DJ SWEF: Annual Audited Accounts 2020
Starwood European Real Estate Finance Ltd (SWEF)
SWEF: Annual Audited Accounts 2020
26-March-2021 / 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.
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Starwood European Real Estate Finance
Annual Report and Audited Consolidated Financial Statements
for the year ended 31 December 2020
The Company has today published its annual financial report for the year ended 31 December 2020 and has made it
available online at www.starwoodeuropeanfinance.com.
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's assets are managed by Starwood European Finance Partners Limited, an indirect wholly-owned subsidiary of
the Starwood Capital Group.
Financial Highlights
Year ended Year ended
Key Highlights
31 December 2020 31 December 2019
NAV per Ordinary Share 104.18 p 103.23 p
Share Price 90.0 p 104.50 p
NAV total return (1) 6.3% 7.1%
Share Price total return (1) -7.5% 9.1%
Total Net Assets GBP426.7 m GBP426.6 m
Loans advanced at amortised cost (including accrued income) GBP442.7 m GBP390.6 m
Financial assets held at fair value through profit or loss GBP0.9 m GBP30.5 m
(including associated accrued income)
Cash and Cash Equivalents GBP2.9 m GBP36.8 m
Amount drawn under Revolving Credit Facility (excluding accrued interest) GBP19.5 m GBP29.7 m
Dividends per Ordinary Share 6.5 p 6.5 p
Invested Loan Portfolio unlevered annualised total return (1) 6.7% 7.1%
Invested Loan Portfolio levered annualised total return (1) 7.0% 7.0%
Ongoing charges percentage (1) 1.0% 1.0%
Weighted average portfolio LTV to Group first GBP (1) 18.2% 18.4%
Weighted average portfolio LTV to Group last GBP (1) 61.8% 63.0%
(1) Further explanation and definitions of the calculation is contained in the section "Alternative Performance Measures" at the end of this financial report.
Full text of annual financial report for the year ended 31 December 2020
Overview
Objective and Investment Policy
INVESTMENT OBJECTIVE
The investment objective of Starwood European Real Estate Finance Limited (the "Company"), together with its 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 in the UK and the European Union's internal market.
INVESTMENT POLICY
The Company invests in a diversified portfolio of real estate debt investments in the UK and the 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 UK and European Union's internal market. UK exposure is expected to represent the majority of the Company's portfolio. Investment in the European Union's internal market will mainly be focused 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.
In the event that a 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
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Company or investment level recourse borrowings may be used from time-to-time on a short term basis for bridging investments, financing 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 2018 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
Year ended Year ended
Key Highlights
31 December 2020 31 December 2019
NAV per Ordinary Share 104.18 p 103.23 p
Share Price 90.0 p 104.50 p
NAV total return (1) 6.3% 7.1%
Share Price total return (1) -7.5% 9.1%
Total Net Assets GBP426.7 m GBP426.6 m
Loans advanced at amortised cost (including accrued income) GBP442.7 m GBP390.6 m
Financial assets held at fair value through profit or loss GBP0.9 m GBP30.5 m
(including associated accrued income)
Cash and Cash Equivalents GBP2.9 m GBP36.8 m
Amount drawn under Revolving Credit Facility (excluding accrued interest) GBP19.5 m GBP29.7 m
Dividends per Ordinary Share 6.5 p 6.5 p
Invested Loan Portfolio unlevered annualised total return (1) 6.7% 7.1%
Invested Loan Portfolio levered annualised total return (1) 7.0% 7.0%
Ongoing charges percentage (1) 1.0% 1.0%
Weighted average portfolio LTV to Group first GBP (1) 18.2% 18.4%
Weighted average portfolio LTV to Group last GBP (1) 61.8% 63.0%
(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 2020 the NAV was 104.18 pence per Ordinary Share (2019: 103.23 pence) and the share price was 90.0 pence (2019: 104.50 pence).
The Company's share price has been volatile since March 2020. This volatility has been driven by market conditions and trading flows rather than a change in the Company's NAV.
Chairman's Statement
STEPHEN SMITH | Chairman
25 March 2021
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 2020. The last year has seen a great deal of turmoil and has placed a considerable burden on all of us, in both our professional and private lives. Our focus throughout the pandemic has been on the health and wellbeing of everyone associated with the Group while ensuring that our systems have remained fully functional throughout this period of intense disruption. My thanks to the Investment Adviser and all of our service providers for their perseverance in extraordinarily difficult times.
I am delighted to welcome Shelagh Mason and Charlotte Denton to the Board (Shelagh joined the Board on 1 September 2020 and Charlotte on 1 January 2021). Shelagh and Charlotte bring considerable experience to the Board as well as a range of skills that we believe will be both additive and complementary.
I would like to thank Jon Bridel, who left the Board in December 2020, for his contribution to the establishment and success of the Group. Jon's departure is in line with the Company's succession planning process for the phased retirement of Board members. Jon leaves with our very best wishes.
