DJ SWEF: Half Yearly Report 30 June 2020
Starwood European Real Estate Finance Ltd (SWEF)
SWEF: Half Yearly Report 30 June 2020
09-Sep-2020 / 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.
Starwood European Real Estate Finance Limited
Interim Financial Report and Unaudited Condensed
Consolidated Financial Statements
for the six-month period from 1 January 2020 to 30 June 2020
CONTENTS
Overview
Corporate Summary 2
Chairman's Statement 3
Investment Manager's Report 6
Principal Risks 18
Governance
Board of Directors 20
Statement of Directors' Responsibilities 21
Financial Statements
Independent Review Report 23
Unaudited Condensed Consolidated Statement of Comprehensive 24
Income
Unaudited Condensed Consolidated Statement of Financial 25
Position
Unaudited Condensed Consolidated Statement of Changes in 26
Equity
Unaudited Condensed Consolidated Statement of Cash Flows 27
Notes to the Unaudited Condensed Consolidated Financial 28
Statements
Further Information
Corporate Information 44
Overview
Corporate Summary
PRINCIPAL ACTIVITIES AND 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, focusing on Northern and Southern Europe.
Whilst investment opportunities in the secondary market are considered, the
Group's main focus is to originate direct primary real estate debt
investments.
The Group seeks to limit downside risk by focusing on secured debt with both
quality collateral and contractual protection. The typical loan term is
between three and seven years.
The Group aims to be appropriately diversified by geography, real estate
sector, loan type and counterparty. The Group pursues 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.
STRUCTURE
The Company was incorporated with limited liability in Guernsey under the
Companies (Guernsey) Law, 2008, as amended, on 9 November 2012 with
registered number 55836, and has been authorised by the Guernsey Financial
Services Commission ("GFSC") as a registered closed-ended investment
company. The Company's ordinary shares were first admitted to the premium
segment of the UK Listing Authority's Official List and to trading on the
Main Market of the London Stock Exchange as part of its initial public
offering which completed on 17 December 2012. Further issues took place in
March 2013, April 2013, July 2015, September 2015, August 2016 and May 2019.
The issued capital during the period comprises the Company's Ordinary Shares
denominated in Sterling.
The Company makes its investments through Starfin Lux S.à.r.l (indirectly
wholly-owned via a 100% shareholding in Starfin Public Holdco 1 Limited),
Starfin Lux 3 S.à.r.l and Starfin Lux 4 S.à.r.l (both indirectly
wholly-owned via a 100% shareholding in Starfin Public Holdco 2 Limited).
The Investment Manager is Starwood European Finance Partners Limited (the
"Investment Manager"), a company incorporated in Guernsey with registered
number 55819 and regulated by the GFSC. 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.
Chairman's Statement
Dear Shareholder,
I am delighted to present the Interim Financial Report and Unaudited
Condensed Consolidated Financial Statements of Starwood European Real Estate
Finance Limited (the "Group") for the period from 1 January 2020 to 30 June
2020.
INVESTMENT MOMENTUM
The table below summarises the new commitments made and repayments received
in the first six months of each year from 2016 to 2020.
New Repayments & Net Increase in
Commitments Amortisation Commitments
H1 2016 GBP98.9m (GBP92.1m) GBP6.8m
H1 2017 GBP115.5m (GBP85.2m) GBP30.3m
H1 2018 GBP147.5m (GBP74.1m) GBP73.4m
H1 2019 GBP49.9m (GBP45.9m) GBP4.0m
H1 2020 GBP72.7m (GBP65.3m) GBP7.4m
The net increase in commitments during the first half of 2020, whilst still
positive, has been modest. This is not surprising as market activity reduced
significantly due to the Covid-19 pandemic. Repayments were similar to
previous years and the majority occurred in the first quarter, pre lockdown
though the credit linked notes repaid at the end of the second quarter.
Importantly, the Group remains fully invested supporting the Company's
income generation.
We normally anticipate that around 30-40 per cent of loans will repay in an
average year. As things stand we would expect this figure to be lower during
2020 as it may take borrowers longer to sell or execute business plans and
opportunities to refinance following completion of plans may be more
limited. The Company expects all scheduled payments to be made on time and
in accordance with their respective initial or amended terms, as applicable.
