Financial Review

Having successfully survived the effects of the banking crisis in late 2008 and early 2009, and made all appropriate loan-to-value repayments from its own resources, the Group was well placed in July 2009 to raise £100.0 million of new equity (£94.0 million net of expenses), through a Firm Placing, Placing and Open Offer. In March of 2010 we raised new 15-year, fixed rate debt of £58.2 million from Aviva Commercial Finance Limited, secured against a portfolio of new and existing investment properties. In the Spring of 2010, having made excellent progress in deploying the new equity, the Directors identified that the Group was continuing to see a growing stream of opportunities for further investment, and that this would rapidly exceed its remaining equity resources. Consequently, in July 2010, having committed circa £69.0 million of the equity raised in the previous year, the Group again approached shareholders and raised a further £100.2 million of new equity (£93.7 million net of expenses) through a successful Placing and Rights Issue.

Since the equity raising in 2009, as at 31st December 2010 the Group had expended and committed equity of £93.8 million, and deployed net new debt of £133.8 million, increasing to £109.6 million and £133.8 million as at the date of this report.

Consequently, the Group’s gearing (including share of joint ventures) as at 31st December 2010 was 27.7 per cent, compared with 23.9 per cent at the beginning of the year. During the year this ratio peaked at 54.2 per cent, immediately before the Placing and Rights Issue. If joint ventures are excluded, the figures for December 2010 and 2009 were 21.4 per cent and 18.7 per cent respectively.

The current relatively low level of gearing reflects the recent equity issue. We expect to see this level continue to increase as the funds are invested. In line with our risk-averse policy of maintaining a conservative level of gearing, as described in our Business Model, we target a level of between 50 and 60 per cent as an efficient operating level for the business.

Our cash and overall liquidity is managed at Group level, with our investment, development and trading portfolios assessed and monitored according to their own specific risks. Within our debt facilities we maintain a mix of fixed and variable rates, in general preferring the certainty of fixed rates for our larger and longer-term borrowings.

As described in Risks, the Group limits its risk in major development projects through the principle of forward sales. This is achieved in various ways, from the completed forward sale of the land and project assets, through to the contracted sale of the prospective development, with appropriate guarantees of completion. The Group’s direct contribution to more modest development project finance is provided by way of equity and medium-term bank facilities which provide the necessary flexibility to draw down funds as required.

The Group's investment portfolio is financed by a blend of equity, the debenture loan and bank borrowings of an appropriate term for each asset or group of assets. Our investments in joint ventures and associates are funded from equity, with any relevant gearing deployed within the ventures themselves.

Responsibility for management of cash and liquidity risk rests with the Board. The executive team has systems in place for the monitoring and management of this key aspect of our business. Daily review is delegated to the Finance Director, who discusses this with the other members of the executive team at least on a weekly basis. The Board formally reviews the position at its meetings, which occur eight times per annum.

The principal tools of assessment are a 15-month cash flow forecast, which is updated in full on a quarterly basis and monthly for material changes, a schedule of agreed bank facilities and amounts drawn against them, a summary of net debt, including derivative instruments, a summary of current cash deposit balances and a formal commentary on the position prepared by the Finance Director for each Board meeting.

For the longer-term, the Directors review the Group’s capital structure, taking account of the real estate cycle, any changes in the nature and liquidity of the Group’s asset portfolio, the likely forthcoming risks and opportunities for the Group, and the market for equity and debt finance. This is formally revisited at least twice per annum, via the Group’s Risk Committee, which reports to the Board, and at the Board’s annual strategy review. In addition this is discussed informally as appropriate at each Board meeting.

Medium-term liquidity is arranged through a mix of the Group’s equity and its debt facilities. The continuing net withdrawal of bank debt from the property sector means that lending is very cautious. However, the Group has strong relationships with its lenders, and has not been constrained in arranging new debt during 2010, completing new facilities totalling £137.0 million.

Reflecting the nature of the Group’s business, short-term liquidity requirements are fairly predictable. Cash requirements are monitored on a monthly and weekly basis, and short-term cash balances are deposited accordingly.

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Cash management

The Group's temporarily high levels of cash have prompted a reconsideration of our policy on treasury management. Cash may be invested across a wider range of instruments, including instant and term deposit accounts, money market funds and commercial paper. The policy prioritises security and liquidity ahead of returns, and the Board has set limits for both minimum credit ratings and maximum concentrations with respect to counterparties. As at the year-end the Group had £104.1 million of cash held across eight banks.

