bank facilities, but it is quite popular. A margin for mis-matches and illiquidities suggests this should have a value greater than 1.0 but an even higher value might be required by covenants. A decreasing ratio might suggest that the company using cheap short-term funds, but it could be the result of poor profitability or inadequate re-financing.

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