Tom Paul from Amicushorizon on Brexit effect

Comment
A treasury director’s post
EU referendum checklist
Risk mapping
Factor
Impact
The economy
higher bad debts
Interest rates
Tom Paul
Treasury & risk director,
Amicushorizon
From public finances
to property prices
More than a month on from the
EU referendum, it is tempting to
believe the dust is starting to settle,
but I’m sure we all know this is
wishful thinking.
‘Interesting times’ will continue
for some time yet, and the true
impact of Brexit won’t be known
for a long while. Expressions like
‘uncertainty’, ‘volatility’, ‘wait and
see’ will continue to be in vogue for
some time.
From here there are a wide range
of possible outcomes over the coming
years, and to a significant extent
the fate of the UK economy is now
in the hands of our erstwhile EU
partners. What will the UK be able to
negotiate? What will Brexit look like?
As business leaders we need
to make sure our organisations
are positioned to cope with
negative outcomes, but ready to
exploit positive ones. For many,
this means retaining flexibility:
deferring big capital investment
decisions; diversifying trading or
procurement relationships; holding
ample liquidity; being ready to
exploit situations where the market
overreacts.
From a stress testing perspective,
it’s worth considering what a ‘worst
case’ scenario might look like and
how our businesses are positioned
to respond. So what follows is a
narrative of one scenario we may see
playing out in the coming years.
1. THE ECONOMY
Having voted to leave, the question
now is what flavour leave will we get.
As the 52 per cent who voted leave
did so for disparate reasons, it’s likely
that whatever route we take will leave
a majority of people unhappy.
Broadly (and there are many
12/Social Housing/August 2016
Pension liabilities
Lending conditions
EU Nationals
Cost inflation
Property market
Public finances
Cause
economic growth stalls
and unemployment rises
cheaper cost of debt, higher low expectations for
standalone derivative mark economic growth
to market
higher deficit reduction
lower interest rates
contributions
and weaker investment
returns
higher credit margins
lenders wary due to
economic uncertainty
staff upheaval
uncertainty on right
to remain
higher cost inflation
decline in sterling
potential fall
low expectations for
economic growth
unknown
lower tax receipts
and higher welfare
expenditure
shades of grey here) it seems likely
Theresa May will need to some extent
choose between satisfying those who
prioritise access to the single market
and those who prioritise an end to
free movement of people.
For the UK economy it seems
much rests on this choice, but we
won’t know the outcome for some
time. In the interim, a drop off in
economic activity is a real risk.
During the last recession it was
the poorest who were hit hardest,
and there is nothing to suggest
the structure of the economy or
political environment has changed
significantly. An economic
downturn (or slower growth) is
likely to affect ‘in work’ residents
disproportionately – if costs rise
and employment falls residents
may find paying their rent harder.
2. INTEREST RATES
Our standalone derivative portfolio
hit a record low ‘out of the money’
balance at the end of June 2016,
as interest rate expectations have
collapsed since the result.
On most ISDAs (International
Swaps and Derivatives Association
contracts) HAs can charge property
as security to meet margin calls,
rather than charge cash. Having
to charge cash reduces business
flexibility and increases the chance
of insolvency, so I’m sure HAs were
ready with property in place.
Low interest rates are good for
borrowers, and as most HAs expect
to be net borrowers into the future
a fall in rates is good for financial
plans. News of One Housing
Group’s opportunistic fixing is
evidence of this (see p.7).
3. PENSION LIABILITIES
Large numbers of HAs carry the risk
of defined benefit pension schemes,
including SHPS (Social Housing
Pension Scheme) and LGPS (Local
Government Pension Scheme).
The value of assets in the scheme
may have fallen in the last few
weeks, depending on the investment
strategy. But likely to be far more
significant for these schemes is the
collapse in gilt yields, against which
scheme liabilities are discounted.
Should interest rate expectations
remain low, we could see a
significant increase in the deficit
reduction contributions HAs are
required to make into the schemes,
eroding investment capacity.
4. LENDING CONDITIONS
Swan Housing and Peabody (see p.67) have demonstrated successfully
that lending markets remain open,
though credit spreads seem at higher
levels than before the referendum.
The HA sector remains
fundamentally sound, though we
can now expect credit analysts to
put yet greater emphasis on sales
risks. If economic conditions, and in
particular the property market, do
weaken we may see lenders pull back.
5. EU NATIONALS
EU Nationals currently living
and working in the UK have no
certainty on their future, and
neither do their employers.
Tim Farron and Nicola Sturgeon
have been on the front foot calling
for rights to be confirmed, and while
uncertainty persists there is clearly
potential for a significant impact
on specific staff and morale more
generally. If rights for EU nationals
are not confirmed some businesses
may see an exodus of staff, with the
associated operational challenges
and costs.
6. COST INFLATION
The recent fall in sterling is likely
to lead to cost inflation, though
estimates of the impact vary. Higher
cost inflation would impact on
the personal finances of residents
and on HA cost bases, given social
housing rental income to 2020 is no
longer inflation linked but has been
fixed at -1%.
7. PROPERTY MARKET
The core social housing business
model is – whilst not unaffected –
well insulated from property market
volatility. Sub market rents ensure
strong demand, and assets are held
for rental rather than sales income.
Development programmes,
however, are far more sales
dependent. What happens to the
business if the market freezes up
and nothing can be sold? What
happens if residential valuations do
start to fall significantly?
It goes without saying, property
market stress testing is vital. And a
review of liquidity rules to ensure
the business is adequately covered.
For those HAs with significant
commercial interests there will be
particular concerns, though likely to
be different on a site-by-site basis. On
a more positive note, a reduction in
land costs will be considered positive
for many HAs with growth ambitions.
8. PUBLIC FINANCES
The big unknown. Tax revenues will
weaken if the economy stutters. Less
income from transaction taxes or
corporate taxation.
If unemployment rises we’ll
see higher benefit bills and lower
income tax receipts.
All this would put pressure on
government to respond, and may
impact the political environment in
which we operate.