CROYDON IN CRISIS: It is nearly three years since this website began exposing the financial disaster that Brick by Brick was creating for Croydon Council. NICHOLAS PANES, the construction industry expert who advised on our reports, looks at the options for extricating the council from this mess of its own making
Following the issue of a Section 114 notice by Croydon Council, the scramble begins to balance the yawning gap in the budget. The council is under a legal obligation to produce a balanced budget. Stripped of any meaningful amount of reserves to fall back on, this will require concessions from government.
One such concession is that Croydon may be allowed to sell capital assets and use the proceeds to meet revenue expenses to keep services running. Northampton Council, which issued a S114 notice in 2018, closed libraries, cut back on subsidies for bus services and a number of other services, but in addition, it had to raise more than £100million from various capital disposals, including the sale of the council office building.
At first sight, selling capital assets may appear an obvious thing for the council to do, an easy way to raise money quickly, but despite being overstuffed with non-core properties, Croydon has invested so badly that in the current climate, it may struggle to do so. A bankrupt hotel will find no takers until the covid-19 crisis is past and the Colonnades shopping centre is not only adversely affected by the virus but stands in the middle of a potentially seismic shift towards online shopping.
Inevitably, this focuses a spotlight on the loss-making house-builder Brick by Brick, which has used £250million of public money.
Brick by Brick has been funded by Croydon Council with a series of loans. In their report published this week, Price Waterhouse Coopers pointed out that some of these loans were in default, Brick by Brick having failed to make any repayments or pay any interest.
To make these loans, Croydon Council borrowed the money from the Public Works Loan Board, a body controlled by the Treasury. If Croydon fails to make repayments or interest payments to PWLB, then a receiver could be appointed who would take over the task of selling assets to reduce debt.
PwC’s damning report on Brick by Brick pointed out poor financial controls, limited management accounting and the absence of cash flow forecasts. They laid out seven options for the future of BxB.
PwC’s conclusions are that the least-worst option for Brick by Brick is to continue to trade with a limited build-out of current developments or continuing with some of the early tranches of developments (see the two left-hand blue boxes on the chart). PwC does point out that this would involve further borrowing before it yields results.
They will be doing much more work before the options are fully assessed. It is already quite clear that some of the options simply will not work.
In July – months after financial distress signals had already been sent up from the Town Hall – the council agreed to purchase 165 properties from Brick by Brick through the borrowing of another £30million. It appears that this was done to provide Brick by Brick with further funding, either to continue building or to pay back to the council as interest, thus removing the “defaults” on some of BxB’s loans. The council’s external auditors, Grant Thornton, flagged up concerns about this deal as being unusually “circular”.
PwC warned that the price paid for these properties should be reviewed to ensure it is proper market value. I would go further. Croydon is bankrupt. It should now be substantially reducing borrowings, not adding to them. Buying-in these properties which were intended to be sold (many as shared ownership homes) simply locks in the associated debt for the long-term.
The contracts for this purchase have yet to be confirmed and the latest advice given to the council by its auditors and consultants is that this deal should be halted.
So what are the council’s options for dealing with Brick by Brick?
Sale of BxB
It might seem odd that PwC has discounted the quick and easy solution of simply selling Brick by Brick. However, like me, they must have concluded that it is currently unsaleable.
Brick by Brick has a record of little or no financial control, poor forecasting and an inability to deliver construction and development on time. We know that certain properties, like those in the co-ownership scheme, have problems attached. They could not be sold because the company somehow forgot to get registered as a recognised provider of shared ownership homes.
We also know of disputes with contractors that have caused long delays on some sites and that some of Brick by Brick’s sites are odd, comprising small pieces of ex-council land that most commercial house-builders would not try to develop.
These problems mean that any purchaser of Brick by Brick as a whole has several messes to untangle. For the council to put together decent information for potential buyers might well take months because it appears that record-keeping within Brick by Brick has been far from perfect. Any corporation buying Brick by Brick, rather than just some of its properties, faces an additional layer of legal due diligence to ensure that BxB has complied with the law and to ensure that liabilities are understood.
Furthermore, given Brick by Brick’s lack of success, who would want to inherit the depleted management team and the staff of the organisation, when in all probability they have people of their own?