Our reputation and risk-averse capital structure has enabled us to raise both equity and debt in a market where liquidity is constrained. Since the equity raising in 2009, the Group has invested or commited equity of £109.6 million and deployed new debt of £133.8 million.

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Current bank facilities and borrowings

The Group's bank facilities are set out in the table above. As at 31st December 2010 the value of the Group’s gross borrowings was £175.5 million (2009: £126.2 million). Cash balances were £104.1 million (2009: £80.6 million), including amounts of £27.0 million held as restricted deposits, giving net debt of £71.4 million and gearing of 21.4 per cent (2009: £45.6 million and 18.7 per cent).

The Group's share of net debt in joint ventures was £20.8 million (2009: £12.8 million); if this is aggregated with the Group balances, net debt rises to £92.2 million and gearing to 27.7 per cent (2009: £58.4 million and 23.9 per cent).

During 2010 the Group repaid loans totalling £18.9 million and refinanced other borrowings totalling £24.1 million. We also cancelled certain facilities originally intended to finance the extension and redevelopment of certain investment assets, but which were deemed no longer appropriate for our asset management plans.

In addition to the new loan of £58.2 million, the Group has drawn debt against several asset acquisitions. In June the Group arranged a two–year facility of £10.0 million for the acquisition and development of Westminster Palace Gardens; in the same month we drew down a five–year facility of £6.2million from Bank of Ireland, secured against Airport House, Croydon, as part of the agreement for the acquisition of the asset from the administrator acting for the bank. Similarly in October we drew stapled three–year debt of £15.3 million from Lloyds Banking Group, in connection with the acquisition of the Rock portfolio.

In March the Group and its partner each lent a further £5.0 million to the Curzon Park Limited joint venture, to enable the joint venture to make a part prepayment of its bank loan, reducing that borrowing to £15.6 million. In June the Group drew down £47.5 million for a term of three years in respect of the acquisition of the Manchester Arena Complex; in August this facility was transferred into the joint venture vehicle, in which the Group retains a 30 per cent stake.

Committed facilities as at 1st March 2011 total £176.8 million, with a weighted average term of 9.1 years (falling to 8.5 years including the Group’s share of joint ventures). Unutilised facilities are £27.9 million.

In the Group’s portfolio the earliest maturity date is June 2012, in respect of the Westminster Palace Gardens project, where the debt is expected to be repaid from project cash flows and the Group has no plans to refinance. The earliest maturity in respect of facilities financing longer–term assets is January 2013.

The bank loan to Curzon Park Limited matures in May 2015, and the Group is keeping this under review, whilst monitoring the prospects for the asset itself (see note 16a). The borrowings in respect of the Manchester Arena Complex joint venture mature in 2013; the Directors currently anticipate that this will either be refinanced closer to that time, or repaid from an earlier sale of the asset.

The Directors keep bank covenants under review, and are content with the current position. We aim to agree our loan–to–value covenants at comfortably tolerable levels, leaving sensible headroom for foreseeable changes in the general market or the specific asset. We also incorporate cure mechanisms into the facility documentation, such that we have an appropriate opportunity to restore the required loan–to–value ratio by making cash deposits or prepayments.

Interest rate risk and hedging

As at 31st December 2010 the summary of the Group’s interest rate exposure was as follows:

	Excluding share of joint ventures %	Including share of joint ventures %
Fixed rate	43.8	39.0
Floating rate, swapped into fixed	26.5	30.7
Floating rate with cap	8.6	7.7
Floating rate	21.1	22.6

The weighted average interest rate payable was 5.8 per cent (5.6 per cent including joint ventures).

As noted in the table in note 16(d), interest rate caps and swaps are used to provide protection against exposure to interest rate fluctuations. The Directors have maintained a mix of fixed and variable rates, in order to provide an appropriate measure of certainty within the portfolio.

Facilities with variable rates of interest, in particular longer–term facilities, expose the Group to the risk of interest rate fluctuation, whilst fixed rate instruments reduce flexibility and incur break costs in the event of early settlement. The Directors keep these risks under continual review, and regularly consider the possibility and likely cost of extending our interest rate hedging.

Interest rate swaps also carry counterparty risk, in respect of the potential failure of the bank on the other side of the transaction. The Group mitigates this risk by dealing only with major banks and monitors their continuing creditworthiness. There is no current indication that any of the Group’s hedging counterparties may be unable to settle its obligations.

