December 2017

December 2017

Commentary

This week saw the Centrus team at the sharp end of Christmas festivities and so this month’s update is penned by a somewhat weary and flagging correspondent. Despite some late nights, we have soldiered on and one interesting client discussion this week focused on a shifting landscape in terms of approaches to liquidity within the housing sector.

When one thinks of crisis episodes in housing associations, liquidity or lack thereof usually looms large as one of the most obvious issues that bring these problems to light. The underlying equation between assets and liabilities usually demonstrates a clearly solvent position – hence the queue of other housing associations usually lining up to acquire those assets and liabilities with no acquisition consideration involved. However, the old adage of “cash is king” is as true for a housing association as for any other business, and if liquidity is insufficient to pay liabilities as they come due, then it is time to have some awkward discussions with lenders and the regulator. A sudden shortage of liquidity may be the result of a range of causes including poor governance and risk management structures, a sharp drop in sales or in some cases a failure to prepare security in readiness for charging to draw on committed loan facilities. The legal and constitutional structure of housing associations prevents them from raising equity capital from shareholders in the way that a corporate can in distressed situations simply serves to underline the importance of treasury liquidity.

Recognising the important role of treasury liquidity in a housing association context, regulators and ratings agencies have, over recent years, applied much greater scrutiny to this area. This was demonstrated recently, with Notting Hill Housing’s downgrade by Moody’s having explicitly flagged the fact that the company had not adhered to its liquidity standards as set out in its treasury management policy. In addition, clients which have been through regulatory In-Depth Assessments have suggested a strong focus on the part of the HCA in ensuring that liquidity policies and the implementation of such policies are in line with general sector standards.

Regulators and ratings agencies are generally focused on the “letter of the law” i.e. the position stated within the treasury management policy of the organisation in question. Typical wording from a TMP might be something along the lines of the HA having sufficient committed liquidity to meet [18] months of net funding requirements based on committed (although some HAs include some element of uncommitted but aspirational) development spend. In the past this allowed HAs with reasonably predictable net cash outflows relating to their social/affordable housing programmes and refinancing to monitor their liquidity requirements without too much risk of deviation, at least in terms of liquidity requirements rising more quickly than forecast – many HA treasurers will attest to their development colleagues having perhaps over-egged their estimation of the speed at which developments would come on stream.

So what has changed? Firstly, the change in the commercial models of many HAs has moved the dial. Any organisation undertaking meaningful volumes of mixed use development takes on additional exposure around its liquidity requirements. In the event of a market downturn, with sales income slowing down, the obvious recourse is to draw on committed facilities to fund any shortfall. As a result, many HAs which are exposed to commercial risks of this nature have factored these downside scenarios into their treasury and liquidity planning and our own advice to clients on these issues usually involves looking at downside-sales scenarios for working out how much liquidity to hold. Secondly, the same changes to operating models have shifted borrowing patterns away from the traditional approach which was an almost total reliance on long term funding to one which relies on larger volumes of shorter term liquidity which needs to be rolled over on an on-going basis. Again, HAs are able to mitigate this risk by widening their banking relationships and staggering maturities as well as structuring in extension options to some facilities. All of these actions help to guard against a repeat of the sort of meltdown in the banking sector that took place in 2008, but for some is something of a paradigm shift in terms of a level of active ongoing management of liquidity.

Perhaps more difficult is the issue that many clients now face when pursuing stock acquisition, land acquisition and rescue strategies is that success or otherwise in achieving these goals can lead to some binary outcomes in terms of liquidity needs. We have seen situations where opportunities have arisen in fairly short order which suddenly throw carefully calculated liquidity needs out by some distance and leave HAs trying to secure new funding rapidly. The only way to mitigate this is to carry material amounts of additional liquidity over and above the minimum requirements of the policy. Of course, this comes at a cost but for banking facilities, this is relatively low, particularly if non-utilisation fees can be minimized. Some HAs consider this a reasonable “flexibility premium” allowing them to undertake business in a more agile and light-footed way than might otherwise be the case.

Many HAs with more traditional models will be more comfortable in sticking to traditional approaches to liquidity. But at the larger and consolidating end of the market, we are seeing clients taking a much more commercially guided and less policy driven view of liquidity. Unless an HA has access to unsecured borrowing, it is important to remember that committed facilities are only as effective as your ability to manage security efficiently enough to be able to charge collateral and draw down on them and there have been notable cases of failure to address this in the past. A growing trend towards accessing more “opportunistic liquidity” will in our view be one of the themes impacting many treasury strategies in 2018.

Notable deals in the housing sector since our last update included an issue of £75m of retained bonds by Centrus client CHP and a £250m unsecured bond issued by Places for People as part of a liability management exercise which saw them buy in £155m notional of an older secured bond issue.

Given that this is our last update until January, we would like to take the opportunity to wish our clients a very happy Christmas and all the very best for a successful, peaceful and prosperous 2018.

Financial Markets and Economics Overview

The chancellor, Philip Hammond, during the presentation of the Autumn budget report, confirmed that OBR’s forecast of economic growth in 2018 is  1.4%, marginally lower than the 1.5% this year.  Furthermore, they predicted that CPI would peak at 3% in Q4 2017 and gradually move down towards the target of 2%. On another point, the chancellor reiterated government borrowing to be £49.9bn this year, £8.4bn lower than Spring’s budget forecast.

A key announcement in the Autumn report was a house building initiative, where construction of 300,000 new homes was promised to be delivered by mid-2020s. The government will support the housing market by providing a £44bn housebuilding package over the next five years. A housing  infrastructure fund will be set up with £2.7bn committed to it. On the demand side, it was announced that stamp duty for first time buyers will be scrapped for homes up to £300,000.

CPI inflation unexpectedly stayed at 3.0% in October, below the 3.1% consensus, prompting analysts to speculate that price pressures for the UK have now peaked, despite the weak pick up in wages.

UK manufacturing PMI surged to a four year high of 58.2, beating market expectations of 56.0 and October’s PMI 56.3. The competitive benefits of a weaker pound increase global trade in November.

Annual house price growth stayed at 2.5% in November, as indicated by the Nationwide House Price Index. This resembles a stable level of house price growth, despite current tougher market conditions, lower consumer confidence and the seasonality effect. Government’s plan of action, as set out in the Autumn report, is to tackle the supply shortage in homes. That will effectively put some downward pressure on prices, although we are still in the early days to observe any significant impact on either supply or demand.

1-month and 3-month Libor have both steadily increased to 0.49% and 0.52%, respectively, which is in line with market expectations of the recent rate hike. Swap rates and gilt yields have seen little movement over the last month.

On the Brexit front, deal falls through at the moment over the Irish border dispute, despite PM’s effort to bridge differences by offering a generous divorce package worth €45bn-€55bn. The PM and her team, aim to persuade the DUP to drop their veto on the Irish border.

Interest Rates

Inflation

Capital Markets

Bank Credit