February 2017

February 2017

February saw the publication of the long-awaited housing white paper, with the encouraging title of “Fixing our broken housing market”.

In our view, the white paper lacks any major radical reform, either on planning or financing. But there are a number of ideas which clearly have had some thought given to them and which may have an impact. That isn’t intended to be overly damning as a summary but equally it is hard to be overly enthusiastic.

On the town planning front, there is a more forceful push for local authorities to use consistent methods to assess housing need, as well as to adopt local plans (for the laggards who still do not have one). There is still on the face of it a clear commitment to protecting the Green Belt (which was a party manifesto promise), but with some nuance to the approach and the focus on “process” is probably sensible. Local authority planning functions should see more funding from the proposals, as well as simplification of the system for calculating planning gain (s.106 and the Community Infrastructure Levy) and a proposal for a “housing delivery test” to make consent for development easier if an area is falling well short on delivery. There is even some creeping in of a regional dimension to decision-making, famously unpopular with the Coalition government, with references to spatial strategies produced by new “combined authorities”.

There has been plenty of public debate about “landbanking” by developers and the speed with which planning consents are built out. The housebuilding industry has generally remained on the front foot in that debate, but there is clearly some suspicion that developers have it too much their own way. So, there is the suggestion of shortening to two years the time within which a consent must start to be built out and plans to make greater use of compulsory purchase to push forward stalled sites.

One area where there could have been an “easy win” would have been to state more clearly the intent regarding rent policy from 2020; it is said instead that the government will “set out, in due course, a rent policy for social housing landlords (housing associations and local authority landlords) for the period beyond 2020 to help them to borrow against future income, and will undertake further discussions with the sector before doing so.” Centrus would continue to maintain that CPI + 1% is a reasonable base assumption so long as combined with sensible real inflation on the cost side, but it also continues to make sense for boards to be fully aware of less generous rent settlement scenarios from business plan stress tests.

Housing tenure issues probably see the most change. The “starter homes” initiative has been significantly watered down, being dropped from 20% to 10% (and the 10% can be a mix of starter homes and other affordable home ownership products such as shared ownership). The terms of the 2016-21 Affordable Homes Programme funding round have been loosened to be more capable of being used for affordable rented housing, highlighting the shift in emphasis that has taken place with the change of Conservative leadership. Voluntary right to buy is going to see another (relatively small) pilot scheme rather than a renewed major push (and no mention of forced council housing sales). However, it would be wrong to conclude that housing associations are seen as the only game in town for affordable housing, with various references to institutional investment – not meaning just via associations or in the standard ‘affordable’ products.

So overall, nothing overly “housing association unfriendly” but equally no major initiative to grab hold of and use to energise new investment commitments. As for the references to increased institutional investment, we are already seeing relatively significant moves being made in this area as the market itself responds to market failure over the balance of housing supply and demand.

While we may be fairly underwhelmed by the content of the white paper, it was interesting to note Moody’s response which was published last week and which set out three broad strands from a credit perspective, two of which are negative and one positive:

  1. Continued pressure on HAs to increase housebuilding beyond current levels (credit negative)
  2. Increase in development pipelines funded with debt, surpluses from riskier market sales activity, limited contribution from capital grant (credit negative)
  3. Government will provide clarity on new social rent policy, consult with sector (credit positive)

The 2:1 balance probably underscores a broadly credit negative flight path for the sector as a whole as it seeks to strike a balance between financial strength and prudent risk management on the one hand, while at the same time responding to its social objectives and playing a significant role in meeting the UK’s housing supply needs.

As individual HAs seek to calibrate their approach to this dilemma, we are often asked to quantify the impact of different levels of credit rating on borrowing costs. We have recently undertaken some analysis to this end in order to try and provide an evidence based answer. However, because of the small sample set and a limited number of issuers outside of the A1 and A2 ratings levels, it is difficult to show any strong or reliable correlation.

It is more instructive perhaps to look at the graph below which shows pricing levels for 11 different issuers in the A1 to A3 bracket.

This graphic illustrates a number of points. Firstly, that the range from tightest to widest pricing is 62bps. To put this another way, on every £100m of long term (say 30 years) debt, this gap represents a net present value to the issuer of £12m. The other striking point from the analysis is the extent to which pricing divergence between different credit rating levels has increased significantly since the middle of 2015, when the same pricing range was only 19bps.

What are the possible explanations behind this? The BoE’s bond purchase programme may provide some skew to the data but the divergence in pricing levels had already begun pre-Brexit. Perhaps a more logical explanation is that with the growth in HAs as a recognised and understood asset class, investors are becoming better a pricing risk as well as recognising a theme that we have discussed more than once in this publication, namely an increasing divergence in both credit quality and business and operating models across the HA sector. It also demonstrates that while credit ratings are one element considered by investors, they do not provide as reliable a link to pricing as might be expected – for example, note above that both the highest and lowest spreads are on A2 rated issuances. Other factors, including scale, management, business model, investor engagement and frequency of activity in the market all have a bearing upon investors’ perception of credit quality and by extension pricing.

As clients consider different approaches to their corporate financing decisions, the impact of changes to their credit profiles on their cost of funding should figure highly in this process, but this requires a more holistic view than simply focusing on credit ratings.

Despite the much publicised political headwinds (in a month dominated by Brexit headlines and Donald Trump tweets and Executive Orders), the Bank of England (“BoE”), in its February 2017 inflation report, revised upwards to 2.0% its central expectation for UK GDP growth in 2017. This is a significant revision upward from the 1.4% projected in November 2016 and the 0.7% projection in August 2016 shortly after the Brexit vote. The key drivers of the revised forecast, as cited by the BoE, include the fiscal stimulus announced in the Chancellor’s Autumn statement, an improved global outlook, higher equity prices and stronger credit conditions for households.

In the latest ONS data release both CPI and RPI measures of UK YoY inflation increased in December 2016, by 0.4 and 0.3 percentage points respectively. Transport (largely air fares and motor fuels) and food / nonalcoholic beverages (in particular vegetables) were the key contributors. Current market expectations are that CPI inflation will rise above 2% in 2017.

Gilt yields increased in the month across the curve, the 30 year Gilt yield increased by 17bps to 2.05%, as did swap rates which increased by 16bps and 23bps for 5 and 30 year tenors respectively. However at the time of writing, and further highlighting the recent trend of volatility, much of these increases had reversed with the 30 year Gilt trading at a yield of 1.94%.

UK house price growth continued to slow in the month with YoY growth reducing under both of the key market measures (-0.2% Nationwide HPI and -0.8% Halifax HPI). General consensus seems to be toward a more modest level of house price growth in 2017 with Savills, in their February 2017 UK Housing Market Update, actually projecting no house price growth in 2017; reduced consumer spending power expected to offset the recent general improvement in economic sentiment.

After a strong surge in December 2016 (and in 2016 more generally when the index rose c.15%) the FTSE 100 lost some ground in January 2017, falling slightly to 7,099 (-0.5%) although remaining close to all time highs.