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Treasury Management. 24 October 2013. Strictly confidential | October2013 . Agenda. Introduction and basic principles Investment Bank creditworthiness Borrowing and interest rates Sources of finance. Introduction and basic principles.

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Treasury Management

24 October 2013

Strictly confidential | October2013

Strictly confidential | October 2013 |

agenda
Agenda
  • Introduction and basic principles
  • Investment
  • Bank creditworthiness
  • Borrowing and interest rates
  • Sources of finance

Strictly confidential | October 2013 |

introduction and basic principles
Introduction and basic principles
  • “The management of the organization’s cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks” (CIPFA)

Strictly confidential | October 2013 |

decision making criteria
Decision making criteria
  • Risk protection
      • Increased costs
      • Running out of funds
      • Loss on investments
  • Flexibility
      • Repay loans
      • Access funds
  • Cost
      • High interest payable
      • Low interest received

Strictly confidential | October 2013 |

treasury management context
Treasury management context

Current position

Business plan projections

Economy and interest rate outlook

Political and business outlook

Conditions in the financial markets

Strictly confidential | October 2013 |

treasury risks
Treasury risks
  • Liquidity
  • Credit, market
  • Interest, inflation, refinancing
  • Exchange rate
  • Legal and regulatory
  • Fraud, error, corruption, contingencies

Strictly confidential | October 2013 |

typical treasury trade offs
Typical treasury trade-offs
  • Interest rate risk needs fixed rates, which increase inflation risk
  • Fixed rates provide certainty, but are inflexible
  • Committed facilities ensure liquidity, but have non-utilization fees
  • Risky investments have higher returns
  • Cash balances have a ‘cost of carry’
  • ‘There’s no such thing as a free lunch’

Strictly confidential | October 2013 |

uncertainty
Uncertainty
  • Economists distinguish between uncertainty and risk
  • There has been unusually high uncertainty over the last few years
      • Economy : when will rates rise?
      • Political : elections, wars, US budget/debt ceiling
      • Natural disasters
  • Difficult to hedge against ‘unknown unknowns’
  • Trade off between certainty and flexibility

Strictly confidential | October 2013 |

investment
Investment
  • Sound principles of investment
      • Spread risks
      • Check counterparties’ creditworthiness
      • Ensure ability to access when required
  • Policies
      • Limit amount invested with each institution
      • Establish minimum credit criteria
      • Limit term of investments
  • Based on preparation of cash flows

Strictly confidential | October 2013 |

cash management
Cash management
  • Need to ensure sufficient cash available
  • Costs involved in holding cash
  • Cash flows can be difficult to predict
  • Minimum ‘safe’ balance is not likely to be nil

Strictly confidential | October 2013 |

bank creditworthiness
Financial sector is still fragile following credit crunch

Economy is still smaller than before crisis

Unresolved structural problems within eurozone

Change in regulatory attitude

Major banks all suffering rating downgrades

Bank creditworthiness

Strictly confidential | October 2013 |

rating agencies
Independent view of creditworthiness aimed at investors

Ratings paid for by company being rated

Criticized after sub-prime fiasco

Independence questioned

Can be slow to react

Rating agencies

Strictly confidential | October 2013 |

how risky are the banks raters views
How risky are the banks? – raters’ views

Strictly confidential | October 2013 |

implications
Implications
  • The credit risk will be included in the margin that banks pay
  • This cost is high and volatile
  • Hence lending margins have increased

Strictly confidential | October 2013 |

credit default swaps
Market view of cost of ‘insurance’

More timely than ratings

Used for speculation as well as protection

Price affected by matters other than pure credit factors

Can be used to gauge the banks’ cost of funds

Credit default swaps

Strictly confidential | October 2013 |

the market view
The market view

Strictly confidential | October 2013 |

borrowing and interest rates
Borrowing and interest rates
  • Sources
      • Banks and building societies
      • Capital markets
  • Structures
      • Bullet and amortizing
      • Short and long-term
      • Capital holidays

Strictly confidential | October 2013 |

underlying interest bases
Underlying interest bases
  • Floating (variable)
      • LIBOR (London Interbank Offered Rate)
      • Base rate
      • Rate changes (quarterly, annually)
  • Fixed
      • Priced from interest rate swaps (plus spread)
      • Rate fixed for term of fix
  • Index-linked
      • Rate payable linked to RPI used for rents
      • Changes annually in April