Interest rate swaps are marked to market in the Balance Sheet, giving rise to the risk of fair value movements in the derivative instrument, and a consequent impact on net asset value. The Group also holds a cross–currency interest rate swap, which is designated as a cash flow hedge. Movements in the foreign currency leg of this swap provide a hedge against movements in the fair value of the €47 million loan notes. Movements in the interest leg are taken to reserves. The effects of these fair value adjustments in the year to 31st December 2010 are set out in the note Derivative financial instruments.

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Other financial instrument risks

Development and trading portfolios

The principal financial instrument risks in these assets are the credit risk in counterparties. Given the nature of these assets the amounts owed to the Group can be significant, and these arrangements are monitored very closely both before contracts are exchanged and throughout the execution period.

The current phase in the cycle means that the Group has no major development debtors. The Group is contracted to provide £5.0 million of development funding for each phase at PaddingtonCentral, in respect of which it earns interest and a profit share, both subject to the profitability of the phase. The Group’s development partners, who are contracted to pay this interest and profit share at the completion of each phase, and to repay the capital at the end of the development, are large financial institutions. This risk capital is held as a development participation within available–for–sale financial assets, and at the year–end was valued at £5.0 million (2009: £5.0 million), as described in note 16(a) to the Group financial statements. The Directors are satisfied that the combination of the Group’s risk–averse approach to development funding, its cautious selection of development partners and its focused and active management of each project provide reasonable comfort over the risks of these financial exposures.

Investment portfolio

The principal financial instrument risk in the investment portfolio is the credit risk implicit in potential tenant failure. The Group maintains the portfolio under continuous review. The portfolio is managed by local agents, with active involvement by the Group’s investment team. The Board receives at each of its meetings analyses of tenant profile (including the concentration of credit risk, both by sector and by entity), existing and anticipated voids, overdue rents, and future and outstanding rent reviews, as well as a formal commentary by the investment team. The current profile of the portfolio and comments on performance in 2010 are set out here.

Projects in partnership

As described in the Operating Review, the Group is conducting an increasing proportion of its business in partnership with others, where the Group brings both development expertise and funding. These interests are carried in a number of balance sheet categories, and are summarised in note 26 to the Group financial statements.

The financial instrument risks in respect of projects in partnership are the financial strength and integrity of the operating partner, the contractual risk in the partnership arrangements and the operating success of the venture. The Group manages these risks by securing appropriate rights in each case over the use of the Group’s invested capital and by active participation in the joint strategic and operating control of the ventures. The Directors have increased the resources dedicated to this element of our internal control, and refined the required level of reporting to the Board in this regard.

Contingent liabilities

Contingent liabilities are described in note 23 to the Group financial statements. The Directors ensure that these risks are appropriately documented and monitored, and that the risk of actual liabilities arising is restricted so far as is possible.

Foreign currency risk

The Group’s operations are conducted almost exclusively in the UK. The Group’s principal exposure to foreign currency movements is in the €47 million Euro–denominated loan notes, which is fully hedged to provide an effective Sterling liability. The details of the Group’s sensitivity to exchange rate movements are set out in note 16(c) to the Group financial statements.

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Maximum credit risk exposure

The Directors consider that the maximum credit risk exposure in each class of financial asset is represented by the carrying value as at 31st December 2010.

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Going concern

The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out on Business Model and Risks, in the Chief Executive’s statement and in the Operating Review. The financial position of the Group, its cash flows, liquidity position, borrowing facilities and financial instrument risks are described in the Financial Review, which also cover the Group’s objectives, policies and processes for managing its capital, its financial risk management objectives, details of its financial instruments and hedging activities, and its exposures to credit risk and liquidity risk. Note 16 to the Financial statements gives further information about the Group’s financial instruments and hedging activities.

The Group has considerable financial resources. Rental income continues to be robust, with the risk of significant default assessed by the Directors as low. Our development and trading activities are well–diversified across regions and sectors. Our debt finance is secured for appropriate periods and we are comfortable with our covenant positions. As a consequence, the Directors believe that the Group is well placed to manage its business risks successfully, despite the continuing uncertain economic outlook.

The Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Thus they continue to adopt the going concern basis of accounting in preparing the financial statements.

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Result for the year and net asset value

Profit before tax for the year was £2.6 million, an improvement from the prior year loss of £11.4 million. After an unrealised loss of £2.8 million in respect of an interest rate swap, and a small loss on operating property revaluation, Total comprehensive income for the year was a negative £0.7 million (2009: negative £9.0 million).

