HRA Interest Costs Mark Swallow mswallow@arlingclose.com

The Housing Revenue Account (HRA) Subsidy reform exercises that took place in England in 2012 and Wales in 2015 saw many local authorities with housing stock taking on additional debt relating to the HRA in order that they could buy themselves out of the subsidy system.

Before Subsidy reform the method for calculating the amount of interest on debt recharged to the HRA was set out in the annual HRA Item 8 Determination and was based upon the calculation of the authority’s Consolidated Rate of Interest (CRI).  The CRI took account of all the “debt” outstanding including external and internal borrowing and the calculated CRI was then applied to the mid-year HRA CFR to calculate the annual interest recharge.

The calculation of the CRI was undertaken as follows:

• If actual external borrowing was at the same level or greater than the borrowing CFR, then the CRI was the average rate of interest on that borrowing.
• If actual external borrowing was less than the borrowing CFR (i.e. the local authority was internally borrowed) the CRI was based on a combination of the actual interest on physical external borrowing along with an assumed amount of interest on internal borrowing.
• If a local authority was internally borrowed it arose because it had used cash resources available from the existence of Usable Reserves and positive Working Capital to fund capital expenditure. As this cash had been used to fund capital expenditure it was therefore not available to be invested to generate investment income. The CRI used 3-month LIBID as the benchmark interest rate on internal borrowing. The reason for using LIBID was that if a local authority was not internally borrowed it would have had cash available to be invested to generate investment income.

With the advent of the subsidy reform system the CRI method became redundant with subsequent Item 8 Determinations stating that interest on loans is “the interest on loans, both external and internal, in relation to the Housing Revenue Account Capital Financing Requirement”, it is therefore up to each local authority to determine how it charges interest costs to the HRA.

At the outset of the HRA reform exercise the guidance from CIPFA was to move away from a one debt pool approach and CRI and to determine which loans related to the HRA. It was expected that any outstanding loans at the point of the subsidy payment that could be attributed to the HRA would be placed in a separate debt pool. Any debt taken on to make the subsidy buyout was allocated to that same HRA pool and for future borrowing the guidance was to effectively make decisions on a separate basis for General Fund (GF) and the HRA.

Since subsidy reform, interest rates have fallen dramatically, and many local authorities have borrowed either on a short-term basis or internally rather than take on external debt. In the current interest rate environment where long term borrowing rates are significantly higher than short term investment rates Treasury Management Strategies have been based upon maximising exposure to short-term interest rates.

Internal borrowing reduces the cost of debt and by reducing cash available for investment also reduces credit and counterparty risk. For short-term borrowing that is taken to fund HRA capital expenditure the recharging of these interest costs should be relatively easy to calculate using the two-pool approach but for internal borrowing the methodology may be harder to determine.

As already stated, internal borrowing is achievable due to the existence of Usable Reserves and positive Working Capital. As the HRA tends to be a smaller component of a local authority’s Balance Sheet, internal borrowing tends to be achievable due to non-HRA resources. In these circumstances the low level of recharge provides a benefit to the HRA at the expense of the GF as the GF resources could be invested in higher yielding investments

Many local authorities have policies in place to recharge the HRA at a rate linked to a similar risk-free investment rate meaning that the HRA is borrowing at rates more closely linked to Base Rate rather than the underlying PWLB rate, the reason for this approach is linked to the reduced credit risk that the GF is exposed by effectively lending to another part of the authority rather than linking the recharge to the rate at which the HRA could borrow itself.

HRA business plans were produced at the outset of the subsidy reform exercise based on several assumptions around rent levels and limits on future borrowing. The abolition of the HRA debt cap in 2018 and recent changes to PWLB lending arrangements (where rates on HRA specific borrowing are 1% lower than the GF rate) provide an opportunity for the debt profiles of the HRA to be revisited as well undertaking a review of the relationship between the GF and HRA regarding the levels of internal borrowing and the calculation of an interest rate on which any HRA recharge is based.

If you feel that now is an appropriate time to review this area, then please contact Mark Swallow mswallow@arlingclose.com.