DJ SWEF: Annual Audited Accounts 2018
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Starwood European Real Estate Finance Ltd (SWEF)
SWEF: Annual Audited Accounts 2018
26-March-2019 / 07:00 GMT/BST
Dissemination of a Regulatory Announcement that contains inside information
according to REGULATION (EU) No 596/2014 (MAR), transmitted by EQS Group.
The issuer is solely responsible for the content of this announcement.
26 March 2019
Starwood European Real Estate Finance Limited
Annual Report and Audited Consolidated Financial Statements
for the year ended 31 December 2018
The Company has today published its annual financial report for the year
ended 31 December 2018 and has made it available online at
www.starwoodeuropeanfinance.com [1].
Starwood European Real Estate Finance Limited is an investment company
listed on the main market of the London Stock Exchange with an investment
objective to provide Shareholders with regular dividends and an attractive
total return while limiting downside risk, through the origination,
execution, acquisition and servicing of a diversified portfolio of real
estate debt investments in the UK and the wider European Union's internal
market.
The Group is the largest London-listed vehicle to provide investors with
pure play exposure to real estate lending.
The Group's assets are managed by Starwood European Finance Partners
Limited, an indirect wholly-owned subsidiary of the Starwood Capital Group.
Key Highlights Year ended Year ended
31 December 2018 31 December 2017
NAV per Ordinary Share 102.66 p 102.17 p
Share Price 102.00 p 109.50 p
NAV total return(1) 7.1% 7.2%
Share Price total return(1) (1.0%) 7.6%
Total Net Assets GBP385.0 m GBP383.1 m
Loans advanced at amortised GBP413.4 m GBP370.0 m
cost (including accrued
income)
Financial assets held at fair GBP21.9 m GBP22.1 m
value through profit or loss
(including associated accrued
income)
Cash and Cash Equivalents GBP28.2 m GBP11.8 m
Amount drawn under Revolving GBP68.8 m GBP13.3 m
Credit Facility (excluding
accrued interest)
Dividends per Ordinary Share 6.5 p 6.5 p
Invested Loan Portfolio 7.4% 7.5%
unlevered annualised total
return(1)
Invested Loan Portfolio 8.0% 7.7%
levered annualised total
return(1)
Ongoing charges percentage(1) 1.1% 1.0%
Weighted average portfolio LTV 16.7% 14.5%
to Group first GBP(1)
Weighted average portfolio LTV 64.1% 63.2%
to Group last GBP(1)
(1) Further explanation and definitions of the calculation is contained in
the section "Alternative Performance Measures" at the end of this financial
report.
For further information, please contact:
Duncan MacPherson - Starwood Capital - 020 7016 3655
Full text of annual financial report for the year ended 31 December 2018
Objective and Investment Policy
INVESTMENT OBJECTIVE
The investment objective of Starwood European Real Estate Finance Limited
(the "Company"), together with its wholly owned subsidiaries Starfin Public
Holdco 1 Limited, Starfin Public Holdco 2 Limited, Starfin Lux S.à.r.l,
Starfin Lux 3 S.à.r.l, and Starfin Lux 4 S.à.r.l, (collectively the
"Group"), is to provide its shareholders with regular dividends and an
attractive total return while limiting downside risk, through the
origination, execution, acquisition and servicing of a diversified portfolio
of real estate debt investments (including debt instruments) in the UK and
the wider European Union's internal market.
INVESTMENT POLICY
The Company invests in a diversified portfolio of real estate debt
investments (including debt instruments) in the UK and the wider European
Union's internal market. Whilst investment opportunities in the secondary
markets will be considered from time to time, the Company's predominant
focus is to be a direct primary originator of real estate debt investments
on the basis that this approach is expected to deliver better pricing,
structure and execution control and a client facing relationship that may
lead to further investment opportunities.
The Company will attempt to limit downside risk by focusing on secured debt
with both quality collateral and contractual protection.
The Company anticipates that the typical loan term will be between three and
seven years. Whilst the Company retains absolute discretion to make
investments for either shorter or longer periods, at least 75 per cent of
total loans by value will be for a term of seven years or less.
