Adjusting to higher interest rates

Originally published in Social Housing magazine 16/08/23

Will Stevenson, Group Treasurer of THFC, says the quicker social housing providers can adjust to the ‘new normal’ of higher interest rates, the better.

Throughout my many years working in the social housing sector, never have I seen the topic of interest rates, and when they might drop, being discussed as frequently and with such fervour as in recent times.

Higher rates have led to an unprecedented dip in long-term issuance from housing associations (HAs).

Rather than securing new long-term funding, providers have been raising short-term facilities and using cash reserves from pandemic times in anticipation of longer-term rates coming down.

The spark behind this sudden flurry of conversation has been, of course, the abrupt end to more than a decade of historically low interest rates.

This was an extremely favourable funding environment that many took for granted in the years following the 2008 financial crisis.

But in December 2021, everything changed.

As the UK celebrated the first post-pandemic holiday season, the Bank of England raised the base rate for the first time in three years in an effort to curb steadily rising inflation.

This move represented the beginning of a trend of consistently rising interest rates, with the Bank of England’s current rate set at 5.25 per cent, the highest since April 2008.

The social housing context

So, where does the social housing sector fit into interest rate conversations? And how have HAs responded to the onslaught of rate shocks?

With a total of £69.8bn of registered debt across the UK, it goes without saying that social housing has a significant stake in interest rate activity. The knock-on effects of higher interest rates have not been immediate, though, at least for existing debt.

A significant 79 per cent of the largest English HAs’ drawn debt is fixed, with 59 per cent of that debt fixed for over 10 years. In an age marked by interest rate instability, this portion of fixed-term funding serves as a welcome financial cushion for the sector.

The effects of rising rates on new debt funding, however, have been a different story.

New debt funding has fallen across the sector, with just £9.9bn raised in the year that ended in March 2023.

This represents the lowest annual sum of new financing since 2016-17 and falls significantly below the five-year £11.9bn average, according to the Regulator of Social Housing (RSH).

Long-term funding, in particular, has become much more expensive. With 30-year gilt rates currently at around 4.5 per cent, compared with around 0.5 per cent at the beginning of 2020, the knock-on effects for HAs have been palpable.

Increasing interest rates have not only affected how much funding HAs are taking on, but also where they are seeking new money.

As long-term capital markets funding has become more expensive, HAs have relied on short-term bank funding to finance their operational costs.

According to data from the RSH, the majority of new facilities from 2022-23 came from bank lenders, as opposed to the capital markets, for the first time in three years.

It is understandable that the social housing sector has adopted a wait-and-see approach to taking on new long-dated debt.

But at a time when critical, long-term issues like stock condition and decarbonisation are taking the spotlight, HAs should think carefully about how they invest for the future.

Adjusting to the new normal

It is not all bad news for social housing.

With the Bank of England predicting that inflation will drop to around five per cent by the end of this year, it is reasonable to assume that interest rate rises could be nearing their peak.

That being said, times have clearly changed, and the low-interest train appears to have left the station for good. The quicker we can adjust to this ‘new normal’, financially and psychologically, the better.

Even with the Bank of England’s hopeful inflation estimates, the chances that we will return to the heyday of below two per cent all-in rates for long-term funding seem slim.

Another factor to keep an eye on is gilt yields, which are a significant factor in the cost of most long-term funding.

The uptick in gilt issuance expected in the coming years to fund the government’s deficit and, crucially, the unwinding of quantitative easing, could offset any downward pressure on yields coming from lower inflation and a decrease in the Bank of England base rate.

So, where does this leave the social housing sector?

With over a million families on the social housing wait list, the demand for new affordable housing is not going away.

Whether HAs can get comfortable with the new normal and rework their business plans to accommodate today’s higher rates will be an essential factor in determining the level of new housing supply available in the coming years.