From Conventional Loans to Index-Linked Finance

Tim Jackson

Resources Director, Golding Homes

What am I going to cover?

• Index-linked financing – what is it?

• Impact on capacity

• Key risks

• Benefits

• Risk Management

Experience of sale and leaseback

• 2 deals completed

• 1 was to raise additional finance for the Group

• 1 was to fund stock acquisition – 190 properties

Sale and leaseback – what is it?• RP sells long lease to investor for a lump sum – probably around £100k a unit but the exact

price will affect the ability to pay, after management and maintenance costs, the annual sublease payments in the next bullet point

• Investor simultaneously sells a sublease for say 48 years in return for an annual lease payment which starts low (I can’t disclose the exact figure)

• The annual lease payment goes up by rpi or cpi each year

• At the end of the 48 years the leases collapse and the RP can buy the properties back for £1

• This means in effect the annual lease payments include capital repayments

• In accounting terms this is all on balance sheet and the lump sum at bullet point 1 is treated as a loan

Benefits

• Relationship and documentation very different from a bank, e.g.. far fewer default clauses – this is a key benefit

• Very security efficient – only interest is the legal interest in the lease – no other security required. Asset cover is effectively 75%-80% versus lenders who seek 110% upwards

• ‘Security’ in place day one

Benefits (continued)• Very little else in treasury portfolio benefits the business

if inflation is low

• Will pricing rise as much as loan pricing if interest rates go up?

• Cash flows match rents

• Makes sale and leaseback great for stock acquisition – cash positive day one

Sale and leaseback – capacity issues

• No financial covenants, so gearing of no concern to the investor

• So if it can be done in a part of the group that does not impact on the group’s gearing it can enhance capacity

• Very useful if gearing is constraining for non-financial reasons, e.g. lender re-pricing needed to change historic gearing covenants

• Works well where a deal can ‘stand alone’, i.e. cash flow positive day 1 – e.g. stock acquisitions

• Useful if security is a limiting factor

Risks/Issues

• CPI/RPI increases• Very long agreement• Asset security cover inefficient in later years• Accounting is odd• ‘Jam today’ – brings forward future surplus

Cash flows – so reduced strength in later years• It’s different! Regulatory interest

Risk Management – Supporting a separate lease vehicle

• Key risk is not meeting lease payment• Deal must be solid in the first place, i.e. really

strong cash flows, i.e. buffer between net income and lease payments

• Raise extra cash, use to acquire stock to increase rental income with no lease payment attached

• Other RP’s can give vehicle additional stock to increase income

• Parent has resources to support vehicle (RP)

Risk Management (continued)

• Transaction can be novated to other RP’s in the group

• Limit the amount of index linked funding to the group

• Inflation collar on lease uplift• Stress testing, etc.• Property substitution

Enhancing the leaseback model

• Proactive investor• CPI escalator• Security release• Shorter lease period and bullets repayment• Some fixed element• Range of tenure types

Summary• Challenge is to stretch but protect finances

• As new sources of finance emerge, how diversified should our funding sources be – managing multiple agreements and relationships is risky

• Real need for treasury systems and processes

• Link between development risk and treasury risk has never been greater