The Company's portfolio is intended to be appropriately diversified by
geography, real estate sector type, loan type and counterparty.
The Company will pursue investments across the commercial real estate debt
asset class through senior loans, subordinated loans and mezzanine loans,
bridge loans, selected loan-on-loan financings and other debt instruments.
The split between senior, subordinated and mezzanine loans will be
determined by the Investment Manager in its absolute discretion having
regard to the Company's target return objectives. However, it is anticipated
that whole loans will comprise approximately 40-50 per cent of the
portfolio, subordinated and mezzanine loans approximately 40-50 per cent and
other loans (whether whole loans or subordinated loans) between 0-20 per
cent (including bridge loans, selected loan-on-loan financings and other
debt instruments). Pure development loans will not, in aggregate, exceed 25
per cent of the Company's Net Asset Value ("NAV") calculated at the time of
investment. The Company may originate loans which are either floating or
fixed rate.
The Company may seek to enhance the returns of selected loan investments
through the economic transfer of the most senior portion of such loan
investments which may be by way of syndication, sale, assignment,
sub-participation or other financing (including true sale securitisation) to
the same maturity as the original loan (i.e. "matched funding") while
retaining a significant proportion as a subordinate investment. It is
anticipated that where this is undertaken it would generate a positive net
interest rate spread and enhance returns for the Company. It is not
anticipated that, under current market conditions, these techniques will be
deployed with respect to any mezzanine or other already subordinated loan
investments. The proceeds released by such strategies will be available to
the Company for investment in accordance with the investment policy.
Loan to Value ("LTV")
The Company will typically seek to originate debt where the effective loan
to real estate value ratio of any investment is between 60 per cent and 80
per cent at the time of origination or acquisition. In exceptional
circumstances that justify it, the ratio may be increased to an absolute
maximum of 85 per cent. In any event, the Company will typically seek to
achieve a blended portfolio LTV of no more than 75 per cent (based on the
initial valuations at the time of loan origination or participation
acquisition) once fully invested.
Geography
The Company's portfolio will be originated from the larger and more
established real estate markets in the European Union's internal market. UK
exposure is expected to represent the majority of the Company's portfolio.
Outside of the UK, investment in the European Union's internal market will
mainly be focussed on Northern and Southern Europe. Northern European
markets include Germany, France, Scandinavia, Netherlands, Belgium, Poland,
Switzerland, Ireland, Slovakia and the Czech Republic. Southern European
markets include Italy and Spain. The Company may however originate
investments in other countries in the European Union's internal market to
the extent that it identifies attractive investment opportunities on a risk
adjusted basis.
The Company will not invest more than 50 per cent of the Company's NAV
(calculated at the time of investment) in any single country save in
relation to the UK, where there shall be no such limit.
When and if the UK ceases to be a member of the European Union or in the
event that any other member state ceases to be a member of the European
Union's internal market, it will not automatically cease to be eligible for
investment.
Real Estate Sector and Property Type
The Company's portfolio will focus on lending into commercial real estate
sectors including office, retail, logistics, light industrial, hospitality,
student accommodation, residential for sale and multi-family rented
residential. Investments in student accommodation and residential for sale
are expected to be limited primarily to the UK, while multi-family
investments are expected to be limited primarily to the UK, Germany and
Scandinavia. Further, not more than 30 per cent, in aggregate, of the
Company's NAV, calculated at the time of investment, will be invested in
loans relating to residential for sale. No more than 50 per cent of the
Company's NAV will be allocated to any single real estate sector of the UK,
except for the UK office sector which is limited to 75 per cent of the
Company's NAV.
Counterparty and Property Diversification
No more than 20 per cent of the Company's NAV, calculated at the time of
investment, will be exposed to any one borrower legal entity.
No single investment, or aggregate investments secured on a single property
or group of properties, will exceed 20 per cent of the Company's Net Asset
Value, calculated at the time of investment.
