15 Feb 2019

Yew Grove completes Cork office acquisition

Yew Grove REIT (YEW) has announced: (i) the acquisition of an office building in Cork; (ii) the ahead of schedule completion of its investment at Athlone; and (iii) an update on its portfolio metrics.

To start with the acquisition, YEW has purchased a two storey 40,953 sq ft office building (Unit 2600) at the Cork Airport Business Park. The asset comes with a 163 space car park and was refurbished to a high standard in 2015. It is tenanted by Deutsche Borse AG subsidiary Clearstream under a 25 year lease with final expiry in just over five years’ time. The €7.5m acquisition represents a NIY of 7.85% after accounting for purchase costs. This implies a yield of around €15 psf for the office space, which is well below rents being achieved by high end office assets in Cork at this time, so at first blush there would appear to be some good medium-term reversionary potential.


Secondly, YEW has announced the completion of its car park investment at the IDA Athlone Business and Technology Park for its tenant, KCI Manufacturing. The €0.5m capital project was only announced on 25 October, so its completion ahead of schedule (and on budget) is very welcome. The car park is subject to a new lease with a maturity matching the leases on KCI’s buildings (with breaks in 2023 and 2028).


Adding in the Cork acquisition and the Waterford purchase announced last Friday to the YEW portfolio means that the group now controls 18 properties totalling in excess of 550,000 sq ft of space and generating annualised rents of over €7.35m. The group is nearly fully invested (on the basis of the proceeds from June’s IPO and the revolving credit facility). To this end, we note
management’s view that “the company’s geographic target market continues to combine attractive purchase yields and rising rent levels”. YEW says that “against these market dynamics, the company continues to pursue a number of attractive investment opportunities that would enhance shareholder value and reduce on-going costs per share, if acquired. As set out in the Company's IPO admission document, the Board continues to believe that consolidation within its target market offers the opportunity to build a €300-500 million portfolio of high-yielding, high-quality assets over a three year period and the Board will consider options available to it to increase the scale of the Company to capture such opportunities”.


Today’s news of an investment in Cork on attractive terms is a further illustration of YEW’s successful strategy of marrying blue chip tenants and high yields. Looking ahead, YEW’s stated ambitions suggest that the group will keep its options for growing the balance sheet under review.


Irish Banks: Ulster Bank read-through for the sector


RBS’ FY18 annual results, released this morning, contain a few interesting items in regard to its Ulster Bank Ireland subsidiary.


Total income was flat year on year at €689m (FY17 €689m), as net interest income increased by €22m or 4.6%, but non-interest income fell by a similar amount, with net loans dropping to €21.0bn from €22.0bn at end FY17 but NIM increasing from 167bps to 179bps y/y. Operating expenses dropped by €115m or 14.9% to €657m (FY17 €772m), though almost all of this relates a €113m reduction in litigation and conduct costs (FY18 €79m vs FY17 c.€192m), these primarily relate to provisions against the tracker mortgage redress examination but also include other legacy business issues. We also assume litigation issues were at least partly behind the c.400 or 15% increase in full time employees at end 2018 vs end 2017 (though there could be timing issues involved in this as well), this led to a 6% increase in staff costs on the year.


There was a net impairment charge on the year of €17m which reflected a charge associated with the sale of a c.€0.6bn portfolio of NPLs during Q4, though there was actually a provision release of €21m on Q4 itself due to the original provision taken in Q3 against the loan sale being overly conservative. Risk weighted assets reduced by €3.8bn or 19% y/y, reflecting both the NPL portfolio disposal and an improvement in credit metrics. Overall operating profit for FY18 of just £12m generated an ROE of 0.5%.


Overall, the results suggest a mixed outlook for banks seeking to dispose of legacy NPL portfolios given the charge taken in executing the transaction, while the cost picture also highlights both the problem with legacy litigation resolution as well as potential wage inflation. The expansion in NIM, however, highlights the relatively benign competitive conditions that we would point to remaining in place in the Irish banking sector despite much discussion recently about potential challenger entrants to the mortgage market.


Cairn Homes: Irish Times report on planning


Today’s Irish Times reports that Cairn Homes’ (CRN) plans for 420 homes at Newcastle, South-West Dublin “face a potential delay after planners [have said CRN] would be unlikely to get permission for the development in its current form”.


