Annual Report and Accounts 2009

Notes to the Consolidated Financial Statements for the year to 31 December 2009

21. Financial instruments

Refinancing

On 7 April 2009 the Group successfully reached agreement with its banks and private placement holders regarding a revised covenant and financing package (the Override Agreement). The Group also reached similar agreement with the holders of its two public Eurobond issues on 30 April 2009. The principal terms of the refinancing consisted of an alignment of all debt maturity dates to 3 July 2012, an increase in margin or coupon, an additional interest charge in the form of payment in kind (PIK) and warrants giving all lenders at the time the right to subscribe in cash for a combined total of approximately 5% of the Company's ordinary share capital at a fixed price and a revised operating and financial covenant package. Following the equity raise in June 2009 the Group was able to reduce its borrowings to below a level such that PIK stopped accruing, the additional interest reduced and restrictive operating covenants relaxed.

Capital management

The Group's objective is to obtain a strong credit rating for the business and to have an appropriate funding structure based on a minimum interest cover and maximum gearing. In the current circumstances maintaining interest cover is not applicable as cash generation has been the Group's primary focus, however complying with policy remains an objective of the Group when market conditions allow. Shareholder's equity and long term debt are used to finance fixed assets and medium to long term land bank. Revolving credit facilities are used to fund net current assets including work in progress and short term land.

Financial assets and financial liabilities

Categories of financial assets and financial liabilities are as follows:

Financial assets Note 2009
Carrying
value
£m
2008
Carrying
value
£m
Cash and cash equivalents (b) 132.1 752.3
Derivative financial instruments:
Designated as effective hedging instruments (a) 11.1 0.4
Held for trading (a) 2.7
Loans and receivables:
Land receivables (b) 21.0 55.6
Trade and other receivables (b) 121.6 95.4
Mortgage receivables (b) 41.7 31.7
    327.5 938.1

Land receivables and trade and other receivables are included in the balance sheet as trade and other receivables for current and non-current amounts.

Current and non-current trade and other receivables, as disclosed, in Note 17 include £41.8m (2008: £43.4m) of non-financial assets.

Financial liabilities Note 2009
Carrying
value
£m
2008
Carrying
value
£m
Derivative financial instruments:  
Designated as effective hedging instruments (a) 1.8
Held for trading (a) 12.9 12.6
Amortised cost:    
Bank loans and overdrafts 161.1 1,312.5
Land creditors (b) 325.7 645.3
Trade and other payables (b) 577.8 701.1
Debentures (c) 721.9 969.1
    1,799.4 3,642.4

Land creditors and trade and other payables are included in the balance sheet as trade and other payables for current and non-current amounts.

Current and non-current trade and other payables, as disclosed in Note 20, include £122.2m (2008: £152.6m) of non-financial liabilities.

(a) Derivative financial instruments are carried at fair value. The fair values are derived from inputs that are observable for the asset or liability either directly or indirectly and relevant for the term, currency and instrument and are therefore Level 2 as described in the IFRS 7 update effective 1 January 2009.

(b) The Directors consider that the carrying amount of other financial assets and liabilities recorded in the financial statements approximates their fair values.

(c) Details of fair values of debenture loans are provided in Note 19.

The Group has the following types of derivatives:

  2009
Notional
amount
2009
Weighted
average fixed
2008
Notional
amount
2008
Weighted
average fixed
Designated as held for trading:
Floating £ to fixed £ interest £185.0m 5.28% £185.0m 5.28%
Fixed US$ to floating US$ interest US$145.0m 5.16%
Designated as hedging instruments:
US$160.5m floating US$ to fixed £ interest £100.0m 6.63% £100.0m 6.63%

In addition, forward contracts have been entered into to hedge transaction risks on intra-Group loans to buy against Sterling: US$37m, €2.5m and C$54.5m (2008: US$nil, €2.5m and C$nil). The fair values of the forward contracts are not material as they were entered into on or near 31 December 2009 and mature not more than one month later.

