March 2019

March 2019

Commentary

The last month has seen a handful of stories, and much private discussion, about market exposure of RPs with mixed development programmes. There have been several headlines on the topic, referring to specific associations such as L&Q and Notting Hill Genesis – i.e. primarily to major London-focussed developing associations.

It does seem clear that there is an element of slowdown at least in some areas, and that it relates to shared ownership homes as well as homes built for outright sale. As the charts below reproduced from the latest quarterly survey of the Regulator of Social Housing show, unsold stock has been on an upwards trend for a year or longer and this seems broadly consistent with anecdotal reports and discussions with clients. Each home can represent a significant sum and particularly for homes built for outright sale, and the burden is not spread evenly across the sector; however, it does not at this point look like a ‘rout’.

It may be that the “Brexit quarter” running to end of March will show a further increase in homes completed and unsold – Q4 traditionally shows a spike in reported build completions anyway, for various reasons including grant commitments. (This is visible in the data below if one tracks the yellow ‘acquired / developed’ line.) The quarterly surveys usually come out a couple of months after the quarter end – no doubt there will be discussion on an ongoing basis and reports from housebuilders as well as RPs, but we will likely see the detail on the Q4 position in late May.

 

At a practical level there is a point readers will recognise as a consistent theme in our advice over the last few months – namely the importance of holding liquidity to deal with a slowdown in sales.

The implications of a slowdown can be managed by a combination of just waiting, if liquidity is adequate (albeit holding unsold stock does have a real cost, in terms of security, opportunity cost and the impact on the interest bill), and of switching tenures. For some projects it may represent sensible protection of value to slow down build programmes; this will depend on the scheme and contracting arrangements.

We are aware of some associations making bulk sales, much as there are reports of housebuilders doing the same, but tenure change could mean switching homes built for sale / part-sale to using them for market / affordable rent. This was an effective response after the credit crunch as many readers will recall and we would expect Homes England / Greater London Authority to be open to sensible discussions and especially if it protects the bigger ‘delivery’ picture.

For RPs with adequate liquidity it only really gets problematic if there is a material issue around impairment. The liquidity point still holds – it is better to have a tricky discussion with lenders where one is in a good liquidity position, if only because covenants may vary across a portfolio.

Most RPs will be forming a view of their year-end position already. This is important for impairment like any other income / expenditure line; making decisions around assets held as work-in-progress or stock may have an accounting consequence in terms of the position at the balance sheet date. For any properties being built for sale with third-party developers or finance, for example in joint ventures, then it is important to understand as part of that analysis the perspective of the other parties. They may have different views or consequences from adverse sales performance compared to agreed and funded budgets.

This is not a new issue. However, it may well be that 31st March 2019 balance sheets feature bigger unsold stock numbers and impairments than recent years. As ever, please contact us if a more detailed discussion may be of use for your organisation.

New financing in the month

There were a couple of own-name issues in the month, from Futures Housing and Metropolitan Thames Valley. The former was £200m at a spread of 168 bps over the gilt, Futures having a rating of A+ from S&P. The latter was a sale of retained bonds of £100m, at a price of 175 bps over the gilt and with Metropolitan Thames Valley having a rating, also from S&P, at A-.

MORhomes also completed its first issue in February. It was of course predicated on its ability to address a number of sector challenges around pricing, ease of market access and structure. It is fair to say that we were always somewhat sceptical as to whether it could deliver on its stated objectives around pricing (other perhaps than for the very weakest credits) but we had no evidential basis to support this. However, the spread on its debut issue of 190bps now provides a clear benchmark for HA borrowers weighing up their options, including own name approaches, private placements and the more competitively priced THFC aggregation vehicles. For larger and/or stronger credits, MORhomes (taking assumed additional enhancement/vehicle costs into account) is probably somewhere in the region of 40-60bps more expensive than what these borrowers might achieve in their own right. Even at the smaller/weaker end of the credit spectrum, it is likely that many borrowers would be able to achieve comparable or better pricing in their own name, although some may see non-pricing benefits in terms of structure and/or speed of execution (at least in respect of future transactions).

Financial Markets and Economics Overview

February 2019 was marked by implied uncertainty about the outcome of the Brexit process with the approaching deadline on the 29th of March putting pressure on policy makers. The end of the month was marked by Theresa May promising MPs a vote on delaying the UK’s departure from the EU in the case that the House rejects her current deal in a March vote. Further to that, the Labour party expressed interest in supporting a potential second referendum on Brexit. During the month, members of the Conservative and the Labour party quit their positions to join a new Independent Group.

In the last two weeks of February sterling marked significant gains against major trading currencies – EUR and USD. The pound struck the highest level against the Euro since May 2017. Movements in the currency are attributed to the potential extension of Article 50 as investors perceive the delay as decreasing the likeliness of a no-deal Brexit.

British sovereign debt posted a heavy sell-off towards the end of February on the back of news (e.g. potential Brexit delay) which made a no-deal Brexit scenario less likely. As a result the 30 year Gilt yields rose to 1.82% from 1.72% the previous month.

Late February saw the release of UK Manufacturing PMI data with the headline figure falling to a second lowest level since the Brexit vote. Manufacturing firms have cut employee numbers and increased stockpiles. Brexit stockpiling has resulted in the lowest level of optimism in the manufacturing sector as shown by industry research by IHS Markit. The trend is not unique to the UK, similar decline in expectations is observed in the eurozone, Japan and China on the back of trade tensions and declining economic growth rates.

The UK Manufacturing PMI was followed by a release of Construction PMI numbers which show that the UK construction industry has contracted amid Brexit uncertainty. The construction industry had the worst performance since the snow storm of 2018 with no major seasonal factors contributing to the trend in 2019. UK House price growth remained subdued in February as Brexit uncertainty was matched by relatively robust real economic performance.

Bank of England Base Rate has remained unchanged. However, the MPC and Mark Carney have consistently warned about the potential risks of a no-deal Brexit. Most recently, the Governor stated that the Bank expects significantly poorer economic and financial conditions under a no-deal Brexit scenario.

Interest Rates

Inflation

Capital Markets

Bank Credit