Our Board monitors a range of financial and non-financial risks which affect the business, and these are covered in the tables which follow.

As property is a capital intensive business, we place a strong emphasis on the management of financial risks. In light of the relationship between risk and return, we set out below an overview of our management of financial risks in the context of our investment return objectives and also our approach to capital allocation.

The Group’s primary financial metric is total return. For shareholders, total return consists of a combination of share price movement and dividend payments. On a portfolio of properties, total return consists of movements in asset valuations together with the income yield from receipt of rents. Although our focus is on total return, we recognise that, with property, income is an important component of total return – and that, for our shareholders, the dividend is likewise an important part of Total Shareholder Return.

When making capital allocation decisions (whether to buy, sell or develop a property), we do so on the basis of prospective ungeared total returns, adjusted for risk, relative to our weighted average cost of capital (WACC) and also relative to alternative investment opportunities. Our capital allocation decisions on properties are made on the basis of ungeared total returns because we manage gearing levels centrally at the Group balance sheet level.

Evidence shows that in the property sector, asset selection decisions are more important than sector allocation in terms of generating outperformance, and we would expect to focus our capital allocation decisions more around the choice between development and investment than around sector allocation. However, if there is a material difference in the prospective returns between sectors, this will be reflected in our capital allocation.

Our capital management decisions are concerned not only with prospective returns, but also with risk both at the asset level and at Group level. The assessment and management of risk is a dynamic process but, from a financial perspective, we believe there are four key areas of risk: our balance sheet gearing levels; the amount of property development we undertake; the terms and mix of our debt facilities; and the composition of our property portfolio. Our experience is that the first two of these risks, gearing levels and the amount of development, tend to be the principal sources of volatility of returns, and hence risk, for a property company. We describe below how we manage these key financial risks.

Gearing magnifies the effect of movements in income on corporate earnings and the effect of movements in property values on shareholders’ net assets (NAV). So, we assess balance sheet gearing levels in terms of both Interest Cover Ratios (ICR) and LTV ratios. The UK property sector tends to focus particularly on LTV ratios, and we seek to manage the business within an inner gearing range of 35% to 45% LTV, which we would expect to apply in normal market conditions. At certain stages of the cycle, we would be prepared to allow our LTV ratios to move to an outer range of 25% to 55% LTV. (To put these figures in the context of balance sheet gearing ratios calculated by reference to debt to equity, 35% to 45% LTV is approximately equivalent to 54% to 82% gearing on the basis of debt to equity).

The amount of property development we undertake is the second key financial risk area. Property development has the potential to deliver new buildings at attractive rental income yields and also to generate valuation surpluses materially ahead of general market movements. However, property development can also be associated with higher volatility of valuation movements and income shortfalls if projects do not let up to plan. We therefore manage our risk exposure to development through both income and capital risk control measures. The income-related risk measure is that, adopting conservative assumptions on leasing, the targeted rental income from the unlet element of our development programme should not exceed the Group’s retained earnings. The purpose of this is to safeguard against unlet development projects resulting in the Group having an uncovered dividend. We also control the proportion of our capital deployed in development: the proportion of our capital in development will generally not exceed 20% of our total capital upon completion of those schemes – save that, where a material part of the development programme is pre-let, this proportion can rise to 25%. In addition, we monitor the level of committed future capital expenditure on our development programme relative to the level of our undrawn debt facilities.

In terms of risks relating to our debt facilities, we ensure that we have: a spread of maturity dates for debt facilities; a mix of fixed and flexible or repayable debt to ensure that we can manage liquidity around asset purchases and sales; and a high proportion of our debt at fixed interest rates or else hedged in order to manage our exposure to interest rate volatility. In addition, we monitor compliance and headroom around covenants in our debt facilities, the provisions of which are covered in more detail in the section of the Financial Review on financing strategy.

Risks potentially arising from the composition of our property portfolio are managed through monitoring: asset concentration (our largest asset is only 6.2% of the total portfolio); tenant concentration (our largest tenant, the Government, represents only 7.8% of rents); the spread of lease expiry dates (we have an average unexpired lease term of 8.9 years with a maximum of 8.6% of gross rental income expiring or subject to break clause in any single year); and also the proportion of our portfolio represented by pre-development properties. In addition, we review the liquidity of assets in our portfolio and, in this respect, we generally favour full control and ownership of assets. Currently, 13.0% of our assets are held in joint ventures.

Our Board regularly reviews the appropriate risk appetite for the business through the cycle and uses its discretion as to when to increase or reduce risk exposure. We have recently demonstrated this with our decision to gain early mover advantage through restarting a large development programme in 2010/11 for delivery in 2012/14. Risk is not perceived by our Board to be negative as a matter of course; we are alive to the fact that taking on risk can be a source of financial outperformance at the appropriate stage in the cycle.

The tables in the following tabs show the principal risks and uncertainties facing the business and the processes by which we aim to manage them.

