Finance review
Financing
Financing, net debt and cash flow
As a result of the £201.8m of property sales proceeds referred to in the Finance review: Results page, the group’s net borrowings have been reduced by £142.0m from £865.4m to £723.4m during 2009 despite investing £104.8m of capital expenditure and property acquisitions in our portfolio during the same year. The net cash generated during 2009 and available to repay loans was £140.2m.
A summarised cash flow for the last two years is shown below:
| 2009 | 2008 | |
|---|---|---|
| £m | £m | |
| Cash received from tenants | 125.4 | 109.6 |
| Development and other income | 1.0 | 14.1 |
| Less: direct property expenses | (10.2) | (22.8) |
| 116.2 | 100.9 | |
| Property disposals including trading properties | 202.0 | 72.6 |
| 318.2 | 173.5 | |
| Administrative and staff expenses | (17.1) | (16.2) |
| Net interest paid | (39.1) | (45.6) |
| Acquisitions of properties | (10.2) | (31.9) |
| Capital expenditure | (94.6) | (72.9) |
| REIT conversion charge | – | (53.6) |
| Dividends paid | (24.3) | (23.5) |
| Taxation | 6.5 | (8.9) |
| Other | 0.8 | (4.6) |
| Increase/(decrease) in cash before loan movements | 140.2 | (83.7) |
Derwent’s ability to sell in difficult market conditions is a major part of the reason for the modest level of balance sheet gearing at the end of the year, assisted by the moderate level of gearing at the start of the credit crunch. Balance sheet gearing has correspondingly been reduced to 62.2% in December 2009 from 71.2% a year earlier and the ratio of net debt to property values fell from 39.7% in December 2008 to 36.4% at 31st December 2009. Other factors in explaining why we have not needed to recapitalise the business during 2009 were sensible financial covenants under debt facilities and our consistent focus on maintaining income across the portfolio. These characteristics have, over a number of years, instilled confidence in our lenders and we will continue to nurture the valued relationships that have been built up, as well as forging new ones, through the coming years. In addition to the facilities refinanced in 2008, the group renewed a £125m bank facility in the second quarter of 2009 such that the next facility due for refinancing does not arise until December 2011. We have already started to consider options to refinance this facility and it is clear that banks are willing to lend again though only to their chosen customers.
Interest margins charged by lenders on newly negotiated facilities appear to have stabilised at a level roughly twice that of two years ago and are based on lower loan-to-value ratios of up to around 60%-65%. There are signs of increasing confidence and competition amongst lenders which should lead to slightly more favourable lending terms as the year progresses but we remain cautious about medium-term refinancing prospects. The combined impact of the exceptional level of government borrowing, the weight of refinancing requirements facing the lending banks and commercial mortgage backed securities sectors over coming years and the Bank of England’s programme of quantitative easing will take some time to work through the economy.
While there are uncertainties ahead, opportunities to add more projects to our portfolio will undoubtedly arise. Crucially, the actions taken by the board have increased further the headroom on our bank facilities, most of which include revolving credit facilities thereby allowing us the flexibility that we need to respond quickly. As at 31st December 2009, the group held available undrawn loan facilities of £425m, up from £291m at 31st December 2008. Based on the December 2009 security and property valuations, about £353m was immediately drawable and the group also held properties totalling £338m uncharged to lenders.
All financial covenants under loan facilities have been comfortably exceeded during the year. The group’s overall interest cover ratio is an important key performance indicator within the business and an emphasis on striking the right balance between income and added value through refurbishment or development has long been an inherent trait of Derwent. The lower finance costs referred to above have prompted a strengthening of group interest cover (defined as gross property income excluding surrender premiums received less ground rents, divided by interest payable on borrowings net of cash) to 330% in 2009 against 247% in 2008. Note also that our accounting policy is not to capitalise interest relating to any refurbishment or development project during which a property is typically not producing income.
Liability risk management
The group started 2009 with 65.7% of its debt protected by a combination of fixed rate or floating rate loans subject to interest rate swaps or caps. While the group’s revolving loans have been reduced, the cost of closing out existing swap contracts was considered to be unattractive and the notional amount of swapped or capped loans has increased by £28m during the year as a new loan facility entered into in 2008 was hedged during the year. Accordingly, the proportion of loans hedged has increased to 82.1% of total debt as at 31st December 2009. This is a little above our target range of 40% to 75%; however, all other things being equal, it will revert to within that range during October 2010 upon the maturity of a £50m swap contract.
The fair value of the group’s interest rate hedging derivatives has improved by £3.9m during 2009 as medium-term interest rate expectations have moved up after the significant falls of 2008 though the mark-to-market adjustment remains a liability in the group balance sheet as at 31st December 2009 of £23.0m against £26.9m in 2008.
As reported last year, IFRS 3 required the £175m secured bond to be fair valued at the date of acquisition by the group and for that fair value to be amortised over the remaining life of the bond. The residual amount as at 31st December 2009 was £20.2m (20p per share) compared with £20.9m (21p per share) in 2008.
The weighted average cost of the group’s debt reduced to 5.00% as at 31st December 2009 from 5.47% a year earlier and is currently about 5.02%. The weighted average cost of the group’s bank debt is 4.52% inclusive of margin.