CRN began consulting with the State planning authority, ABP, in November, about its plans for the site. The scale of the development qualifies it for the ‘fast track’ planning regime applying to schemes of more than 100 units. ABP told the newspaper that further unspecified “consideration/amendment” would be required to get the development through planning, although it is important to note that this is not a formal refusal, as CRN had not yet reached that stage in the planning process.


While CRN does not comment on projects that are navigating the planning process, the paper hints that management do not expect that these engagements with ABP will seriously delay the scheme (which is, of course, just one of a number of sites across which CRN will be delivering thousands of units in the coming years).


Irish Economy: Residential prices +6.5% y/y in December


Preliminary RPPI data for December show that the 2018 exit rate for annual residential property price inflation was 6.5%, a little below the 7% we had pencilled in, although we had flagged downside risks to this. Prices fell marginally (-0.1%) for a second successive month. However, we would not be surprised to see a return to growth in the New Year when the impact of Central Bank restraints on mortgage lending are relaxed again (these apply to lending in a calendar year as opposed to being on a rolling 12 month basis, and we note press reports that some institutions had tightened up on exemptions in order to ensure compliance for the full year).


Regional data show a very mixed picture, with prices outside of the capital rising 0.8% m/m and +9.6% y/y, while Dublin residential prices fell 0.8% m/m and were ‘only’ +3.8% y/y. This divergence is explained by affordability, with asking prices in the country’s main urban centre some 46% above the national average, while disposable incomes in Dublin are 15% above the mean for the State. The Central Bank applies LTI and LTV ceilings across the majority of front book mortgage lending.


Relative to peak, prices are 18.0% adrift of the high water mark of the Celtic Tiger period, but they have rallied 83.0% from the trough. The peak-to-current move is in sharp contrast to the 30-40% we understand that the high street banks here use in their provisioning models, which provides comfort in terms of asset quality.


Notwithstanding the marginal m/m declines posted in November and December, our sense is that the most powerful force in the Irish residential property market is a glaring mismatch between supply (18k new build units in 2018) and the range of estimates of new household formation (30-50k per annum). Moreover, new household formation is endogenous – it doesn’t happen absent available supply – so there is a large ‘tail’ of unmet housing need. Collectively, this suggests to us that the path of least resistance for both prices and rents into the medium term lies to the upside.


Irish Economy: Consumer prices fall 70bps in January


CPI data for January show a 70bps m/m fall in average prices. On an annual basis prices were +70bps y/y.


The drop in prices seen in January was almost entirely explained by deflation in Clothing & Footwear (-9.2% m/m due to New Year sales) and Transport (-3.1% m/m, due to lower fuel and air fare prices).


Three sub-indices that we closely monitor are Private Rents, Insurance and Accommodation. The Private Rents index rose 40bps m/m and was +6.6% y/y, reflecting ongoing housing shortages. Insurance rates were +30bps m/m but -3.3% y/y, with the annual move reflecting a change in the claims environment. Accommodation rates fell 3.3% m/m, reflecting seasonal factors, but were still +1.9% y/y, with this rise down to strong trading conditions.


The headline annual rate of inflation has been sub-1% for 71 successive months now, underpinning a meaningful rise in real earnings (gross average weekly labour earnings were +3.2% y/y in Q318) and (by extension) living standards for the majority of Irish people.


Irish Economy: NTMA taps the market for €1.25 billion


Yesterday the National Treasury Management Agency (NTMA) completed an auction of €1.25 billion of the benchmark Irish Government bonds, 1.1% Treasury Bond 2029 and 1.7% Treasury Bond 2037.


The tap of the Treasury Bond 2029 raised €950 million at a yield of 0.846%, receiving total bids of €2.13 billion (with a cover ratio of 2.2 times). The tap of the Treasury Bond 2037 raised €300 million at a yield of 1.414%, with total bids standing at €839 million (implying a cover ratio of 2.8 times). Aggregate bids received at yesterday’s auction totalled €2.97 billion, giving a blended bid to cover ratio of 2.4 times.


Along with the €4 billion 10yr syndication in January, yesterday’s auction brings the total amount raised so far this year to €5.25 billion. This issuance equates to almost 33% of the midpoint of the stated target range of €14 to €18 billion for 2019. This leaves between €8.75 and €12.75 billion to be raised for the remainder of the year in order to reach the NTMA’s target.


Tesco IFRS 16 impact quantified


Prior to its IFRS 16 briefing this morning Tesco has noted, as expected, that the implementation of IFRS 16 will have no effect on how the business is run, group revenue or cash flows. It will, however, have a significant impact on how the assets and liabilities and the income statement will be presented.


