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What does the latest autumn statement mean for debt markets?

November 28, 2022 8 Minute Read

By Chris Gow

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Interview with Chris Gow, Head of OPRE Debt

1) Since the autumn statement, what do lenders and borrowers need to be aware of with the changing economic climate in terms of lending?

The initiatives were so well briefed, financial markets were fully prepared and, as a result, there has been little movement in interest or forex rates, which is a marked contrast to the mini budget. Borrowers are continuing to adjust to the new lending market and are specifically focused on where loan liquidity is, what leverage attachment points are available and how much debt now costs. Lenders are very focused on valuation trends and interest cover, which has been impacted given the increase to the all-in cost of debt.

Consequently, we are seeing lower leverage being offered across all asset classes, but loans are still being written and we have closed or are closing very substantial loans in office, residential and hotels at attractive leverage and pricing points.

2) Are there any further challenges for OPRE compared to other sectors?

The challenges are slightly different for OPRE and they vary between the different asset classes. The main challenge affecting borrowing is energy and wage inflation - hospitality and social care businesses have been particularly affected - so these sectors continue to face challenges. On the other hand, some sectors, such as self-storage, have high margins and low head count, so are less affected. These challenges hit all parts of the economy and could impact occupancy and rental levels in other real estate asset classes, but OPRE will be challenged first.

3) Corporation tax is due to rise from 19% to 25% in April 2023. How are corporations going to attract new investment to the UK?

What investors are looking for is an attractive and stable investment environment and the UK’s reputation took a significant hit globally after the mini-budget. The present government is trying to recover that reputation and the market reaction to the budget represents some progress from the previous regime. While tax on profits is a consideration for investors, I think it’s a secondary element to the overall country risk and a move from 19% to 25% is probably unlikely to be the deciding factor. In addition, if you compare UK corporation tax to a lot of other countries, the higher 25% remains competitive.

For a reasonable period, the gap between mid-term SONIA and Euribor Swaps has been between 75bps and 100bps. During Trussonomics, that gap rose to over 3% highlighting investor views of the growth strategy proposed – that gap is now back c1% suggesting the new PM has recovered some of the lost market reputation.

4) The government’s review of business rates means from April 2023, many businesses will be facing new business rates bills. Will the new business rates valuation incentivise investment opportunities to the UK?

The biggest beneficiaries are going to be retailers and hospitality. The connection between rates and rents are misaligned - rents remained relatively flat, but rates kept increasing. As we enter a downturn, retailers and operational real estate businesses will struggle, so reducing their overhead will give them a good chance of survival, if not the ability to thrive once the market begins to recover.

5) Where are margins/interest rates going to go?

It is worth noting the all-in cost of debt is down now by about 175 bps since the peak seen after the mini budget and that is because the markets feel more secure.

The market expects base rates to increase a further 1-1.5% over the next 6-9 months as the Bank of England seeks to control inflation. This is evident from the forward curves, and is already priced into 3-5 year swap rates that underpin much of commercial and mortgage borrowing in the UK. Rates are expected to start reducing later in 2023, but there is a risk to the downside if inflation remains stubbornly high.

On the margin side, most lenders have already priced in the current economic climate, and I am not convinced margins are going to move much further. Banks have increased margins by around 25-50bps, particularly in sectors where sector limits have come under pressure as reduced M&A volumes slow down the rate of churn in loan books. There are concerns sectors that have had a favourable rating until now could be red flagged as credit committees seek to moderate the rate of loan book growth.

The position with debt funds is more complex. They have an ability to be more flexible and pragmatic, but that could lead to opportunistic pricing in certain sectors. We have seen pricing move 100bps wider in the last few months as funds have adjusted to the new environment and because they have found it hard to access back leverage over the summer and early autumn. That market has started to thaw in recent weeks, and we anticipate pricing could improve slightly as many non-bank lenders remain keen to deploy.

The biggest known unknown on rates is Ukraine. Being optimistic, if there was somehow a short-term resolution to the war, inflationary pressures would reduce, and future base rate increases could be avoided. But some commentators believe there is risk the war could escalate further and, in that scenario, all bets are off.

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