Corporate Borrowings
Company or investment level recourse borrowings may be used from
time-to-time on a short term basis for bridging investments, financing
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DJ SWEF: Annual Audited Accounts 2018 -2-
repurchases of shares or managing working capital requirements, including
foreign exchange hedging facilities and on a longer term basis for the
purpose of enhancing returns to Shareholders and/ or to facilitate the
underwriting of whole loans with a view to syndication at a later point. In
this regard, the Company is limited to aggregate short and long term
borrowings at the time of the relevant drawdown in an amount equivalent to a
maximum of 30 per cent of NAV but longer term borrowings will be limited to
20 per cent of NAV in any event.
Hedging
The Company will not enter into derivative transactions for purely
speculative purposes. However, the Company's investments will typically be
made in the currency of the country where the underlying real estate assets
are located. This will largely be in Sterling and Euros. However,
investments may be considered in other European currencies, and the Company
may implement measures designed to protect the investments against material
movements in the exchange rate between Sterling, being the Company's
reporting currency, and the currency in which certain investments are made.
The analysis as to whether such measures should be implemented will take
into account periodic interest, principal distributions or dividends, as
well as the expected date of realisation of the investment. The Company may
bear a level of currency risk that could otherwise be hedged where it
considers that bearing such risk is advisable. The Company will only enter
into hedging contracts, such as currency swap agreements, futures contracts,
options and forward currency exchange and other derivative contracts when
they are available in a timely manner and on terms acceptable to it. The
Company reserves the right to terminate any hedging arrangement in its
absolute discretion.
The Company may, but shall not be obliged to, engage in a variety of
interest rate management techniques, particularly to the extent the
underlying investments are floating rate loans which are not fully hedged at
the borrower level (by way of floating to fixed rate swap, cap or other
instrument). Any instruments chosen may seek on the one hand to mitigate the
economic effect of interest rate changes on the values of, and returns on,
some of the Company's assets, and on the other hand help the Company achieve
its risk management objectives. The Company may seek to hedge its
entitlement under any loan investment to receive floating rate interest.
Cash Strategy
Cash held by the Company pending investment or distribution will be held in
either cash or cash equivalents, or various real estate related instruments
or collateral, including but not limited to money market instruments or
funds, bonds, commercial paper or other debt obligations with banks or other
counterparties having a A- or higher credit rating (as determined by any
reputable rating agency selected by the Company), Agency RMBS (residential
mortgage backed securities issued by government-backed agencies) and AAA
rated CMBS (commercial mortgage-backed securities).
Transactions with Starwood Capital Group or Other Accounts
Without prejudice to the pre-existing co-investment arrangements described
below, the Company may acquire assets from,
or sell assets to, or lend to, companies within the Starwood Capital Group
or any fund, company, limited partnership or other account managed or
advised by any member of the Starwood Capital Group ("Other Accounts"). In
order to manage the potential conflicts of interest that may arise as a
result of such transactions, any such proposed transaction may only be
entered into if the independent Directors of the Company have reviewed and
approved the terms of the transaction, complied with the conflict of
interest provisions in the Registered Collective Investment Scheme Rules
2015 issued by the Guernsey Financial Services Commission (the "Commission")
under The Protection of Investors (Bailiwick of Guernsey) Law, 1987, as
amended, and, where required by the Listing Rules, Shareholder approval is
obtained in accordance with the listing rules issued by the UK Listing
Authority. Typically, such transactions will only be approved if: (i) an
independent valuation has been obtained in relation to the asset in
question; and (ii) the terms are at least as favourable to the Company as
would be any comparable arrangement effected on normal commercial terms
negotiated at arms' length between the relevant person and an independent
party, taking into account, amongst other things, the timing of the
transaction.
Co-investment Arrangements
Starwood Capital Group and certain Other Accounts are party to certain
pre-existing co-investment commitments and it is anticipated that similar
arrangements may be entered into in the future. As a result, the Company may
invest alongside Starwood Capital Group and Other Accounts in various
investments. Where the Company makes any such co-investments they will be
made at the same time, and on substantially the same economic terms, as
those offered to Starwood Capital Group and the Other Accounts.