STEPHEN SMITH | Chairman
8 September 2020
NAV AND SHARE PRICE PERFORMANCE
The NAV of the Group remained relatively stable over the first half of the
year. Notably, the Company has not experienced any defaults or increase in
expected credit losses during the period of market dislocation and
importantly all scheduled interest payments have been received on time. The
Company has delivered a NAV total return during the period of 4 per cent.
We would not expect to see significant movements in NAV as the Group's loans
are held at amortised cost and Euro exposures are hedged. The NAV would only
be materially impacted if there was an increase in credit risk which
resulted in an expected credit loss or actual default. Please refer to the
Investment Manager's report on page 10 for further useful information on the
accounting for our loans and an assessment of expected credit losses for the
period ended 30 June 2020. The Investment Manager also presents an analysis
of the potential fair values of the loans against the amortised cost that is
reflected in these financial statements.
At 30 June 2020, the share price traded at a significant discount to NAV of
17 per cent which has improved from the historic low (of 63.4 pence per
share) experienced during the Covid-19 crisis. However, the Board and the
Investment Adviser believe the shares represent very attractive value at
this level and members of the Investment Adviser team and the Board have
made personal purchases during the quarter, as disclosed by the Group.
The Company received authority at the recent AGM to purchase up to 14.99 per
cent of the Ordinary Shares in issue on 8 June 2020. The Directors continue
to closely and regularly monitor the discount to NAV and on 10th August we
announced the appointment of Jefferies International Limited as buy-back
agent to effect share buy backs on behalf of the Company. This engagement
lasts until 31 December 2020 and any share buyback will be subject to
sufficient cash being available to cover commitments to borrowers, working
capital or the payment of dividends. As at 8 September 2020 the Company had
repurchased 872,000 Ordinary Shares at an average price of 85.35 pence per
share. These shares are being held in Treasury.
DIVIDENDS
The Directors declared a dividend in respect of the first two quarters of
2020 of 1.625 pence per Ordinary Share, equating to an annualised 6.5 pence
per annum. This was approximately 0.9x covered by earnings excluding
unrealised FX gains. With the current portfolio, we expect the dividend
cover to reduce to approximately 0.87x during the second half of the year.
The Board and Investment Adviser recognise the importance of stable and
predictable dividends for our shareholders. Accordingly, we held a dividend
reserve (within retained earnings) built up over several years which we have
been using to maintain the annual dividend at 6.5 pence per share over the
last eighteen months even though the dividend has not been covered by
earnings more recently. As a result, dividends have not, to date, been paid
out of capital reserves. The Company intends to continue to use the
remaining dividend reserve to maintain the annual dividend at 6.5 pence per
share for the rest of 2020 which will leave a small dividend reserve
remaining.
In the period since the Group's inception, the Bank of England base rate has
reduced from 0.50 per cent to 0.10 per cent. The average 5 year GBP swap
rate from inception to year end 2019 was 1.16 per cent, compared to 0.13 per
cent at 30 June 2020 representing a fall of over 1 per cent on average. At
inception LIBOR / EURIBOR might have contributed up to 10 per cent of the
company's underlying return profile, today it makes up less than 1 per cent.
In light of this declining interest rate environment, from 1 January 2021
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the Group intends to reduce the dividend target to 5.5 pence per annum
(payable quarterly) which, in the Board and the Investment Adviser's view,
is a sustainable level and which should be fully covered by earnings whilst
ensuring we maintain our strong credit discipline and risk management. The
share price at 30 June 2020, assuming a dividend of 5.5 pence per annum
would deliver an attractive 6.4 per cent yield (this equates to a 5.3 per
cent yield on NAV at 30 June 2020).
BOARD COMPOSITION AND DIVERSITY
The Board previously mentioned that it is mindful of the need to plan for
succession and to implement this in a timely and constructive fashion that
supports and builds on a cohesive Board. On 3 August 2020 the Company
announced the appointment of Shelagh Mason with effect from 1 September 2020
and Charlotte Denton with effect from 1 January 2021 as Non-Executive
Directors of the Company.
The new appointments are in accordance with the Board's Succession Planning
Memorandum which states that a new Director will be appointed to the Board
during the second half of 2020 allowing time for induction prior to Mr.