The investment portfolio produced a contribution of £9.5 million, together with net revaluations of £8.8 million in the direct portfolio and a further £3.4 million in the Manchester Arena Complex joint venture. Profits from development and trading were £5.5 million. Operating costs totalled £12.9 million and net finance costs (including swap revaluations) were £12.8 million.

Other movements in net assets were dividend payments of £3.9 million and the proceeds of the Placing and Rights Issue of £93.7 million, giving a net asset value as at 31st December 2010 of £333.1 million and 272 pence per share (2009: £244.0 million and 297 pence per share). The movement in net asset value is set out in the table below.

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Net rental income

Gross rental income from the investment portfolio grew by 28 per cent to £12.8 million (2009: £9.9 million), the increase arising from both new investment properties acquired (£1.4 million) and letting and rent review activity on the existing portfolio (£1.5 million). Direct costs reduced to £3.7 million from £4.6 million in 2009, with the net charge within this figure in respect of onerous lease provisions falling from £1.7 million in 2009 to £0.4 million in 2010. As a result net rental income improved to £9.2 million from £5.5 million in 2009.

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Development and trading profits

Profits from development and trading activity recovered to £5.5 million, net of abortive costs, from a net breakeven in 2009, with contributions from several projects. The sale of Canon House, Wallington produced a profit of £1.1 million, and a further £1.0 million of profit arose from the premium in respect of the lease surrender at the Wick Site, Littlehampton. The hotel development at West Quay, Southampton generated a profit of £0.7 million (being accounted for as a construction contract under IAS 11), and HDD’s sale at Stanground contributed £0.5 million (over and above its fair value on acquisition in March 2010). Rents from the development and trading property portfolio contributed £2.4 million, including £1.1 million from the Weeke Local Centre, Winchester.

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Operating costs

Operating costs were £12.9 million, a slight increase from the 2009 figure of £12.8 million. Within these totals, staff costs increased in 2010 by £0.7 million to £7.5 million, principally reflecting the consolidation of HDD since the acquisition in March. The 2009 total included a non–recurring charge of £1.4 million for a capital contribution in respect of a sub–letting.

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Net finance costs

Interest income during the year was £1.4 million, slightly above the prior year figure of £1.0 million on higher average cash balances, but continuing to reflect very low deposit rates. Interest payable increased to £10.9 million from £9.1 million in 2009, on higher average borrowings and a slightly higher proportion of fixed rate debt.

Interest payable included a charge of £0.8 million in respect of the revaluation of swap instruments on two loans. During the year both loans were repaid, incurring break costs of £2.9 million, of which £2.1 million had been provided as at 31st December 2009. A further charge of £2.8 million was taken to Other comprehensive income in respect of the cross–currency fixed rate swap relating to the €47 million 2027 Unsecured Subordinated Loan Notes (see note Derivative financial instruments).

Interest capitalised against development projects was £nil in 2010, compared with a figure of £1.4 million in 2009.

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Investment portfolio

The carrying value of investment property increased from £181.0 million in December 2009 to £199.2 million at December 2010.

Details of acquisitions, disposals and valuation movements are set out in note 10(c) to the financial statements, and further analyses of the management and performance of the portfolio are given in the Operating Review.

Sales of investment properties during the year produced a small net gain of £0.3 million over their fair value as at 31st December 2009.

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Inventory – development and trading properties

As described in the Operating Review, following the equity raises in 2009 and 2010 the Group has acquired a number of sites with potential for redevelopment. Under accounting rules this work in progress is stated not at fair value, but at the lower of cost and net realisable value; hence any improvement in value is reported only on sale. Acquisitions of development and trading assets during 2010 were £89.7 million, with a further £3.2 million added to existing schemes. Included in this were the Rock portfolio at £24.6 million and Westminster Palace Gardens at £10.5 million, as well as HDD projects of a further £23.1 million, including £18.1 million of existing work in progress consolidated on acquisition. Net of disposals during the year, inventory increased by £79.1 million to £157.7 million.

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Joint ventures

The increase in the carrying value of investments in joint ventures from £nil in 2009 to £9.7 million in 2010 reflects the Group’s 30 per cent share of the Manchester Arena Complex joint venture (MAC), established in July 2010.

MAC reported profit for the six–month period since acquisition of £11.4 million. Key to this level of performance was the revaluation gain, achieved primarily through the regearing of the principal lease. The Group’s share of profit after tax was £3.4 million.