UK Listing Authority Investment Restrictions
The Company currently complies with the investment restrictions set out
below and will continue to do so for so long as they remain requirements of
the UK Listing Authority:
* neither the Company nor any of its subsidiaries will conduct any trading
activity which is significant in the context of its group as a whole;
* the Company will avoid cross-financing between businesses forming part of
its investment portfolio;
* the Company will avoid the operation of common treasury functions as
between the Company and investee companies;
* not more than 10 per cent, in aggregate, of the Company's NAV will be
invested in other listed closed-ended investment funds; and
* the Company must, at all times, invest and manage its assets in a way
which is consistent with its object of spreading investment risk and in
accordance with the published investment policy. The Directors do not
currently intend to propose any material changes to the Company's investment
policy, save in the case of exceptional or unforeseen circumstances. As
required by the Listing Rules, any material change to the investment policy
of the Company will be made only with the approval of shareholders.
Financial Highlights
Key Highlights Year ended Year ended
31 December 2018 31 December 2017
NAV per Ordinary Share 102.66 p 102.17 p
Share Price 102.00 p 109.50 p
NAV total return(1) 7.1% 7.2%
Share Price total return(1) (1.0%) 7.6%
Total Net Assets GBP385.0 m GBP383.1 m
Loans advanced at amortised GBP413.4 m GBP370.0 m
cost (including accrued
income)
Financial assets held at fair GBP21.9 m GBP22.1 m
value through profit or loss
(including associated accrued
income)
Cash and Cash Equivalents GBP28.2 m GBP11.8 m
Amount drawn under Revolving GBP68.8 m GBP13.3 m
Credit Facility (excluding
accrued interest)
Dividends per Ordinary Share 6.5 p 6.5 p
Invested Loan Portfolio 7.4% 7.5%
unlevered annualised total
return(1)
Invested Loan Portfolio 8.0% 7.7%
levered annualised total
return(1)
Ongoing charges percentage(1) 1.1% 1.0%
Weighted average portfolio LTV 16.7% 14.5%
to Group first GBP(1)
Weighted average portfolio LTV 64.1% 63.2%
to Group last GBP(1)
(1) Further explanation and definitions of the calculation is contained in
the section "Alternative Performance Measures" at the end of this financial
report.
SHARE PRICE PERFORMANCE
As at 31 December 2018 the NAV was 102.66 pence per Ordinary Share (2017:
102.17 pence) and the share price was 102.00 pence (2017: 109.50 pence).
Source: Thomson Reuters
Chairman's Statement
STEPHEN SMITH | Chairman
25 March 2019
Dear Shareholder,
It is my pleasure to present the Annual Report and Audited Consolidated
Financial Statements of Starwood European Real Estate Finance Limited for
the year ended 31 December 2018.
OVERVIEW
The Group had another successful origination year in 2018 with GBP208 million
of new commitments made to borrowers. With repayments and amortisation at a
more typical level than in 2017, net commitments increased by GBP70.8 million
during the year.
The Group declared an aggregate dividend for the year of 6.5 pence per
Ordinary Share. The Group's NAV for the year remained stable and NAV total
return (including dividends) was 7.0 per cent. The Company's share price
total return across the financial year was 1.0 per cent downward, reflecting
weaker equity market sentiment generally across several asset classes in
late 2018.
As at 31 December 2018, the Group had investments and commitments of GBP477.2
million (of which GBP45.5 million was committed but unfunded at the end of the
year). The average maturity of the Group's loan book was 2.8 years. The
Group had net debt of GBP40.6 million leaving unused liquidity facilities of
GBP73 million, available to fund undrawn commitments and new lending. The
gross annualised levered total return of the invested loan portfolio was 8.0
per cent. The Net Asset Value ("NAV") was GBP385.0 million, being 102.66 pence
per Ordinary Share.
The table below shows the loan commitment and repayment profile over the
last five years.