Jonathan Bridel standing down from the Board in December 2020. In addition,
the Company has decided that it is appropriate to make a second new
appointment to add to the Company's skills, experience and diversity as well
as to assist in the succession process when I retire from the Board in
December 2021 and when Mr. John Whittle stands down in December 2022. The
Board believes in the value and importance of diversity in the boardroom and
it continues to consider the recommendations of the Davies Report which will
be a key factor in its succession planning.
We are pleased that Shelagh and Charlotte have accepted these appointments
to the Board and the Company believes that as the succession plan unfolds
the Board will be fully equipped with the necessary skills, experience,
knowledge and diversity to continue to grow a successful business in the
coming years. The Board believes that it has addressed concerns expressed by
shareholders at this year's AGM.
GOING CONCERN
Under the UK Corporate Governance Code and applicable regulations, the
Directors are required to satisfy themselves that it is reasonable to assume
that the Group is a going concern.
The Directors have undertaken a rigorous review of the Group's ability to
continue as a going concern including assessing the possible impact of the
Covid-19 pandemic on the Group's portfolio, a review of the ongoing cash
flows and the level of cash balances as of the reporting date as well as
forecasts of future cash flows. After making enquiries of the Investment
Manager and the Administrator and having reassessed the principal risks, the
Directors have a reasonable expectation that the Group has adequate
resources to continue in operational existence for at least one year from
the date the unaudited consolidated financial statements were signed. A
range of scenarios have been evaluated as part of this analysis. The worst
case scenario evaluated was an interest payment default on all hotel and
retail loans. In this scenario the company is still able to meet its
liabilities as they fall due although the dividend would need to be reduced
to reflect the reduced cash received. Accordingly, the Directors continue to
adopt a going concern basis in preparing the Interim Financial Report and
Unaudited Condensed Consolidated Financial Statements.
COVID-19 AND OUTLOOK
The Board is pleased that the robust underwriting, initial loan structuring
and active asset management of the Investment Manager and Adviser during
this turbulent time has contributed significantly to a very robust
performance during the period. The Investment Manager and Adviser have
actively engaged with our borrowers during this time when amendments and
waivers under loan documentation have been required due to the disruption to
business plans. Just under a quarter of the portfolio has required some sort
of amendment or waiver as a result of Covid-19 with most waivers required in
respect of income based covenants. However, despite this, all interest has
been paid in full and on time and although in many cases credit risk may
have changed and some loans have moved from Stage 1 to Stage 2, no
impairments have been required. Importantly, we expect interest payments to
continue to be paid, in full, based on the forecast and for conditions to
gradually improve if lockdown continues to be relaxed across the UK and
Europe. For further information on the performance of the various components
of the portfolio during Covid-19 please refer to the Investment Managers
report on page 7.
The Investment Adviser expects to see a strong pipeline of opportunities as
the markets begin to stabilise and will continue to apply its rigorous
approach to the selection of appropriate opportunities as it re-invests
capital into new opportunities. At 30 June 2020, the Group was very modestly
levered with net debt of GBP15.1 million (3.5 per cent of NAV) and undrawn
revolving credit facilities of GBP101.9 million to fund the Group's existing
commitments of GBP67.2 million. If the Group does not receive any further
repayments this year, it means the Group has approximately GBP44 million of
capacity for new loans.
The Board believes that the Company is well placed and that its portfolio
and investment pipeline should, over the long term, continue to deliver an
attractive risk-adjusted return. I would like to close by thanking you for
your commitment and support.
Stephen Smith
Chairman
8 September 2020
Investment Manager's Report
CONTINUED INVESTMENT DEPLOYMENT
As at 30 June 2020, the Group had 18 investments and commitments of GBP514.7
million as follows:
Sterling Sterling equivalent
equivalent unfunded commitment (1)
balance (1)
Hospitals, UK GBP25.0m -
Hotel & Residential, UK GBP49.9m -
Office, Scotland GBP4.6m GBP0.4m
Office, London GBP13.0m GBP7.6m
Residential, London GBP37.0m GBP2.7m
Hotel, Oxford GBP16.7m GBP6.3m
Hotel, Scotland GBP25.9m GBP15.5m
Hotel, North Berwick GBP10.5m GBP4.5m
Logistics Portfolio, UK (2) GBP12.0m -
Total Sterling Loans GBP194.6m GBP37.0m
Three Shopping Centres, GBP34.1m GBP5.9m
Spain
Shopping Centre, Spain GBP15.6m -
Hotel, Dublin, Ireland GBP55.0m -
Hotel, Spain GBP40.1m GBP9.5m
Office & Hotel, Madrid GBP17.0m GBP0.9m
Mixed Portfolio, Europe GBP31.3m -
Mixed Use, Dublin GBP2.0m GBP11.5m
Office Portfolio, Spain GBP19.6m GBP2.4m
Office Portfolio, Dublin GBP32.2m -
Logistics Portfolio, GBP6.0m -
Germany (2)
Total Euro Loans GBP252.9m GBP30.2m
Total Portfolio GBP447.5m GBP67.2m
(1) Euro balances translated to sterling at period-end exchange rate.
