At 31 December 2013 Available- for-sale £m At fair value through the income statement £m Loans and receivables £m Derivatives used for hedging £m Other financial liabilities £m Total £m Financial assets
Unlisted equity securities 1.5 – – – – 1.5 Investment loan – – 20.8 – – 20.8 Non-designated foreign exchange forward contracts – 0.1 – – – 0.1 Interest rate swaps in relation to GBP denominated bonds – – – 7.7 – 7.7 Currency swaps in relation to US$ denominated bonds – – – 139.4 – 139.4 1.5 0.1 20.8 147.1 – 169.5
Financial liabilities
Overdraft – – – – 453.0 453.0 Unsecured loan notes – – – – 10.4 10.4 Bonds – – – – 1,267.3 1,267.3 Term loan – – – – 200.0 200.0 Cash flow hedges – – – 30.2 – 30.2 Non-designated foreign exchange forward contracts – 1.8 – – – 1.8 Currency swaps in relation to US$ denominated bonds – – – 13.5 – 13.5 Contingent consideration – – – – 35.2 35.2 Deferred consideration – – – – 58.6 58.6 Obligations under finance leases – – – – 17.3 17.3 Public sector subsidiary partnership payment – – – – 52.2 52.2 Put options of non-controlling interests – – – – 96.0 96.0 Fixed rate interest rate swaps – 26.6 – – – 26.6 – 28.4 – 43.7 2,190.0 2,262.1 The fair value of financial instruments has been calculated by discounting the expected future cash flows at prevailing interest rates, except for unlisted equity securities and investment loans. The valuation models incorporate various inputs including foreign exchange spot and forward rates and interest rate curves. Unlisted equity securities and investment loans are held at amortised cost. The Group enters into derivative financial instruments with multiple counterparties, all of which are financial institutions with investment grade credit ratings.
Fair value hierarchy
The Group uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique: Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities
Level 2: other techniques for which all inputs which have a significant effect on the recorded fair value are observable, either directly or indirectly Level 3: techniques which use inputs which have a significant effect on the recorded fair value that are not based on observable market data. As at 31 December 2014, the Group held the following financial instruments measured at fair value:
2014
£m 2013 £m
Assets measured at fair value
Non-designated foreign exchange forward contracts – 0.1 Interest rate swaps in relation to GBP denominated bonds 9.8 7.7 Currency swaps in relation to US$ denominated bonds 175.6 139.4
Liabilities measured at fair value
Bonds 1,181.8 1,142.3
Cash flow hedges 18.7 30.2
Non-designated foreign exchange forward contracts 1.2 1.8 Currency swaps in relation to US$ denominated bonds 0.6 13.5 Fixed rate interest rate swaps 63.3 26.6 Public sector subsidiary partnership payment 54.3 52.2 Contingent consideration 56.1 35.2
Notes to the consolidated financial statements continued
Capita plc 145
26 Financial instruments (continued)
During both years, the Group only had Level 2 assets or liabilities measured at fair value apart from contingent consideration, the public sector subsidiary partnership payment and the put options of non-controlling interests which are Level 3 liabilities. It is the Group’s policy to recognise transfers between levels of the fair value hierarchy at the end of the reporting period during which the transfer occurred. During the year ended 31 December 2014, there were no transfers between Level 1 and Level 2 fair value measurements and no transfers into or out of Level 3 fair value measurements.
Contingent consideration arises in business acquisitions where the Group has agreed to pay the vendors additional consideration dependent on the achievement of performance targets in the periods post acquisition. These performance periods are of up to 3 years in duration and will be settled in cash and loan notes on their payment date on achieving the relevant target. The Group makes provision for such contingent consideration for each acquisition based on an assessment of its fair value at the acquisition date. Contingent consideration has been calculated based on the Group’s expectation of what it will pay in relation to the post-acquisition performance of the acquired entities by weighting the probability of a range of payments to give an estimate of the final obligation. A sensitivity analysis was performed on the expected contingent consideration of £56.1m. The sensitivity analysis performed adjusted the probability of payment of the contingent amounts. A 10% increase in the probability of contingent consideration being paid results in an increase in potential contingent consideration of £4.4m. A 10% decrease in the probability of the contingent consideration being paid results in a decrease in potential contingent consideration of £4.9m.
