July 2019

July 2019

Commentary

The atmosphere was slightly subdued at Centrus HQ this morning after all the excitement of our Housing Sector Conference and Summer Drinks party yesterday. Our conference saw speakers from across the sector sharing views and ideas on some of the current and emerging themes impacting their businesses. We heard upbeat views from lenders and investors in relation to the funding market, which in spite of the on-going political saga playing out in the background, appears to remain in rude health.

The conference happened to coincide with the announcement of a ground-breaking financing deal for Sovereign, which has raised a £250m unsecured revolving credit facility, syndicated across five lenders. The deal has a three-year maturity with two one-year extension options. The deal represents a major break with the market convention of secured bank funding and may provide a template for other borrowers looking to bring greater flexibility to their shorter-term financing arrangements.

RPs with substantial development programmes now carry significant levels of liquidity in order to deal with development cashflows and to manage risk in the event of a downturn in sales. Together with risk parameters set out in treasury management policies, this can result in large debt requirements which can remain substantially un-drawn. The cheapest means of obtaining this funding is through short term RCFs. Given the short tenor and rolling nature of these requirements and the fact that they can remain substantially un-drawn, we have often questioned whether securing these facilities, which clients will be acutely aware is a slow, painful and expensive process as well as an additional liquidity risk, is necessary.

The deal also sees a return to the use of syndicated bank deals, a format which largely fell out of favour in the aftermath of the financial crisis. Borrowers often found themselves hamstrung by legacy syndicated deals containing banks that were virtually impossible to deal with and simply wanted to be repaid. However, these problems were a function of long-term low margin deals and for new, shorter term, “on-market” facilities, we believe that some of the benefits of syndicated deals – namely standardised terms and documents and streamlined reporting – will make them more attractive to borrowers. In addition, where borrowers are seeking more innovative structures and terms, syndicated arrangements can often give lenders comfort that other institutions are taking a similar credit and pricing view to them (albeit that on more vanilla deals, borrowers may well prefer to maintain the tension on pricing and terms that bi-lateral arrangements offer them).

The Sovereign transaction plays to two trends we are continuing to observe across our housing clients. Firstly, the on-going divergence or “de-standardisation” of funding in a sector which has traditionally been fairly homogeneous in terms of its funding structures and approaches. And secondly, the increasing willingness of larger RPs to set the basis on which they want to borrow, supported by their ability to access a much wider range of banks and institutional investors.

On a related point, we also observe RPs becoming more responsive and opportunistic in their interactions with the investor market. We will cover the increased interest in EMTN programmes in a future update but for now, another leg down in bond yields is piquing the interest of a number of clients keen to lock in coupons which at some maturities are currently sub 3%, even for deferred funding. With the political situation looking like it will remain volatile for the foreseeable future, a number of private deals look likely to be concluded over the normally quiet summer months.

Financial Markets and Economics Overview

UK economic data released last month largely held up however markets sense storm clouds ahead with the continuing Brexit uncertainty driven largely by the Tory leadership race and the resulting increasing probability of a no deal Brexit. Additionally, central banks around the world were seen to recognise global economic headwinds and position themselves for a loosening of monetary policy.

UK GDP growth was confirmed at 0.5% for Q1 2019, boosted by stockpiling ahead of the first Brexit deadline. We are likely see some reversal of the stockpiling effect that provided a temporary boosttoQ1 growth. The Bank of England predicts Q2 2019 growth will be flat. Notably, the purchasing managers index (PMI) for the manufacturing sector was weaker than expected and fell to a 6 year low of 48.0 for June 2019. UK unemployment continued its healthy trend in the three months leading to April as it remained at 3.8%, a record low since 1974.

May’s inflation figure of 2.0% hit the 2% target set by the Bank of England. The decrease from 2.1% in April was caused by falling fares for transport services, particularly air fares influenced by the timing of Easter in April, and falling car prices. The Bank’s monetary policy committee (MPC) voted unanimously to keep rates at 0.75% after cutting Q2 growth forecasts to nil and warning economic risk has risen. Mark Carney, governor of the Bank of England, indicated to the UK Treasury Select Committee that if headwinds to the economy lift, higher rates may be appropriate ,with the Bank anticipating interest rates to rise gradually in the coming years, conditional on its assumption  of a  smooth  Brexit  transition. Carney, however, indicated that the Bank would change its forecasts in the event the government switches policy towards a different Brexit outcome and a cut in rates would be more likely under a no deal Brexit scenario. The pound continued its weak performance and fell to $1.26 and €1.12, a near 6 month low against the Dollar and Euro, due to growing fears of a no deal Brexit as a result of Boris Johnson’s lead in the Tory leadership polls.

Financial markets have continued to reflect the political uncertainty as well as on the whole dovish central bank sentiment. This can be seen through rates, with Gilt yields across much of the curve decreasing slightly since May. From 31 May 2019 to 30 June 2019, the 5 year Gilt yield decreased by 1 bp to 0.63% and the 30 year Gilt yield decreased by 2 bps to 1.47%.

UK government borrowing was higher than expected, with the budget deficit for May 2019 of £5.1bn being £1bn higher than the same time last year. The Office for National Statistics now predicts borrowing to rise to £24bn for the financial year, £500m higher than previously expected, and above Chancellor Philip Hammond’s £22.8bn target. The Nationwide House Price Index showed annual house price growth remained subdued at 0.5% in June 2019, suggesting that consumer confidence remained subdued.

Interest Rates

Inflation

Capital Markets

Bank Credit