Loss before tax has been arrived at after charging/(crediting) the following gains and losses: 2009
£m
2008
£m
Change in fair value of financial liabilities designated as effective hedged items (0.5) 6.9
Change in fair value of derivatives designated as effective hedging instruments 0.5 (6.9)
Change in fair value of derivatives classified as held for trading (2.1) (10.8)
  (2.1) (10.8)

Market risk

The Group's activities expose it to the financial risks of changes in both foreign currency exchange rates and interest rates. The Group aims to manage the exposure to these risks by the use of fixed or floating rate borrowings, foreign currency borrowings and derivative financial instruments.

(a) Interest rate risk management

The Group is exposed to interest rate risk as the Group borrows funds at both fixed and floating interest rates. The exposure to these borrowings varies during the year due to the seasonal nature of cash flows relating to housing sales and the less certain timing of land payments. A combination of fixed rate borrowings and interest rate swaps are used to manage the volatility risk such that at the year end, taking all interest rate derivatives into account, fixed rate borrowings are not more than 70% of total borrowings but not less than 50%. Group policy does not allow the use of derivatives to speculate against changes to future interest rates and they are only used to manage exposure to volatility.

In order to measure the risk, floating rate borrowings and the expected interest cost for the year are forecast on a monthly basis and compared to budget using management's expectations of a reasonably possible change in interest rates. Interest expense volatility remained within acceptable limits throughout the year although our fixed rate exposure is currently in excess of policy. At the year end the Group had £802.0m (2008: £827.1m) of fixed rate exposure equivalent to 107% (2008: 62%) of net debt. The Group are currently not permitted to enter into new derivatives or cancel existing derivatives, if resulting in cash outflow, due to the terms of its renegotiated debt facilities.

Hedge accounting
Hedging activities are evaluated periodically to ensure that they are in line with policy.

The cross currency, fixed to floating interest rate swaps have been bifurcated for hedging purposes and designated as fair value hedges such that the Group receives interest at a fixed rate of 6.625% based on a nominal value of £100.0m matching the underlying borrowing and pay US dollar floating rates on a nominal value of US$160.5m. During the period, the hedge was 100% effective (2008: 100%) in hedging the fair value exposure to interest rate movements and as a result the carrying amount of the loan was increased by £4.9m (2008: reduced by £6.9m) which was included in the income statement offsetting the fair value movement of the bifurcated interest rate swap.

A number of derivatives are held which, while providing an economic hedge to the volatility of interest rates, do not satisfy the strict requirements for hedge accounting and are therefore designated as held for trading.

Interest rate sensitivity
The effect on both income and equity, based on exposure to non-derivative floating rate instruments at the balance sheet date, for a 1% (2008: 1%) rise in interest rates is £(0.3m) (2008: £(5.6m)), before tax, a 1% (2008: 1%) fall in interest rates gives the same but opposite effect. For derivatives the fair values have been calculated based on rates available from a recognised financial information provider adjusted for the sensitivity as shown in the tables below.

Due to seasonal fluctuations the level of net borrowings at the financial year end are not representative of net borrowings during the year and therefore interest rate sensitivity before tax for a reasonably possible 1% (2008: 1%) rise in floating rate instruments as shown below is based on a monthly average for the year. The table assumes all other variables remain constant and in accordance with IFRS 7 does not attempt, for example, to include the effects of any resultant change in exchange rates.

1% increase in interest rates Sensitivity
income
2009
£m
Sensitivity
equity
2009
£m
Sensitivity
income
2008
£m
Sensitivity
equity
2008
£m
Derivatives 3.2 3.4 4.4 4.7
Non-derivatives (based on average for the year) (4.2) (4.2) (9.5) (9.5)
  (1.0) (0.8) (5.1) (4.8)
1% decrease in interest rates Sensitivity
income
2009
£m
Sensitivity
equity
2009
£m
Sensitivity
income
2008
£m
Sensitivity
equity
2008
£m
Derivatives (3.3) (3.5) (4.6) (4.8)
Non-derivatives (based on average for the year) 4.2 4.2 9.5 9.5
  0.9 0.7 4.9 4.7

(b) Foreign currency risk management

The Group's overseas activities expose it to the financial risks of changes in foreign currency exchange rates primarily to US dollars, Canadian dollars and the Euro.

