- Financial Statements
Notes to the Consolidated Financial Statements
for the year to 31 December 2007
22. Financial instruments
Capital management
The Group operates within policies and procedures approved by the Board. The Group’s capitalisation policy established last year sets overall parameters for the consolidated capital structure designed to maintain a strong credit rating and an appropriate funding structure.
The Group seeks to match long term assets with long term funding and short term assets with short term funding. Equity, retained profits and long term fixed interest debt are used primarily to finance intangible assets, fixed assets and land. Short term borrowings are required primarily to finance net current assets, other than landbank assets of more than one year, and work in progress. Cash balances made available by our construction business are used to reduce our short term borrowing requirements.
Net debt as a percentage of equity was 38.2% (2006: 18.6%) however, the Group aims to maintain a strong credit rating by seeking to keep year end modified net gearing (defined as borrowings less cash or cash equivalents as a percentage of tangible net assets adjusted for deferred tax assets and retirement benefit obligations) between 40% and 60% and interest cover greater than 5 times but less than 7 times. The forecast numbers are reviewed regularly. Modified net gearing on this basis was 46.9% (2006: 21.1%). Interest cover (profit on ordinary activities before exceptional items and finance costs divided by finance costs less interest receivable) was 4.2 (2006: 7.3).
Financial assets and financial liabilities
Categories of financial assets and financial liabilities are as follows:
| 2007 | 2006 | ||
| Carrying | Carrying | ||
| value | value | ||
| Financial assets | £m | £m | |
| Derivative financial instruments: | |||
| Designated as effective hedging instruments | (a) | 17.7 | 15.2 |
| Held for trading | (a) | 2.2 | – |
| Loans and receivables: | |||
| Cash and cash equivalents | (b) | 130.0 | 236.5 |
| Land receivables | (b) | 108.6 | 121.2 |
| Trade and other receivables | (b) | 192.3 | 124.7 |
| Joint ventures | (b) | 26.8 | 15.6 |
| 477.6 | 513.2 | ||
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 18 include £146.9m (2006: £89.9m) of non financial assets. | |||
| 2007 | 2006 | ||
| Carrying | Carrying | ||
| value | value | ||
| Financial liabilities | Note | £m | £m |
| Held for trading: | |||
| Derivative financial instruments | (a) | 1.5 | 9.1 |
| Amortised cost: | |||
| Bank loans and overdrafts | (b) | 720.7 | 14.7 |
| Land creditors | (b) | 829.0 | 373.0 |
| Trade and other payables | (b) | 892.0 | 560.3 |
| Debentures | (c) | 824.7 | 613.1 |
| 3,267.9 | 1,570.2 | ||
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 21, include £206.2m (2006: £106.7m) of non financial liabilities.
- Derivative financial instruments are carried at fair value. The fair values are calculated using quoted market prices relevant for the term, currency and instrument.
- The Directors consider that the carrying amount recorded in the financial statements approximates their fair values.
- Details of fair values of debenture loans are provided in note 20.
The Group has the following types of derivatives:
| 2007 | 2006 | |||
| 2007 | Weighted | 2006 | Weighted | |
| Notional | average | Notional | average | |
| amount | fixed | amount | fixed | |
| Designated as held for trading: | ||||
| Floating £ to fixed £ interest | £235.0m | 5.10% | £35.0m | 5.80% |
| Fixed US$ to floating US$ interest | US$145.0m | 5.16% | – | – |
| Floating US$ to fixed US$ interest | US$50.0m | 5.63% | – | – |
| Fixed US$ to fixed £ interest | – | – | US $(81.0)m | 6.59% |
| £49.5m | 7.04% | |||
| 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 and intra Group loans to buy or (sell) against £, US$55m, €(70.9m) and C$90.0m (2006: US$(2.2m), €(16.0m) and C$ nil). The fair values of the forward contracts are not material as they were entered into on or near the 31 December 2007 and mature not more than one month later.
| 2007 £m |
2006 £m |
|
| Profit before tax has been arrived at after charging/(crediting) the following gains and losses: | ||
| Changes in fair value of financial liabilities designated as effective hedged items | 1.7 | (3.7) |
| Change in fair value of derivatives designated as effective hedging instruments | (1.7) | 3.7 |
| Change in fair value of derivatives classified as held for trading | 5.4 | 4.0 |
| Net foreign exchange (gains)/losses on financial liabilities at amortised cost | – | (5.8) |
| 5.4 | (1.8) |
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 acquisitions. 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%.