The public sector subsidiary partnership payment liability is an estimate of the annual preferred payments to be made by Axelos Limited (the partnership formed with the Cabinet Office) to the Cabinet Office in years 3 to 9. This payment is funded by Axelos Limited and is contingent on profits. The fair value of £54.3m has been derived by discounting the expected payment at the Group cost of debt to arrive at its present value. If the discount rate was to increase/decrease by 1% the present value would decrease/increase by £3m.
The carrying value of all assets and liabilities that are measured at amortised cost is equivalent to their fair value.
The put options of the non-controlling interests (see note 22) are measured at amortised cost based on the expected redemption value of the shares that will be paid in cash by the Group. This value is determined by reference to the expected date of exercise of the options, which is then discounted to arrive at a present value. The sensitivity of the valuation to movements in both the discount rate and the cash flows that have been used to calculate it, are as follows: a 10% increase/decrease in the earnings potential of the business results in a £10.8m increase/decrease in the valuation; a 1% increase/decrease in the discount rate applied to the valuation results in a £4.0m decrease/£4.1m increase in the valuation. The following table shows the reconciliation from the opening balances to the closing balances for Level 3 fair values.
Contingent consideration £m Subsidiary partnership payment £m Put options of non- controlling interests £m At 1 January 2014 35.2 52.2 96.0 Arising from business combinations in the period 39.5 – –
Profit and loss movement – administrative expenses (9.4) – –
Utilised (9.2) – –
Movement of put options recognised in equity – – 13.4
Discount unwind – 2.1 –
At 31 December 2014 56.1 54.3 109.4
Interest rate risk
The Group’s exposure to the risk of changes in market interest rates arises primarily from the Group’s long term debt.
The Group’s policy is to manage its interest cost using a mix of fixed and variable rate financial instruments to generate the desired interest rate profile and to manage its exposure to interest rate fluctuations.
The Group has primarily issued fixed rate coupon US$ denominated bonds, which have been swapped to floating rate GBP liabilities at the date of issuance using currency swaps. These currency swaps are designated as fair value hedges against changes in the fair value of the bonds due to changes in prevailing foreign currency exchange and interest rates.
In February 2008, Capita executed a series of fixed rate interest rate swaps to convert from paying floating rate GBP interest to fixed rate GBP interest on certain of its swapped bonds. Up to June 2012, the counterparty held the option to cancel these swaps on each semi-annual coupon payment date. In June 2012, the counterparty’s option to cancel was removed, the duration of the swaps was extended and the fixed rate was reduced, taking advantage of the lower prevailing interest rate environment. These fixed rate interest rate swaps are not designated in any hedge relationship so their change in fair value is recognised in net finance costs in the income statement – see note 9 – Net finance costs.
Following the fall in prevailing interest rates at the end of 2008 and the low base interest rates maintained thereafter, these fixed rate interest rate swaps show a negative mark to market value of £63.3m at 31 December 2014 (2013: negative mark to market value of £26.6m). This movement results in a non-cash accounting loss in the year of £36.7m (2013: gain of £26.3m).
In addition to the fixed rate bonds of £753.1m in issue as at 31 December 2014 (underlying value – not adjusted for the impact of the swaps), the Group had a further £371.0m of swapped bonds, a £300.0m 2-year term loan and a £600.0m undrawn committed revolving credit facility, all paying floating rate interest. This gives the Group, as a whole, a balanced interest rate risk profile through the use of both fixed and floating rate financial instruments.