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OVERVIEW
As at 31 December 2020, the Group had investments and commitments of GBP490.1 million (of which GBP49.2 million was committed but unfunded at the end of the year). The average remaining maturity of the Group's loan book was 2.4 years. The Group had net debt of GBP16.6 million and unused debt facilities of GBP106.5 million, available to fund the undrawn commitments of GBP49.2 million and new lending. The gross annualised levered total return at the year end was 7.0 per cent. The Net Asset Value ("NAV") was GBP426.7 million, being 104.18 pence per Ordinary Share.
INVESTMENT ACTIVITY
The Group started 2020 with a strong first quarter, making new commitments of GBP54.9 million. Loan origination is often slow in the first quarter and this was a promising start to the year. However, from March onwards, as the general level of economic activity spiralled downwards due to the Covid-19 pandemic, the focus of the Group understandably shifted to the management of the existing portfolio. In parallel, even though the pipeline at the time was healthy, the Group took a cautious approach to origination closing just one loan of GBP17.9 million in the second quarter. During the third quarter, the Group committed to fund an upsize of GBP1.3 million to an existing loan. There was no origination in the fourth quarter.
As activity in the investment and financing markets slowed, there was in the market, in general, a significant reduction in the volume of early repayments. As might be expected, borrowers who had previously decided to refinance or sell, were unable or became reluctant to do so.
We received repayment in full of two loans prior to the pandemic totalling GBP14.1 million and a repayment in full of the credit linked notes totalling GBP21.8 million in June 2020. During the year to 31 December 2020, we received a further GBP45.5 million of partial loan repayments.
The Group funded a further GBP23.9 million in relation to loan commitments made in prior years so net cash invested in the year increased by GBP16.6 million. This was primarily due to the redevelopment of the Hotel, Spain.
2017 2018 2019 2020 New loans to borrowers (commitment) GBP245.8m GBP208.0m GBP224.7m GBP74.1m Loan repayments and amortisation -GBP213.1m -GBP137.2m -GBP198.3m -GBP81.4m Net Commitment GBP32.7m GBP70.8m GBP26.4m -GBP7.3m
PORTFOLIO PERFORMANCE
All loan interest and scheduled amortisation payments up to 31 December 2020 have been paid in full and on time, in accordance with their respective initial or amended terms, as applicable.
In the Board's opinion the Investment Manager and Investment Adviser have performed well during this period of disruption. Robust underwriting, detailed due diligence and considered loan structuring and restructuring have been combined to produce a resilient portfolio which continues to perform in spite of very considerable and obviously stressed market conditions.
In some instances, the Investment Manager and Investment Adviser have worked closely with borrowers to agree loan amendments and changes to business plans, where appropriate, to ensure loan compliance and to maintain adequate capitalisation (if needed). 49.1 per cent of loans were subject to no modification, as a result of Covid-19, in 2020, a testament to the quality of underwriting standards and loan structuring. All economic modifications to date have been neutral to returns with no interest deferrals. In asset classes subject to greater Covid-19 impact we have sought additional sponsor equity, amortisation and / or deleveraging. The loan performance has been resilient. In the sectors that are most affected by the Covid-19 pandemic, hospitality and retail, borrowers continue to meet their obligations including regular interest and capital repayments in line with the agreed revised business plans. At 31 December 2020 six loans with exposure predominantly to hospitality and retail with a value of 35.3 per cent of NAV are classified as Stage 2 and the remaining loans are still classified as Stage 1 in accordance with the Group's credit risk assessment in determining expected credit losses.
In light of the considerable disruption from Covid-19 the Board has sought to provide more detailed updates and disclosure to our shareholders during the year through its quarterly factsheets, which are available on the Company's website. Please refer to the Investment Manager's report on page 27 for detailed updates on portfolio performance.
STABILITY OF NET ASSET VALUE ("NAV")
Loans made by the Group are measured at amortised cost in line with the requirements of IFRS 9 with which we are obliged to comply. As our business model is to invest for interest and hold loans to maturity we do not follow fair value accounting for the vast majority of our loans. In our eight year history only one position has been recognised at fair value (the credit linked notes which repaid in the second quarter of this year). Therefore our NAV does not show significant fluctuations during periods of market volatility.
Had the underwriting, including loan to value ("LTV") headroom, on the Group's loans not been as strong as it is, the Group may well have faced more volatility in its NAV as the Group might have had to recognise expected credit losses ("ECLs"). However, after taking into consideration the current market conditions, independent valuations of the underlying assets secured against the Group's loans, the receipt of expected cash flows and the credit worthiness of the counter parties to the loans, the Group sees no need to recognise any ECLs in any of the Group's loans. The reasons, estimates and judgements supporting our current assessment are described on page 19 of the Investment Manager's report.
BOARD COMPOSITION AND DIVERSITY
As the Company approaches its ninth year of existence, as articulated in previous reports, the Board has been mindful of the need to plan for succession accordingly. The Company is using this moment as an opportunity to promote new talent and diversity, whilst being mindful of passing on the experience that the Board has gained since IPO. The succession plan began late last year with the retirement of the first Director, as well as the excellent replacement found in Shelagh Mason. Additionally, we are delighted that Charlotte Denton has joined the Board recently to further help with the Company's development. Further details of the Board's succession planning can be found in the Corporate Governance Statement on page 37.
