July 2020

July 2020

Commentary

So, it is July already. The long hot days of April, May and June have given way, for the time being at least, to rather more traditional British summertime weather. The usual plans for summer holiday are on ice, along with many other facets of “normal” life, but whatever other pain the country has gone through these last few months, one cloud lifted this weekend as pubs re-opened their doors.

The big unknown for pubs, restaurants, hotels and other leisure, retail and entertainment businesses is not so much the evident damage done to what were already often stretched or declining business models, but also the extent of post C19 behavioural changes on the part of customers. For activities which have traditionally been predicated on lots of people in close proximity to one another – think live sport, bars and nightclubs, conferences, music & theatre to name but a few – business models will need to adapt quickly or die. Indeed, one effect of C19 has been to quicken the pace of trends that were already taking place, such as the demise of high street retail in favour of online shopping or the increased trend in home food delivery at the expense of eating out.

As has often been the case previously, clients in the housing sector have been fortunate that their fundamental business model remains very much intact while other parts of the economy suffer. Although most HAs have seen and expect further interruption to rent payments for obvious reasons, for most this has been counterbalanced by reduced spending on maintenance as well as development spend slowing significantly. This has supported the credit case that has so often been made by HAs that they provide an essential service to their customer base and the country as a whole and that demand for their properties continues far to outstrip supply.

However, in our view, it would be remiss of the housing sector to think that it is a case of “as you were” in the post C19 world. While the core business model of provision of affordable housing is needed as much as ever, it is worth scanning the horizon for changes that might impact housing associations in various ways.

  1. End of 40-year bull market in rates (& the return of inflation?)

We’ve referred on a number of occasions to the on-going debate amongst economists and market commentators over deflation vs inflation. While this rages on, one thing is clear. If governments and central banks ever needed cover to fully open the spigots of monetary and fiscal largesse, the economic disruption caused by C19 has provided it. A substantive migration from Quantitative Easing to Modern Monetary Theory (“MMT”) which sees much more overt injections of stimulus into the veins of the real economy, would shift the pendulum towards inflation, at least in the medium term. If so, the availability of +/- 30 year money at 2-2.5% may one day be a cause for nostalgia amongst HA treasurers.

  1. Growing role of “policy” and intervention

Another theme we’ve touched upon in previous months is that there may come a greater propensity for policy direction and a return to levels of regional and industrial policy seen to some extent under Tony Blair (e.g. Regional Development Agencies) but not really since the 1970s/80s. Talk of an imminent shake up to the planning system and “build, build, build” suggests that housing and construction will figure large in these plans. HAs wishing to ride the crest of this wave will need to consider more creative use of their capital structures in order to be able to deploy the necessary financial resources.

  1. “Green recovery” and the decarbonisation agenda

Again, part of the cover of legitimacy that governments are likely to use in respect of (2) above will be to put a liberal coat of “greenwash” over large spending programmes. This may accelerate the move towards retrofitting parts of the existing UK housing stock, also increasing the visibility of the elephant in the room, namely the question of who pays for it. Higher build volumes, skills shortages and more stringent environmental standards may also provide a boost to the widespread adoption of modern methods of construction and modular housing.

  1. Impact on cities and the property market

One of the major unknowns is the likely long-term impact of C19 on what has been a long-term global megatrend towards urbanisation. Data suggests that major cities like London, Paris and New York saw significant drops in population during the pandemic as residents sought refuge in second homes or with friends and family in suburban or rural locations. While the economic and infrastructure dynamic in poorer countries may be different, residents of developed countries have choices in this area; a second wave of C19 or even just the recognition that it won’t be the last may change behaviour.

With some of the move to home working likely to become permanent, the “declining cost of distance” and a reduced draw to traditional retail, leisure & entertainment activities, commuting patterns are likely to change and perhaps along with that, the spatial economics of land values and housing demand. With commercial property likely facing at least a degree of structural decline, HAs may see increased opportunity to convert commercial and retail property into much needed residential. HAs need to be flexible enough to challenge conventional assumptions around new development, from inside the business or from developer partners and planners.

These are a few thoughts on the changing landscape faced by our HA clients. We would be interested in your views on these as well as other themes you may be considering in your internal discussions.

There were a number of sales of public bonds in the HA sector in the month. Interestingly, all were either taps or sales of existing retained bonds. Catalyst tapped for £150m, Lincolnshire Housing Partnership sold the balance of their 2059 retained bonds (£75m notional), and Futures Housing and Karbon sold a further £150m between them. GB Social Housing sold £14m in their 2038 bond. Pricing (where not confidential) is provided in the capital markets update at the back of this paper. The run of private placements also continues with another three in the month. Centrus continues to be active in these markets and pricing remains competitive with a number of investors actively buying.

Financial Markets & Economic Overview

The International Monetary Fund lowered its global growth forecast for 2020 and 2021, with a decline of 4.9%, significantly worse than what was forecast in April this year. Italy, France and Spain are forecast to exhibit the largest contraction with the UK expected decline by more than 10% in 2020 followed by a partial recovery next year.

The severity of the coronavirus pandemic on government finances was further compounded with the money owed to holders of gilts, national savings and creditors of Network Rail exceeding £2tn surpassing the size of the UK economy. The demand for increased borrowing arose to fund coronavirus mitigation measures. The last time the UK government debt exceeded the size of the economy was back in 1963.

Despite the initial gloom in June, the UK economy did experience a small increase in confidence largely due to the rebound in UK retail sales by 12%, this was significantly boosted by 42% rise in homeware sales, with a hike in demand for furniture as DIY shops opened their doors once again. Both the UK manufacturing and services PMI improved from May to June rising from 40.7 to 50.1 and 29.0 to 47.0 respectively. CPI fell by 0.3 percentage points from 0.8% in May, predominantly due to the cost motor fuels being much cheaper than they were this time last year.

The Bank of England Base Rate remained flat at 0.10% for the fourth month running, as the Bank resisted taking interest rates into negative territory. The UK 30-year gilt yield ended the month a six percentage basis points higher than last month. Corporate spreads continued to narrow but are still considerably higher than pre-COVID spreads.

House price growths in the UK fell below zero for the first time in eight years to -0.1%, as measured by the Nationwide index. The magnitude of the shock is considered unsurprising given tumbling sales and a pause on viewings as buyers and sellers are impelled to rethink property plans due to income uncertainties.

The pound strengthened by 0.5% compared to the dollar, whereas GBP/EUR fell marginally to 1.100 against last month. The fall against the Euro is sparked by the worry over the UK’s plan to financially recover from the coronavirus crisis.

Interest Rates

Capital Markets

Bank Credit