December 2016

December 2016

Commentary

It is that time of year again. Retailers are unveiling schmaltzy adverts, bookies are making odds on a White Christmas (6/1 if you are interested) and livers are groaning as the festive party season gets underway. Here at Centrus we are looking forward to our office party tomorrow night – dinner at a pop up restaurant for our resident young hipsters and a sop to us more old school types with a darts contest afterwards. Injuries to be reported in the next edition.

Enough of seasonal frivolity though. The big news in November was the shock election of President Elect Donald Trump. Far from rattling confidence in financial markets, his “Make America Great Again” slogan appears to have been taken to heart by investors, sending equities and the US Dollar on an absolute tear post-election on the expectation of an expansionary fiscal policy (major infrastructure spending), business friendly tax cuts and interest rate increases. The flip side of this is that a tightening bias by the Federal Reserve combined with an expansionary (for which read inflationary) policy environment have served to further roil the bond markets. As covered in last month’s report, the real question is whether the mythical “bond vigilantes” are back with a vengeance or whether market anticipation of normalisation of rates will once again fade away as bond yields crash in another deflationary heap of disappointment.

In the meantime, despite the seismic political events of 2016, for our clients, troupers that they are, the show must go on. After some high-profile aborted mergers, we were delighted to support both the Sovereign-Spectrum and the Affinity-Circle combinations in successfully navigating their lender negotiations, together with all of the other challenges they faced in order to create their new businesses. Their success in this regard will no doubt provide confidence to other HAs deciding to embark on consolidations in 2017.

Elsewhere, another Centrus client, A2Dominion continued its track record of treasury innovation by becoming the first HA to issue a listed bond at “HoldCo” level, i.e. from its non-asset owning group parent. The £250m transaction which was issued at a spread of 230bp and a coupon of 3.5% provides A2D with unsecured funding which can be used anywhere within the group, including A2D Residential (PRS) and A2D Developments which builds out mixed use schemes. The transaction highlights an increasing trend towards diversification of funding sources and structures, which itself reflects the range of business activities and models being pursued by RPs. Another recent development in this area is Places for People’s recent announcement of a retail bond issue guaranteed by PfP Ventures – the holding company for its commercial activities, spanning leisure, property development and property management services. The offering, which is unrated, comes with a 4.25% coupon and a 7-year maturity.

Both transactions also reflect the challenges in financing growing commercial activities within RP groups. In the past, many HAs were able to finance such activities through on-lending and investment from the regulated entity, but as these activities have grown in scale, limitations around on-lending and a greater focus on risk management around regulated entities have meant that borrowers are increasingly looking to non-recourse borrowing structures, secured directly against the non-regulated assets or businesses. Given that this sort of lending sometimes “falls between the cracks” of social housing and corporate/developer/housebuilder lending at the banks, appetite can be patchy and inconsistent. These factors go some way to explaining why A2D, in the shape of a HoldCo issuance and PfP through a retail bond have decided to use non-conventional models and less widely used markets to access specialist funding. As the housing sector continues to evolve, expect to see more diversification and innovation around funding structures and models.

Elsewhere, L&Q became the first borrower under the Private Rented Sector bond scheme guaranteed by the UK Government. L&Q drew £175m at a coupon of 1.75% for a ten-year issuance at a spread of 46bp. The costs to L&Q were expected to be tens of basis points higher once issue costs and the costs for the provision of the guarantee are factored in. Nonetheless, the deal represents good value for funding procured into a PRS vehicle. The structure also offers relatively high leverage and reasonable interest cover, although on the negative side, it does tie up assets longer term, requiring a test of 2x asset cover to be met before properties can be released.

Hopefully you can all “just about manage” to get through the festive period without another Financial Markets Overview, so we’ll sign off for this year by wishing all our readers a very happy and peaceful festive season and a prosperous and successful 2017. Thank you for your custom during 2016 and we look forward to continuing our enjoyable working relationships with you in 2017.

Financial Markets and Economics Overview

As discussed in our opening piece, the election of Mr. Trump into the White House caused a momentary wobble in the financial markets before everything seemed to return to some semblance of “normal”. Over the last month, we have seen gilt yields and interest rates continue to rise (the 30 year gilt yield is up 17bps and 5 year swap rate is up 12bps), this continues the theme discussed in previous editions whereby we may have seen the bottom of the low interest rate environment.

Growth in inflation dropped slightly over October, falling to 0.9%. Pricing for fuel and housing drove the largest part of the increase whilst the cost of clothing fell over the month, with the US-import Black Friday discounting tradition gracing our shores once again towards the end of November.

Nationwide’s house price index showed a 4.4% growth in the year to November, down from 4.6% in the month prior, which is the slowest rate since January. However, the relatively low number of homes on the market and modest rates of construction are likely to keep the supply/demand balance tipped towards increasing prices, even if economic conditions weaken if Brexit negotiations are drawn out.

We also saw the first Hammond Autumn Statement in November. With the JAMs taking most of the headlines in the lead up, Spreadsheet Phil ended up keeping things fairly simple: with only 18 new tax measures (half that of Osbourne’s last statement) and a couple of gimmicky policies (such as restoring stately homes). Out is the target of a budget surplus by the end of this parliament and in is a target to reduce overall government borrowing to below 2% of GDP by 2021. Infrastructure spending also got a mention, with an extra £23bn being put towards new railway signalling and upgraded digital infrastructure.

Interest Rates

 

Inflation

Capital Markets

Bank Credit