SUCCESSION PLANNING
The Company enters its ninth year in 2021 and the Board has been mindful that a succession plan needs to be implemented for a lengthy period of time. During Q4 2019, the Directors devised a Succession Planning Memorandum. The Memo states that a new Director will be appointed to the Board during the second half of 2020 giving them time to embed themselves in the role prior to Jonathan Bridel standing down from the Board in December 2020. Shelagh Mason was duly appointed on 1 September 2020. In addition, the Company has decided that it is appropriate to appoint an additional Director to the Board to further improve the Company's skills, experience and diversity as well as to assist in the succession process. To that end, Charlotte Denton was duly appointed on 1 January 2021.
The Boards intention remains that Stephen Smith will retire from the Board in December 2021. At the point of Stephen Smith's retirement, only John Whittle would have served as a Director of the Company since its IPO. In context of John Whittle's familiarity with the Company, he will probably be appointed as Chairman until his own departure from the Board. In light of (i) John Whittle's extensive familiarity with the Company; (ii) the current challenging market circumstances facing the Company and; (iii) the extensive rotation of the Board in recent years, the Board are of the view that it is in shareholders best interests that John Whittle remains on the Board until December 2023, a year longer than originally envisaged under the Succession Planning Memorandum. This will ensure that there is a phased and orderly succession of the Board which allows new Directors the opportunity to benefit from the significant experience John Whittle has developed since the Company's IPO.
In terms of the new appointments, the Directors believe that the current composition of three Guernsey Directors and one Director from the United Kingdom works well in terms of satisfying the Company's requirements. The Board also intend to consider diversity when making the new appointments to the Board.
SHARE BUYBACKS AND SHARE PRICE PERFORMANCE
The year end share price was 90 pence reflecting a 13.6 per cent discount to NAV. Despite continued market dislocation and fluctuation, the share price was starting to look less volatile in the second half of 2020 (compared to the first half of 2020), trading in a range between 83.6 pence and 94.0 pence and ending the period at 90.0 pence, although there is still certainly inherent value which is not being recognised in the market at this time. This price stability has been supported by the share buy-back programme which commenced at the end of the second quarter. The Board continue to believe that the shares represent very attractive value at this level and certain members of the Board and individuals at the Investment Adviser have made personal purchases during the year, as previously disclosed, and as referenced in note 22. We believe this reflects not only strong corporate governance demonstrating our alignment with our shareholders, but it also demonstrates the strong belief in the valuation of the portfolio.
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The Company received authority at the most recent Annual General Meeting ("AGM"), to purchase up to 14.99 per cent of the Ordinary Shares in issue on 8 June 2020 and since then, in August 2020, the Board engaged Jefferies International Limited as buy-back agent to effect share buy backs on behalf of the Company. During the third and fourth quarters the Company bought back 3,648,125 shares at an average cost per share of 86.9 pence per share and these shares are held in treasury. Share buy backs are subject to sufficient cash being available.
FUTURE SHARE ISSUANCE
At the last 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. As at the date of this report, this authority has not been utilised.
The Covid-19 pandemic has caused dislocation in the real estate sector and we are partly through this now and potentially working to come out the other side. The market is still trying to ascertain what the longer term impact on real estate values will be. The Investment Adviser feels that the market reaction has been too cautious and that has led to considerable investment market opportunity which we feel will remain the case throughout 2021. Whilst the discount to NAV persists, we do not intend to raise additional equity. Nevertheless, we do expect the market to recognise the value in the shares during the year and the Board believes that the Group should maintain its capacity to access capital within a short time frame in expectation of improved markets. The Directors believe that as the market improves and the discount to NAV narrows, immediate access to capital could have the following additional benefits for the Company and shareholders: - to enable the Company to pursue larger investment opportunities and broaden its lending range and capacity; - to enable the Company to increase diversification and the depth of its portfolio; - increased scale is attractive to a wider investor base; - a greater volume of shares, creating increased secondary market activity; and - fixed running costs spread across a larger equity capital base reducing the Company's ongoing expenses per share.
To take advantage of opportunities as and when they present themselves, the Directors believe it is appropriate for the Company to renew the existing authorities at the forthcoming AGM, in respect of issuance of up to 10 per cent of the Ordinary Shares in issue.
DIVIDENDS
Total dividends of 6.5 pence per Ordinary Share were declared in relation to the year ended 31 December 2020.
Dividend Payment Amount
Period
declared date per share
1 January 2020 to 31 March 2020 23 April 2020 20 May 2020 1.625p
1 April 2020 to 30 June 2020 23 July 2020 28 August 2020 1.625p
1 July 2020 to 30 September 2020 22 October 2020 20 November 2020 1.625p
1 October 2020 to 31 December 2020 22 January 2021 05 March 2021 1.625p
Total 6.5p
The 2020 dividends were covered 0.9x by earnings (excluding unrealised FX gains and losses). We have 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 two years 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.
