Social Housing – Interest Rate Management
With an impending budget in the UK, coupled with an election in the USA, social housing providers are focused on their finance costs and how to manage interest rate risk.
There are two options generally available to social housing providers.
Embedded fixed rates
Most facility agreements align interest to SONIA (previously LIBOR) and allow for borrowers to enter into fixed rate loans. Over the last 20 years or so, this is the basis on which the majority of social housing providers have managed interest rate risk.
Over time, the fixed rate options available to social housing providers have become more constrained. At one point, facility agreements would have provided not only for plain vanilla fixed rate loans, but also RPI linked loan, cap and collars etc. Gradually, however, the optionality available to borrowers has reduced and generally in the current market place, only straightforward fixed rate loans tend to be available.
Fixed rate loans also now are usually only available under term loan facilities. Whereas previously we also saw them provided in the context of revolving credit facilities, particularly when operated on a quasi-term basis, this is not generally now permitted, with RCFs only being available on a floating rate basis.
The minimum amount to be fixed has also often increased, making fixed rate loans no longer a viable option often for smaller loan facilities.
We have also seen the term of fixed rate loans reduced with 10 years or thereabouts often being the maximum available.
The overall impact is to make fixed rate loans a more restrictive, and potentially less attractive, hedging strategy for social housing providers than used to be the case. In consequence, there has more recently been a move back to an alternative hedging option.
Loan linked ISDA hedging
Again, if one looks back to 20 years ago or more, it was more common for social housing providers to manage their interest rate risk on an ISDA based structure. This however fell out of fashion, predominantly due to the availability of embedded fixed rate products but also due to regulatory opposition to such interest rate management, particularly for smaller social housing providers lacking treasury sophistication. A concern over the use of ISDA based hedging for speculative purposes as opposed to true interest rate risk management was also a live concern.
With however the growing restrictions applicable to embedded fixed rate arrangements, the flexibility provided by ISDA based solutions is driving a return to such hedging arrangements and we are increasingly seeing this as a norm for social housing providers.
ISDA stands for the International Swaps and Derivatives Association. They publish a form of 'master agreement' to regulate interest rate hedging transactions.
The master agreement is entered into between a social housing provider and a hedging counterparty, commonly a clearing bank or a subsidiary of such a bank. Once entered into it acts an enabling agreement under which specific hedging transactions can be entered into. For social housing providers these transactions tend to be straightforward and often take the form of a swap transaction, under which a future stream of interest payments (on a variable rate basis) is swapped for another (on a fixed rate basis).
The social housing provider's facility agreement will also need to be amended to accommodate such hedging. The wording used for this purpose is fairly standardised across the sector not usually the subject of substantial debate.
The hedging counterparty will also need to be made a finance party in order to benefit from the security provided by the social housing provider.
A hedging provider needs to be satisfied that a social housing provider has the relevant power and capacity to enter into ISDA based hedging and will look to their legal advisers to formally confirm that this is the case. They will want to see that the constitutional rules of the social housing providers specifically allow for such hedging transactions to be entered into rather than relying on general corporate powers or the absence of specific provision prohibiting such interest rate management.
In summary the current market trend appears to be away from embedded arrangements and back to ISDA based arrangements and it would be prudent for social housing providers to make sure that their rules and facility documentation are updated if necessary to accommodate this move.
Chris Dun
Partner
Brodies LLP
28 October 2024
Contributor
Partner