Treasury solutions Treasury Management 24 October 2013 Strictly confidential | October2013 1 Strictly confidential | October 2013 |

Treasury solutions 1Strictly confidential | October 2013 |

Treasury Management

24 October 2013

Strictly confidential | October2013

Treasury solutionsStrictly confidential | October 2013 | 2

Agenda

Introduction and basic principles

Investment

Bank creditworthiness

Borrowing and interest rates

Sources of finance


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)


Decision making criteriaRisk protection

– Increased costs– Running out of funds– Loss on investments

Flexibility– Repay loans– Access funds

Cost– High interest payable– Low interest received


Treasury management context

Current position

Business plan projections

Economy and interest rate outlook

Political and business outlook

Conditions in the financial markets


Treasury risksLiquidity

Credit, market

Interest, inflation, refinancing

…

Exchange rate

Legal and regulatory

Fraud, error, corruption, contingencies


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’


UncertaintyEconomists 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


InvestmentSound 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


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


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


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


How risky are the banks? – raters’ viewsWeekly Credit List: 18/10/2013

Long Term

Short Term

Viability

Support

Long Term

Short Term

FSRLong Term

Short Term

Barclays Bank plc A F1 a 1 A2 P-1 C- A A-1Clydesdale Bank A F1 bbb+ 1 Baa2 P-2 D+ BBB+ A-2Co-operative Bank Plc BB- B bb- 5 Caa1 NP E - -Credit Suisse International A F1 - 1 A1 P-1 - A A-1HSBC Bank plc AA- F1+ a+ 1 Aa3 P-1 C AA- A-1+MBNA Europe Bank A- F1 - 1 - - - - -Santander UK plc A F1 a 1 A2 P-1 C- A A-1Nationwide BS A F1 a 1 A2 P-1 C A A-1Newcastle BS BB+ B bb+ 5 - - - - -Yorkshire BS BBB+ F2 bbb+ 5 Baa2 P-2 C- - -Lloyds Banking Group plc A F1 bbb+ 1 A3 - - A- A-2Royal Bank of Scotland Group plc A F1 bbb 1 Baa1 P-2 - A- A-2

Yellow shading indicates rating is not 'stable'

Fitch Moody's S&P


Implications

The credit risk will be included in the margin that banks pay

This cost is high and volatile

Hence lending margins have increased


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


The market view


Borrowing and interest ratesSources

– Banks and building societies– Capital markets

Structures– Bullet and amortizing– Short and long-term– Capital holidays


Underlying interest basesFloating (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


Variations on fixed ratesForward 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


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


Interest rate environmentPeriod %

1 month 0.5503 months 0.6006 months 0.720

12 months 0.970

3 years 1.1865 years 1.7987 years 2.237

10 years 2.71615 years 3.14320 years 3.32025 years 3.38130 years 3.403

22/10/2013


Fixed rates are higher than last year

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

%

Term

Interest rate swaps now, 1 and 12 months ago

22-Oct-13 1 Month ago 1 Year ago


Still historically low

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

%

Interest rate swaps since 1998

30yr 25yr 15yr 10yr 5yr


Economic forecastsQ/E4 2013 Q/E1 2014 Q/E2 2014 Q/E3 2014 Q/E4 2014 Q/E1 2015 Q/E2 2015 Q/E3 2015 Q/E4 2015

Bank RateCapital Economics 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%UBS 0.50% 0.50% 0.50% 0.50% 0.50% - - - -Capita 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%

10-year giltCapital Economics 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 3.00%UBS 3.10% 3.20% 3.20% 3.30% 3.30% - - - -Capita 2.90% 2.90% 2.90% 3.00% 3.00% 3.10% 3.20% 3.30% 3.40%

Long-term giltCapital Economics 3.45% 3.45% 3.45% 3.45% 3.45% 3.45% 3.45% 3.45% 3.55%UBS 3.60% 3.70% 3.70% 3.80% 3.80% - - - -Capita 3.60% 3.60% 3.60% 3.70% 3.70% 3.80% 3.90% 4.00% 4.10%

Q/E4 2013 Q/E1 2014 Q/E2 2014 Q/E3 2014 Q/E4 2014 Q/E1 2015 Q/E2 2015 Q/E3 2015 Q/E4 2015CPICapital Economics 2.20% 1.70% 2.00% 1.70% 1.70% 1.70% 2.00% 2.10% 2.10%UBS 3.40% 3.20% 3.10% 3.00% - - - - -

RPICapital Economics 2.80% 2.60% 2.60% 2.50% 2.40% 2.40% 2.60% 2.70% 2.70%UBS 3.70% 3.70% 3.80% 3.70% - - - - -


Market expectations for LIBOR

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15

Implied 3 month rates

22/10/2013 22/09/2013


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


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


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


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


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


US private placement processApproach to investors through Placement AgentMaster Note Purchase Agreement is governed by English lawPrivate Placement Memorandum circulated to investorsInvestors invited to bid:– Amount– Tenor– Rate– Revisions to termsObjective to ‘hit sweet spots’ reducing average cost of fundsResult is funding structure with different maturity tranchesRequires NAIC-1 designation (after the issue)


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

Treasury solutionsStrictly confidential | October 2013 |

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.

Documents

Treasury solutions Treasury Management 24 October 2013 Strictly confidential | October2013 1 Strictly confidential | October 2013 |