Talking to one of our housing association (HA) clients recently, the conversation turned to funding efficiency and the sector’s attachment to long-term debt. With a sharply rising yield curve, this currently involves borrowing fixed rate at over 6% for maturities of 20 or 30 years when new social housing may struggle to make a return of over 5% even after grant and internal subsidy.

This focus on long-term debt as core to funding strategy distinguishes HAs from most other sectors in the UK economy, including financial institutions, commercial and industrial companies and utilities, where average debt maturity has fallen over the last 10 years. 

It appears to have its roots in two things:

  • The focus of the Regulator of Social Housing (RSH) on the importance of a 30 year business plan; originally introduced in the 1990’s to ensure social housing was viable across its expected life – but contributing to a desire to borrow fixed and long dated, and
  • Concerns over refinancing risk, built on the challenges faced by HAs in the early 1990’s when raising debt.

Yet should these issues really be driving decisions on the maturity of fixed rate debt in the current market?

Over the last 30+ years, Housing Associations have grown into one of the largest and best-rated groups of borrowers in the UK, with £110bn outstanding through bank loans, private placements and public bonds from a wide range of lenders in the UK and overseas.

Over the last 30+ years, HAs have grown into one of the largest and best-rated groups of borrowers in the UK, with £110bn outstanding through bank loans, private placements and public bonds from a wide range of lenders in the UK and overseas.

In the process they have survived two extreme financial crises, neither of which led to serious problems or materially interrupted credit to the sector: 2007–10 and 2020–22.

This does not suggest that HAs should ignore refinancing risk or prudential liquidity, but given the current yield curve it raises three questions:

  • Are some of the criteria used for judging liquidity and refinancing risk correct?
  • What cost do they impose on the sector? and
  • How does this impact the capacity to expand social housing?

Managing liquidity and the life of debt

Over the last 50 years there have been five financial crises, or roughly one every 10 years, which have materially affected the price and availability of credit. While their causes have differed, none has lasted more than 1.5–2 years as the Government/Bank of England have had to intervene to avoid wider failures in the UK economy. 

Market crises justify considerable emphasis on short-term liquidity and refinancing risk attached to debt maturing over the next three to five years. The harder question is whether that same risk supports the weight treasury committees often place on maintaining a much longer average life of debt – particularly where this leads to a preference for 20 to 35-year fixed-rate borrowing. 

There have been periods when long-term borrowing has been highly beneficial for HAs, as for other borrowers. Those that raised long-term debt at yields of 1.625% to 3.5% are now sitting on an attractive cost of funds. 

The point is not that long-term fixed-rate debt is inherently wrong. Used at the right point in the cycle, it can be a powerful source of stability.

But the same strategy can also have a downside. HAs that borrowed fixed-rate debt between 1990 and 2012 through bonds or fixed-rate bank loans at rates of 5% or more were constrained during the declining interest-rate environment that followed. Their high cost of debt reduced operational flexibility, while the mark-to-market cost of refinancing made those positions expensive to unwind. 

The point is not that long-term fixed-rate debt is inherently wrong. Used at the right point in the cycle, it can be a powerful source of stability. Used as a matter of policy, however, it can become a significant inhibitor of financial flexibility, unable to respond efficiently to a changing environment. 

Taking a more flexible approach to managing the average maturity of debt 

We believe the current shape of the yield curve calls for a different approach to managing the average maturity of debt. This reflects a broader principle: borrowing should support the delivery of the business plan, not become a constraint on performance. 

When interest rates fall substantially below the yields available on an organisation’s assets, as they did between 2017 and 2022, there is a clear case for locking into long-term fixed-rate debt. When the opposite is true, however, a different approach may be required. 

Any alternative approach needs to address three principal risks: 

  • Liquidity risk – the risk of running out of cash 
  • Refinancing risk – which is closely linked to liquidity risk 
  • Interest-rate risk – the risk that higher funding costs undermine the business. 

The first two risks clearly justify careful management of liquidity and refinancing requirements over the next three to five years. They also highlight the need to avoid excessive bunching of refinancing obligations further along the maturity curve. However, given the established position HAs now enjoy in both domestic and, for the large ones offshore, debt markets, it seems unlikely that they would be unable to refinance for anything other than relatively short periods. 

It justifies limits on the level of short-dated debt but a less rigorous requirement as tenors get longer

If debt is a permanent feature of the business model, it needs to be managed efficiently. This points to a shift in boards’ attitude to risk

Interest-rate risk is also a legitimate concern. However, while this clearly requires careful management of fixed-rate exposure over a two-to three-year horizon, it is harder to justify locking in protection for substantially longer periods where doing so imposes a significant cost on the business. An increasing number of HAs now understand, and have access to, derivatives. Unlike 20 years ago, they can therefore manage their cost of debt and interest-rate risk more dynamically as market conditions change. 

Where long-term rates appear cheap relative to asset yields or the short-term cost of borrowing, there is a strong argument for fixing debt for longer. But that argument is much less compelling when fixing debt for 25 years costs 0.5% to 1.0% more than fixing for seven to ten years. 

HAs and the Regulator both accept that simply running down debt over a 30-year period is unlikely to be the most efficient way to deliver new and well-maintained homes. If debt is a permanent feature of the business model, it needs to be managed efficiently. This points to a shift in boards’ attitude to risk: building in the flexibility to adjust policies, limits and authorisations as market conditions change, and giving treasury teams greater authority to manage these risks proactively. 

Want to explore whether your debt maturity strategy still fits today’s yield curve? Get in touch with Allia C&C’s advisory and funding team on info@alliacc.com.