In order to measure the risk, floating rate borrowings and the expected interest cost for the year is 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. 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.
The Group’s exposure to, and the way in which it manages interest rate risk, has not changed from the previous year.
Hedge accountingHedging 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 receive interest at a fixed rate of 6.625% based on a nominal of £100m matching the underlying borrowing and pay US$ floating rates on a nominal of US$160.5m. During the period the hedge was 100% effective (2006: 100%) in hedging the fair value exposure to interest rate movements and as a result the carrying amount of the loan was increased by £1.7m (2006: reduced by £3.7m) which was included in the income statement offsetting the fair value movement of the bifurcated interest rate swap.
As a result of the merger in July 2007 the Group acquired a number of derivatives 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 sensitivityThe effect on both income and equity determined based on exposure to non derivative floating rate instruments at the balance sheet date for a 1% rise in interest rates is £(5.8)m (2006: £2.3m), before tax, a 1% fall in interest rates gives the same but opposite effect. For derivatives the fair values have been calculated based on market quoted rates 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% rise in floating rate instruments as shown below is based on a monthly average for the current period. 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 | Income sensitivity 2007 £m |
Equity sensitivity 2007 £m |
Income sensitivity 2006 £m |
Equity sensitivity 2006 £m |
| Derivatives | 5.3 | 1.8 | 1.6 | (2.7) |
| Non derivatives (based on average for the year) | (4.6) | (4.6) | (1.8) | (1.8) |
| 0.7 | (2.8) | (0.2) | (4.5) | |
| 1% decrease in interest rates | Income sensitivity 2007 £m |
Equity sensitivity 2007 £m |
Income sensitivity 2006 £m |
Equity sensitivity 2006 £m |
| Derivatives | (5.6) | (1.9) | (2.1) | 2.4 |
| Non derivatives (based on average for the year) | 4.6 | 4.6 | 1.8 | 1.8 |
| (1.0) | 2.7 | (0.3) | 4.2 |
(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. Construction has certain contracts in non functional currencies and aims to match its expenditure in the same currency to reduce risk and these risks are not material in relation to the Group. 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 £. 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 historic 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 accountingThe Group designates the bifurcated cross currency swaps such that the nominal amount of US$160.5m (2006: US$160.5m) is used to hedge part of the Group’s net investment in US$ denominated assets and liabilities.
The Group has also designated the carrying value of US$982.5m (2006: US$250.0m) borrowings as a net investment hedge of part of the Group’s investment in US$ denominated assets.
During the period the hedges were 100% effective (2006: 100%) and as a result the change in the carrying amount of the derivatives and the change in the carrying value of the borrowings offset the exchange movement on the Group’s US dollar net investment and are therefore included in the translation reserve.
Foreign currency sensitivityThe 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 10% increase in the respective currencies against £ and in accordance with IFRS 7 all other variables remaining constant. A 10% decrease in the value of £ would have an equal but opposite effect.
The 10% change represents a reasonably possible change in the specified foreign exchange rates in relation to £.
| Income sensitivity 2007 £m |
Equity sensitivity 2007 £m |
Income sensitivity 2006 £m |
Equity sensitivity 2006 £m |
|
| US$ | (15.1) | (20.2) | (0.1) | 16.2 |
| Canadian $ | 0.2 | (15.6) | – | (13.5) |
| Euro | 0.2 | 0.2 | – | – |
| (14.7) | (35.6) | (0.1) | 2.7 |
The sensitivity analysis does not extend to the retranslation of the Group’s US dollar net investments as had such changes been included they would have offset equity sensitivity in respect of the hedging instruments included above.