As announced on 24 July 2020, from 1 January 2021 the Board intends to target a dividend of 5.5 pence per annum (payable quarterly) which reflects the broader lower interest rate environment. This will provide a level of dividend which should be fully covered by earnings whilst ensuring the Company maintains strong credit discipline without having to increase the risk of the portfolio.
OUTLOOK
The focus of the Group for 2021 remains the continued robust asset management of the existing loan portfolio. We also expect that we will see good origination opportunities during the year. Disruption due to the Covid-19 pandemic may reduce as the year progresses and the vaccine roll out across the United Kingdom is particularly heartening. More stable conditions could herald greater market volumes to come.
Of particular note is the significant reduction in lending by balance sheet bank lenders, particularly to development, refurbishment and non-core property asset classes. This trend will inevitably produce interesting opportunities for alternative lenders and we fully expect to benefit.
Finally, the Board note that one positive outcome of the pandemic could be the recognition by the global business community of the need for affirmative action in relation to climate change and other related environmental, social and governance considerations.
The Board continues to work with the Investment Manager and Investment Adviser to enhance both origination capacity and portfolio construction in order to deliver attractive risk adjusted returns to its investors. The Board will continue to inform you of progress by way of the quarterly fact sheets.
On behalf of the Board, I would like to close by thanking shareholders for your commitment. I sincerely hope that we all have a more stable time in 2021 and I look forward to briefing you on the Group's progress later this year.
Stephen Smith | Chairman
25 March 2021
Strategic and Business Review
Strategic Report
The Strategic Report describes the business of the Group and details the uncertainties, principal and emerging risks associated with its activities.
CORPORATE PURPOSE
As an investment company, the general corporate purpose is to provide long-term prosperity to our shareholders through providing regular dividends and preserving capital by limiting downside risk. In addition to this, the Board and Investment Manager also recognise that by furthering their understanding of the needs of other relevant stakeholders, the Company can provide better returns to its shareholders.
OBJECTIVE, INVESTMENT POLICY AND BUSINESS MODEL
The Objective and Investment Policy set out on pages 2 to 4 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 movement in NAV per Ordinary Share; - The movement in share price and the discount / premium to NAV; - The payment of targeted dividends; - The portfolio yield, both levered and unlevered; - Ongoing charges as a percentage of undiluted NAV; and - Weighted average loan to value for the portfolio.
Details of the KPIs achieved are shown in the Financial Highlights section on page 6.
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. In deciding which risks are principal risks the Board considers the potential impact and probability of the related events or circumstances, and the timescale over which they may occur. Consequently, it has put in place mitigation plans to manage those identified risks. Details of the principal and emerging risks considered as part of the review of the risk matrix are highlighted below.
Principal Risks
Cybercrime
The Group is subject to the risk of unauthorised access into systems, identification of passwords or deleting data, which could result in loss of sensitive data, breach of data physical and electronic, amongst other potential consequences. This risk is managed and mitigated by regular reviews of the Group's operational and financial control environment. The matter is also contained within service providers surveys which is completed by Group's service providers and is regularly reviewed by the Board. No adverse findings in connection with the service provider surveys have been found. The Company and its service providers have policies and procedures in place to mitigate this risk, the cybercrime risk continues to be closely monitored.
Long Term Strategic Risk
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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 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. Since the Covid-19 pandemic the shares have traded 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 and announced a share buyback programme during the year in order to support the share price. 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 page 33 for further information on the discount management mechanisms.
The Investment Adviser provides the Investment Manager and the Board with a regular 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 underlying assets versus underwritten business plan and the likelihood of any early repayments, the need for any loan amendments to allow the loans continue to perform in different economic circumstances 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 Investment Adviser is monitoring the transition from LIBOR to SONIA and will manage any transition required on behalf of the Group. The Group has ensured that loan agreements for the current portfolio are in a form which accommodates the flexibilities required to manage the transition.
The loans in place at 31 December 2020 have been structured so that 20.8 per cent by value of the loans are fixed rate, which provides protection from downward interest rate movements to the overall portfolio (but also prevents the Group from benefiting from any interbank rate rises on these positions). In addition, whilst the remaining 79.2 per cent is classified as floating, 100 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 and emerging 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 (circa 58.3 per cent as at 31 December 2020). 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. Most non-Sterling loan principal is hedged back to Sterling to the maturity date of the loan.
Interest payments are normally 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 GBP273.4 million of hedged notional exposure with Lloyds Bank plc at 31 December 2020 (converted at 31 December 2020 FX rates).
As at 31 December 2020 the hedges were in the money. If the hedges move out of the money and 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 2020, the Company had sufficient liquidity and credit available on the revolving credit facility to meet any cash collateral requirements.
Market Deterioration Risk
The Group's investments are comprised principally of debt investments in the UK, and the 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.
The Covid-19 pandemic has had a material impact on global economies and on the operations of the Group's borrowers during 2020 and this will continue in 2021. The Covid-19 pandemic presents a major risk to growth and the full impact of the consequences for the world economy is unclear. The Board have considered the impact of Covid-19 on the current and future operations of the Group and its portfolio of loans advanced. Because of the cash and loan facilities available to the Group and the underlying quality of the portfolio of loans advanced, both the Investment Manager and the Board still believe the fundamentals of the portfolio remain optimistic and that the Group can adequately support the portfolio of loans advanced despite current market conditions.
