My interest was piqued recently when I read a number of articles marking the tenth anniversary of the Global Financial Crisis. Although most people connect 2008 with the GFC, it was the news on August 9, 2007 that the French bank, BNP Paribas, had frozen three of its funds because of an inability to value their holdings of complex, mortgage-backed securities. This signalled the start of the contagion which would end in spectacular fashion with the implosion of Bear Stearns, Lehman Brothers, RBS, HBOS and other and the resulting policies of taxpayer funded bail outs and monetary accommodation, the consequences of which last to this day. That we still have “emergency stimulus” measures in place across the G7 economies ten years on from the start of the crisis perhaps tells its own story in terms of the success and ability of central banks and policy makers to engineer soft landings through the economic cycle.
As shown in the chart above, in 2017, global debt hit a new all-time high of $217 trillion, or over 327% of global GDP, up by $70 trillion over the past decade. This supports the argument that much of the economic growth achieved in recent years has been fueled by higher borrowing levels and also that the increased leverage across the financial system is not only a result of record low levels of interest rates but actually makes “normalisation” of interest rates far more difficult to achieve.
Bringing all of this back to a housing sector context, the HCA’s own data shows a similar pattern of increase in housing association indebtedness over recent years.
Are Housing Associations gearing levels similarly linked to the aftermath of the GFC? Arguably, fiscal austerity following on from the crisis forced housing associations to increase borrowing as grant levels for affordable housing disappeared, although it is fair to say that provision of social housing grant was anyway on a path of decreasing generosity before the austerity programme accelerated it. However, we would argue that lower borrowing costs have allowed and encouraged HAs (along with many other corporate borrowers) to increase leverage (by 25% in 7 years at a global level) without troubling their ability to service this debt. Eventually, the ability to continue increasing leverage has its limits even in an era of ultra-low interest rates and we are now seeing HA clients looking at a range of alternative means of delivering their growth plans.
The other GFC related impact that continues to shape much of our work with HA clients is the continued working through of legacy loan and derivatives positions established pre-2008. Readers will be well aware of the pricing benefits associated with these facilities. However, it is also true that the regulatory and policy landscape, scale, complexity, business activity and management of many parts of the HA sector have changed beyond all recognition over that ten-year period.
While the terms of many of these facilities perhaps reflected the nature of the borrowers at the time as well as the fact that they were long dated in nature, many of them are not appropriate nor fit for purpose for modern HAs operating in a different business environment. One of the themes we increasingly find ourselves discussing with clients is the extent to which they are able to operate opportunistically and with flexibility in relation to M&A or rescue opportunities and portfolio or site acquisitions. Holding and paying for additional liquidity for as yet unidentified opportunities is a perfectly valid business strategy for a growing HA. However, if the business is unable to deploy that capital effectively or indeed do much at all without the consent of lenders, not all of whom can be relied upon to act either reasonably or in the spirit of the original intention of the consent itself, then it risks being out-maneuvered by more nimble competitors as business opportunities arise.
Of course, in following sound commercial logic and the value for money approach required by the regulator, most organisations will want to fight to protect value in old loans and we are happy to support these efforts. However, Boards and management teams are increasingly willing to concede value embedded in legacy loan arrangements to remove associated limitations and pursue a strategy of expansion. In doing so, housing associations are moving on in their own way from the Global Financial Crisis as we mark its 10th anniversary.
Financial Markets and Economics Overview
*Market data in this report is as of the 31st August 2017 close of business
The UK economy is now showing signs of stability amongst a backdrop of Brexit uncertainty. The ONS “headline” rate of unemployment among people available and looking for work is at a record low, of just 4.5%. Although the latest round of PMI surveys on the UK economy shows an apparent slowdown in the key services sector, this is somewhat offset by the sharp rise in manufacturing PMI. This renewed confidence amongst manufacturers results from the competitive boost to exports following the continued depreciation in sterling. The average level of the all-sector PMI in Q3 so far, which weights together the services, construction & manufacturing surveys, is consistent with c.0.4% quarterly GDP growth.
The BOE took no clear stance on the UK’s eventual relationship with the EU at its MPC meeting earlier in August. Alongside its decision to leave rates unchanged, it published the August 2017 Inflation Report, containing modest downward revisions to GDP predictions for this year and next. Nonetheless, it still expects inflation to remain above its 2% inflation target over the next few years. The report shows the market-implied path for the Bank Rate reaching 0.8% in three years’ time, within that, a full 25 basis point rise in Bank Rate is now implied by late 2018. However, the robustness of the UK labour market, the drop in the pound, the rise in inflation and the strength of the global economy all present near term upside risks.
Swap rates have fallen by c.10 bps at the shorter end of the curve vs. last month, with the 30 year swap rate falling by as much as 15 bps over the same period. The 10 year Gilt yield also fell by c.12 bps over the month of August, with the 30 year coming down by c.10 bps over the same period. The large drop in central bank buying that is set to occur in 2018 could be a substantial headwind to global bond yields, with changes due to be announced to QE policies in coming months. Bond yields could face upwards pressure as a result of these potential QE tapering measures.
With regards to the housing sector, Nationwide’s reported annual rate of house price growth fell by 0.8% in August to 2.1%. This compares with higher levels of c.4-5% in 2016, therefore signalling signs of a slowdown in the housing market this year. However, the number of new homes coming onto the market remains subdued, providing underlying price support.