The Group is not materially exposed to transaction risks as nearly all Group companies conduct their business in their respective functional currencies. Group policy requires that transaction risks are hedged to the functional currency of the subsidiary using foreign currency borrowings or derivatives where appropriate.

The Group is also exposed to the translation risk of accounting for both the income and the net investment held in functional currencies other than Sterling. The net investment risk is partially hedged using foreign currency borrowings and derivatives. Assets and liabilities denominated in non-functional currencies are retranslated each month using the latest exchange rates and resultant exchange gains or losses monitored each month. Income is also measured monthly using the latest exchange rates and compared to a budget held at historical exchange rates. Other than the natural hedge provided by foreign currency borrowings the translation risk of income is not hedged using derivatives. The policy is kept under periodic review.

The Group's exposure to, and the way in which it manages, exchange rate risk has not changed from the previous year.

Hedge accounting
The Group designates the bifurcated cross currency swaps such that the nominal amount of US$160.5m (2008: US$160.5m) is used to hedge part of the Group's net investment in US dollar denominated assets and liabilities.

The Group has also designated the carrying value of US$287.5m and €75.0m (2008: US$527.5m and €75.0m) borrowings as a net investment hedge of part of the Group's investment in US dollar and Euro denominated assets respectively.

Due to net realisable value provisions and derecognition of deferred tax assets in North America the designated hedging instruments exceeded the carrying value of hedged investments for part of the year and in accordance with policy any exchange gains or losses on the excess hedge have been recognised in the income statement. The change in the carrying amount of the derivatives which were effective hedging instruments and the change in the carrying value of the borrowings offset the exchange movement on the Group's US dollar and € net investments and are included in the translation reserve.

Foreign currency sensitivity
The Group is primarily exposed to US dollars, Canadian dollars and the Euro. The following table details how the Group's income and equity would increase/(decrease) on a before tax basis, to a 20% increase (2008: 20%) in the respective currencies against Sterling and in accordance with IFRS 7, all other variables remaining constant. A 20% (2008: 20%) decrease in the value of Sterling would have an equal but opposite effect.

The 20% (2008: 20%) change represents a reasonably possible change in the specified foreign exchange rates in relation to Sterling.

  Income
sensitivity
2009
£m
Equity
sensitivity
2009
£m
Income
sensitivity
2008
£m
Equity
sensitivity
2008
£m
US dollar (5.4) 29.6 (4.4) 10.6
Canadian dollar (1.2) (37.7) (0.4) (35.2)
Euro (0.8) (14.1) 0.4 (14.1)
  (7.4) (22.2) (4.4) (38.7)

Credit risk

Credit risk is the risk of financial loss where counterparties are not able to meet their obligations.

The Group's policy is that surplus cash when not used to repay borrowings is placed on deposit with the Group's revolving credit facility syndicate banks and with other banks based on a minimum credit rating. Credit risk on derivatives where the fair value is positive is closely monitored and remains within acceptable limits.

Land receivables arise from sales of surplus land on deferred terms. A policy is in place such that if the risk is not acceptable then the deferred payment must have adequate security either by the use of an appropriate guarantee or a charge over the land. The fair value of any land held as security is considered by management to be sufficient in relation to the carrying amount of the receivable to which it relates.

Trade and other receivables comprise mainly amounts receivable from various housing associations and other housebuilders. Management consider that the credit quality of the various debtors is good in respect of the amounts outstanding and therefore credit risk is considered to be low. There is no significant concentration of risk. A small allowance for credit losses against sundry debtors is held, however, the balance is not material in relation to the gross carrying value of this particular class of financial asset.