(2) Logistics Portfolio, UK and Logistics Portfolio, Germany is one single
loan agreement with sterling and Euro tranches.
Between 1 January 2020 to 30 June 2020, the following significant investment
activity occurred (included in the table above):
NEW LOAN: OFFICE PORTFOLIO, DUBLIN:
On 2 January 2020, the Group committed to an investment in a c. 6 year
floating rate loan secured by a portfolio of assets in Ireland, together
with Starwood Property Trust, Inc (through a wholly owned subsidiary)
participating in 50 per cent of the mezzanine loan amount, providing the
Group with a commitment of &euro35.15 million. The portfolio consists of 12
high occupancy properties in Central Dublin with primarily office and some
small amounts of retail and residential space totalling over 600,000 sqf in
total.
NEW LOAN: HOTEL, NORTH BERWICK, SCOTLAND:
On 12th February 2020, the Group committed to fund a hotel acquisition
financing for a commitment of GBP15.0 million. The sponsor is a repeat
borrower for the Group. The financing, which was provided in the form of a
significant initial advance to finance an asset acquisition together with a
smaller capex facility, will support the sponsor's capital expenditure for
improvement and rebranding of the hotel. The day one advance amount is GBP10.5
million whilst the total commitment is GBP15.0 million. The loan is for a term
of 5 years.
LOAN UPSIZE: HOTEL & RESIDENTIAL, UK:
On 27th February 2020 the Group also committed to fund a GBP20.0 million
upsize to an existing fixed rate mezzanine loan to support the development
of a mixed-use scheme in London. Starwood Property Trust, Inc (through a
wholly owned subsidiary) is participating in 50 per cent of the loan amount,
providing the Group with a commitment of GBP10.0 million.
NEW LOAN: LOGISTICS, UK AND GERMANY:
On 17 June 2020, the Group closed an investment in the funding of a
&euro71.9 million, 36 month floating rate senior loan secured by a portfolio
of industrial/logistics assets in the UK and Germany. The investment was
made alongside Starwood Property Trust, Inc (through a wholly owned
subsidiary) with the Group participating in &euro20 million (27.8 per cent)
of the senior loan amount. The Group expects the transaction to generate
attractive risk-adjusted returns, in line with its stated investment
strategy.
Loan Repayments & Amortisation: the following material loan repayments and
material amortisation were received during the first half:
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? a full and final repayment of the &euro16 million loan on an office in
Paris;
? &euro16.4 million of unscheduled amortisation on the loan on the mixed
portfolio;
? Full and final repayment of the mixed use development, South East UK loan
(approximately GBP700k) as the borrower completed their business plan;
? Credit Linked notes: a full and final repayment of the GBP21.8 million
balance. This repayment was earlier than the contractual settlement date but
was anticipated given the relatively high yield that was being earned on the
credit linked notes compared to the current market conditions; and
? Residential, London: GBP15.0 million of amortisation following the sale of
residential units
The Group also advanced GBP16.5 million to borrowers to which it has
outstanding commitments.
PORTFOLIO OVERVIEW IN LIGHT OF COVID-19
We have always had a detailed, hands on approach to asset management, almost
all our loans are direct origination with the borrowers. We therefore know
our borrowers well and we monitor the credit closely through the life of the
investments.
Typically, loans are structured in line with underwritten borrower business
plans. Financial and other milestone covenants are set and ratchet up over
time to track those business plans, which means that should underlying
performance start to deteriorate, early triggers are in place which
effectively allow us to review the position with the borrower and recommend
loan amendments or restructurings as appropriately tailored to each deal.
These loan structures, close relationships and monitoring have proved
particularly useful during Covid-19 where disruption to business plans has
resulted in requirements for amendments and waivers under loan
documentation.