2014 2015 2016 2017 2018
New loans to GBP143.2m GBP118.7m GBP175.9m GBP245.8m GBP208.0m
borrowers
(commitment)
Loan repayments and -GBP48.8m -GBP49.0m -GBP129.3m -GBP213.1m -GBP137.2m
amortisation
Net Investment GBP94.4m GBP69.7m GBP46.6m GBP32.7m GBP70.8m
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The Group continues to see good opportunities to deploy capital in the
target markets. The origination pipeline is healthy, with a number of
transactions under review which present attractive risk adjusted returns.
The Group is cautious about raising equity until it is confident that
appropriate transactions may be closed in sufficient volume to at least
match an underlying repayment trend averaging 35 to 40 per cent of the loan
book per annum. New loan closings and repayments tend to be irregular and
are often dependent on factors outside the Group's control, though there is
a trend towards greater activity pre-holidays in Easter, summer and
Christmas. The Group will continue to closely monitor markets and will
adjust its capital structure and its appetite for new loans consistent with
the availability of suitable investment opportunities.
SHARE ISSUANCE AND SHARE PRICE PERFORMANCE
The year end share price was 102 pence reflecting a 0.7 per cent discount to
NAV. The Company has typically traded at around a 4 to 8 per cent premium in
the last few years. We believe this recent downward movement is a reflection
of general market sentiment, particularly towards the end of the year, and
we note that the share price has moved back to a premium in early 2019.
At the last Annual General Meeting ("AGM"), the Company sought and received
authority to disapply Pre- Emption Rights on the allotment of equity
securities for up to 10 per cent of the Ordinary Shares in issue and, at an
Extraordinary General Meeting ("EGM") convened shortly thereafter, for a
further 10 per cent. As at the date of this report, this authority has not
been utilised.
The Company intends to seek approval to renew these authorities at the
upcoming AGM and EGM. As noted above, the Company is currently GBP40.6 million
drawn on its revolving credit facilities of GBP114 million (net of cash), with
GBP45.5 million of commitments unfunded, meaning it has approximately GBP28
million of available capacity which is undrawn on its revolving credit
facilities (absent of any repayments). If the net investment in 2019 is at a
similar level to 2018 (GBP70.8 million) then the Company would need to issue
more than 10 per cent of existing Ordinary Shares to fund the additional
commitments.
The Directors believe that having access to capital within a short time
frame is important to maintaining access to attractive investment
opportunities while at the same time ensuring that the Company does not
unnecessarily incur cash drag by raising equity in advance of deployment
opportunities (which could negatively impact the Company's dividend target).
The Directors believe that such access to capital will also have the
following benefits for the Company and the shareholders:
* to enable the Company to pursue larger investment opportunities and hence
broaden the range of lending that can be undertaken;
* to enable the Company to further increase the diversification of the
Company's portfolio of investments;
* increasing the size of the Company should help to make the Company more
attractive to a wider investor base;
* having a greater number of Shares in issue is likely to provide
shareholders with increased secondary market liquidity; and
* the Company's fixed running costs would be spread across a larger equity
capital base, thereby reducing the Company's ongoing expenses per Share.
In order to take advantage of such opportunities, the Directors believe it
is appropriate for the Company to renew these existing authorities at the
forthcoming AGM, in respect of issuance of up to 10 per cent of the Ordinary
Shares in issue, and at a separate EGM, to be convened for shortly after the
AGM, in respect of issuance of a further 10 per cent. Any new Shares issued
will be issued at a minimum issue price equal to the prevailing NAV per
ordinary Share at the time of allotment together with a premium intended to
cover the costs and expenses of the relevant issue.
The explanation of the advantages for the Company and its shareholders of
granting such authorities is set out in the Notice of the AGM and in a
notice of EGM which is intended to be published shortly.
DIVIDENDS
Total dividends of 6.5 pence per Ordinary Share were declared in relation to
the year ended 31 December 2018.