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Fixed rate
Bonds 24.4 182.9 128.2 95.7 109.5 342.6 883.3
Obligations under finance leases 5.1 5.3 1.5 – – – 11.9
Interest rate swap in relation to GBP denominated bonds – – – – (4.7) – (4.7)
Foreign currency swaps in relation to US$ denominated
bonds – (42.0) (38.7) (29.3) (4.2) (13.1) (127.3)
Fixed rate interest rate swaps 0.4 6.0 7.4 8.3 11.9 29.3 63.3
Floating rate Cash in hand (458.9) – – – – – (458.9) Overdraft 429.8 – – – – – 429.8 Investment loan – – (0.2) (0.3) (0.3) (4.2) (5.0) Bonds 86.5 – 33.5 115.7 – 187.8 423.5 Term loan – 200.0 – – 100.0 – 300.0
Cash flow hedges 3.1 3.9 4.1 4.3 3.3 – 18.7
Non-designated foreign exchange forward contracts 0.3 – 0.1 0.2 0.3 0.3 1.2
Interest rate swap in relation to GBP denominated bonds (1.3) – – – – (3.8) (5.1)
Foreign currency swaps in relation to US$ denominated
bonds (13.2) – 0.3 (28.8) – (6.0) (47.7) At 31 December 2013 Within 1 year £m Between 1–2 years £m Between 2–3 years £m Between 3–4 years £m Between 4–5 years £m More than 5 years £m Total £m Fixed rate Bonds 13.1 24.7 179.7 125.5 77.4 178.6 599.0 Obligations under finance leases 4.9 5.2 5.0 2.2 – – 17.3 Foreign currency swaps in relation to US$ denominated
bonds (2.7) – (38.8) (35.1) (21.8) 3.1 (95.3) Fixed rate interest rate swaps 0.2 0.9 7.6 6.0 3.7 8.2 26.6
Floating rate Cash in hand (610.8) – – – – – (610.8) Overdraft 453.0 – – – – – 453.0 Investment loan (0.3) (3.5) (4.0) (5.0) (8.0) – (20.8) Bonds – 86.7 – 32.0 125.5 424.1 668.3 Term loan – 200.0 – – – – 200.0 Cash flow hedges 6.0 4.6 5.2 5.4 5.4 3.6 30.2 Non-designated foreign exchange forward contracts 0.4 0.5 0.2 0.2 0.2 0.2 1.7 Interest rate swap in relation to GBP denominated bonds – (2.7) – – – (5.0) (7.7) Foreign currency swaps in relation to US$ denominated
bonds – (12.0) – 1.8 (28.1) 7.7 (30.6) The following table demonstrates the sensitivity to a reasonably possible change in interest rates, with all other variables held constant, of the Group’s profit before tax (through the impact on floating rate borrowings). There is no impact on the Group’s equity.
Increase/(decrease)
in basis points Effect on profit before tax £m
2014 1 (1) (0.1) 0.1
2013 13 (13) (0.8) 0.8
Foreign currency risk
The Group has exposure to foreign currency risk where it has cash flows in overseas operations and foreign currency transactions in UK operations which are affected by foreign exchange movements. The Group is not generally exposed to significant foreign currency risk except in respect of its cash flows in overseas operations in India which generate exposure to movements in the INR/GBP exchange rates. The Group seeks to mitigate the effect of this exposure by entering forward currency contracts (in the form of Non-deliverable Forward Contracts (NDFs)) to fix the GBP cost of highly probable forecast transactions denominated in INR.
It is the Group’s policy to negotiate the terms of the hedge derivatives to match the terms of the underlying cash flows in order to maximise hedge effectiveness.
At 31 December 2014, the Group had cash flow hedges in place against forecast monthly INR costs in 2015 and each year up to and including 2019. These forecast INR costs have been determined on the basis of the underlying cash flows associated with the delivery of services under signed contracts which run to 2019.