Finally, there is an issue of reputation. Resistance against Brick by Brick developments has become stronger and stronger, linked to Croydon’s willingness to grant inappropriate planning consents. Many commercial developers may prefer to avoid this.
All of these pitfalls make it unlikely that Croydon could readily find a buyer for Brick by Brick. In any case, if they did, the price might be little better than that achieved on closure.
Closure of BxB
PwC shows two options under the heading of closure: winding-up and managed winding down.
Winding-up implies an immediate cessation of all physical construction and the attempted sale of everything “as is”. As Brick by Brick has so many sites still in construction, this means that a lot of construction contracts would be breached, creditors may lose money, and Croydon would be left trying to sell unfinished building sites to anyone that would take them on.
As Brick by Brick is a company, it is uncertain whether the government would stand behind its debts. While those who trade with Brick by Brick would be entitled to think they have no more risk than if they were trading with government, I doubt whether this is correct – could the council and the Treasury just let BxB collapse?
While some residents might think this is somehow appropriate, it seems likely to be the option which would yield the least cash, create a flurry of litigation while damaging the community and Croydon’s built environment the most.
A managed winding down, by contrast, is certainly a credible option.
Calling a halt to any new developments, the council would simply seek to sell all finished properties and complete sites that are currently in construction. Any consented sites that have not been started could be offered for sale. They would have to be, as the council, like any public sector body, is under a legal obligation to get best value for its assets, locking in the additional value that the planning consent has created.
Continuing to trade
The options presented by PwC under the heading of continuing to trade include “limited build-out”, “build out all of tranche 1 and some of 2”, and “do nothing, trade as is”.
While PwC identifies the first two of these options as the least-worst, I am not sure if in practice they differ much from a managed winding down. Presumably, if Brick by Brick builds out certain sites but does not advance any of its longer-term plans, that leaves open the option to build up the business up again in better times. I am not sure the residents of Croydon or Croydon’s lenders would like that very much, and Option 3, “Continue as is”, seems out of the question.
Importantly, however, the council must try to get best value for its assets, so this may require an orderly wind-down or continuing to trade with more limited scope, at least in the short term.
The Big Picture
Despite the claims of Colm Lacey, now the company’s former director, the future of Brick by Brick is wholly dependent on its owner, Croydon Council.
Many residents now feel that Brick by Brick should never have been created, and I would be surprised if its future life is a very long one. However, in the short term, it will be big picture economics with a pinch of politics that determine the way forward.
In order to reach a sensible decision on the future of Brick by Brick, a deep-dive into its books and records will be necessary. The legal status of every site, site boundaries, ownership, restrictive covenants, debts secured upon them, estimates of future construction costs, forecasts of cash requirements, and so on….
A list of assets that are ready for sale will be prioritised and the costs and benefits of completing further properties will be considered. Balancing the need for haste against the need to raise cash will be difficult as this is, in every sense, a distressed sale.
And what of Croydon Council’s main lender, the Treasury? Will they turn a blind eye to the low prices achievable by prioritising the need for debt repayment? Will they allow any further borrowing to facilitate a “build-out”?
It was a Conservative government that introduced legislation to allow local authorities to undertake commercial activities. It is clear that this system was not fully controlled and has been abused by Croydon’s Labour-controlled council.
Surely it is obvious that the public sector has never been any good at running commercial businesses?
Surely it is obvious that public money should not be used for highly cyclical and risky activities like property development?
Much as it will upset some residents, the best outcome for Croydon Council Tax-payers may be to allow Brick by Brick a little leeway to finish some of its developments. By yielding maximum cash from this source, some local authority services will be preserved.
One big worry for the future is any Brick by Brick sites still without planning consent. Brick by Brick has continued to submit applications for sites – there’s one in Thornton Heath due for consideration at Thursday’s planning meeting.
But what will the Treasury impose on Croydon? Will the council rush to create further cash by granting planning permission on more sites? Can proper control be imposed on the planning process when Croydon is so conflicted by the need for funds?
That, as they say, is another story.
- Nicholas Panes is a former finance director in construction and development with experience of selling sites on behalf of public sector organisations
Read more: Brick by Brick gets 100%: 38 housing projects are all delayed
Read more: Building towards the council’s financial ruin, Brick by Brick
Read more: £63m ‘slippage’ in council budget caused by Brick by Brick
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