July 2017

July 2017

The most significant event in UK social housing in June was of course the terrible disaster at Grenfell tower. There seems significant uncertainty about what should or will be the investment consequences of this. Some clients have been modelling quite significant potential changes to their business plans as a consequence of the possible requirement for investment in existing buildings to improve safety. It will take time for a settled view on the right way forward to emerge but clearly there is the potential from this to reduce investment in new homes for organisations with greater exposure to the issues currently being investigated. We would expect that in any specific cases where exposures to additional spending requirements are significant, lenders will take a pragmatic view in providing carve-outs from covenant calculations and clearly early engagement and transparency with lenders will be key to this.

It does rather feel that there has been a series of set-backs to associations being able to plan with confidence – the 1% rent cuts, Brexit vote, and now this uncertainty. But the reality is that these sorts of changes in the external environment are just a normal part of doing business – look at the changes affecting other parts of the economy, plenty of businesses experience and adapt to fast-changing environments. The consistent element of an effective response to change is the importance of understanding the financial resilience of a business (in respect of eventualities which have been foreseen and included in scenario testing and those which haven’t) and the real constraints on its capacity, and consistently approaching opportunities with that understanding in mind.

The host at the recent HANA awards made quite a cute observation when observing that he could no longer take the mickey out of audience members from the US about the chaotic

state of their political system, looking at what was going on in the UK. Headlines even just over this weekend would appear to support this, with parts of the Conservative party seeming to think that a leadership change might go down well with the electorate and Tony Blair swallowing his pride and acknowledging the possibility of a Jeremy Corbyn premiership – neither would have looked like likely headlines in, say, March. Grenfell is a sad event the consequences of which are yet to play out, but it is not as if there were not significant uncertainty anyway.

We mentioned last month the failure of Banco Popular in Spain and its acquisition by Santander for EUR1. The bail-in of junior bondholders – i.e. the experience of financial loss by them – was a test of the post-crisis bank regulatory regime and on balance a successful one, even if less “popular” for junior bondholders. Our final comment on the topic was a question about the potential “next test” of the system with the various weaker Italian banks. Since then, there have been a couple such tests:

  • The Italian government has given Intesa Sanpaolo (one of the two main Italian banks) EUR5bn to acquire two small regional lenders. The rescue was deemed small enough for the Italian state to side-step the requirements of the shiny new Bank Recovery and Resolution Directive.
  • Another much larger Italian bank and the world’s oldest, Monte dei Paschi di Siena (MPS), with c.8% of Italian deposits, has also been rescued. MPS apparently had the largest proportion of non-performing loans of any major Italian lender, at nearly 25%. Equity and junior bondholders have been burnt again but not senior funders, again, costing Italian taxpayers EUR4bn.

If one were an Italian taxpayer one might be wondering what was going on if nearly a decade after the financial crisis started these problems are still be cleared up and at significant cost. Senior funders are consistently keeping their shirts intact through these hurried reorganisations of the market even while junior debt (with some further “fudge factor” around retail investors who invested in the higher yielding junior debt who will be compensated effectively for “mis-selling”) and equity holders are taking some pain.

It isn’t just the Italians and Spanish who are taking time to work through the consequences of past decisions and keeping parts of their financial system on life support. Nonetheless, the issues are real and these moves can perhaps be seen as part of a direction of travel towards a more rational financial system. On the other hand, just as regulators belatedly get to grips with the banking system in the aftermath of the global financial crisis, the budget and pensions crisis in Illinois may present an early signal that the next crisis may be less about the banking system and more about the unsustainable trajectory of public and related unfunded or underfunded pensions schemes which continue to bear the strain of seven years and counting of near-zero interest rates.

One area of good news, if on a smaller scale, is that we are starting to see clients benefit from the removal of the section 133 consent process as part of the government’s deregulatory drive. Our own assessment is that experience will be mixed and potentially we will see a more permissive approach from institutional funders than some bank lenders. Documentation varies and it is relatively early days in terms of clients pushing for greater security headroom as a result of this change.

Financial Markets and Economics Overview

The most significant event for the UK financial markets in June was quite possibly the UK general election result, where Theresa May, the conservative party leader, failed to achieve an overall majority in the 8th June vote; this despite calling an early election with a view to extending her majority (increasing stability in the lead up to Brexit) and having large leads in the polls only months earlier.

The Tories held on to power by entering into a “confidence and supply” agreement with the Democratic Unionist party, and at the expense of an additional £1bn of funding for Northern Ireland – a deal that was not well received by the SNP and Labour parties. The Queen’s speech saw Theresa May backtrack on several  headline manifesto pledges including policies around elderly social care, fox hunting and removal of the pension triple lock, amongst others.

Against this backdrop, interest rates, as measured by UK government bond yields, were up significantly in the month with the 30 year Gilt trading at a yield of 1.86% on 30th June, up from 1.66% at the previous month close. There were similar upward movements in swap rates, with 5 and 30 year tenor swaps up to rates of 0.99% and 1.61% respectively, representing a 26bps rise on the previous month close.

CPI inflation rose to 2.9% for the year to 31st May, up from 2.7% in the year to April 2017 and inching further above the MPC’s 2% target. In the month Mark Carney stated in a speech that the “time is not right” for a rise in interest rates, suggesting continued tolerance by the BoE of above target inflation in favour of other economic variables such as GDP growth and employment. Nonetheless, despite the BoE holding the Base Rate at 0.25% in the month, three of the five MPC members did in fact vote for an increase. Post month-end, the recent release of June’s inflation figures showed a surprise drop in CPI inflation to 2.6%.

Meanwhile, there was mixed data from the housing market with Nationwide reporting a rebound in house price growth – a 1.1% monthly increase in June 2017. However, Halifax reported a continuation of the recent slowing trend with a 1% decline in UK house prices in the month and the annual increase, at 2.6%, representing a further decline in the rate of house price growth.

Interest Rates

Interest Rates


Capital Markets

Bank Credit