January CPI was flat at 4.0% against expectations of 4.2%. The market reacted with the 5-year and 10-year swaps increasing by c. 10bps on the day of the announcement.
The 10-year swap rate (3.8%) is pretty much where it was after the last month’s ‘surprise’ CPI release. It was at 3.8% almost exactly a year ago too. It peaked in August 2023 at 4.7% and has bounced from the December 2023 low of 3.2%.
Wage inflation was down from 6.7% in November to 6.2% in December, a sharp fall, but analysts expected a fall to 6%.
Natural gas and power futures are down almost 10% in the last month, so a materially lower energy price cap from April 2024 appears ever the more likely. It has certainly been a mild winter.
The SONIA curve remains remarkably flat with the 3.8% to 3.9% range from the 5-year through to 30-year swap rates.
New issue premiums have decreased significantly in recent weeks with some bond issues reporting premiums as low as 0 bps. This is quite unusual.
The news that the Affordable Homes Guarantee Scheme has increased to £6bn and is extended with flexibility to invest up to 50% in existing stock is an encouraging opportunity for the sector.
Implications for our affordable housing clients
The flat SONIA curve means clients can hedge over a tenor that suits their loan portfolio and swap rates remain attractive. Why take the risk of variable rates, particularly when you can reduce short term interest costs and remove that risk buffer?
High investor demand and very low spreads creates opportunity for long term covenant light funding.
Latest client activity
Interest rate risk analysis: Using Resi Analytics, we’ve conducted thorough analyses of the interest rate risk buffers in our clients’ 2023 FFRs. The results showcase a spectrum of risk appetites, from no risk buffer to a cautious outlook.
Strategic deal closures: Following strategic reviews and lender negotiations, several deals are set to close before year-end (31st March 2024). These initiatives aim to bolster liquidity headroom and improve covenant definitions. It is a busy time of year for banks, advisors and lawyers.
Active advisory on various fronts: Detailed strategic thinking is vibrant across our client base, we’re actively advising clients on strategic asset disposals, hedging strategies, covenant changes, and the impact of combining business plans.
Private placement mandate launch: Amidst high investor demand and low spreads, we’re gearing up to launch an active private placement mandate. We anticipate increased private placement activity in 2024, providing valuable opportunities for our clients.
To learn more about our work in the affordable housing sector, click here.
December CPI of 4.0% surprised to the upside against expectations of 3.8% and the market reacted with the 5-year and 10-year swaps increasing by c. 20bps on the day of the announcement.
Expectations for rate cuts probably got a bit ahead of themselves, and following the correction, the market now expects the Bank of England to begin cutting in late summer 2024 steadily down to 3.5% in 2026 where it is expected to remain for some time.
Regular wage inflation of 6.6%, down from 7.2% in the prior 3 months, was in line with market expectations, and energy prices are expected to fall in the spring. The Bank of England is unlikely to be too concerned.
The SONIA curve remains remarkably flat at 3.8% from the 5-year through to 12-year swap rates.
The Government has launched the consultation on Awaab’s Law with a proposal that providers must investigate hazards within 14 days, start fixing within a further 7 days, and make emergency repairs within 24 hours.
Implications for our affordable housing clients
Trouble in the Red Sea and connected geopolitical events are upside risks to inflation and interest rates. Predicting further volatility would not be a particularly brave call. It is important to include a risk buffer within the floating rate assumptions in the business plan.
The flat SONIA curve means clients can hedge over a tenor that suits their loan portfolio and swap rates remain attractive. Why take the risk of variable rates, particularly when you can reduce short-term interest costs and remove that risk buffer?
Housing Organisations should consider the benefit of longer dated and covenant light debt capital market funding, particularly when funding long term investments. Activity has been picking up in recent months.
Latest client activity
1. Hedging transactions for interest cost savings: Centrus has successfully advised several clients through hedging transactions, saving interest cost in the tightest years and creating additional headroom and certainty in our client’s business plans.
2. Strategic support for Newlon Housing: We provided analysis and advice to Newlon Housing on options as a £50m swap matured and supported through the execution of a new 10-year swap that closed in December at 3.6% plus margin.