26 Financial instruments (continued)
The interest rate profile of the interest-bearing financial assets and liabilities of the Group as at 31 December is as follows:
At 31 December 2014 Within 1 year £m Between 1–2 years £m Between 2–3 years £m Between 3–4 years £m Between 4–5 years £m More than 5 years £m Total £m Fixed rate Bonds 24.4 182.9 128.2 95.7 109.5 342.6 883.3
Obligations under finance leases 5.1 5.3 1.5 – – – 11.9
Interest rate swap in relation to GBP denominated bonds – – – – (4.7) – (4.7)
Foreign currency swaps in relation to US$ denominated
bonds – (42.0) (38.7) (29.3) (4.2) (13.1) (127.3)
Fixed rate interest rate swaps 0.4 6.0 7.4 8.3 11.9 29.3 63.3
Floating rate Cash in hand (458.9) – – – – – (458.9) Overdraft 429.8 – – – – – 429.8 Investment loan – – (0.2) (0.3) (0.3) (4.2) (5.0) Bonds 86.5 – 33.5 115.7 – 187.8 423.5 Term loan – 200.0 – – 100.0 – 300.0
Cash flow hedges 3.1 3.9 4.1 4.3 3.3 – 18.7
Non-designated foreign exchange forward contracts 0.3 – 0.1 0.2 0.3 0.3 1.2
Interest rate swap in relation to GBP denominated bonds (1.3) – – – – (3.8) (5.1)
Foreign currency swaps in relation to US$ denominated
bonds (13.2) – 0.3 (28.8) – (6.0) (47.7) At 31 December 2013 Within 1 year £m Between 1–2 years £m Between 2–3 years £m Between 3–4 years £m Between 4–5 years £m More than 5 years £m Total £m Fixed rate Bonds 13.1 24.7 179.7 125.5 77.4 178.6 599.0 Obligations under finance leases 4.9 5.2 5.0 2.2 – – 17.3 Foreign currency swaps in relation to US$ denominated
bonds (2.7) – (38.8) (35.1) (21.8) 3.1 (95.3) Fixed rate interest rate swaps 0.2 0.9 7.6 6.0 3.7 8.2 26.6
Floating rate Cash in hand (610.8) – – – – – (610.8) Overdraft 453.0 – – – – – 453.0 Investment loan (0.3) (3.5) (4.0) (5.0) (8.0) – (20.8) Bonds – 86.7 – 32.0 125.5 424.1 668.3 Term loan – 200.0 – – – – 200.0 Cash flow hedges 6.0 4.6 5.2 5.4 5.4 3.6 30.2 Non-designated foreign exchange forward contracts 0.4 0.5 0.2 0.2 0.2 0.2 1.7 Interest rate swap in relation to GBP denominated bonds – (2.7) – – – (5.0) (7.7) Foreign currency swaps in relation to US$ denominated
bonds – (12.0) – 1.8 (28.1) 7.7 (30.6) The following table demonstrates the sensitivity to a reasonably possible change in interest rates, with all other variables held constant, of the Group’s profit before tax (through the impact on floating rate borrowings). There is no impact on the Group’s equity.
Increase/(decrease)
in basis points Effect on profit before tax £m
2014 1 (1) (0.1) 0.1
2013 13 (13) (0.8) 0.8
Foreign currency risk
The Group has exposure to foreign currency risk where it has cash flows in overseas operations and foreign currency transactions in UK operations which are affected by foreign exchange movements. The Group is not generally exposed to significant foreign currency risk except in respect of its cash flows in overseas operations in India which generate exposure to movements in the INR/GBP exchange rates. The Group seeks to mitigate the effect of this exposure by entering forward currency contracts (in the form of Non-deliverable Forward Contracts (NDFs)) to fix the GBP cost of highly probable forecast transactions denominated in INR.
It is the Group’s policy to negotiate the terms of the hedge derivatives to match the terms of the underlying cash flows in order to maximise hedge effectiveness.
At 31 December 2014, the Group had cash flow hedges in place against forecast monthly INR costs in 2015 and each year up to and including 2019. These forecast INR costs have been determined on the basis of the underlying cash flows associated with the delivery of services under signed contracts which run to 2019.