Strictly confidential | October 2013 |

variations on fixed rates
Variations on fixed rates
  • Forward rates
      • Start in the future
      • Rate calculated from today’s rates
      • Commits to drawdown
  • Cancellable fixed rates
      • Fixed rate with the lender’s option to break
      • If rates go up, fix is broken
      • Achieves lower rate for the borrower

Strictly confidential | October 2013 |

other financial instruments
Other financial instruments
  • Caps
      • Sets a maximum interest rate payable

Collars

      • Sets both a maximum and minimum rate payable

Interest rate swap

      • Another way of fixing rates

Strictly confidential | October 2013 |

interest rate environment
Interest rate environment

Strictly confidential | October 2013 |

fixed rates are higher than last year
Fixed rates are higher than last year

Strictly confidential | October 2013 |

still historically low
Still historically low

Strictly confidential | October 2013 |

economic forecasts
Economic forecasts

Strictly confidential | October 2013 |

market expectations for libor
Market expectations for LIBOR

Strictly confidential | October 2013 |

sources of funding
Sources of funding
  • Banks (now only short-term)
      • Bilateral
      • Syndicated
  • Financial institutions (capital markets)
      • Own name public issues (£100 million)
      • Private placements (£30 million)
      • Aggregated issues (£1 million)
      • Direct lending
  • Typical refinancing structure
      • Keep existing fixed rate debt
      • Short-term revolver
      • Long term from capital markets

Strictly confidential | October 2013 |

public issue
Public issue
  • Large issue size
  • Formal credit rating required
  • Listed on a stock exchange
  • Bought mainly by UK pension and life companies
  • Usually long-term bullet loan with no financial covenants
  • Some of the initial issue can be retained for future use
  • Subsequent amounts can be raised through a ‘tap’ issue

Strictly confidential | October 2013 |

private placement
Private placement
  • Smaller issue amount
  • Credit rating not a requirement (but it may help)
  • Not listed (and not designed to be traded)
  • Can involve US based investors
  • Can involve tranches of different maturities
  • Covenants may mirror required by the bank lenders
  • Further amounts can be raised
  • Quicker than a public issue

Strictly confidential | October 2013 |

aggregated issue
Aggregated issue
  • The Housing Finance Corporation (usually)
  • Public issue on lent to associations
  • Can be for as little as £1 million
  • High level of asset cover (150%)
  • Income test on security
  • Cash reserve
  • Annual management fee
  • Long-term bullet loans

Strictly confidential | October 2013 |

us private placements
US private placements
      • Several US institutions interested in investing in UK housing associations
      • Small number (about 6) investors in sterling direct
  • ‘Real’ GBP investors
  • Investor makes arrangements to convert sterling to US dollars
      • Amounts £50m to £100m (or more)
      • Issue under a Master Note Purchase Agreement (can use again)
      • Asset cover and covenants mirror borrower’s bank facilities
      • Make-whole provisions include currency swap

Strictly confidential | October 2013 |

us private placement process
US private placement process
      • Approach to investors through Placement Agent
      • Master Note Purchase Agreement is governed by English law
      • Private Placement Memorandum circulated to investors
      • Investors invited to bid:
  • Amount
  • Tenor
  • Rate
  • Revisions to terms
      • Objective to ‘hit sweet spots’ reducing average cost of funds
      • Result is funding structure with different maturity tranches
      • Requires NAIC-1 designation (after the issue)

Strictly confidential | October 2013 |

banks and advisers
Banks and advisers
      • Private placement
  • Investment bank acting as placing agent
  • Lawyers for borrower (UK and US)
  • Lawyers acting for investors
  • Valuers
      • Public issue
  • Investment bank acting as bookrunner
  • Lawyers for borrower
  • Lawyers for the bookrunners
  • Valuers
  • Auditors
  • Rating agency

Strictly confidential | October 2013 |

regulatory information legal disclaimer
Regulatory information / Legal disclaimer
  • Capita Asset Services is a trading name of Sector Treasury Services Limited which is authorised and regulated by the Financial Conduct Authority only for conducting advisory and arranging activities in the UK as part of its Treasury Management Service.
  • Capita does not warrant, either expressly or impliedly, the accuracy, timeliness, or appropriateness of the information contained in this document. Capita disclaims any responsibility for content errors, omissions, or infringing material and disclaims any responsibility associated with relying on the information provided in this document. All materials, content and forms contained in this document are the intellectual property of Capita and may not be copied, reproduced, distributed or displayed without Capita’s express written permission. If you have not received this document from Capita you must not disseminate, copy or take any action in reliance on it and should notify Capita immediately.

Strictly confidential | October 2013 |