September 2019

September 2019

Commentary

There appears to be a lot more business plan stress testing going on at the moment than we would typically find in September. For some associations this is part of the process of regular review, which we support, but of course for many it is yet another look at business plans in the context of Brexit.

For many it is also a consequence of looking seriously at the potential merits of “filling their boots” on cheap long-term funding, at a time of unprecedented low interest rates … but also unprecedented high political and economic uncertainty and the potential for an extended period of low or even negative interest rates (other countries have gone there, maybe the UK too?)

A client asked us earlier in the week “when is Brexit” – meaning not so much “when will it happen” (which I am sure they realised we have no special insight into) as trying to define really what is the substance of it for them as a business. Like many major political events, while there may be a number of key headline moments, the actual change process on the ground will be really a collection of many smaller events. The practical question for anyone trying to run a business is to understand which of those are significant and what practical steps should be taken in response to them and when – hence the question.

We thought in that context that it would be useful to set out some of the key “headline events” and how they potentially map on to actual real consequences for people.

Some of them are immediate: no freedom of movement = can’t up sticks and get a job in Latvia (that example not directly relevant to HAs I realise). Some of them are slower burn: imposition of tariffs may lead to imported inflation and potentially an impact on interest rates. Some of them are indirect and messy: a change in government from Conservative to Labour could lead to all sorts of things; opinions vary from the good to the less good (let’s leave it there).

Happily, business planning is an exercise in judgement and risk management – the majority of board members will not expect unequivocal answers to imponderable questions. But they do expect support in making risk-based decisions about investment and funding activities, such as:

  • what level of discretionary costs to commit to;
  • what investment strategy to adopt and what opportunities to pursue;
  • financing decisions including the fixing ratio and liquidity as well as whether or not to take advantage of the current very attractive funding rates, and
  • Philip Hammond’s favourite: how much time and money to invest in contingency planning, whether that is human resources to support tenants facing challenges in their personal finances, diversification of supply chains, liquidity again, etc.

We set out below a number of key decision points and potential dates to consider, and lastly the potential implications for RPs to consider in business plan stress testing. We have been discussing these issues with a number of clients in the last month, in terms of stress testing and in terms of financial rules / ‘golden rules’ for plan updates.

We include the last one as we had to have one non-Brexit-related point. In the long term the political trends behind that loom pretty large in all the rest, but that is a discussion for another day.

In terms of transactions in the capital markets in August, Moat tapped their 2011 bond for £100m (Centrus advised on this transaction). Optivo have sold retained bonds in the first few days of September and we are aware of / have advised on a number of other private transactions accessing institutional money, often in deferred format.

Financial Markets and Economics Overview

Much of August was denominated by economic performance outside of the UK, with the global economy continuing to experience a slowdown as Donald Trump engages the US in a trade war with China. Tariffs on Chinese imports from the US and potential currency manipulation from China has increased tensions between the world’s two largest economies. Further trade talks are expected to go ahead in September.

With Boris Johnson’s continued hard stance on the UK’s exit from the European Union at the end of the October, many sectors are experiencing decreases in output,  most notably, UK manufacturing. Slowing global economic growth coupled with mounting concerns over a no-deal Brexit saw the manufacturing sector record the sharpest drop in factory output since July 2012. Fears of the UK economy potentially on the brink of recession following crunch period of Brexit negotiations are growing.

The UK fell to the bottom of the G7 growth league table off the back of the unrelenting uncertainty surrounding Brexit. With Canada topping the charts with strong growth 0.9% in the second quarter, the UK contracted by 0.2%. The contraction in was largely due to a build up stocks to meet the original Brexit deadline in March. Many economists believe companies are likely to be stockpiling again in preparation for October. Germany was the only other economy to experience a decrease, 0.1%, in Q2.

The British 30-year government bond yields fell below 1% for the first time on record signaling sluggish growth expectations by financial markets and a potential reduction in Bank of England interest rates.

The pound/dollar fell again last month to $1.217 – the lowest average rate in the last six months. However, following the flash Eurozone inflation figure, the pound/euro exchange rate rose by 0.82% to €1.107 against July. Despite being Brexit-stressed the pound still managed to strengthen against the euro further highlighting the Eurozone economic woes.

In light of global economic downturn and Brexit uncertainties the original fiscal spending pot for 2020-21 has been slashed from £14bn to £4bn. However, with the current budget deficit at a 17-year low, the Chancellor of the Exchequer Sajid Javid can afford to borrow and spend more on public services. As a result Mr. Javid is set to break government spending rules within this year, proposing a one-year spending plan including higher funding for education, health and the police, increasing suspicions that the UK should prepare for an imminent government election.

Interest Rates

Inflation

Capital Markets

Bank Credit