Credit risk
Credit risk is the risk of financial loss where counterparties are not able to meet their obligations.
Surplus cash, when not used to repay borrowings, is placed on deposit with banks in accordance with a policy that specifies the minimum acceptable credit rating and the maximum exposure to each counterparty. 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 in excess of the carrying amount of the receivable to which it relates. No amounts outstanding are past due.
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. No material amounts are past due and there is no significant concentration 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.
Loans made to joint ventures are in most cases part of the investment and carry equity like risk. Other loans to joint ventures are made on normal arms length terms which will include security where appropriate and are usually repayable from sales proceeds.
There has been no change in the Group’s exposure to credit risk or how that risk is managed from the prior year. The merger with George Wimpey Plc did not create any new classes of financial asset with different risk profiles for the Group.
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 through the use of term borrowings, overdrafts and committed revolving credit facilities with a range of maturity dates to ensure continuity of funding. Future borrowing requirements are forecast on a monthly basis and funding headroom is maintained above forecast peak requirements to meet unforeseen events.
There have been no adverse changes in the Group’s exposure to liquidity risk or how it is managed from the prior year.
In addition to term borrowings and on demand overdraft facilities the Group has access to committed revolving credit facilities. The total unused committed amount is £1,192.9m (2006: £629.5m) and management believe it is adequate to meet both forecast and unforseen requirements.
The maturity profile of the anticipated future cash flows including interest where 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 £ |
| On demand | 12.3 | – | – | 12.3 | |
| Within one year | 40.8 | 444.3 | 848.6 | 54.1 | 1,387.8 |
| More than one year and less than two years | 42.2 | 250.3 | 8.3 | 124.7 | 425.5 |
| More than two years and less than five years | 809.6 | 143.5 | 3.8 | 430.6 | 1,387.5 |
| In more than five years | – | 30.6 | – | 514.8 | 545.4 |
| 31 December 2007 | 904.9 | 868.7 | 860.7 | 1,124.2 | 3,758.5 |
| Financial liabilities | Bank loans and overdraft £m |
Land creditors £m |
Other trade payables £m |
Debenture loans £m |
Total £ |
| On demand | 12.3 | – | – | – | 12.3 |
| Within one year | 0.8 | 252.0 | 541.2 | 39.9 | 833.9 |
| More than one year and less than two years | 0.1 | 86.9 | 0.4 | 81.2 | 168.6 |
| More than two years and less than five years | 1.8 | 42.1 | 0.2 | 80.2 | 124.3 |
| In more than five years | – | 5.8 | 0.4 | 651.5 | 657.7 |
| 31 December 2006 | 15.0 | 386.8 | 542.2 | 852.8 | 1,796.8 |
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.
| Derivatives | Net settled derivatives net amount £m |
Gross settled derivatives receivable £m |
Gross settled derivatives payable £m |
Total £m |
| Within one year | 2.0 | 132.1 | (130.8) | 3.3 |
| More than one year and less than two years | 0.1 | 6.6 | (4.5) | 2.2 |
| More than two years and less than five years | (1.4) | 119.9 | (96.4) | 22.1 |
| In more than five years | – | – | – | – |
| 31 December 2007 | 0.7 | 258.6 | (231.7) | 27.6 |
| Derivatives | Net settled derivatives £m |
Gross settled derivatives receivable £m |
Gross settled derivatives payable £m |
Total £m |
| Within one year | (0.1) | 14.6 | (14.7) | (0.2) |
| More than one year and less than two years | (0.1) | 48.6 | (56.2) | (7.7) |
| More than two years and less than five years | (0.6) | 19.9 | (17.8) | 1.5 |
| In more than five years | (0.3) | 106.6 | (84.6) | 21.7 |
| 31 December 2006 | (1.1) | 189.7 | (173.3) | 15.3 |