Dividend Payment Amount
Period declared date per share
1 January 2018 to 31 March 2018 16 Apr 2018 17 May 1.625p
2018
1 April 2018 to 30 June 2018 27 Jul 2018 31 Aug 1.625p
2018
1 July 2018 to 30 September 23 Oct 2018 16 Nov 1.625p
2018 2018
1 October 2018 to 31 December 23 Jan 2018 22 Feb 1.625p
2018 2019
Total 6.5p
NEW ACCOUNTING STANDARDS
IFRS 9 "Financial Instruments" became effective for annual periods beginning
on or after 1 January 2018. The Group has applied IFRS 9 retrospectively
which did not result in a change to the classification or measurement of
financial instruments. A detailed description of IFRS 9 adoption is provided
in Note 2(b)(i) of these consolidated financial statements.
BREXIT AND MACRO-ECONOMIC OUTLOOK
The United Kingdom's imminent departure from the European Union, with or
without an agreement, represents a potential threat to the UK economy as
well as wider Europe. On a cyclical view, national economies across Europe
appear to be heading at best towards lower growth and in some cases towards
recession. The potential impact of Brexit could have a further destabilising
effect.
To some extent the potential impact of an unsatisfactory UK exit from the EU
has already been priced into markets and forecasts, but significant
headwinds could arise should there be an unstructured settlement. It is
extremely difficult in the circumstances to anticipate the potential impact
on markets, so your Board is keeping a particularly watchful eye on the
macro position.
PORTFOLIO OUTLOOK
The strategy to incrementally grow the overall size of the Group, to
minimise cash drag from repayments and to use the revolving credit facility
where appropriate, will continue to be our focus during 2019.
We anticipate that we will build on the successes of the recent past and the
Directors remain optimistic about the prospects and opportunities for the
Group in the year ahead.
The Board will continue to inform you of progress by way of the quarterly
fact sheets and investment updates as deals are signed. On behalf of the
Board, I would like to close by thanking Shareholders for your commitment
and I look forward to briefing you on the Group's progress later this year.
Stephen Smith | Chairman
25 March 2019
Strategic and Business Review
Strategic Report
The Strategic Report describes the business of the Group and details the
principal risks and uncertainties associated with its activities.
OBJECTIVE, INVESTMENT POLICY AND BUSINESS MODEL
The Objective and Investment Policy describes the Group's strategy and
business model.
The Investment Manager is Starwood European Finance Partners Limited, a
Company incorporated in Guernsey with registered number 55819 and regulated
by the Guernsey Financial Services Commission (the "Commission"). The
Investment Manager has appointed Starwood Capital Europe Advisers, LLP (the
"Investment Adviser"), an English limited liability partnership authorised
and regulated by the Financial Conduct Authority, to provide investment
advice, pursuant to an Investment Advisory Agreement.
CURRENT AND FUTURE DEVELOPMENT
A review of the year and outlook is contained in the Investment Highlights
and Portfolio Review sections of the Investment Manager's Report and within
the Chairman's Statement.
PERFORMANCE
A review of performance is contained in the Investment Highlights and
Portfolio Review sections of the Investment Manager's Report.
A number of performance measures are considered by the Board, the Investment
Manager and Investment Adviser in assessing the Company's success in
achieving its objectives. The Key Performance Indicators ("KPIs") used are
established industry measures to show the progress and performance of the
Group and are as follows:
* The portfolio yield, both levered and unlevered;
* The payment of targeted dividends;
* The movement in NAV per Ordinary Share;
* The movement in share price and the discount / premium to NAV;
* Ongoing charges as a percentage of undiluted NAV; and
* Weighted average loan to value for the portfolio.
Details of the KPIs are shown in Financial Highlights section.
RISK MANAGEMENT
It is the role of the Board to review and manage all risks associated with
the Group, both those impacting the performance and the prospects of the
Group and those which threaten the ongoing viability. It is the role of the
Board to mitigate these either directly or through the delegation of certain
responsibilities to the Audit Committee and Investment Manager. The Board
performs a review of a risk matrix at each Board meeting.
The Board considers the following principal risks could impact the
performance and prospects of the Group but do not threaten its ability to
continue in operation and meet its liabilities. Consequently, it has put in
place mitigation plans to manage those identified risks.