Just under a quarter of the portfolio has required some form of amendment or
waiver as a result of Covid-19. As at the date of approval of the Unaudited
Condensed Consolidated Financial Statements, most waivers required were in
respect of income based covenants.
An example of this has been debt yield test or income covenant waivers to
allow for the disruption of hospitality assets performance. However it is
important to note that these deals are well capitalised with cash reserves
in place to fund forecast shortfalls of income and, no deal or project has
identified a funding shortfall in the medium term.
Amendments to-date have also included refurbishment or ground up
construction loans where loans are structured with required project
completion dates. Where construction progress has been hampered by either
mandatory government shutdowns or the introduction of Covid-compliant social
distancing measures, some milestones have been pushed out to account for the
time lost. Again, these deals are all adequately capitalised where any cost
increase identified as a result of on-site delays, has identified funding in
place.
All loan interest up to the date of publication has been paid in full and on
time and future interest payments are expected to be paid in full based on
the forecast gradual continued easing of lockdowns across the UK and Europe.
The performance of the portfolio has been robust during the Covid-19 crisis
and performance by sector is summarised below.
Hospitality (34.7 per cent of Investment Portfolio)
? Of the Group's investments, the hospitality industry has been most
affected by the Covid-19 pandemic.
? Four hotels, which equates to 40 per cent of hotels in the portfolio had
to close during the pandemic.
? All hotels are now open and operational, aside from the Hotel, Spain which
remains under construction and is due to achieve completion in Q3 2020. The
Hotel, Dublin has remained open and has benefited from a contract with the
Irish Health Authority during the pandemic.
? Every hospitality loan within the Group's loan book continued to pay
interest on time.
? All hospitality loans have adequate resources to meet their cash needs for
the medium term.
Retail (12.7 per cent of Investment Portfolio)
? The retail sector has also been hard hit by the Covid-19 pandemic. This is
on the back of a number of difficult trading years for the retail "bricks
and mortar" sector as a whole.
? Across Europe almost all non-essential retail assets were shut for a
number of months. These retail assets are now beginning to open once again
and starting to become operational.
? In some parts of the retail market we have witnessed footfall return to as
much as 70 per cent of its pre-Covid level. However, we do expect to see
more insolvencies across the sector as 2020 continues.
? The Group's retail investments are either a small part of a large
portfolio of mixed assets or benefit from robust loan structures including
interest / cash reserves which will enable the borrower to weather the storm
over the medium term.
Office, Industrial & Residential (47 per cent of Investment Portfolio)
? These three sectors have been the most resilient sectors during the
Covid-19 pandemic.
? Underlying office rent collections for loans with greater than 75 per cent
exposure to office remain strong at 96 per cent year to date.
? Residential sales have continued to progress well during the Covid-19
related disruption with a number of units being sold since 1 March 2020 at
premiums to underwritten values. The loan-to-value for this segment is 59.6
per cent.
? Underlying industrial loan rent collections remain strong at 100 per cent
year to date.
Construction (34 per cent of Investment Portfolio including some hospitality
and residential assets included above)
? Construction sites have continued to make progress during the Covid-19
pandemic.
? In the UK construction sites were able to remain open at all times. In
Spain and Ireland, construction sites were closed for 14 and 52 days
respectively.
? We expect to see more moderate delays to final completion in our
construction deals as a result of Covid-19.
? However, every deal remains fully funded by debt and equity with ample
contingencies and cost overrun protections to enable borrowers to mitigate
any Covid-19 impacts.
COMPANY PERFORMANCE
Share price, NAV and discount/premium
Source: Thomson Reuters
PORTFOLIO STATISTICS
As at 30 June 2020, the portfolio was invested in line with the Group's
investment policy. The key portfolio statistics are as summarised below.
