Treasury Management
24 October 2013
Treasury solutions
Strictly confidential
confidential || October
October2013
Strictly
2013 |
1
Agenda
Introduction and basic principles
Investment
Bank creditworthiness
Borrowing and interest rates
Sources of finance
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2
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)
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3
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
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4
Treasury management context
Current position
Business plan projections
Economy and interest rate outlook
Political and business outlook
Conditions in the financial markets
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5
Treasury risks
Liquidity
Credit, market
Interest, inflation, refinancing
…
Exchange rate
Legal and regulatory
Fraud, error, corruption, contingencies
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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’
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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
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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
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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
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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
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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
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How risky are the banks? – raters’ views
Weekly Credit List: 18/10/2013
Fitch
Moody's
S&P
Long Short Viabili Supp Long Short
Long Short
FSR
Term Term ty
ort Term Term
Term Term
Barclays Bank plc
Clydesdale Bank
Co-operative Bank Plc
Credit Suisse International
HSBC Bank plc
MBNA Europe Bank
Santander UK plc
Nationwide BS
Newcastle BS
Yorkshire BS
Lloyds Banking Group plc
Royal Bank of Scotland Group plc
A
A
BBA
AAAA
A
BB+
BBB+
A
A
F1
a
F1 bbb+
B
bbF1
F1+ a+
F1
F1
a
F1
a
B
bb+
F2 bbb+
F1 bbb+
F1
bbb
1
1
5
1
1
1
1
1
5
5
1
1
A2
Baa2
Caa1
A1
Aa3
A2
A2
Baa2
A3
Baa1
P-1
P-2
NP
P-1
P-1
P-1
P-1
P-2
P-2
CA
A-1
D+ BBB+ A-2
E
A
A-1
C
AA- A-1+
CA
A-1
C
A
A-1
CAA-2
AA-2
Yellow shading indicates rating is not 'stable'
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Implications
The credit risk will be included in the margin that banks pay
This cost is high and volatile
Hence lending margins have increased
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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
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The market view
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Borrowing and interest rates
Sources
– Banks and building societies
– Capital markets
Structures
– Bullet and amortizing
– Short and long-term
– Capital holidays
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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
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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
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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
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Interest rate environment
Period
%
1 month
3 months
6 months
12 months
0.550
0.600
0.720
0.970
3 years
5 years
7 years
10 years
15 years
20 years
25 years
30 years
1.186
1.798
2.237
2.716
3.143
3.320
3.381
3.403
22/10/2013
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Fixed rates are higher than last year
Interest rate swaps now, 1 and 12 months ago
4.00
3.50
3.00
2.50
2.00
%
1.50
1.00
0.50
0.00
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
22-Oct-13
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1 Month ago
1 Year ago
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Still historically low
Interest rate swaps since 1998
8.00
7.00
6.00
%
5.00
4.00
3.00
2.00
1.00
30yr
Treasury solutions
25yr
15yr
10yr
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0.00
5yr
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Economic forecasts
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 2015
Bank Rate
Capital Economics
UBS
Capita
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
10-year gilt
Capital Economics
UBS
Capita
2.75%
3.10%
2.90%
2.75%
3.20%
2.90%
2.75%
3.20%
2.90%
2.75%
3.30%
3.00%
2.75%
3.30%
3.00%
2.75%
3.10%
2.75%
3.20%
2.75%
3.30%
3.00%
3.40%
Long-term gilt
Capital Economics
UBS
Capita
3.45%
3.60%
3.60%
3.45%
3.70%
3.60%
3.45%
3.70%
3.60%
3.45%
3.80%
3.70%
3.45%
3.80%
3.70%
3.45%
3.80%
3.45%
3.90%
3.45%
4.00%
3.55%
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 2015
CPI
Capital Economics
UBS
2.20%
3.40%
1.70%
3.20%
2.00%
3.10%
1.70%
3.00%
1.70%
-
1.70%
-
2.00%
-
2.10%
-
2.10%
-
RPI
Capital Economics
UBS
2.80%
3.70%
2.60%
3.70%
2.60%
3.80%
2.50%
3.70%
2.40%
-
2.40%
-
2.60%
-
2.70%
-
2.70%
-
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Market expectations for LIBOR
Implied 3 month rates
2.00
1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
Dec-13
Mar-14
Jun-14
Sep-14
22/10/2013
Treasury solutions
Dec-14
Mar-15
Jun-15
22/09/2013
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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
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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
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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
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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
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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
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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)
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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
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Regulatory information / Legal disclaimer
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arranging activities in the UK as part of its Treasury Management Service.
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Treasury solutions
Strictly confidential | October 2013 |