Long Term Strategic Risk
The Group's targeted returns are based on estimates and assumptions that are
inherently subject to significant business and economic uncertainties and
contingencies and, consequently, the actual rate of return may be materially
lower than the targeted returns. In addition, the pace of investment has in
the past and may in the future be slower than expected or the principal on
loans may be repaid earlier than anticipated, causing the return on affected
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investments to be less than expected. Furthermore, if repayments are not
promptly re- invested this may result in cash drag, which may lower
portfolio returns. As a result, the level of dividends to be paid by the
Company may fluctuate and there is no guarantee that any such dividends will
be paid. The shares may, therefore, trade at a discount to NAV per share and
shareholders may be unable to realise their investments through the
secondary market at NAV per share.
The Board monitors the level of premium or discount of share price to NAV
per share. While the Directors may seek to mitigate any discount to NAV per
share through the discount management mechanisms set out in this Annual
Report, there can be no guarantee that they will do so or that such
mechanisms will be successful. Please see Report of the Directors for
further information on the discount management mechanisms.
The Investment Adviser provides the Investment Manager and the Board with a
weekly report on pipeline opportunities, which includes an analysis of the
strength of the pipeline and the returns available. The Directors also
regularly receive information on the performance of the existing loans,
including the performance of the underlying assets and the likelihood of any
early repayments, which may impact returns.
The Board monitors investment strategy and performance on an ongoing basis
and regularly reviews the Investment Objective and Investment Policy in
light of prevailing investor sentiment to ensure the Company remains
attractive to its shareholders.
Interest Rate Risk
The Group is subject to the risk that the loan income and income from the
cash and cash equivalents will fluctuate due to movements in interbank
rates.
The loans in place at 31 December 2018 have been structured so that 19.9 per
cent of the loans are fixed rate, which provides protection from downward
interest rate movements to the overall portfolio (but also prevents the
Group from benefitting from any interbank rate rises on these positions). In
addition, whilst the remaining 80.1 per cent is classified as floating, 93.7
per cent of these loans are subject to interbank rate floors such that the
interest cannot drop below a certain level, which offers some protection
against downward interest rate risk. When reviewing future investments, the
Investment Manager will continue to review such opportunities to protect
against downward interest rate risk.
The Board considers that the following principal risks could impact both the
performance and prospects of the Group and could also threaten its ability
to continue its operations and meet its liabilities but has identified the
mitigating actions in place to manage them.
Foreign Exchange Risk
The majority of the Group's investments are Euro denominated. The Group is
subject to the risk that the exchange rates move unfavourably and that a)
foreign exchange losses on the loan principal are incurred and b) that
interest payments received are lower than anticipated when converted back to
Sterling and therefore returns are lower than the underwritten returns.
The Group manages this risk by entering into forward contracts to hedge the
currency risk. All non-Sterling loan principal is hedged back to Sterling to
the maturity date of the loan. Interest payments are hedged for the period
for which prepayment protection is in place. However, the risk remains that
loans are repaid earlier than anticipated and forward contracts need to be
broken early. In these circumstances, the forward curve may have moved since
the forward contracts were placed which can impact the rate received. In
addition, if the loan repays after the prepayment protection, interest after
the prepayment-protected period may be received at a lower rate than
anticipated leading to lower returns for that period. Conversely, the rate
could have improved and returns may increase.
As a consequence of the hedging strategy employed as outlined above, the
Group is subject to the risk that it will need to post cash collateral
against the mark to market on foreign exchange hedges which could lead to
liquidity issues or leave the Group unable to hedge new non-Sterling
investments.
The Company had approximately GBP264.8 million of hedged notional exposure
with two UK banks at 31 December 2018 (converted at 31 December 2018 foreign
exchange ("FX") rates).
As at 31 December 2018 the hedges with one of the counterparties was out of
the money in an amount of GBP8.8 million. If at any time this mark to market
exceeds GBP15 million, the Company is required to post collateral, subject to
a minimum transfer amount of GBP1 million. This situation is monitored
closely, however, and as at 31 December 2018, the Company had sufficient
liquidity and credit available on the revolving credit facility to meet any
cash collateral requirements.