3. Successful £400m public issuance for Sovereign Network Group: Sovereign Network Group completed a £400m new public issuance this week, pricing at 108 bps over gilts and a coupon of 5.5%. SNG are A3 Moody’s / A S&P rated, and the pricing highlights investor demand and the benefit of scale. Centrus provided advice on the transaction
4. Advising on mergers in a growing trend: We are currently advising on 6 mergers and note an accelerating trend of non-profit Housing Associations seeking to improve financial resilience and sustainability by combining resources.
To learn more about our work in the affordable housing sector, click here.
Last year, the Scottish Government set out a deal with the onshore wind industry to deliver 20GW of onshore wind in Scotland by 2030. David Craig, Director at Centrus, describes the deal as a “blueprint for the rest of the UK”, and an example of the regulation and reforms needed to facilitate energy transition to net zero and build a green economy.
I’m going to whisper it quietly, but after a brutal couple of years, we are starting to see signs of confidence, or as former Chancellor Norman Lamont famously described it, “green shoots of recovery” in the capital and M&A markets as we start 2024.
Real asset sectors are still benefiting from the tailwind of the sharp reversal in rate rises at the back end of 2023 – as demonstrated by the significant narrowing of discounts in the listed Infrastructure & Real Estate Investment Trusts. This has been followed by the tentative start of a long overdue process of consolidation in this sector which may also support (again whisper it quietly) fresh equity capital being raised this year by existing and new trusts. This would provide a real boost to the much maligned UK equity markets and I wonder whether 2024 might herald a broader recovery in this space as UK & International investors capitalise on the stark undervaluation of UK equities.
In turn, this would provide a platform for increased IPO volumes and M&A activity in both public and private markets – both of which have a significant confidence aspect to them. With confidence and fresh capital both in very short supply over the last two years, investors have largely sat on their hands and focused on managing the many risks they have faced. Anecdotally, 2024 has seen many of our clients returning with renewed vigour and confidence and a determination to get deals done and there are clear signs of Keynes’ “animal spirits” returning to the markets.
Although borrowing rates have reversed, the jury is still out as to whether this is a mid-cycle reversal in a secular higher-rate world or a return to a low rate environment. On balance, my view is that it is the latter. Either way, higher quality sponsors and businesses appear to have got past the shock phase and have now adjusted to the realities of a higher cost of capital. Public, private and banking markets are all feeling positive and confident going into 2024, albeit with a degree of price discovery taking place in the public bond market following a period of exceptionally low volumes. Tight credit spreads are indicative of strong investor demand and confidence and compared to January 2023, our own Capital Markets team is seeing a much stronger deal pipeline, which is hopefully indicative of a healthy broader market.
It would be unwise to become overly exuberant just yet – many risks remain – political, geopolitical, inflation and energy related – to name but a few, but investors and financial markets have perhaps become more resilient after the last two years and are learning to live with higher levels of uncertainty and volatility.
So I hope that I’m not tempting fate and that 2024 is a year which sees a bit of swagger returning to UK and European markets and in particular a reversal in the fortune of the UK listed equity and debt markets, with a positive knock on effect to private markets.
Multi-year analysis conducted by Centrus has revealed that UK housing associations are having to make difficult decisions, with a significant reduction in the spending on new affordable homes for 2024 onwards.
Plans drawn-up last year cut expected investment for 2024 by 9%, or £1.5bn, compared with the previous year’s forecast, while funding over the coming decade was cut by £20bn, or 15% (Centrus, 2023).
John Tattersall, Managing Director at Centrus, shared his thoughts on the research with The Financial Times, encouraging policy-makers to provide radical support to a “resilient” and “mission-focused” sector.
“The substantial decrease in spending on new home delivery is driven by three core challenges; increased costs of building, increased costs of debt, and competing priorities.
Assuming the election next year results in a change of party, we are likely to see affordable housing shoot up the political agenda – and rightly so. Housing associations are unsung heroes in the UK. Social housing is held to extremely high standards of tenancy conditions relative to the private sector. While charging lower rents, providers are working tirelessly to deliver high quality homes for people in need while navigating an economic landscape which is especially tricky given their business models.”