Number of investments 18
Percentage of currently invested portfolio in floating 79.5%
rate loans
Invested Loan Portfolio unlevered annualised total 6.7%
return (1)
Portfolio levered annualised total return (2) 7.0%
Weighted average portfolio LTV - to Group first GBP (3) 18.4%
Weighted average portfolio LTV - to Group last GBP (3) 62.9%
Average loan term (stated maturity at inception) 4.4 years
Average remaining loan term 2.8 years
Net Asset Value GBP430.1m
Amount drawn under Revolving Credit Facilities (GBP24.1m)
(excluding accrued interest)
Loans advanced GBP448.9m
Cash GBP9.0m
Other net assets / (liabilities) (including hedges) (GBP3.8m)
Origination Fees - current quarter GBP0.1m
Origination Fees - last 12 months GBP1.9m
Management Fees - current quarter GBP0.8m
Management Fees - last 12 months GBP3.2m
1) The unlevered annualised total return is calculated on amounts
outstanding at the reporting date, excluding undrawn commitments, and
assuming all drawn loans are outstanding for the full contractual term. 14
of the loans are floating rate (partially or in whole and some with
floors) and returns are based on an assumed profile for future interbank
rates but the actual rate received may be higher or lower. Calculated only
on amounts funded at the reporting date and excluding committed amounts
(but including commitment fees) and excluding cash un-invested. The
calculation also excludes the origination fee payable to the Investment
Manager.
2) The levered annualised total return is calculated as per the unlevered
return but takes into account the amount of net leverage in the Group and
the cost of that leverage at current LIBOR/EURIBOR.
3) LTV to Group last GBP means the percentage which the total loan drawn
less any amortisation received to date (when aggregated with any other
indebtedness ranking alongside and/or senior to it) bears to the market
value determined by the last formal lender valuation received by the
reporting date. LTV to Group first GBP means the starting point of the loan
to value range of the loans drawn (when aggregated with any other
indebtedness ranking senior to it). For development projects the
calculation includes the total facility available and is calculated
against the assumed market value on completion of the relevant project.
The maturity profile of investments as at 30 June 2020 is shown below.
Principal value %
of loans of invested
Remaining years to contractual GBPm portfolio
maturity (1)
0 to 1 years 20.2 4.5%
1 to 2 years 133.2 29.8%
2 to 3 years 147.2 32.9%
3 to 5 years 89.7 20.0%
5 to 10 years 57.2 12.8%
Total 447.5 100.0%
1) Excludes any permitted extensions. Note that borrowers may elect to
repay loans before contractual maturity.
The Group continues to achieve good portfolio diversification as shown in
the graphs below:
% of invested assets
* the currency split refers to the underlying loan currency, however the
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capital on all non-sterling exposure is hedged back to sterling.
The Board considers that the Group is engaged in a single segment of
business, being the provision of a diversified portfolio of real estate
backed loans. The analysis presented in this report is presented to
demonstrate the level of diversification achieved within that single
segment. The Board does not believe that the Group's investments constitute
separate operating segments.
LIQUIDITY AND HEDGING
The Group is very modestly levered with net debt of GBP15.1 million (3.5 per
cent of NAV) at 30 June 2020, has no repo facilities outstanding and
significant liquidity available with undrawn revolving credit facilities of
GBP101.9 million to fund existing commitments as summarised below.
As at 30 June 2020 GBP million
Drawn on Group debt facilities (24.1)
Cash at hand 9.0
Net Debt (15.1)
Undrawn Debt Facilities available to Group 101.9
Undrawn Commitments to Borrowers (67.2)
Available Capacity 43.7
The way in which the Group's borrowing facilities are structured means that
it does not need to fund mark to market margin calls. The Group does have
the obligation to post cash collateral under its hedging facilities.
However, cash would not need to be posted until the hedges were more than
GBP20 million out of the money. The mark to market of the hedges at 30 June
2020 was GBP4.5 million (out of the money) and with the robust hedging
structure employed by the Group, cash collateral has never been required to
be posted since inception.
The Group has the majority of its investments currently denominated in Euros
(although this can change over time), although the Group is sterling
denominated. The Group is therefore subject to the risk that 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 functional and presentation currency of
the Group is sterling as capital is raised in sterling, it is listed on the
London Stock Exchange and the majority of expenses are sterling. The Group
focuses on the UK and Europe but at 30 June 2020 the investment portfolio is
slightly Euro dominant. The portfolio split between sterling and Euro will
fluctuate over time depending on where the best opportunities arise.
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 (unless it was funded using the revolving
credit facilities in which case it will have a natural hedge). Interest
payments are generally 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.
EXPECTED CREDIT LOSSES (IMPAIRMENT)
All loans within the portfolio are classified and measured at amortised cost
less impairment.
