A quick smorgasbord of observations within the funds’ space.
First up, are SME lending rates just too damned low? One of the big advantages of disruption within financial services is that intensified competition tends to result in lower interest rates charged to borrowers as capital providers swarm into markets opened up by technology. This seems to be the case in SME lending where great outfits like Funding Circle have worked wonders in advancing capital to borrowers.
The downside of this is that during some years or vintages, that pricing of the interest rate is just plain wrong i.e the interest rate charged is too low compared to the level of arrears and defaults, all revealed after a year or two.
We can see a glimpse of this in reporting from FCs SME Income fund. According to a note out on Monday from analysts at Liberum “The high impairment rate in the [most recent] month maintains the trend seen in H2 2018. UK loans have been the driver of a material increase in credit losses. We calculate an impairment rate of 7.0% to date in FY2019 (ten months to January 2019) before IFRS 9 provisions. This compares to 2.0% in the whole of FY2018. The volatility in UK loan performance is expected to continue for a number of months which will make it difficult for the company to achieve the guidance of a 4% NAV TR in the 12 months to December 2019.”
The chart below from Liberum sums up the deteriorating situation for the fund.
I’ve heard many stories of SMEs successfully refinancing their rates on platforms like Funding Circle in the single digits. Many of these are businesses that may have chosen to go with a high street bank (where interest rates are even lower) but chose FC because of its speed, efficiency and flexibility. But my hunch is that an equally large number of borrowers are much riskier entities who the high street bank would never have lent to. And those losses are feeding through into the default rate. If we broke SME borrowing down into segments, I accept that the investment grade-ish borrowers would have interest rates in the middle single digits. But my hunch is that the ‘junk-like’ less worthy borrowers should be facing rates of between 10 and 15% while truly risky entities should be facing pricing closer to 20%. They aren’t currently facing those rates, which should be worrying for all of us.
Next up, Schroders European REIT, ticker SERE. I constantly watch this fund and its frankly random share price. It seems to move up and down not based on the results or any particular worries about its portfolio but on who needs to sell shares. The fund is currently trading at around 106/107p. The running yield is a around 6.1% based on around 6.5p of dividends per annum. The discount to net asset value is running at 14.5% which is usually slapped on funds that have serially failed. Which this hasn’t. In fact, it’s a boring, steady Eddie fund which has been making solid progress. I think this is a buy all the way upto 115p a share.
Lastly social housing. This week we have yet more (baddish) news about some of the housing associations the big social housing investment trusts work with. Here’s the Canaccord note from Monday about Inclusion Housing.
“On Friday, the Regulator of Social Housing published its regulatory judgement on Inclusion Housing Community Interest Company (Inclusion). Inclusion has been graded as ‘non-compliant’ with a G3 grading in terms of Governance and a V3 grading in terms of Financial Viability. Inclusion represents 21% of the Triple Point Social Housing portfolio (31 December 2018) and 7.5% of NAV of Civitas Social Housing (31 December 2018). Importantly, both Civitas and Triple Point note that Inclusion remains fully up to date with all lease payments, and they expect this to continue to be the case going forward. Triple Point also states that following confirmation from its independent valuer, it expects no impact on the valuation of its property portfolio as a result of the non-compliant grading. Inclusion’s commitment to meet index-linked lease payments over the long-term, the risk from ‘Full Repairing and Insurance’ lease terms and if demand for specialist supported living were to fall, or if government policy were to change, then these housing associations would need to engage with private sector landlords to remain financially solvent. The risks noted in the judgement are inherent to the lease model. However, there is currently excess demand for specialist supported housing. This is expected to grow over the next decade driven by more people in the UK requiring care and the government’s drive to get people out of institutions and into community-based accommodation which can result in cost savings for local authorities in excess of £1,000 per week per tenant.”
This all sounds reassuring and there’s no doubting the huge demand for supported housing, especially for young adults (who will become old adults) with LDs. I completely buy the long term driver for structural demand.
BUT there is an awkward fact here. The private sector is gauging the local authority and NHS buyers with ever higher fees. These state purchasers of specialist services simply can’t afford to pay these rates in the longer term and there will be a settling of scores.
Take local authorities. More and more of their already tight budgets are being gobbled up by these charges for adult social care. At the moment, suppliers can play authorities off against each other but sooner or later there will be a rationalization and dare I say a nationalization of social care provision. I think it distinctly likely that local purchasers will be merged into a national buying framework and costs ruthlessly culled by big centralized buyers.
In the meantime, we’ll see a continuous ratcheting up of pressure on weak housing association ‘middlemen’. They act between the LA purchasers and the investment financiers. They work with private landlords and buy their own properties. They fund via ironclad long-term index-linked deals but their main source of cash flow – LAs and the NHS – are under incredible pressure and only willing to commit to pricing for a few years at a time. That forces Has to over promise and under deliver. They also force cost control measures back down to the private landlords, if there are any. Corners will be cut and the system is frankly unworkable over the long term. And when the turn comes, maybe in 5 or 10 years time, the repricing of capital will be monumental.
Why isn’t the Treasury funding a thought through a national scheme which lowers the cost of capital to the taxpayer and insists on better services? What earthly reason is there for taxpayers to fund such expensive cost of capital to provide essential public social services? If the government really cared about austerity and getting a better deal for the taxpayer it would fundamentally alter the funding equation for assisted and supported living. And that would be terrible news for the specialist funders of assisted living.