John Tattersall, Managing Director – Centrus
Click here for Joshua Oliver’s article in The Financial Times.
Congratulations to all those developers successful in the inaugural Hydrogen Allocation Round (HAR) 1 announced last week by The Department for Energy Security and Net Zero, with 11 projects totalling 125MW awarded. Excitingly, this is backed up by the simultaneous launch of the second HAR 2, supporting the UK Government’s ambition of having up to 1GW of electrolytic hydrogen in construction or operation by the end of 2025.
The starting pistol has been fired on what will be a marathon strategy for the UK’s energy security, with a long-term focus on greening transport and other energy intensive industries, providing deep storage and increasing energy security through our own renewable resources. Centrushas been proud to support a number of hydrogen projects (with clients such as DBE Energy and NGN/CKI) and we will continue to support our clients and new investors over the coming years.
Key lessons learnt for future projects from the HAR 1 include:
Ensure contracts/partnerships are in place for selling hydrogen to specific companies
Place solar/wind farms either within the facilities or nearby
Take advantage of existing infrastructure that can be repurposed
Have a local economy and industry cluster preservation perspective
Future price-based competitive allocation regimes will likely need to beat the weighted-average HAR 1 price of £241/MWh (£175/MWh in 2012 prices)
Terence Amako and David Craig would be delighted to discuss where we can help with the delivery and funding of future projects.
Pathway to Board works to address the lack of ethnic diversity on boards in and outside of the housing sector. The programme helps individuals be ‘board ready’, ultimately giving them the opportunity to influence decision making in the housing community.
Centrus is pleased to have supported the programme as a volunteer partner, providing treasury management training to students throughout the year.
Congratulations to all the Pathway to Board graduates on a fantastic achievement. To find out more about the initiative, click here.
On the 25th October 2023, we welcomed our clients to the UK titanTreasury User Day 2023. The day provided a fantastic opportunity to bring titanTreasury users together to learn about new platform functionalities and input ideas for future developments.
Gilles Bonlong, Melina Lambrou and George Roffey were joined by our partners at 3V Finance, Alexis Paulet and Alexandre Marage, to lead workshops throughout the day.
titanTreasury is our expert Treasury Management System (TMS) that offers financial departments and treasurers the best functionalities for monitoring and controlling operational market risk (rate, foreign exchange, commodities), credit and liquidity risks.
To learn more about titanTreasury, please contact Gilles Bonlong, Director at Centrus.
As the dust settles on two recent Centrus-advised mergers between Abri and Silva, and Sovereign and Network Homes, Centrus considers the role mergers have historically played in the affordable housing sector, and why, particularly given ongoing economic and political volatility, the theme of consolidation is likely to remain in focus into the future.
Navigating the perfect storm – why might housing associations wish to merge?
As Winston Churchill opined, “the further backward you can look, the farther forward you are likely to see”. Indeed, the practice of UK housing associations merging appears not novel, but cyclical, with each burst of activity more pronounced, with ever greater calls on finite financial resources.
Understandably, during significant uncertainty, such as that caused by the pandemic or the 2008 financial crisis, housing associations had very little time to peruse the sector for potential partners, instead focusing on the immediate concern of getting their own houses (pardon the pun) in order.
Furthermore, while we don’t possess a crystal ball, consolidation looks set to continue, with the total number of UK housing associations decreasing nine per cent in the past decade alone, according to statistics from the Regulator of Social Housing.
For an increasing number of housing associations, this landscape has forced at least consideration of mergers and the appeal of ‘combining and conquering’.
Partnering with an organisation with complimentary geographies and ambitions is an attractive prospect for some, particularly where resources may be stretched thin. The benefits of a merger will vary and be specific to the organisations involved. However, as a general rule, the key advantages of undertaking such an exercise include:
1. Economies of scale, efficiencies and bargaining power
Often the primary driver behind any merger, and the most obvious benefit, is the resulting pooling of resources to achieve economies of scale. The newly merged organisations will benefit from sharing administrative and operational platforms, reducing duplication, eliminating costs and improving efficiency.