Under IFRS 9 a three stage approach for recognition of impairment is
applicable, based on whether there has been a significant deterioration in
the credit risk of a financial asset since initial recognition. These three
stages then determine the amount of impairment provision recognised.
At Initial Recognition Recognise a loss allowance equal
(if asset is not credit to 12 months expected credit
impaired) losses resulting from default
events that are possible within
12 months.
After initial recognition:
Stage 1 Credit risk has not increased
significantly since initial
recognition. Recognise 12 months
expected credit losses.
Interest income is recognised by
applying the effective interest
rate to the gross carrying
amount of financial assets.
Stage 2 Credit risk has increased
significantly since initial
recognition. Recognise lifetime
expected losses.
Interest income is recognised by
applying the effective interest
rate to the gross carrying
amount of financial assets.
Stage 3 Credit impaired financial asset.
Recognise lifetime expected
losses.
Interest income is calculated by
applying the effective interest
rate to their amortised cost
(that is net of expected loss
provision).
The Group has not recognised expected credit losses at initial recognition
on any of its loans due to the detailed and conservative underwriting
undertaken, robust loan structures in place and a strong equity cushion with
an average LTV of 62.9 per cent (based on the latest available valuation for
each asset).
Stage 2: Significant increase in credit risk
The Group uses both quantitative and qualitative criteria which is monitored
no less than quarterly in order to assess whether an increase in credit risk
has occurred. Increased credit risk would be considered if, for example, all
or a combination of the following has occurred:
? underlying income performance is at a greater than 10 per cent variance to
the underwritten loan metrics;
? loan to value is greater than 75-80 per cent;
? loan to value or income covenant test results are at a variance of greater
than 5-10% of loan default covenant level (note that loan default covenant
levels are set tightly to ensure that an early cure is required by the
borrower should they breach which usually involves decreasing the loan
amount until covenant tests are passed);
? late payments have occurred and not been cured within 3 days;
? loan maturity date is within six months and the borrower has not presented
an achievable refinance or repayment plan;
? covenant and performance milestones criteria under the loan have required
more than two waivers;
? increased credit risk has been identified on tenants representing greater
than 25 per cent of underlying asset income;
? income rollover / tenant break options exist such that a lease up of more
than 30 per cent of underlying property will be required within 12 months in
order to meet loan covenants and interest payments; and
? borrower management team quality has adversely changed.
Stage 3: Non-performing assets
Non-performing financial assets would be classified in Stage 3, which is
fully aligned with the definition of credit- impaired, when one or more of
the following has occurred:
? the borrower is in breach of all financial covenants;
? the borrower is in significant financial difficulty; and
? it is becoming probable that the borrower will enter bankruptcy.
An instrument is considered to have been cured, that is no longer in
default, when it no longer meets any of the default criteria for a
sufficient period of time.
At the end of 2019 all loans were classified as Stage 1. As at 30 June 2020
six loans with a value of 33 per cent of NAV have moved to Stage 2 but no
loan has moved to Stage 3. The loans classified to stage 2 are predominantly
in the retail and hospitailty sectors. Out of the list of considerations
outlined above the main reason for moving the loans to stage 2 was expected
income covenant breaches due to the disruption from Covid-19. It is
important to note that classification to Stages 2 does not automatically
mean that an expected credit loss will be recognised. This is because the
formula for calculating the expected credit loss is:
"Present Value of loan" x "probability of default" x "value of expected
loss"
The Group does not instruct independent third party valuations on a strict
annual basis, only when it is considered necessary to obtain one. We
generally consider this to be a conservative approach to the LTV stated as
many of our borrowers have business plans which are in execution and the
plans would have be gradually de-risked as the business plan progresses. The
Investment Adviser does closely analyse all available market and internal
information on a regular basis and as at 30 June 2020 considers that it is
still very likely that the third part of the formula "value of expected
loss" will remain as nil for all loans, even if they have moved from Stage 1
to Stage 2, due to the significant headroom the Group has with an average
loan to value (based on the latest third party valuations performed) of 62.9
per cent.
The table below shows the sensitivity of the loan to value calculation for
movements in the underlying property valuation.
Change in Hospitality Retail Residential Other Portfolio
Valuation Average
-15% 73.0% 82.1% 70.1% 74.3% 74.0%
-10% 68.9% 77.5% 66.2% 70.2% 69.9%
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September 09, 2020 02:00 ET (06:00 GMT)
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