13.10.17

Snapshots is impressed by all the records currently being broken. Lionel Messi’s package to remain at Barcelona despite the Catalonia troubles. The FTSE all share index despite Brexit. They are proof that you have to look underneath the soundbites we are bombarded with to truly understand what is going on.

Little Blighty On The Down*

Central Banks are rolling back Quantitative Easing and their associated liquidity programmes. One such programme, the Bank of England Term Funding Scheme, is expiring in February next year. It currently stands at £75bn and has provided UK banks with cheap term funding to make consumer and business loans. Some commentators have said it is partly responsible for the price war in the mortgage and consumer loan market.

The recent BOE Credit Conditions survey shows some interesting trends. Default rates on secured loans to households fell in Q3 and are expected to fall again in Q4. However, default rates on unsecured loans have been rising steadily over the course of the year amid tightening access. This doesn’t surprise us and is in line with our analysis. The mortgage market is now heavily regulated with strict underwriting standards. However, unsecured consumer credit has not been as regulated and has been booming. We believe there will be repercussions in the challenger bank and non-bank lending space and are monitoring these developments closely.

JOMO

The record breaking environment is feeding through to the credit markets. We are seeing post crisis lows in the spread per turn of leverage in some transactions and we refinanced the liabilities in one of our own CLOs at post crisis lows. In the UK and Europe we have high debt service coverage ratios, low defaults and negative net supply in the High Yield market. It is hard not to suffer FOMO as we turn deals away that we think are priced below their fair risk adjusted credit spread. It just takes strong mental discipline and a JOMO attitude (Joy of Missing Out).

Basel 4, Solvency 2 and IFRS 9

Despite the diminishing returns in the liquid markets we note that the private credit pipeline across regulatory capital, speciality finance, warehouses and real estate continues to grow with attractive risk adjusted returns on offer. The reason these opportunities are still available, despite unattractive valuations elsewhere, is that Basel 4 and Solvency 2 continue to help manufacture lots of lending opportunities for non banks. We don’t expect these regulations to change anytime soon. We therefore expect these opportunities to be available for the foreseeable future. In fact IFRS9 which comes into effect early next year may create even more opportunities.

 

*Little Blighty on the Down was a satirical radio comedy series broadcast on BBC Radio 4 between 1988 and 1992. It was a parody of British life set in the made up village of Little Blighty. The village protagonists were the privileged Rotarians who saw themselves as benevolent and were a satire of the Conservative Party. Their opponents were the Working Men’s Club who were a satire of the Labour Party. Their ambition to take power from the Rotarians was constantly frustrated by their own indecisiveness and internal fighting. We can’t help but note how political and economic cycles seem to repeat themselves.

Asif Godall
Co-Chief Investment Officer