April 2017

April 2017

As we commence the new financial year, having frequently focused on the many exciting opportunities out there in a fast changing and innovating market, we thought it might be worth channelling our inner Jeremiah and highlighting some of the potential risks lurking out there in the next 12 months. Frankly, with the funding side of the sector having been in such a sluggish state over the last 12-18 months, the last thing we want to do is throw a few more bogeymen into the mix and send any nervous clients or board members scurrying for cover. Nonetheless, there are a few clouds gathering that are worth keeping a careful eye on, even if they aren’t sufficiently dark to don the waterproofs.

Risk is, after all, a funny business. Pay it too much attention and you will see Armageddon hiding around every corner, fearful of your own shadows. Too little and before you know it you were the careless ones, asleep at the wheel when disaster struck. Perhaps risk should be approached a bit like Alan Greenspan’s “Goldilocks Economy” – not too hot and not too cold, just right.

Not Brexit Again?

So what are the issues that we see on the horizon? Brexit? Well, we are all suffering a bit of Brexit fatigue and the obvious risks associated with uncertainty and a possible hard Brexit are plain for all to see. However, perhaps less obvious is an indirect risk associated with the UK’s decision to leave the European Union. Recent data highlights include:

February 2017’s CPI print coming in 2.3% higher than February 2016

UK unemployment rate for January falling to 4.7% which is the lowest level since 1975

Office of Budgetary Responsibility revising its UK growth forecast for 2017 to 2% from 1.4%

In spite of a decidedly inflationary set of data and CPI pushing through the BoE’s 2% target, the last MPC meeting in March voted a resounding 8-1 in favour of holding interest rates at 0.25%. Many commentators have highlighted the risk of the BoE “falling behind the curve” in respect of its inflation mandate, particularly as the US Federal Reserve has already embarked upon a process of raising rates as economic growth takes hold. But the BoE is caught between the rock of inflation on the one side and the hard place of uncertainty following the triggering of Article 50 last week.

For housing associations in the midst of four years of rent cuts, the real risk here is of higher inflation impacting interest costs, wages and building costs at the very time when the usual counterweight to these factors – namely rental inflation – has been cast aside. The 1% cuts were in part a short-term response to pressure on the housing benefit bill and hopefully a better understanding will be reached with government this time around.

Borrowing Costs

If data continues to point to inflationary pressures in the UK economy then gilt yields may be vulnerable to a change of sentiment on the part of investors. Currently, ten year gilts are at a record low compared to US treasuries. The post referendum bout of QE which has seen the BoE buying gilts and corporate bonds is drawing to a close as it nears its limits. Any sharp increase in gilt yields (albeit from historic lows) would negatively impact borrowers accessing the debt capital markets this year.

Housing Market

Moody’s have recently highlighted that their rated HAs (which account for over 40% of the social housing units owned by HAs) are “planning a material increase in their development pipelines relative to their most recent business plans (FY2017-FY2021). Political pressure to build is also fuelling internal ambitions to increase development”. They further observe that, in aggregate, market sales receipts will overtake debt as the primary funding source for development from FY 2019. Against this backdrop, the UK house price lexicon has started to include words like “slump” and “sluggish” with Nationwide reporting a small month-on-month fall (0.3%) in UK house prices in March, the first monthly fall since June 2015. Some more bearish commentators have been calling time on the bull market in UK housing for some time but for the time being, it is difficult to pinpoint the catalyst for sustained falls in prices, unless of course interest rates surprise on the upside. Nonetheless, mean reversion and history would both suggest that at some point sentiment will change and could change rapidly and materially. Many HAs would argue that they have implemented strong risk management frameworks around market sales risk and this is undoubtedly true in many cases. Nonetheless, as Warren Buffett once famously said, “it is only when the tide goes out that you see who has been swimming naked”.

Market Disclosure & Investor Engagement

For those of you with listed debt already in the market or with plans to issue listed debt in future, Social Housing recently reported a shot across the bows from the Investment Association, the main representative of UK institutional investors. The IA expressed concern around potential breaches of the Market Abuse Rules, where market sensitive information relating to the issuer is shared with certain parties without being disseminated to the market more generally through official channels. In addition, the IA called for regular investor updates from issuers and the publication of half yearly accounts, amongst a wider set of recommendations around governance, good practice, regulatory compliance and investor engagement.

There is no doubt that those issuers which have focused on clear and regular investor engagement are acting to support both their secondary trading performance as well as demand when they access the market. Just as many borrowers have invested in long term banking relationships, it pays similarly to support strong relationships with institutional investors. Clearly this is all linked to some extent to questions of resourcing, size, credit quality and frequency of issuance in the market and all of these factors will also have an influence when it comes to pricing performance.

The key message here is that while some HAs are meeting investors’ expectations, the IA seems to be sending a clear message to the sector more generally to up its game. To some extent, this game is a relatively new one to many HAs but the risks of not falling into line could be considerable and may serve to exacerbate an already wide discrepancy between pricing levels for different borrowers in the market.

Should any clients have questions or concerns regarding interpretation of disclosure rules, good practice or investor engagement, the Centrus team would be more than happy to help.

On 15th March 2017 the US Federal Reserve increased its base interest rate by 0.25% to 1%, with Janet Yellen, the Chair, citing the strong performance of the US economy across a range of economic indicators as the rationale for the increase. The Federal Reserve have indicated that markets should expect two more rates rises this year.

This messaging may increase the case for the UK to consider raising its own base rate again. The basis for a further rates rise is further strengthened by the continued rise in UK inflation which showed a marked increase in the previous month, with RPI in February up to 3.2% YoY and CPI up to 2.3% YoY, now above the Bank of England’s 2% target. However, the Bank of England voted in the month 8-1 to maintain the base rate at 0.25%.The MPC’s current expectation is that CPI inflation will peak at 2.75% in 2018 before gradually drifting back down to target.

Market rates were generally unchanged month on month, with Gilt yields at 31 March 2017 across all tenors largely static when compared with those at the end of February. The 30-year Gilt was trading at a yield of 1.73% at the end of March. Meanwhile, GBP LIBOR swaps rates crept up 7bps at the short-end (5 year) and by 2bps at the long-end (30 year).

Against this backdrop, the FTSE 100 continued to rise to new highs in the month with the 7,323 level as at 31 March 2017 the highest month end close to date.

Meanwhile, UK house price growth, as measured by the Nationwide HPI, softened in March to 3.5% YoY. This is down from 4.5% YoY the previous month – the lowest year-on-year growth rate since August 2015 and the first seasonally adjusted monthly decline in 21 months (at -0.3%). Similarly, the Halifax HPI indicated a slow down in house price rises with YoY growth in March down to 3.8%. Nonetheless, Halifax maintain that the current environment of low supply of both new homes and existing properties available for sale, together with low mortgage rates, will continue to support house price levels over the coming months.