The rental charge currently on the P&L will be replaced by increased depreciation and interest. This means that under IFRS 16 there will be a boost to operating profit but greater interest charges. Depreciation will be charged on a straight line basis, while interest is charge on outstanding lease liabilities and so will be front loaded, decreasing annually.


In the run up to implementation of IFRS 16 the main concern across all sectors was not any impact on the P&L, as cash flows remain unchanged, but rather the impact of the changes on balance sheet metrics that might trigger a breach of loan covenants (both debt and interest related). From the release this morning, this is not a concern for Tesco. In our note issued yesterday, we highlighted that Sainsbury’s has the largest proportion of its estate leased (50%) with Morrisons the least (c.15%). All will be restating under IFRS 16 in due course.


UK retail sales due


Figures from the ONS showed that UK retail sales volumes had shrunk 0.9% (m/m) in December after a surge of 1.3% in November. Excluding fuel, ‘core’ sales volumes were down 1.3% following a rise of 1.0% in the previous month. Such volatility in the last two months of the year has become more common following the rapid embrace of ‘Black Friday’ discounting in the UK since 2014. Though it is widely known to pull Christmas purchases into November from December, the ONS has struggled to fully seasonally adjust for this effect given that the event’s relative infancy means it provides too few data points. Bearing this in mind, the January release will round off the festive trading period, allowing us to take a holistic assessment of how the high street has performed over these all-important three months. As usual the BRC Retail Sales Monitor may provide something of a steer on the upcoming ONS numbers. They reported a 2.2% (y/y) improvement in sales values, albeit amid widespread efforts to rein in the amount of discounted stock relative to previous Januarys. While this will have helped preserve retailers’ margins, it may well have weighed on sales volumes (upon which the ONS figures are based). Consequently, we look for a modest 0.3% gain in January.


Valentine’s Day Mayssacre


Parliamentarians were offered the opportunity yesterday to express whether or not they supported the government's negotiating strategy for Brexit. This was presented as a motion that effectively endorsed the two amendments backed by MPs last month; to replace the Irish backstop with “alternative arrangements” and reject a no-deal Brexit. Taking issue with the latter part of this was the Eurosceptic Tory European Research Group (ERG), who reportedly pushed for the government to adopt the so-called Malthouse Compromise as its official negotiating policy but the ERG’s demands were rejected by Prime Minister Theresa May, resulting in a large number of the group choosing to abstain from the main vote. They were joined by a number of Europhile Tories, who opposed the reworking of the backstop. All in all, 67 Conservative MPs chose to remain seated in the Commons rather than pass through the division lobbies, resulting in the government losing the vote by 303 to 258 (a majority of 45).


Back to Brussels


While the defeat is somewhat embarrassing for Mrs May, it ultimately has no legal force and is unlikely to have a significant bearing on the future direction of talks. The Prime Minister is set to head back to Brussels next week to again press for legally binding changes to the Irish backdrop. But so far the EU has rebuffed her advances, arguing that the proposed protocol can and will not be renegotiated. As such, Westminster and Brussels remain engaged in a monumental game of political chicken, with each side holding out for the other to blink first. Still, the Prime Minister is constrained in how long she can hold out by a self-imposed deadline. In fact she has less than a fortnight to try and gain some concessions from the EU, having promised to update the House of Commons on her progress on 26 February. If Mrs May has failed to secure a revised deal by that date, MPs will then debate and vote on another non-binding motion. Alternatively, if a deal is agreed, MPs will be given a second "meaningful vote".


Uncertainty continues


In reality the Prime Minister’s real intention might be to run down the clock until the 11th hour if comments by her chief Brexit negotiator, Olly Robbins, are to be believed. How Brexit developments develop from here therefore remains uncertain but notably Europhile MPs are rallying support for an amendment by Labour MP Yvette Cooper that would be attached to the next motion on 27 February. Ultimately, we are unlikely to get further clarity on the exact terms of the UK’s departure for some time, leading to a continued period of uncertainty for businesses and households. But we remain cautiously optimistic that a disorderly no-deal Brexit will be averted given that it appears that neither the Prime Minister nor the majority of MPs have an appetite for it.


Economic releases


09.30 UK Retail Sales

10.00 EU Trade Balance

13.00 EU ECB’s Coeure Speaks

13.30 US Industrial Production

14.15 US Industrial Productions

14.55 US Fed’s Bostic Speaks

15.00 US Michigan Sentiment

15.45 EU ECB’s Angeloni Speaks