August 2019

August 2019

Commentary

Once again, we find ourselves in the midst of the supposed “summer lull” with the Centrus team along with many of our clients’ finance teams firing on all cylinders on a number of fronts.

Rather like the rest of the country, clients appear to have switched off from Brexit and as far as business plan stress tests are concerned, most will be dusting off and updating their Brexit stress tests 4.0 for the looming “do or die/no ifs no buts/[insert other cliché]” 31 October date. If expression of will and apparent determination to meet this deadline were the sole measure of success, then I suspect the odds would be heavily in Boris Johnson’s favour. However, parliamentary dynamics are still stacked against a deal or no deal exit at the end of October. The new Government certainly has the feel of being on an election footing and there is a narrow window for Parliament to engineer a vote of no confidence when MPs return in September. An early Autumn general election would trigger even more uncertainty, with another hung parliament a distinct possibility based on current polling. This may even be part of the strategy and like much in politics could be seen as ‘acknowledgement of reality’ or ‘crazy talk’…

The threat of turmoil enduring through to the end of the year as well as another leg down in long term gilt yields (see graph below) and strong investor demand underpinning credit spreads is leading many of our clients to consider whether to lock in current borrowing rates. A number of recent public bond issuers such as Accent Group, Clarion and Guinness have achieved coupons well below 3%, with Accent issuing £250m at a record low coupon for a long-dated housing association issue of 2.625%.

 

Speed to market

We’ve been recommending to clients for some time that there are significant advantages to being able to access finance more opportunistically than has perhaps been the case in the past, i.e. when market conditions are favourable or in response to reverse enquiries from investors for particular HA names. In markets where timing can make a difference to financing costs of 50bps+ and institutions are willing to do long-term deals this clearly has a material impact on business plans.

 

Conventional approaches relatively cumbersome

Traditionally, HAs have been somewhat hamstrung in this regard by some fairly clunky processes to access the institutional market, including obtaining credit ratings and the joy of “due diligencing” and charging property security. Our general rule of thumb on the security process for major funding transactions is up to 6 months or so, which in a typical bond or PP process then sets the overall timing of within which structure, documentation and if relevant credit ratings are also covered off. At the end of this marathon, borrowers generally (unless there is a very compelling reason to hold off) take the luck of the draw in terms of the then prevailing market conditions, investor appetite and underlying rates.

 

New range of more flexible techniques

Fortunately, market developments have led to a wider range of options for borrowers to access the market in a more flexible and pro-active fashion. These include;

  1. Volume single investor appetite for individual credits in both listed and unlisted form
  2. Deferred settlement for listed transactions (primary issuance, retained bonds and tap issues) offering time for security issues to be resolved and prospectuses to be prepared
  3. Deferred drawing for both listed and unlisted transactions
  4. Shelf arrangements (similar to retained bonds but in PP format)
  5. EMTN programmes supported by numerical apportionment security trusts

Utilising one or more of the above techniques allows HA borrowers to manage their borrowing activities in a more responsive fashion than has historically been the case. Clearly, operating more responsively also requires a) suitably resourced treasury teams and b) governance arrangements (including treasury management policies) to be set up in a way which facilitates this kind of approach rather than the traditionally slower processes of going to market.

We are seeing more associations using these techniques and expect this to continue beyond the present ‘window of opportunity’. If used well, these approaches offer an exciting opportunity for HAs to better manage their funding costs and changing liquidity needs by being more light footed in the way they access the institutional debt markets.

Financial Markets and Economics Overview

 

 

The arrival of Boris Johnson as the United Kingdom’s new Prime Minister has led to some significant movements in the market over a time period that is traditionally quiet as the holidays season gets underway. With Boris’s hard stance on the UK’s exit from the European Union at the end of the October, it is likely that we will continue to see significant movements in the market over the summer.

UK economic data released In July has confirmed that the economy has continued to grow up until the end of May, however, economists are continuing to forecasting a gloomy future due to the continuing Brexit uncertainty and the UK moving closer to a no deal Brexit. Additionally, economic performance outside of the UK is continuing to experience a slowdown with the US and China trade war showing no signs of ending.

UK GDP growth was confirmed at 0.3% for the 3 months to May, reversing a 0.4% decline in April. The Bank of England has lowered its 2019 forecast to 1.3% down from 1.5%. The bank has also cut its outlook in 2020 by 0.3% to 1.3%. The purchasing managers index (PMI) for the manufacturing sector was flat against June’s results of 48.0 for July 2019. UK unemployment continued its healthy trend in the three months leading to May as it remained at 3.8%, while wage growth beat expectations at 3.4%.

June’s inflation figure continued from May at 2.0% hitting the 2% target set by the Bank of England. The Bank’s monetary policy committee (MPC) voted unanimously to keep rates at 0.75%. The MPC cited “an increase in the perceived likelihood of a no-deal Brexit” which has further lowered UK interest rates and the sterling exchange rate. However assuming a smooth Brexit, the Committee said that “a significant margin of excess demand is likely to build in the medium term” which would necessitate an increase in interest rates to return inflation to its 2% target. The MPC also said that increased uncertainty about the nature of EU Withdrawal means that the future of monetary policy is also uncertain and could go in either direction.

The pound sunk to below $1.21 for the first time since January 2019 as concerns continue to mount over a possible hard Brexit, also causing the pound to fall against the Euro to €1.098. Volatility is expected to continue as the markets continue to react to the new Governments hardened stance on Brexit.

Financial markets have continued to reflect the political uncertainty as well continuing signals from Centrals Banks around potential rate cutting, with the Fed as widely expected cutting the US interests rates by 0.25%. This has resulted in continued downward pressure on Gilt yields with reductions across the curves since June. From end of June 2019 to 31 July 2019, the 5 year Gilt yield decreased by 25 bp to 0.38% and the 30 year Gilt yield decreased by 16 bps to 1.31%.

UK government borrowing for the 3 months to June was one third higher than 12 months ago. UK Government borrowing is expected to increase in the short term as the new PM begins to implement his policies which are forecast to add billions to the nations debt. The Nationwide House Price Index showed annual house price growth down compared to June by 0.2% at 0.3% in July 2019, suggesting that consumer confidence may be falling.

Interest Rates

Inflation

Capital Markets

Bank Credit