Funding Conditions and Financial Markets Update
Now and again we are asked by existing or prospective investors in housing association debt to come in for a fireside chat about goings on in the sector. Last week was the turn of one the large institutional investors and I was seated across the table from a group of fund managers and analysts and treated to a proper grilling with a quickfire round which lasted well over an hour. It left me thinking about whether Mastermind would consider “The History of Social Housing Debt Finance 1996-2017” as a specialist chosen subject for some particularly sad individual…
The discussion centred around the question of general credit deterioration amongst housing associations as they face a squeeze on rents while at the same time gearing up their businesses and their balance sheets by upping their game in terms of new development, taking on increasing market risk and in some cases, joining the major house builders in terms of output. Indeed, it was clear from the discussion that both the fund managers and the analysts were distinctly bearish in terms of their view of the sector, at least in terms of the direction of travel. This is perhaps no surprise given the sort of headlines that now seem to be a regular feature of the housing and wider press:
“Moody’s: English Housing Associations 2017 Outlook: Adverse policy changes drive negative outlook”
“S&P warns of ‘more volatile’ housing association sector”
“L&Q snaps up land investor Gallagher Estates in £505m deal”
Anthony Hilton: “Housing associations must beware the risk of going commercial”
Having felt that the degree of bearishness was somewhat excessive, I put across a few points in defence of the developing end of the housing sector remaining a stable and investable proposition. These included the following observations from across our diverse housing association client base:
1) A greater appreciation of risk management and segregation of risk between regulated and non-regulated activities
2) More sophisticated stress testing to identify the key areas of risk and how these might be mitigated
3) An increased focus by both HAs and the regulator on liquidity as a key risk, particularly where commercial activities are increased
4) Larger scale at the developing end of the market as consolidation continues, offering more resilient balance sheets, stronger management and better access to funding
More pertinent perhaps was the observation that it is a mistake to make sweeping generalisations about an increasingly diverse sector and to apply the same credit view to a major G15 developer and a regional LSVT in the Midlands or the North with much more modest development ambitions. The general point being that there remain many more “safe and boring” housing associations than there are apparently racy large developers which attract more headlines.
Having made this case for the defence, the headline in Social Housing that “Ten HAs generate half of sector sales” caught my eye. This showed that of a total of £2.55bn of sales across 137 associations, the largest 10 had combined income from first tranche and open market sales of £1.37bn. Eight of the ten are based either in London or London and the South-East. Furthermore, around half of this group of ten have secured public bonds (the rest do not or have non-comparable unsecured or holding company bonds) of which four trade firmly at the tighter end of comparable secondary HA spreads. This does suggest that in spite of apparent investor concerns over commercial exposures in the sector, the combination of London (and the South East) and scale – which together are often closely linked to scale of development programmes and commercial risk – continues to trump, at least in the eyes of investors, organisations with business models which in many ways are the “safe and boring” investments of old that the same investors appear to be getting nostalgic over and which in many cases trade at wider credit margins. Time for a re-rating perhaps?
The main activity of note during April was the £400m sterling issue by Martlet Homes, a subsidiary of Hyde Group. The 35 year deal priced at a coupon of 3% and a spread of 140bp over gilts. The structure was relatively unusual with the bond issued by a single operating subsidiary of the Group in order to refinance both its own banking facilities as well as some Group funding arrangements. S&P rated the deal A+.
Financial Markets and Economics Overview
Inflation in the UK is certainly making its return, as it hit 2.30% in March for the second month running. This figure reflects more expensive food, alcohol and tobacco – although air fares and petrol prices helped temper the overall inflation level. Economists are warning that as price rises outstrip wage growth, consumers will tend to focus spending on essential items – consumer confidence is already falling according to YouGov, who reported it is at its weakest reading since last July.
The service sector continued its good track record, enjoying its fastest growth for four months in April. The Markit/CIPS PMI surveys signalled a similar rally for the manufacturing and construction industries too.
House prices fell again in April, according to Halifax, with the average property falling by 0.1% MoM. However, this is from an all time peak in December 2016. The annual rate of 3.80% is the lowest rate for four years. According to Halifax, this is due to a deterioration in housing affordability driven by the rapid house price growth of 2014-16, also signs of a decline in the pace of job creation, and the beginnings of a squeeze on households’ finances as a result of increasing inflation, may also be constraining the demand for homes.
Interest remained stable throughout the month, with the 30 year gilt yield ending 1bp lower at 1.72%. The Monetary Policy Committee will meet again in May, but the expectations are that the base rate will remain at 0.25% for the foreseeable future. However, the minutes from the previous meeting had a decidedly more hawkish tone, noting that “some members” were of the opinion that it would not take much more upside news (i.e. higher inflation, positive sector growth news etc.) to justify considering tightening policy. However, the news in April of decreased consumer spending and a softening in the house market may cause them to edge back towards a more neutral stance.