October 2019

October 2019

Commentary

With interest rates remaining anchored at historic lows, we continue to see significant interest from housing association clients to lock into sub-3% long-term yields and by doing so, “out-performing” the assumed cost of borrowing built into their business plans. The institutional bid for housing paper remains strong, albeit that demand can be a little more patchy for debt issued by housing associations with weaker credit ratings and higher exposure to sales, particularly amongst domestic UK investors. This reflects the sensitivity to lower credit ratings of the capital models of insurers operating under the Solvency 2 regime, perhaps as well as a greater familiarity with sentiment in the domestic housing market as political uncertainty continues to weigh heavily (no, let’s not go there this month…).

But overall, deals continue to attract interest across the credit spectrum with a growing body of US investors bolstering the established domestic players. Pleased as we are to support our clients in accessing funding rates of 2.5-3%, we wonder how many of our readers would lend their own money out for 30 years plus at these sorts of rates? Long may it last from a borrower perspective, but we suspect that sometime down the track, these deals may be somewhat akin to the Libor plus 25bps 30-year bank loans that some of our clients are still enjoying the benefits of. This possibility alone underlines the importance of ensuring that the covenant packages relating to these transactions (particularly private placements as listed bonds are generally covenant light) are capable of standing the test of time and giving appropriate corporate flexibility to the organisation in question. Without this, borrowers may one day be faced with challenging negotiations with an “underwater” counterparty where the alternative is the expensive prepayment of an otherwise attractively priced instrument. This relates to financial covenants of course but also consent points such as on-lending, mergers, group restructuring etc.

On a related point, borrowers and issuers which have previously accessed the institutional debt market or plan to do so are set to face increasing scrutiny from investors in relation to their Environmental, Social & Governance (“ESG”) credentials. This theme has been around for some time but over the last few years it has gathered greater momentum as pension funds, insurance companies and other asset managers face greater requirements to demonstrate to their internal and external clients that as well as financial returns being delivered, good stewardship can also be evidenced, in terms of initial credit assessment as well as on-going credit monitoring. We are already aware of clients with existing public bonds receiving questionnaires from different investors following different in-house formats and requiring some fairly heavy lifting in terms of data gathering and analysis.

Slightly paradoxically, given the existence of the regulator and their existing oversight framework, the housing sector is probably some way behind other parts of the market in terms of established frameworks, mechanisms and data sources with which to assess ESG from an investment perspective. The Real Estate market has a number of initiatives and industry bodies which have been up and running for some time which focus on different aspects of a fairly wide discipline both from the perspective of owners of real estate assets and wider investors and funds. One may question the robustness or indeed relevance of some of the reporting which goes on, but there is at least some practice out there which the housing sector could learn from. The housing sector has perhaps felt less need to be proactive given some fairly helpful aspects to its make up. Without wishing to state the obvious:

  • Regulated industry – check
  • Charitable status – check
  • Non-profit distributing – check

However, the whole ESG theme is moving beyond a phase where investors can “take it as read” that HAs meet their ESG needs. And while the Social and Governance elements of ESG are perhaps more obviously met, Environmental is more open to question and debate, particularly in relation to the vast “legacy” assets owned by the sector, rather than just new build which is perhaps easier to address. And it is the “E” where other sectors have invested time and effort in developing benchmarks. The whole subject of ESG has been covered at length in recent articles¹ in the housing press and while individual HAs will tackle this on an individual basis, they risk facing a significant workload in responding reactively to a wide range of investors making varied data and information requests of them.

We believe the time is right for the housing sector to get on the front foot and pro-actively develop its own bespoke approach and framework, using more broadly understood methodologies and measures built around widely available and consistent forms of data. Centrus is currently leading an initiative to get the ball rolling on this so watch this space…

1. Example of articles:

https://www.socialhousing.co.uk/insight/insight/making-an-impact-what-the-rise-of-esg-investment-means-for-social-housing-63040

https://www.socialhousing.co.uk/news/news/social-housing-a-natural-home-for-esg-finance-63041

Financial Markets and Economics Overview

During the month of September, markets across the globe have primarily focused on Central Bank’s monetary policy decisions. As part of Draghi’s stimulus package designed to prevent the eurozone sliding into recession mainly driven by Germany’s economic contraction: the ECB announced a further cut in interest rate on the deposit facility by 10 basis points to -0.5%. The Bank also restarted its asset purchase programme at a monthly pace of €20 billion as from 1 November and introduced a rate tiering system, in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate. A week later, the FED, as expected, lowered the target range for its interest rate by 25 bps to between 1.75% and 2% due to concerns about global growth slowdown and trade wars.  On the contrary, the BoE kept interest rates on hold at 0.75%. However, the Bank stressed that interest rates could move up or down if the UK left the EU without a deal, potentially leading to a cut.

Brexit talks was at the heart of the headlines especially after Boris Johnson announced at the beginning of the month that the parliament would be prorogued from 9th September to 14th October, giving anti-Brexit MPs just two weeks to block a no-deal exit ahead of the deadline. This news impacted negatively the pound which weakened sharply by 0.5% against the dollar and the euro following the announcement. However, both the Scottish Court and the UK Supreme Court ruled the suspension as unlawful and shortly after, MPs returned to Parliament.

Surprisingly, discussions about the Trade War between US and China have been relatively calm in the month of September. At the end of August, Trump announced a rise in tariffs to 30% on $250bn worth of Chinese imports due to take effect on the 1st of October. According to the FED, Trade War has  contributed to 0.8% slowdown in the US GDP. However, at the G7 Summit Trump seemed optimistic about the trade discussions. Moreover, a ‘risk on’ mood prevailed in the markets in mid-September reflected through an increase in global equities and a back-up in government bond yields as signs of progress in US-China talks which reduced some downside concerns about the global economic growth.

Lastly, important to mention the attacks on one of the world’s largest oil facility in Saudi Arabia by Iran triggering oil prices to spike 20% (biggest move since 1990). The US imposed further sanctions targeting Iran’s Central Bank and the National Development Fund of Iran.

Interest Rates

Inflation

Capital Markets

Bank Credit