Thought leadership for housing associations: Liability management (part 1)

Rising yields have created a completely new dynamic for the debt portfolio

It is important to understand that a sustained rise in interest rates changes the dynamic involved in managing your debt.

• The cost of floating-rate debt could rise steadily over time.
• The cost of new fixed-rate debt may rise steadily – particularly at long maturities.
• Delays in raising additional funding will increase the all-in cost of borrowing.
• Mark-to-market (MtM) losses on legacy bonds and fixes will fall.
• Fixed-rate transactions from 2020/2021 will offer substantial mark to market profits.

This has created a different range of options for managing debt portfolios. To adjust to these, housing associations will need to consider the following:

The appropriate level of fixed-rate debt and liquidity for the business.

Over fixing debt/building excess liquidity now to address future borrowing requirements may be appropriate, despite the short-term impact of cost of carry, to insure against the future impact of rising rates on a portfolio where the percent of floating-rate rises over time.

Use the opportunity of rising rates to readjust the debt portfolio without increasing the overall cost of borrowing.

This can be achieved by offsetting MtM losses on expensive, high-cost legacy debt often with unattractive covenants, with the profits from cancelling newer, lower cost swaps and bonds to achieve a neutral outcome.

Sidestep any constraints imposed by interest cover covenants on mark-to-market losses.

Expensive legacy debt can be paid off without seeking waivers for the Interest Coverage Ratio (ICR) covenant, as MtM losses can be offset against MtM gains from collapsing the newer transactions.

Achieving greater security efficiency on the debt portfolio.

Ability to manage the debt portfolio to realise greater security efficiency by buying back bonds and swaps substantially below par value. At the same time, it has impacted micromanagement of the debt portfolio. It has also changed the strategic approach you may need to take on arranging new debt – particularly from the capital markets.

It has affected the confidence in your business plan about being able to raise new debt through the bond market on the maturities you require when you need it.

Bear markets mean there will be times when the bond market is only available at a very high cost – while investors can become very sensitive about duration. We have seen this in the performance of housing association deals at the end of April. Equally, it undermines confidence that taps and retained bonds sales can always be relied on as an efficient source of liquidity.

It has impacted the ability to use taps or sales of retained bonds on recent issues to meet future requirements for liquidity.

This would mean that many bonds can only now be placed significantly below par. This is likely to make them security inefficient. It also risks walking into the problems of zero-coupon tax legislation. It will require borrowers to start focusing on using older issues with higher coupons for taps and retained bonds as these will still be trading above par.

It may lead to a shift in treasury strategy back toward the banks as a medium-term source of liquidity while also looking at private placements.

Borrowing in steady, smaller amounts may prove a more flexible and cost-effective strategy than building up a funding requirement to justify a single, large index-eligible bond.

It has further increased the potential cost of any sub-benchmark public issue as investors will not believe these issues will be increased to benchmark over time.

This was underlined by the outcome of the BLEND issue in April. If bond prices continue to fall, investors will have little confidence in the use of taps to increase the bond to benchmark size.

It has increased the value of rapid execution and required borrowers to take account of this in any funding decisions.

Based on the market performance since the start of 2022, every one-month delay will add 15 – 17 bps to the overall cost of the deal. This provides an advantage to lenders that can transact quickly, issuers with EMTN Programmes and potentially increases the attraction of deferred drawdowns and forward sales.

It may also prompt changes to treasury management with:

• The need for closer monitoring of markets, particularly borrowers' own name bonds.
• More frequent communications with banks and investors to assess market conditions.
• Greater focus on efficiency gains from managing existing liabilities as well as borrowing new debt at the lowest cost.

Further releases

In our next two pieces, we will explore:

1. The advantages, disadvantages, and practicalities of buying back bond issues trading substantially below par
2. The use of derivatives to
   1. Manage the fixed/floating mix
   2. Swap out existing fixes at advantageous margins to SONIA