The loss of £0.5 million in Curzon Park Limited mainly represented interest on the bank loan. The Group’s share of net assets of the joint venture was written down to £nil in 2008. As at 31st December 2010, the Group has a debtor due from the joint venture of £5.0 million, held within Financial assets and has provided a guarantee for its share of the joint venture’s bank loan of £15.6 million, as noted within contingent liabilities.

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Financial assets

Financial assets are analysed in note 16 to the Group’s financial statements.

Derivative financial instruments

The Group’s Euro–denominated loan notes and the related cross–currency hedge are carried as separate instruments in the Balance Sheet. During 2010 Sterling strengthened slightly against the Euro, decreasing the effective Sterling liability of the loan by £1.4 million and reducing the fair value of the derivative asset by a similar figure. The softening of EURIBOR interest rates over the period caused a further reduction in the value of the swap, such that its total fair value reduced to £3.3 million, from £7.5 million at the previous year end.

Other financial assets

Other financial assets include the Group’s participation in the third phase of PaddingtonCentral, which has been revalued by the Directors at £5.0 million (unchanged from the previous year), together with loans to a number of associate companies. During the year the Group advanced a further £2.4 million to CTP, taking the total investment in that company to £14.3 million. New loans were provided to the Cathedral Group (£1.4 million) and Barwood (£1.2 million). The loans to HDD of £9.9 million as at December 2009 are now eliminated on consolidation, following the acquisition of that group during the year.

The representation of the Group’s projects in partnership under IFRS is complex, being a mixture of equity and loan instruments. An analysis of the Group’s interests and the accounting treatment of each is set out in note 26 to the Group financial statements.

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Cash and borrowings

Details of the Group’s borrowings and cash management are set out in note 16(b) to the Group financial statements and in the Financial Review.

Net debt and gearing			2010	2009
Gross debt	£m		(175.5)	(126.2)
Cash and cash equivalents	£m		104.1	80.6
Net debt	£m		(71.4)	(45.6)
Net assets	£m		333.1	244.0
Gearing*	%		21.4	18.7
Share of net debt in joint ventures	£m		(20.8)	(12.8)
Gearing including joint ventures	%		27.7	23.9
Adjusted gearing	%		12.7	6.3

* Refer to note 1(w).

The gross debt figure includes the €47 million 2027 Unsecured Subordinated Loan Note facility, stated in Sterling at the current fair value of £40.3 million (2009: £41.7 million), and ignoring the hedging instrument. If these loan notes are removed from borrowings, gearing falls to 12.7 per cent. This is calculated by deducting from net debt the current fair value of £40.3 million (2009: £41.7 million) and adding back relevant restricted cash balances of £10.1 million (2009: £10.3 million) and transaction costs of £1.1 million (2009: £1.1 million).

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Taxation

The tax charge for the year was £1.0 million, principally representing an increase in the Group’s deferred tax liability of £0.8 million. The Group has significant potential deferred tax asset balances, but the Directors have restricted recognition to the amount of corresponding deferred tax liabilities, as uncertain market conditions do not offer sufficient probability of profits in the foreseeable future within the terms of IAS 12. The charge in the period principally reflects the deferred tax in respect of revaluation gains. There is a corresponding credit of £0.8 million in Other comprehensive income, representing additional recognition of the deferred tax asset. Tax movements and balances are set out in notes 7 and 17 to the Group financial statements.

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Dividends

The Board will recommend to shareholders at the Annual General Meeting on 27th May 2011 a final dividend of 2.4 pence per share (2009: 2.4 pence per share) to be paid on 6th July 2011 to shareholders on the register on 3rd June 2011. This final dividend, amounting to £2.9 million, has not been included as a liability at 31st December 2010, in accordance with IFRS. The total dividend for the year will be 4.8 pence per share (2009: 4.8 pence per share).

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Earnings/(loss) per share

The basic and diluted earnings per share for the year to 31st December 2010 was 1.7 pence (2009: loss of 16.8 pence on both bases, both restated following the 2010 Placing and Rights Issue).

After removing the unrealised revaluation of the investment portfolio and the mark–to–market adjustment of interest rate swaps, the EPRA adjusted loss per share was 11.8 pence per share (2009: 20.3 pence per share), as set out in note 9 to the Group financial statements.

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Performance measures

Key performance indicators are set out below:

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Further reading

• Board of Directors