U.K.’s $16 Billion Bond Pledge for Builders to Lure Gilt Buyers

Cameron’s $16 Billion Bond Vow for Builders May Lure Gilt Buyers
The U.K.’s housing market is under pressure as the economy struggles to recover from a recession and the euro-area debt crisis drags on, undermining confidence and pushing up borrowing costs. Photographer: Simon Dawson/Bloomberg

The British government’s plan to underwrite as much as 10 billion pounds ($16 billion) of bonds issued by nonprofit housing developers probably will draw U.K. government-bond investors as they seek higher returns.

The proposal would lower the homebuilders’ financing costs by guaranteeing debts and reducing the default risk for bondholders. Government backing makes the bonds more attractive than gilts, according to Alison Murdoch, a director at CCLA Investment Management Ltd. in London, which manages 4.1 billion pounds of assets. The bonds are likely to yield as much as 50 basis points more than government bonds, according to Ignis Asset Management.

“I don’t see how the investor can lose out in this,” Murdoch said in an interview. “Managers of sovereign funds would buy these because it’s cheaper than buying gilts and it’s essentially the same risk.”

Prime Minister David Cameron has loosened regulation on homebuilding and is underwriting some lending as he turns to construction to pull Britain out of its first double-dip recession since the 1970s. His Conservative-led government is counting on nonprofit developers, known as housing associations, to build as many as 70,000 homes and create 140,000 jobs.

New home sales have declined as the economy shrinks and the euro-area debt crisis drags on, undermining confidence and pushing up builders’ borrowing costs. Average rents surpassed 800 pounds a month for the first time in August, while the nation’s ailing banks have scaled back mortgage lending, increasing rental demand. Homebuilding fell to the lowest peacetime level in nine decades last year.

Resistant Banks

A government-backed guarantee would help smaller housing associations issue bonds to pay for new developments, Murdoch said by telephone. Financing new projects has become increasingly difficult as banks shun lending to housing associations, she said.

“With the government guarantee, the smaller players can approach the market when they wouldn’t be able to otherwise, or would have had to go through a collective,” Murdoch said.

A bond issue of 1 billion pounds could create as many as 1,000 new homes, according to Stuart Ropke, head of investment policy and strategy at the National Housing Federation. That could amount to 10,000 homes under the government’s 10 billion-pound proposal.

A housing association is an independent, nonprofit company that was set up to provide homes for people in need. About 5 million people in England live in such developments, with many paying rent at 80 percent of the market rate, according to the National Housing Federation.

‘Win-Win Situation’

“It’s a win-win situation for the housing associations and the government,” said Stuart Thomson, a fixed-income manager at Ignis Asset Management. “The danger is you get a proliferation of these government guarantees over a variety of sectors.”

Ten-year gilt yields approached the lowest level in two weeks Sept. 28 after research group GfK NOP Ltd. said U.K. consumer confidence improved in September, providing “grounds for optimism” on the economic outlook. Gilts returned 1 percent this quarter through Sept. 27, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Yields have remained low since the Bank of England kept its asset-purchase target at 375 billion pounds and maintained the benchmark interest rate at a record low 0.5 percent on Sept. 6, in a bid to spur the economy.

Chasing Yields

Low interest rates on governments bonds are prompting investors to seek higher yields, according to Russel Matthews, a fund manager at BlueBay Asset Management Ltd. The homebuilder bonds would still need a full sovereign guarantee and be priced wider than 40 to 50 basis points over gilts for Matthews to contemplate buying them, he said.

The bonds are likely to trade within that basis-point range, according to Thomson of Glasgow, Scotland-based, Ignis. A basis point is the equivalent of 0.01 percentage point.

“The likelihood is that you would see these housing-association bonds trade at a premium to gilts,” Ignis said by phone. “Taking into account risk, probably somewhere between 30 and 50 basis points over gilts. People will just take the extra premium over gilts.”

Some people don’t think a government guarantee for housing associations is essential. Public backing may not be necessary because a housing association has never defaulted, Affinity Sutton Group Finance Director Mark Washer said in an interview. Affinity, a housing association with more than 57,000 properties, issued 250 million pounds of bonds to 17 institutional investors in September 2008.

Regulatory Action

“A lot of the investors I’ve heard have said if they want gilts, they would buy gilts,” Washer said. “The regulator would be likely to step in if there was a housing association in distress.

“If you’re investing in one of the weaker housing associations, there’s still a perception that the government is de-facto standing behind it,” he said.

The opposition Labour Party has been supportive of the government’s proposal, increasing the chances it will take effect.

“If we had been in power, we would have done something similar in terms of the use of balance-sheet guarantees,” said Jack Dromey, Labour’s housing spokesman. “It’s a step in the right direction.”

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