The United Kingdom's departure from the European Union 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 alongside the economic impact of Covid-19, towards recession. The potential impact of Brexit could have a further destabilising effect as a result of Covid-19. 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 still arise.
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.
However, the Group is mitigated against this with an average weighted loan to value of the portfolio of 61.8 per cent (see page 21 of the Investment Manager's report). 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, assessment of the strength of the borrower's management team 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.
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The Group's loans are held at amortised cost. 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.
Six loans, predominantly in the retail and hospitality sectors with a value of 35.3 per cent of NAV were moved to Stage 2 during the year but no loan has been moved to Stage 3. However, at this point in time we have no reason to believe that any expected credit losses should be recognised against any of the loans, because of the strong LTVs across the loan portfolio, including these 6 loans. The reasons, estimates and judgements supporting our current assessment are described on pages 19-20 of the Investment Manager's report.
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.
Emerging Risks
Emerging risks to the Group are considered by the Board to be trends, innovations and potential rule changes relevant to the real estate mortgage and financial sector. The challenge to the Group is that emerging risks are known to some extent but are not likely to materialise or have an impact in the near term. The Board regularly reviews the risk matrix and identified climate change as an emerging risk. Cybercrime which was an emerging risk in the prior year, has been moved to Principal Risks.
Climate change
Extreme weather events and natural catastrophes and the consequences that climate change could have both on infrastructures and on nature are potentially severe but highly uncertain. The potential high impact of possible losses has done a lot to raise the awareness of this risk in investment circles. The Board, in conjunction with the Investment Adviser, is monitoring closely the regulation and any developments in this area (see 'Environmental, Social and Corporate' section on page 17 for further information).
ASSESSMENT OF PROSPECTS
The Group's strategy is central to an understanding of its prospects. The Group's focus is twofold: i) to manage expected repayments, including proactively managing the investments already made to ensure that during times of economic instability on either a macro (as experienced during the year as a result of the Covid-19 pandemic) or micro level, the loans continue to perform and provide positive returns to the Group, and ii) continuing to grow the Group, by sourcing investments with good risk adjusted returns in order to minimise any potential for cash drag and improve the Group's returns. The Group's prospects are assessed primarily through its strategic review process, which the Board participates fully in. The Directors' have assessed the prospects of the Group over a period of three years which has been selected because the strategic review covers a three-year period. The Group updates its plan and financial forecasts on a monthly basis and detailed financial forecasts are maintained and reviewed by the Board regularly.
In addition the Directors have considered the realisation vote which will, under the Articles, take place no later than 28 February 2023. The Directors have concluded that the shareholders will most likely vote against this realisation vote and the Company will continue as consituted.
ASSESSMENT OF VIABILITY
Although the strategic review reflects the Directors' best estimate of the future prospects of the business, they have also tested the potential impact on the Group of a number of scenarios over and above those included in the review, by quantifying their financial impact. These scenarios are based on aspects of the following selected principal risks, which are detailed in this Strategic Report, and as described below: - Foreign exchange risk; - Market deterioration risk; specifically the risk that the all the Stage 2 loans held default, resulting in a loss
of interest income and delay in the repayment of capital; and - Risk of default under the revolving credit facilities.
These scenarios represent 'severe but plausible' circumstances that the Group could experience. The scenarios tested included: - A high level of loan default meaning that the Group stopped receiving interest on the Stage 2 loans in the
portfolio and that the outstanding capital on these loans was not received until 12 months after the loan maturity
date; and - An analysis of the robustness of the covenants under the revolving credit facility to withstand default of the
underlying investments.
The results of this stress testing showed that the Group would be able to withstand a high level of underlying loan default or impairment resulting from either of the risks identified over the period of the financial forecasts.
VIABILITY STATEMENT
In addition to the assessment of prospects and viability above, the Directors also have a reasonable expectation, based on the scenarios testing, that the Group will continue to meet its liabilities as they fall due over the three-year period ending 31 December 2023, and therefore the Group is expected to remain viable from both a business model, strategic opportunity and financial perspective.
In connection with the viability statement, the Board confirm that they have carried out a robust assessment of the principal and emerging risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity.
ENVIRONMENTAL, SOCIAL AND CORPORATE GOVERNANCE ("ESG")
As an investment company, the Board and the Investment Adviser consider the Group's activities to have a minimal direct impact on the environment.
The Investment Manager and Investment Adviser are part of the Starwood Capital Group (SCG), which is a signatory to the UN Principles for Responsible Investments (UNPRI). In assessing new loans SCG evaluates environmental risks associated with any investments as part of the underwriting process. A formal scope of work is followed by the Investment Adviser, which requires an environmental site assessment to be performed which identifies environmental conditions that may have a material adverse impact on the property being assessed or its immediate surrounding area and an assessment of a property's sustainability and marketability through the review of its environmentally friendly characteristics.