Market Deterioration Risk
As mentioned earlier Brexit might have a destabilising impact on the UK
economy and wider European economy as well.
The Group's investments are comprised principally of debt investments in the
UK, and the wider European Union's internal market and it is therefore
exposed to economic movements and changes in these markets. Any
deterioration in the global, UK or European economy could have a significant
adverse effect on the activities of the Group and may result in significant
loan defaults or impairments.
In the event of a loan default in the portfolio, the Group is generally
entitled to accelerate the loan and enforce security, but the process may be
expensive and lengthy and the outcome is dependent on sufficient recoveries
being made to repay the borrower's obligations and associated costs. Some of
the investments held would rank behind senior debt tranches for repayment in
the event that a borrower defaults, with the consequence of greater risk of
partial or total loss. In addition, repayment of loans by the borrower at
maturity could be subject to the availability of refinancing options,
including the availability of senior and subordinated debt and is also
subject to the underlying value of the real estate collateral at the date of
maturity.
In mitigation, the average weighted loan to value of the portfolio is 64.1
per cent. Therefore, the portfolio should be able to withstand a significant
level of deterioration before credit losses are incurred.
The Investment Adviser also mitigates the risk of credit losses by
undertaking detailed due diligence on each loan. Whilst the precise scope of
due diligence will depend on the proposed investment, such diligence will
typically include independent valuations, building, measurement and
environmental surveys, legal reviews of property title and key leases, and,
where necessary, mechanical and engineering surveys, accounting and tax
reviews and know your customer checks.
The Investment Adviser, Investment Manager and Board also manage these risks
by ensuring a diversification of investments in terms of geography, market
and type of loan. The Investment Manager and Investment Adviser operate in
accordance with the guidelines, investment limits and restrictions policy
determined by the Board. The Directors review the portfolio against these
guidelines, limits and restrictions on a regular basis.
The Investment Adviser meets with all borrowers on a regular basis to
monitor developments in respect of each loan and reports to the Investment
Manager and the Board periodically and on an ad hoc basis where considered
necessary.
The majority of the Group's loans are held at amortised cost with only one
investment (the credit linked notes) held at fair value through profit or
loss at the reporting period end. The performance of each loan is reviewed
quarterly by the Investment Adviser for any indicators of significant
increase in credit risk, impaired or defaulted loans. The Investment Adviser
also provides their assessment of any expected credit loss for each loan
advanced. The results of the performance review and allowance for expected
credit losses are discussed with the Investment Manager and the Board.
Risk of Default Under the Revolving Credit Facilities
The Group is subject to the risk that a borrower could be unable or
unwilling to meet a commitment that it has entered into with the Group as
outlined above under market deterioration risk. As a consequence of this,
the Group could breach the covenants of its revolving credit facilities, and
fall into default itself.
A number of the measures the Group takes to mitigate market deterioration
risk as outlined above, such as portfolio diversification and rigorous due
diligence on investments and monitoring of borrowers, will also help to
protect the Group from the risk of default under the revolving credit
facility as this is only likely to occur as a consequence of borrower
defaults or loan impairments.
The Board regularly reviews the balances drawn under the credit facility
against commitments and pipeline and reviews the performance under the
agreed covenants. The loan covenants are also stress tested to test how
robust they are to withstand default of the Group's investments.
ASSESSMENT OF PROSPECTS
The Group's strategy is central to an understanding of its prospects. The
Group's focus is particularly on managing expected repayments in order to
minimise any potential for cash drag and continuing to grow the Group by
sourcing investments with good risk adjusted returns. The Group's prospects
are assessed primarily through its strategic review process, which the Board
participates fully in. The Directors' have assessed the prospect of the
Group over a period of three years which has been selected because the
strategic review covers a three-year period and this is also the approximate
average remaining loan term. The Group updates its plan and financial
forecasts on a monthly basis and detailed financial forecasts are maintained
and reviewed by the Board regularly.
ASSESSMENT OF VIABILITY
(MORE TO FOLLOW) Dow Jones Newswires
March 26, 2019 03:05 ET (07:05 GMT)
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