Risk and impact

Mitigation

Further commentary

Change from 2009/2010

Liability structure
  • Liability structure is unable to adapt to changing asset strategy or property values resulting in reduced financial and operational flexibility, missed business opportunities and higher finance costs.
  • Asset and Liability Committee meets three times a year to monitor both sides of the balance sheet and recommend strategy;
  • Liquidity and gearing kept under regular review;
  • Assess balance sheet gearing levels in terms of both interest cover ratios (ICR) and loan-to-value ratios (LTV);
  • Seek to manage the business within an inner gearing range of 35% to 45% LTV in normal market conditions;
  • Assets available within the Security Group to sell/provide security for raising new debt.
Financial review Down
  • Limited debt market capacity and/or liability structure impacts ability to meet existing debt maturities and fund forward cash requirements.
  • A mix of fixed term and repayable debt to ensure that we can manage liquidity around asset purchases and sales;
  • Long-term facilities in place with a spread of maturity dates;
  • On-going monitoring and management of the forecast cash position;
  • Commitments are not taken on if funding is not available;
  • Monitor compliance and headroom around covenants in our debt facilities:
    • Our principal debt funding structure benefits from financial default only being triggered at 1.0 times ICR (currently 2.22 times) or 100% LTV (currently 40.1%);
    • At less than 1.45 times ICR or greater than 65% LTV, a persuasive covenant regime applies which is designed to preserve cash for the potential protection of lenders and encourage the business to reduce debt.


  • Movements in interest rates adversely affect Group profits.
  • High proportion of our debt at fixed interest rates or else hedged in order to manage our exposure to interest rate volatility.


Risk and impact

Mitigation

Further commentary

Change from 2009/2010

Composition of our property portfolio
  • Asset concentration and lot size impacts on liquidity and relative property performance.
  • Monitor asset concentration (our largest asset is only 6.2% of the total portfolio);
  • Average investment property lot size of £66.4m;
  • Biannual portfolio liquidity review;
  • Generally favour full control and ownership of assets (we have only 13.0% of assets in joint ventures).
Business review Equal
  • Asset mix creates excessive volatility in income and valuation movements.
  • Large multi-asset portfolio;
  • Secure income flows under UK lease structure;
  • Monitor the spread of lease expiry dates (we have an average unexpired lease term of 8.9 years with a maximum of 8.6% of gross rental income expiring or subject to break clauses in any single year);
  • Monitor the proportion of our portfolio represented by pre-development properties.


Customers
  • Change in trends causes shifts in customer demand for properties with impact on new lettings, renewal of existing leases and reduced rental growth. Also risk of tenant insolvencies.
  • Bespoke research commissioned on the impact of structural change in the Retail sector, the results of which are factored into our Retail business plans;
  • Research into London’s continuing status as a global financial centre;
  • Active development programme to maintain a modern portfolio well suited to occupier requirements;
  • Strong relationships with occupiers;
  • Variety of asset types and geographic spread;
  • Diversified tenant base, with monitoring of tenant concentration (our largest tenant, the Government, represents only 7.8% of rents);
  • Of our income 62% is derived from tenants who make less than a 1% contribution to rent roll;
  • Target for maximum % of leases subject to expiry in any one year;
  • Experienced and skilled in-house leasing teams;
  • Large portfolio allows portfolio leasing deals to reduce voids further.
Business review Up
Environment
  • Properties do not comply with Government requirements and customer expectations on carbon reduction leading to an increased cost base and an inability to attract or retain tenants.
  • Dedicated specialist environment personnel;
  • Established policy and procedures including ISO 14001 certified environmental system;
  • Active environmental programme addressing key areas of impact (energy and waste);
  • Active involvement in legislative working parties.
Corporate Responsibility Equal
Health and safety
  • A failure to manage the safety of our employees, contractors, tenants and visitors to our properties could lead to criminal/civil proceedings and resultant reputational damage.
  • Annual cycle of health and safety audits;
  • Quarterly Board reporting;
  • Dedicated specialist personnel;
  • Established policies and procedures.
Corporate Responsibility Equal

Risk and impact

Mitigation

Further commentary

Change from 2009/2010

Planning constraints and localism
  • Significant cuts in the planning departments within local authorities could lead to delays to the granting of planning permissions.
  • Close working relationships with key local, metropolitan and Government planning authorities;
Business review Up
  • The Government’s localism bill could increase the propensity within London for local residents to hinder development proposals. Outside London, it may lead to an easing of planning constraints as local authorities seek to take advantage of the potential to retain increased non-domestic rate income, therefore it could see an increase in competitor schemes in close proximity to our existing sites.
  • Active membership in industry lobby groups;
  • Active community engagement;
  • Use of professional planning advisers.


Development pipeline
  • Size of the speculative development pipeline and a failure to manage development activity in line with market cycle could result in a major impact on resources, in particular funding, income and potentially dividend cover. If development projects are not let up to plan there could be higher volatility of valuation movements and income shortfalls.
  • Adopting conservative assumptions on leasing, the targeted rental income from the unlet element of our development programme should not exceed the Group’s retained earnings;
  • Proportion of capital employed in development programme (based on total costs to completion) will generally not exceed 20% of our total capital employed, save that where a material part of the development programme is pre-let, this proportion can rise to 25%;
  • Monitor the level of committed future capital expenditure on our development programme relative to the level of our undrawn debt facilities;
  • Risk analysis of speculative development pipeline on capital and income basis;
  • Strategy of flexing size of development programme according to the outlook for the market cycle;
  • In-house property market research capability;
  • Skilled in-house development teams.
Business review Up

Risk and impact

Mitigation

Further commentary

Change from 2009/2010

People skills
  • Failure to have the right people and skills in the business to execute business objectives.
  • Succession planning and skill gaps reviewed by Nominations Committee;
  • Implementation of talent management processes;
  • Remuneration review undertaken by the Board;
  • Monitoring of employee engagement through an annual survey;
  • Internal communication programme;
  • Appropriate mix of insourcing and outsourcing.
Corporate Responsibility Equal