March 2021

March 2021

Commentary

Spring is coming! Well – maybe a bit early to say that but it does seem to be on its way along with much-anticipated improvements on the COVID front. In a sign of our mental states, in our household we have largely now eaten the Brexit stockpile, which was briefly a COVID stockpile then a Brexit stockpile again then officially declared available for consumption (although the tins of spinach did go in the bin). The risk of imports chaos appears to have receded, with the unfortunate exception of Northern Ireland.

We have had a number of discussions with clients in the last month about their funding strategies going into the spring. One underlying theme is communications with investors. The “communications environment” has changed quite significantly over the last couple of years, driven by a number of continuing trends.

First, we have the ongoing and welcome professionalisation of the sector’s approach to communicating with capital markets investors – clear decisions on reporting strategy, investor information on websites, proper use of RNS announcements etc. Second there is the growth of capital markets investment in the sector more generally, which has continued apace through 2020. Thirdly the fact that everyone in the financial sector is working from home makes investor presentations much easier. Institutional investors weren’t always great at actually showing up for “investor days” and particularly if they weren’t in London – but now it’s a 45-minute webinar they can sign in while making a coffee or supervising a bit of home schooling. And fourthly, the growth of the ESG agenda means many issuers are making changes to the information they provide to lenders and investors.

The main macro markets ‘news’ this month has been the significant increases in interest rates. The graph below shows the yield on the 2037 nominal gilt over the last 12 months. That time period covers the peak in March last year with the initial recognition of COVID-19 and the strong rise during February of this year, with gilt rates now back over 1% from around 15 years onwards.

The main underlying driver of this is the growing sentiment that perhaps, after all, the consequence of the significant growth in government indebtedness and quantitative easing by central banks will be inflation. The uplift in the nominal gilt is not entirely replicated in the index-linked gilt market and the reason for that is this slow growth in inflation expectations.

Nonetheless, long-term borrowing rates – even including margins for strong credits like housing associations – remain resolutely below expectations of inflation.

One response for the many housing associations who accessed long-term funding over the last twelve months is to be pleased with the rates achieved. Many borrowers have increased their funding levels and also the levels of interest-rate fixing, partly taking an opportunistic view of the rates of long-term funding achievable over the recent period. However, one notably quiet part of the market has been activity in fixing borrowing costs through the bank market.

Much of the long-term legacy bank funding in the sector is already fixed and more recent loans are often RCFs and shorter tenor so that’s part of the reason for the lack of activity. Another reason is that many associations have been uncertain on development spend with all the economic uncertainty and swaps are generally seen as more complicated / more risky in various ways than fixing borrowing rates in the capital markets – so there seems little need to hedge ahead of investment. However, the banks remain able to offer attractive fixed rates through the swap market and if the coming year sees more rates volatility then it may be worthwhile to consider nailing down budgets or an element of future funding costs using standalone swaps (or indeed embedded fixing where that option exists).

In terms of capital markets activity this month, Monmouthshire HA raised £65m in a private placement, LiveWest raised £250m on a 35-year basis with a public bond, with a yield of 1.904%, from its EMTN programme, and bLEND undertook a tap for a further £50m at 2.25% taking their borrower list to 14 associations.

Lastly, in exciting LIBOR-related news, the FCA has now announced that LIBOR will “no longer be representative” from 31st December. This crystallizes the credit adjustment spread for certain transactions and is another push towards replacement of LIBOR with SONIA. Happy to discuss with clients if they have any questions on next steps.

Financial Markets & Economic Overview

The tide shifted slightly in late February where revised upwards inflation expectations and the earliest whispers of monetary stimulus tapering off in the near future resulted in upward pressure on interest rates

While the economic impact of covid-19 continues to be realised, funding markets have maintained favourable as central banks continue to flood markets with liquidity via their respective quantitative easing and stimulus programmes. Alongside the maintained aggressive stimulus packages February saw economic sentiment lifting on the back of vaccination roll outs. The prospect of rising inflation and stimulus packages tailoring off across the UK, US and Eurozone caused US treasuries and Gilts to experience sell offs leading to higher rates.

Inflation has been a topical conversation within markets over the past two weeks as The prospect of economies gradually beginning to open up has led to rising inflation. The expectations have been cautiously  welcomed in the US and the UK. In the eurozone however, where vaccination rollouts look less optimistic there is a degree of pessimism as the ECB continues to maintain its high purchases via PEPP.

Swap rates across US, Euro and GBP continue to see some upward pressure as higher Gilts/US treasury yields and a rise in inflation expectations begin to slowly feed through into the real economy. The first signs have been seen towards the longer end of the curve in what is known as ‘taper tantrum’. Most monetary stimulus packages are focused on the short to medium tenors meaning any heightened rate volatility is usually first felt at longer maturities.

Central banks continue to downplay the inflation risk right now as seen by the Fed welcoming rising rates, however pledging to step in with further stimulus if they believe rates are rising too quickly.  Meanwhile the BOE have already expressed optimistically that as the economy begins to open it up it plans to scale back its quantitative easing with the scope of rate cuts in the near future looking less likely.

Corporate spreads have continued to their gradual decline over the last 3 months however the last week of February saw it debunk this trend with very slight uplifts seen in UK and US corporate markets.

Interest Rates

Inflation

Capital Markets

Bank Credit