Notes to the consolidated financial statements continued
Capita plc 147
26 Financial instruments (continued)
The following table demonstrates the sensitivity to a reasonably possible change in the INR/GBP exchange rate, with all other variables held constant, of the Group’s profit before tax and the Group’s equity due to changes in the fair value of the Group’s forward exchange contracts.
Increase/ (decrease) in INR exchange rate Effect on profit before tax £m Effect on equity £m 2014 (2.86)% – 5.3 2013 (2.44)% – 3.4 Hedges
Fair value hedges
The Group has in issue fixed rate dollar and sterling bonds which it has hedged through a combination of interest rate and currency swaps. The Group had interest rate swaps in place with a notional amount of £117.0m (2013: £117.0m) whereby it receives a weighted average fixed rate of interest of 5.46% (2013: fixed rate of interest 5.46%) and pays variable rates based on 6 month GBP LIBOR. The swap is being used to hedge the exposure to changes in the fair value of £117.0m (2013: £117.0m) of the Group’s bonds.
The Group had in place currency swaps whereby it receives a fixed rate of interest and pays a variable rate based on 6 month GBP LIBOR. The currency swaps are being used to hedge the exposure to changes in the fair value of £857.1m (2013: £867.7m) of the Group’s bonds, which have coupon rates ranging from 3.72% to 6.51%.
The currency swaps are being used to hedge the exposure to changes in the fair value of its US dollar issued bonds. The bonds, currency and interest rate swaps have the same critical terms including the amount and the date of maturity (see note 22).
The total gain in the year on the fair value hedges of £50.9m (2013: total loss £90.0m), excluding credit risk, was equal to the gain on the hedged items resulting in no net gain or loss in the income statement.
The Group may, at its option, upon notice of not less than 30 days and not more than 60 days, repay at any time all or part of the notes at no more than the present value of future payments.
Cash flow hedges
As noted above, the Group holds a series of forward exchange currency contracts in the form of NDFs designated as hedges of highly probable forecast transactions in INR of the Group’s Indian operations.
Forward exchange contracts Assets £m
2014 Liabilities £m Assets £m 2013 Liabilities £m Fair value – (18.7) – (30.2) The terms of the forward currency contracts have been negotiated to match the terms of the commitments.
The cash flow hedges are in respect of highly probable forecast monthly costs, based on long term contracts that the Group has in place, denominated in INR up to 2019. These were assessed to be highly effective as at 31 December 2014 and a net unrealised loss of £18.7m (2013: loss of £30.2m) less deferred tax of £3.7m (2013: £6.0m) was recognised in equity. The net gain recognised on cash flow hedges during the year was £5.6m (2013: net loss £10.3m) whilst net losses of £6.0m (2013: losses of £2.6m) were reclassified to the income statement and included in administrative expenses. The tax effect of the net movement in cash flow hedges during the year was a debit of £(2.3)m (2013: credit of £0.8m).
Credit risk
The Group trades only with recognised, creditworthy third parties. It is the Group’s policy that all clients who wish to trade on credit terms are subject to credit verification procedures. In addition, receivable balances are monitored on an ongoing basis with the result that the Group’s exposure to bad debts is not significant.
With respect to credit risk arising from the other financial assets of the Group, such as cash and cash equivalents, available-for-sale financial investments, investment loan and certain derivative instruments, the Group’s exposure to credit risk arises from default of the counterparty. The Group manages its operations to avoid any excessive concentration of counterparty risk and the Group takes all reasonable steps to seek assurance from the counterparties to ensure that they can fulfil their obligations.
The Group has a maximum exposure equal to the carrying amount of the above receivables and instruments.
The mark to market movement on derivatives includes the extent to which the fair value of these instruments has been affected by the perceived change in the creditworthiness of the counterparties to those instruments and that of the Group itself (own credit risk). The Group is comfortable that the risk attached to those counterparties is not significant and believes that the currency swaps continue to act as an effective hedge against the movements in the fair value of the Group’s issued US$ denominated bonds.