The Board recognises that it has no direct control over a borrower's company policy towards environment and social responsibility and whilst it is an important part of the due diligence process in understanding the impact of such issues, decisions are not weighted towards those investments with stronger environmental and social characteristics. It should be noted that a number of the loans made by the Group involve refurbishment projects and these will often improve the environmental impact of the real estate concerned. Additionally, whilst it is not an investment criteria, the Group's loan portfolio is significantly funded in sectors with positive social impact such as hospitality, healthcare and residential.
In carrying out its activities and in its relationship with the community, the Group aims to conduct itself responsibly, ethically and fairly; including in relation to social and human rights issues. Our risk management framework is intended to facilitate an enterprise wide view of risk that supports a strong and collaborative risk management culture within the Board and with its relationship with SCG.
The Board (through its relationships with SCG, its brokers and other advisers) is focused on maintaining a productive dialogue with shareholders and gathering feedback to inform the decision making at Board level.
SCG, with in excess of 4,000 employees worldwide, takes its social responsibilities to its employees very seriously offering a challenging, fast-paced and collegial environment to its employees. SCG strives to create diverse and inclusive workplaces where all employees can perform to their full potential and to be a good corporate citizen for their communities by supporting charitable organisations that promote education and social wellbeing.
The Group has no Greenhouse Gas Emissions, other than as noted below, to report from its operations for the current or prior year, nor does it have responsibility for any other emissions producing sources (including those within the underlying investment portfolio).
While there is some travel involved for the Directors and representatives from the Investment Adviser, the Company's service providers are Guernsey office-based companies, and the majority of the Directors are based in Guernsey, thus having a relatively low impact on the environment and negating the need for long commutes or flights to and from Board meetings. As a result of Covid-19 there has been an acceleration in the use of interactive and virtual technology for meetings, further reducing the need for travel.
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The Group has no employees and the Board is composed entirely of non-executive Directors. Therefore, the Group is not within scope of the Modern Slavery Act 2015 and is therefore not obliged to make a human trafficking statement.
BOARD DIVERSITY
The Board considers that its members have a balance of skills, qualifications and experience which are relevant to the Company. The Board supports the recommendations of the Davies Report, the Hampton Alexander Review and the Parker Review and believes in the value and importance of diversity in the boardroom and it continues to consider the recommendations of these reports and reviews as part of its succession planning.
The Company has no employees and therefore has no disclosures to make in this regard.
Stephen Smith | Chairman
25 March 2021
Investment Manager's Report - Investment Highlights
The Investment Manager and Investment Adviser are both part of the Starwood Capital Group (SCG), a leading global real estate investment group.
PORTFOLIO STATISTICS
The Investment Manager and the Board of the Company 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.
As at 31 December 2020, the portfolio was invested in line with the Group's investment policy and is summarised below.
31 31
December December
2020 2019
Number of investments 18 18
Percentage of invested portfolio in floating rate loans (1) 79.2% 79.1%
Invested Loan Portfolio unlevered annualised total return (1) 6.7% 7.1%
Invested Loan Portfolio levered annualised total return (1) 7.0% 7.0%
Weighted average portfolio LTV - to Group first GBP (1) 18.2% 18.4%
Weighted average portfolio LTV - to Group last GBP (1) 61.8% 63.0%
Average loan term (stated maturity at inception) 4.5 years 4.1 years
Average remaining loan term 2.4 years 2.8 years
Net Asset Value GBP426.7 m GBP426.6 m
Amount drawn under Revolving Credit Facility (including accrued interest) (GBP19.6 m) (GBP29.7 m)
Loans advanced at amortised cost (including accrued income) GBP442.7 m GBP390.6 m
Financial assets held at fair value through profit or loss (including associated accrued income and - GBP21.9 m
excluding the value of FX hedges)
Cash GBP2.9 m GBP36.8 m
Other net assets / (liabilities) (including the value of FX hedges) GBP0.7 m GBP7.0 m
(1) Further explanation and definitions of the calculation is contained in the section "Alternative Performance Measures" at the end of this financial report.
PORTFOLIO DIVERSIFICATION
% of invested
Country
assets
UK 41.7
Spain 30.0
Republic of Ireland 20.2
Netherlands 3.8
Germany 3.2
Finland 1.1
% of invested
Sector
assets
Hospitality 35.7
Office 23.2
Residential for sale 15.7
Retail 12.9
Healthcare 5.7
Logistics 4.1
Light Industrial 1.6
Residential for rent 0.9
Other 0.2
% of invested
Loan type
assets
Whole loans 61.2
Mezzanine 38.8
% of invested
Loan currency
assets*
Sterling 41.7
Euro 58.3 - The currency split refers to the underlying loan currency; however, the capital and interest during protected
periods on all non-sterling exposure is hedged back to sterling.
EXPECTED CREDIT LOSSES
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 to 12 months expected credit losses resulting from default
(if asset is not events that are possible within 12 months.
credit impaired)
After initial
recognition:
Credit risk has not increased significantly since initial recognition. Recognise 12 months
expected credit losses.