The Group's exposure to credit risk has reduced compared to the prior year due to the current policy of minimising cash balances in order to reduce carry costs. In 2008 the Group maintained a higher level of liquidity due to the concerns affecting the banking sector.

The carrying amount of financial assets, as detailed above, represents the Group's maximum exposure to credit risk at the reporting date assuming that any security held has no value.

Liquidity risk

Liquidity risk is the risk that the Group does not have sufficient financial resources available to meet its obligations as they fall due. The Group manages liquidity risk by continuously monitoring forecast and actual cash flows, matching the expected cash flow timings of financial assets and liabilities and ideally through the use of term borrowings, overdrafts and committed revolving credit facilities for a minimum of 12 months from maturity. Future borrowing requirements are forecast on a weekly and monthly basis and funding headroom is maintained above forecast peak requirements to meet unforeseen events. Following the debt refinancing all bank loans, debentures and revolving credit facilities are capable of being repayable or mature on 3 July 2012. It is the objective of the Group to return to a more appropriate maturity profile when conditions allow.

In addition to term borrowings and committed overdraft facilities the Group has access to committed revolving credit facilities and cash balances. At the balance sheet date, the total unused committed amount was £1,078.3m (2008: £410.9m) and cash and cash equivalents of £132.1m (2008: £752.3m).

The maturity profile of the anticipated future cash flows including interest using the latest applicable relevant rate based on the earliest date on which the Group can be required to pay financial liabilities on an undiscounted basis is as follows:

Financial liabilities Bank loans
and overdraft
£m
Land
creditors
£m
Other trade
payables
£m
Debenture
loans
£m
Total
£m
On demand 12.7 12.7
Within one year 4.4 132.5 414.8 59.8 611.5
More than one year and less than two years 4.4 90.9 18.1 59.8 173.2
More than two years and less than five years 150.6 95.4 21.4 747.3 1,014.7
In more than five years 29.8 29.8
31 December 2009 172.1 348.6 454.3 866.9 1,841.9
Financial liabilities Bank loans
and overdraft
£m
Land
creditors
£m
Other trade
payables
£m
Debenture
loans
£m
Total
£m
On demand 22.8 22.8
Within one year 60.3 410.1 634.1 160.3 1,264.8
More than one year and less than two years 59.6 83.3 40.1 54.1 237.1
More than two years and less than five years 1,379.4 118.0 13.5 463.0 1,973.9
In more than five years 38.4 13.4 554.9 606.7
31 December 2008 1,522.1 649.8 701.1 1,232.3 4,105.3

The following table represents the undiscounted cash flow profile of the Group's derivative financial instruments and has been calculated using implied interest rates and exchange rates derived from the respective yield curves. Interest rate swaps are settled net and foreign currency swaps and forward contracts are settled gross except in the case of a default by either party where the amounts may be settled net.

Derivatives Net-settled
derivatives
net amount
£m
Gross-settled
derivatives
receivable
£m
Gross-settled
derivatives
payable
£m
Total
£m
Within one year (7.7) 6.6 (2.6) (3.7)
More than one year and less than two years (4.7) 6.6 (4.1) (2.2)
More than two years and less than five years (0.7) 113.3 (107.5) 5.1
31 December 2009 (13.1) 126.5 (114.2) (0.8)
Derivatives Net-settled
derivatives
net amount
£m
Gross-settled
derivatives
receivable
£m
Gross-settled
derivatives
payable
£m
Total
£m
Within one year (1.6) 9.0 (7.3) 0.1
More than one year and less than two years (4.8) 6.6 (5.4) (3.6)
More than two years and less than five years (3.4) 113.3 (112.3) (2.4)
In more than five years (0.8) (0.8)
31 December 2008 (10.6) 128.9 (125.0) (6.7)