Liquidity risk
The Group’s policy is to hold cash and undrawn committed facilities at a level sufficient to ensure that the Group has available funds to meet its medium term capital and funding obligations, including organic growth and acquisition activities, and to meet any unforeseen obligations and opportunities. The Group holds cash and undrawn committed facilities to enable the Group to manage its liquidity risk.
The Group monitors its risk to a shortage of funds using a daily cash management process. This process considers the maturity of both the Group’s financial investments and financial assets (e.g. accounts receivable, other financial assets) and projected cash flows from operations.
The Group’s objective is to maintain a balance between continuity of funding and flexibility through the use of multiple sources of funding including bonds, bank loans, term loans, loan notes, overdrafts and finance leases over a broad spread of maturities to 2021.
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At 31 December 2014 £m £m £m £m £m £m £m
Overdraft 429.8 – – – – – 429.8
Unsecured loan notes 0.1 0.1 – – – – 0.2
Bonds 108.4 169.5 147.0 190.0 101.4 789.5 1,505.8
Interest on above bonds 73.1 65.0 56.9 49.5 37.8 75.8 358.1
Term loan – 200.0 – – 100.0 – 300.0
Interest on above term debt 3.7 1.8 1.7 1.7 0.6 – 9.5
Contingent consideration 33.3 17.5 5.3 – – – 56.1
Public sector subsidiary partnership payment – – 9.4 9.4 9.4 37.6 65.8
Put options of non-controlling interests – – – 39.8 106.1 – 145.9
Obligations under finance leases 5.1 5.3 1.5 – – – 11.9
Currency swaps 0.8 (4.3) (2.2) (3.5) (3.5) (19.5) (32.2)
Fixed rate interest rate swaps 5.5 16.9 20.8 19.5 15.7 13.8 92.2
Non-designated foreign exchange forward contracts 0.1 – – – – – 0.1
Cash flow hedges 2.7 3.0 2.7 2.7 2.0 – 13.1
662.6 474.8 243.1 309.1 369.5 897.2 2,956.3 At 31 December 2013 Within 1 year £m Between 1–2 years £m Between 2–3 years £m Between 3–4 years £m Between 4–5 years £m More than 5 years £m Total £m Overdraft 453.0 – – – – – 453.0 Unsecured loan notes 10.2 0.1 0.1 – – – 10.4 Bonds 12.7 105.4 159.8 138.6 179.1 582.8 1,178.4 Interest on above bonds 60.8 60.1 52.3 44.6 37.6 53.3 308.7 Term loan – 200.0 – – – – 200.0 Interest on above term debt 2.4 1.3 – – – – 3.7 Contingent consideration 9.4 18.3 7.5 – – – 35.2 Public sector subsidiary partnership payment – – – 9.4 9.4 47.0 65.8 Put options of non-controlling interests – – – – – 160.6 160.6 Obligations under finance leases 4.9 5.2 5.0 2.2 – – 17.3 Currency swaps (9.2) (9.2) (5.6) (8.8) (7.7) 5.5 (35.0) Fixed rate interest rate swaps 5.7 10.8 14.2 16.8 12.5 11.4 71.4 Non-designated foreign exchange forward contracts 0.4 0.3 (0.1) (0.2) (0.3) (0.6) (0.5) Cash flow hedges 5.2 3.2 3.4 3.2 3.1 2.3 20.4
555.5 395.5 236.6 205.8 233.7 862.3 2,489.4
Master netting or similar agreements
The Group enters into derivative transactions under International Swaps and Derivatives Association (ISDA) master netting agreements. In general, under such agreements the amounts owed to each counterparty on a single day in respect of all transactions outstanding in the same currency are aggregated into a single amount that is payable by one party to the other. In certain circumstances – e.g. when a credit event such as a default