Stage 1
Interest income is recognised by applying the effective interest rate to the gross carrying
amount of financial assets.
Credit risk has increased significantly since initial recognition. Recognise lifetime expected
losses.
Stage 2
Interest income is recognised by applying the effective interest rate to the gross carrying
amount of financial assets.
Credit impaired financial asset. Recognise lifetime expected losses.
Stage 3
Interest income is recognised by applying the effective interest rate to the amortised cost (that
is net of the expected loss provision) of financial assets.
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 61.8 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; - LTV is greater than 75-80 per cent; - LTV 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: Default and credit-impaired assets
Non-performing financial assets would be classified with 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 31 December 2019 all loans were classified as Stage 1. At 31 December 2020 six loans with a value of 35.3 per cent of NAV are classified as Stage 2 and the remaining loans are still classified as Stage 1. The loans classified to Stage 2 are predominantly in the retail and hospitality sectors (but not all hospitality loans are in Stage 2). The main reason for moving the loans to Stage 2 in the second quarter of 2020 was expected income covenant breaches due to the disruption from Covid-19. Following loan amendments agreed with borrowers, no income breaches have occurred. The loan portfolio performance has been resilient. In 2020 the company collected all interest that was contractually due and all amortisation that was contractually due.
It is important to note that although these six loans have been classified as Stage 2 no ECLs have been 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".
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Although credit risk (and hence probability of default) has increased for these loans, we have considered a number of scenarios and as a result do not currently expect to realise a loss in the event of a default (i.e. the last part of the formula above is considered to be zero for these six loans given the present value of these loans in all scenarios considered).
This assessment has been made, despite the continued pressure on the hospitality and retail markets from Covid-19, on the basis of information in our possession at the date of reporting, our assessment of the risks of each loan and certain estimates and judgements around future performance of the assets. The position on any potential ECLs on the Three Shopping Centres and Shopping Centre, Spain (the "Spain retail assets") in particular continues to be closely monitored and analysed, and we have sought input, analysis and commentary from Spanish market advisers and an updated external valuation in this regard, to supplement our own information. Although we continue to update the information available, at this point in time we have no reason to believe that any ECLs should be recognised against any of the loans determined to be Stage 2. The reasons, estimates and judgements supporting our current assessment are as follows: - Sufficient headroom on the six loans with an average LTV of 67.9 per cent between them based on the latest
independent valuations received. - Performance of the retail centres where local restrictions were lifted following the first wave of Covid-19 was
very encouraging for future recovery with the sites on average in September 2020 reaching 92 per cent of comparable
month prior year footfall and we expect this will re-occur; - We have determined that although there is pressure in this market, it is unlike the UK retail market as we are
currently seeing no evidence of significant liquidations in the Spanish retail market; - We believe that following the rollout of the vaccine and the loosening of lockdown restrictions, income in the
retail centres is well positioned to recover as a result of the above; and - We have reviewed valuations of listed peers of the borrower and valuations have not moved materially and therefore
currently judge that the revised valuation on these assets, which is being appraised by the same markets experts,
is unlikely to result in an ECL being recognised.
FAIR VALUES
The amortised cost loan recognition is required by IFRS 9 and we do not have a choice of methodology to follow - we are not eligible to follow fair value accounting for the vast majority of our loans, and in our eight year history only one position has ever been eligible to be recognised at fair value (the credit linked notes which repaid in the second quarter of this year). Therefore our NAV does not necessarily show significant fluctuations during periods of market volatility.
The table below represents the fair value of the loans based on a discounted cash flow basis using a range of potential discount rates.
The effective interest rate ("EIR") - i.e. the discount rate at which future cash flows equal the amortised cost, is 6.8 per cent. We have sensitised the cash flows at EIR intervals of 0.5 per cent up to +/- 2.0 per cent. The table reflects how a change in market interest rates or credit risk premiums may impact the fair value of the portfolio versus the amortised cost. Further, the Group considers the EIR of 6.8 per cent to be conservative as many of these loans were part of a business plan which involved transformation and many of these business plans are advanced in the execution and therefore significantly de-risked from the original underwriting and pricing (for example the Hotel, Spain). The volatility of the fair value to movements in discount rates is low due to the low remaining duration of most loans.
Discount Rate Value Calculated % of Book Value 4.8% GBP 464.6 m 104.9% 5.2% GBP 459.5 = fair value 103.8% 5.8% GBP 453.4 m 102.4% 6.3% GBP 448.0 m 101.2% 6.8% GBP 442.7 m = book value 100.0% 7.3% GBP 437.4 m 98.8% 7.8% GBP 432.3 m 97.7% 8.3% GBP 427.3 m 96.5% 8.8% GBP 422.4 m 95.4%
LOAN TO VALUE
Given the need for the Group and most of its peers to record loans at amortised cost, the loan to value of companies in our sector has understandably been an area of focus for many of our shareholders and stakeholders seeking to understand underlying risk further.
In order to try to assist in understanding the underlying credit risk, we have always quoted the last GBP loan to value ("last LTV") of our portfolio and have outlined further detail below on our approach to this calculation.
