July 2018

July 2018

Commentary

Manchester conference and Brexit

Coming back from the CIH Manchester conference I was reflecting on the various discussions with clients, funders, and other advisers. There was a real sense of uncertainty but also enthusiasm for some of the changes facing the housing sector at present; also a really positive level of ambition for the sector’s ability to improve the opportunities for being well housed in the UK.

Which is a good parallel for the Brexit negotiations (although, admittedly, at the moment everything feels that way!). There is ambition, personal and for the country, and it is exciting. Maybe the craziness of the 1970s economy or the height of the Cold War felt a bit similar: both of those eras were followed by periods of growth and opportunity in one way or another. But it seems too close to call at the moment whether Brexit will happen or not, be soft or hard, be quick or slow, be up or down, left or right …

Given Brexit, a slowing property market and a series of international issues, there is a real environment of investment uncertainty, which can be seen in ONS data e.g. the decrease in business investment of 0.2% in the most recent quarterly release. At the same time, housing associations are still under pressure to “do more” and from our perspective the last six months have probably seen more discussion with clients about how they could undertake & finance more investment than any other six-month period. Certainly, the interest-rate environment remains very supportive for businesses focussed on long-term assets and long-term funding. Our assessment of the “capacity question” is in most cases that it can be done, but an increasing risk profile requires more careful and detailed planning for downside scenarios and more thought to the overall corporate finance strategy and in some cases an alternative approach to capital structure to bring other forms of investment into play.

Hedge accounting

At the same time as all this excitement, housing associations have been busily finishing off their financial statements for 2017/18. Centrus’s involvement in this is usually fairly limited but this year we have been a bit more involved in the detail of clients’ hedge accounting reporting and documentation than is typical. Clearly clients using Titan or other treasury reporting systems will be engaged every year on the reporting aspects, but the whole principle is of course that the system drives the numbers and the methodologies do not change. Our general assessment of this year’s experience is that some of the nuances of international-standards-style derivatives reporting are still feeding through the auditors’ technical teams and we are seeing as a consequence some uncertainty on what different firms see as the right approach. A particular area this year has been where reporting entities have derivatives used as hedges with material mark-to-market value on inception of the hedge relationship, and the rather subtle question of how that inception MTM amortises through the P&L. There are a number of ways of applying the basic principles, in our view, all different and all with strengths and weaknesses. We expect more work to be done on this in the coming year in preparation for 2018/19 financial statements and will be working with a few clients to analyse the potential reporting scenarios in more detail, please let us know if you would like to be involved and we have not already discussed this with you.

Financial Markets and Economics Overview

June has brought more mixed economic data. Economic growth estimates were upgraded to 0.2% (previously estimated at 0.1%) during the first quarter of 2018, the employment rate remained at a record high of 75.6% in April, and inflation figures came in at slightly below expectation, increasing the likelihood of an August interest rate hike given the increasingly hawkish tone of the Bank of England.

Despite the more positive economic sentiment in the UK, as shown in the strong labour data issued and inflation remaining at 2.4% in May (it was 2.4% in April), the GfK consumer confidence index fell for the third consecutive month in June.

The Bank of England raised the chances of an August rate rise after its chief economist, Andy Haldane, joined two other members of its rate-setting monetary policy committee voting for an immediate hike in borrowing costs. For the first time since joining the MPC four years ago, Andy Haldane broke ranks with the majority on the nine member rate-setting panel to join Ian McCafferty and Michael Saunders in calling for an increase in interest rates. The move is likely to heighten speculation that the Bank of England could be gearing up for a rise in two months’ time.

The uptick in growth estimates for Q1 2018 to 0.2% was largely due to service sector growth of 0.3%, while production output, which includes manufacturing, energy and other utilities, rose by 0.4%, having been revised down from 0.6%. The construction industry’s output fell by 0.8%, an improvement from the previous estimate for a fall of 2.7%, although the quarter remained the worst for the building trade in more than five years. The pound rallied against the dollar as the revision to the growth estimate increased the likelihood that the Bank of England would raise interest rates in August. Growth could pick up a little further in 2019 as real wages recover, but risks are weighted to the downside given uncertainty around the outcome of the Brexit negotiations and the potential threat to global growth from an escalating US-led trade war.

UK public sector borrowing fell to £5bn in May, down £2bn from a year earlier. The fall was bigger than expected and brings borrowing for the financial year to date to £11.8bn, £4.1bn less than in the same period in 2017. If the economy holds up, borrowing is likely to undershoot the Office for Budget Responsibility’s forecast by a more significant margin in subsequent years.

The increased likelihood of an increase in the Bank of England base rate has helped offset the increasing geopolitical and global economic growth slowdown risks. The 30 year Gilt yield was up 4bps to 1.74% on a monthly basis. LIBOR followed a similar trend, with the 30 year 6ML being 5bps up to 1.62% during the same period.

UK annual house price growth, as shown in the Nationwide House Price Index, slowed in June to 2.0% from 2.4% in May, its lowest annual rate for 5 years. Subdued economic activity and ongoing pressure on household budgets is likely to continue to exert a modest drag on housing market activity and house price growth this year, though borrowing costs are likely to remain low. Tight supply, a healthy labour market and a continued lengthening of mortgage terms – 30-year loans now are common – will help to prevent prices from falling outright.

Interest Rates

Inflation

Capital Markets

Bank Credit