Furthermore, the newly formed, larger, housing association may have greater negotiating power via balance sheet strength and an enhanced credit profile, offering improved outcomes with investors, rating agencies, suppliers and local authorities.
There is a risk of diseconomies of scale. When considering a merger, entities must carefully evaluate how the combined organisation will operate and the pathway to that outcome.
2. Financial stability and improved risk management
Combining the financial resources of two or more housing associations can result in greater financial stability, providing a more secure foundation for delivering housing services and investing in property development and maintenance.
Additionally, there is a reasonable expectation of risk diversification across a larger number of properties, potentially reducing exposure to specific challenges or risks in a single geographic area or property type, such as flood risk.
Again, careful due diligence on the asset base of each partner is required to ensure the resulting portfolio of homes achieves the aspirational profile.
3. Improved service delivery and development capacity
Mergers can enable housing associations both to increase their development capacity and to provide and invest more into a broader range of community services for tenants.
The combination of cost savings and enhanced bargaining power achieved via merging may unlock additional building capacity for the merged entities to deliver new affordable housing units.
However, in a larger organisation, the distance between the tenant and the board may increase; careful consideration of operational structure is needed to ensure due focus remains on delivery for tenants.
Overall, the case for mergers appears strong.
The saying about laws being like sausages (best not to see how they are made), applies to mergers as well. Mergers are complex, representing a substantial undertaking for all stakeholders and are not to be undertaken lightly.
While mergers can offer excellent benefits, this requires careful planning and execution.
Achieving the merger may require lender consent solicitation initially, while unlocking maximum capacity may need financial covenants and corporate controls to be reshaped.
Both can engender potentially complex and expensive negotiations with lenders. These can result in treasury costs, and ensuring they are outweighed by savings is a critical test of a business case.
Cultures will need to be harmonised, tenant concerns surveyed and allayed, while employee stakeholders will see significant disruption, but potentially a broader range of career development opportunities.
The resulting, larger entity will naturally be more complex, and it is reasonable to expect some short-term administrative challenges to ensure all parties are comfortable, from governance and risk management perspectives.
However, it is important to ensure that this is transient; any long-term drag on decision-making speed can result in poor responsiveness, worse outcomes for tenants, and undermine any business case.
Mergers also have the potential to result in overextension during execution, where the level of effort required to deliver the process is too big for the existing personnel to achieve effectively.
This is where the selection of experienced advisors can be critical to ensure that lender negotiations are successful, and the loss to EV (with EV representing the present value of existing borrowing versus a like-for-like replacement at current market rates) is minimised.
Key success factors
1. Choose the right partner
Easier said than done, but the success of any merger depends first and foremost on selecting the right merger partner. A shared vision, culture and geographic focus are key to reducing the risk of integration issues.
2. Evaluate the business case early
Careful planning, effective communication and a clear understanding of the objectives of any merger are vital. A key step in merger execution is constructing an outline business case which should define the ‘merger ambition’ and assess to what extent the merger may deliver this.
It’s also important to ensure that the interests and needs of tenants and communities are at the forefront of the merger process. Ongoing tenant engagement is paramount (often formally required) throughout the process to ensure they feel their needs are heard and any dissatisfaction avoided.
3. Get the right support
Depending on the entities involved and the legal mechanism opted for, the transaction can take between six and 18 months to complete. During this period, there is likely to be an operational drag on day-to-day business, with deal-fatigue a real risk.
Mergers are not insignificant in terms of cost and will require specialist support from financial, legal and operational advisors to execute effectively. Selecting the right professional partners is important.
Creating resilient businesses
Mergers are not a universal cure for operating pressures. They have, however, been used successfully to create more resilient businesses that are greater than the sums of their parts.
Organisations should be prepared not only to proactively consider mergers, but also how to respond if approached, as many neighbouring entities will be pondering the same conundrum of how best to navigate their current challenges.
This article was originally published in Social Housing Magazine on 31st October 2023.