April 2020

April 2020

Commentary

 

Welcome to the first Centrus monthly report produced under lockdown. We are very aware that the practical travails of a corporate finance business consultancy with 60 team members are probably fewer than those of our clients, most of whom have big teams and practical responsibilities such as providing services in people’s homes. Nonetheless it has been a trying month for us all.

The big questions of course include how long will this last and what state will the nation’s physical, emotional and financial health be in when things return to normal. The follow-on question is what ‘normal’ will look like after such an intense period of living in different conditions – how will people feel about their neighbours after avoiding contact with them for so long, how will the world’s ecosystem get over the shock of being returned to the normal pummelling after a brief relative respite, and will the user traffic of Zoom and House Party return to pre-COVID levels or have work and social practices changed forever?

When we issued our ‘exceptional’ update to business planning assumptions in mid-March, it was partly in response to client queries about the impacts of the real lows in interest rates being plumbed at the time in response to the emerging COVID-19 situation and the battling over oil prices within and between OPEC-plus and the US. However, it was also to highlight the impact of increased volatility in inflation on business plans, particularly for housing associations where rent is typically set by the trailing September CPI rate whilst costs will tend to be slightly more ‘current’. We forget at our peril how challenging uncertain inflation expectations can be.

It may be that as the world figures out the appropriate medium-term response to COVID-19 that there is more to watch for on inflation than in the past. There has been no time to formulate an exit strategy for the issuance of government debt which pretty much everyone would in normal times ascribe to belief in the notorious ‘magic money tree’. Some will argue that the crisis will pave the way for a greater acceptance of government action and internationalism. Others will be concerned about countries which may lose any shreds of fiscal credibility they have clung on to since 2008 and that this will have major ramifications for politics and policy-making post-crisis. Low demand (e.g. everyone staying at home) tends to lead to depression and to downwards pressure on prices, but if the government offsets that with massive increases in money supply that will tend to increase prices – the ‘quantity theory of money’. This theory was invented by Nicolaus Copernicus, the chap who gave us the earth going around

going around the sun, so it has some credentials at big-picture level despite being a bit old-school in its simplicity. Timing is everything and we do not know which effect will be the larger over the next decade. But for a sector which has not had to think too hard about inflation for a number of years it is important to be mindful of its importance. Low inflation could hit many HAs’ interest cover positions; inflation risk is also over time connected to interest-rate risk and refinancing risk.

Capital markets and ratings agencies

During parts of March, debt capital markets ended up in their own form of lockdown as investors balked at levels of volatility unprecedented in recent years. However, the last week or so has seen primary issuance activity returning in large scale with financial, corporate and sovereign/sub sovereign issuers tapping the market for liquidity. Significantly wider credit spreads and higher than normal new issue premia have tempted investors back into play in spite of continued uncertainty.

In the housing sector, Optivo was the first issuer to take the plunge with a new 15-year bond which priced at 230bp over gilts following initial price talk in the +250bp area. The bonds have since tightened in to around +200bps demonstrating that for the time being at least, investors are holding sway in terms of extracting value for themselves at the expense of issuers. At the time of writing, Sanctuary is in the market for a new 30-year benchmark transaction with price talk in the +200bp area.

Both of these associations have strong name recognition and having new primary issuances like this, albeit at levels 100bps or more wider than earlier in the year, should help to bring confidence back to both the public and private debt markets, with new transactional activity and post deal spread performance offering genuine benchmarks for borrowers and investors alike.

The ratings agencies have so far offered relatively little by way of public comment on the sector. Clearly there is plenty going on in the wider universe of rated entities. Speaking to them privately, they appear to remain relatively positive. Fitch has broken ranks with Moody’s and S&P in relation to the UK sovereign rating with a downgrade to AA-

(negative outlook) whilst the UK remains AA with S&P and Aa2 with Moody’s. However, it is notable that in relation to HAs, Fitch has put four A+ associations on negative outlook on the basis that they presently get a one-notch uplift from A underlying to A+; should the sovereign go down to A+ they would not uplift ratings to the level of the sovereign and they would stay at A. So, at the present time something of a ‘technical’ point rather than specific to a view on the associations.

The agencies are now required to pre-plan announcement dates for sovereign ratings actions, barring exceptional circumstances, and the next S&P and Moody’s days for the UK sovereign are both later in April (24th and 17th, respectively) so it will be interesting to see what they do and say then. As with Fitch, many associations will be aware that they receive one or two notches of uplift based on implied sovereign support and this is more vulnerable for some associations depending on the relative levels. Centrus is able to offer more detailed advice on ratings strategy and the communications aspect of that in relation to any upcoming reviews. It may be that the agencies take a more cautious stance around liquidity where their methodology is nuanced (e.g. around retained bonds) and we have already seen some evidence of that in discussions on specific clients; happy to discuss further on a client-specific basis.

Information overload!

Clients will have received a number of communications from us in the last month: the usual quarter-end Business Planning projections; the exceptional refresh of the same earlier in March, plus the COVID-19 webinar on 26th March and associated paper and slide deck. Please let us know if you require copies of any of these documents or would like to discuss any of these issues in more detail.

We have decided to keep this months’ introductory comments brief, given the overwhelming numbers of news sources regarding COVID-19 and also the being mindful of how busy people are right now running their respective organisations. The following pages contain the usual market data and update.

We wish you and colleagues all the best for the month of April; keep safe and best of luck with network connectivity.

 

Financial Markets & Economic Overview

 

March has seen Fitch downgrade the UK’s credit rating to AA- (negative outlook) from AA, citing the budget impact of the coronavirus pandemic and continued uncertainty over Brexit. Fitch has forecasted the UK’s economic output to drop nearly 4% for 2020.

The news comes off the back of BoE announcements to keep policy unchanged after its recent actions this month, including cutting Bank Rate to a record low of 0.1%, announcing £200bn of asset purchases (including new commercial paper facilities) and introducing a term funding scheme for SMEs.

Despite the downgrade, Gilts have traded down from February as investors head for the exit across equities with the 30yr yielding 0.82% at month end. Corporate spreads across A and AA issuers widened from February to 186 bps and 173 bps respectively. However, this is down from highs seen mid-month.

Despite best efforts, March UK PMI data shows that employers are cutting headcounts at the fastest pace since 2009, despite some companies saying they are placing staff on furlough.

Across the eurozone composite PMI index dropped from a reading of 51.6 in February to only 29.7 in March, the lowest reading since the survey began.

In US markets, news of the recently approved $2 trillion Fed stimulus package and a recovery in oil (on hopes of a ceasefire in the price war between Saudi Arabia and Russia) provided some respite for equities towards the end of March, before abating into early April.

Junk bond funds have attracted record inflows in the week ending March. The hunger for yield follows the Fed’s pledge to buy billions of dollars in investment grade credit of which will impact the junk bond market.

Looking across to China where recent economic data may be a template for other major economies. PMI showed that, relative to February, manufacturers are now experiencing a modest expansion in business activity. Exports and GDP data will be released mid-April providing a clearer picture as to the fallout

Nationwide’s house price index indicated that property values continued their post-election recovery with March recording a year on year increase of 3.0%, up from 2.3% in February. How the impact of COVID-19 through the month will play out will need to be awaited in next month’s figures.

Interest Rates

Inflation

Capital Markets

Bank Credit