Methodology
Our methodology to calculate the last LTV for each individual loan is:-
Total loan drawn less any deductible lender controlled cash reserves and less any amortization received to date (including any debt provided by other lenders which rank alongside or senior to the Group's position)
Market value determined by the last formal lender valuation received by the reporting date
Each individual loan LTV is then weighted by the amount of the loan currently drawn (in the Group only, ignoring the position of other third party lenders) to give a weighted average last LTV across the Group's portfolio.
Valuations Process
The following describes the valuation basis that is used in our calculation. As the vast majority of our portfolio is originated directly by the Investment Adviser, the Group has discretion over when and how to instruct valuations. We consider this to be a strength of our valuation process as we have control over timing and complete access to the detail of the valuation process and the output. Where loans are not directly originated the lender could have a lack of control over the timing and no input to the process which we prefer to avoid where possible. - On the origination of a loan, for a straight forward standing investment asset (for example, an occupied office),
the independent open market value determined by an independent valuer under RICS guidelines will be used. When
considering the relevance of these valuations in the current market, it is important to consider how quickly a
portfolio churns. Our average loan term from origination to repayment is approximately 2.5 years and therefore our
valuations have always been fresh. At 31 December 2020, 15.7 per cent of our total portfolio was originated in the
last 12 months and 40.6 per cent in the last 18 months (including the 15.7 per cent in the last 12 months). - After loan origination the Group has the right under loan documents to obtain valuations on an annual basis at the
expense of the borrower (based on loan anniversary, not Group financial year end). Where a follow on valuation has
been done we use the latest valuation number in our calculations. However, the Group does not instruct independent
third party valuations on a strict annual basis, only when it is considered necessary and useful to obtain one. Of
the 84.3 per cent of loans on our books which are older than 12 months, 44.5 per cent have had the valuation
updated since the loan was originated (comprising 37.5% of the total loan book). - A revised, independent valuation of the Spanish retail loan assets has been instructed by the Group post year-end.
Initial indicative output confirms that the Group's loan exposure continues to have adequate headroom against the
valuation basis but values have declined in line with expectation and the wider market trend given the current lack
of certainty and liquidity for retail assets. Once these valuation reports are finalised, the Group will reflect
the formal updated valuation basis in post year-end reporting. We expect the impact on the overall portfolio's last
Sterling LTV to be low. - The Group has not sought independent valuations on every position given consideration of the individual risk
factors considered of each loan position. Instead, the Investment Adviser has undertaken desktop reviews of the
last valuations for each of the assets and evaluated the key inputs based on the latest information they have, to
update any valuations in the assessment of the LTV for each loan below, preferring to maintain the option of an
independent valuation at a time when the valuation will provide better information to both the Group and borrower -
as was decided for the Spain retail assets. - For development projects there are a number of potential valuation methodologies. Our selected approach is based on
giving the clearest and most consistent presentation of the risk. For development projects our calculation includes
the total facility available and is calculated against the appraised market value on completion of the relevant
project. There are other potential approaches such as using current drawn loan balance and current value or using
total cost as a proxy for value. However each of these approaches has limitations. For example, using the approach
of drawn loan balance divided by current project value will typically understate the LTV in the earlier days of a
development when less debt is drawn before converging to a higher LTV that matches our methodology at the end once
all the debt is drawn. We generally retain the same rights to valuation on development loans as for investment
assets. It is also worth noting that the weighting of the loan within the portfolio calculation is based off the
latest drawn balance and not the total loan commitment.
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On the basis of the methodology previously outlined, at 31 December 2020 the Group has an average last LTV of 61.8 per cent.
Change in Valuation Hospitality Retail Residential Other Total -25% 80.9% 89.2% 76.9% 83.9% 82.3% -20% 75.8% 83.6% 72.1% 78.6% 77.2% -15% 71.4% 78.7% 67.8% 74.0% 72.6% -10% 67.4% 74.3% 64.1% 69.9% 68.6% -5% 63.9% 70.4% 60.7% 66.2% 65.0% 0% 60.7% 66.9% 57.7% 62.9% 61.8% 5% 57.8% 63.7% 54.9% 59.9% 58.8% 10% 55.1% 60.8% 52.4% 57.2% 56.1% 15% 52.7% 58.2% 50.1% 54.7% 53.7%
The table above shows the sensitivity of the LTVs for movements in the underlying property valuations, disclosed by sector, and demonstrates that the Group has considerable headroom within the currently reported last LTVs. The valuations used in the calculations for the table above are the most recent final valuations available for the assets against which loans are held. As previously disclosed the Group has instructed updated, independent valuations of the Spanish retail loan assets. These valuations are not yet final but the indicative results of these valuations indicate that the LTV of the Group as a whole will change from 61.8% (as set out in the table above) to 63.2%, a deterioration of 1.4%. We will update shareholders as to the final findings of the valuations in the quarterly factsheet following the finalisation of the valuations. We do not anticipate that the position on Expected Credit Losses (i.e. that currently no ECL is recognised) with regard to these assets will change as a result of these valuations.
FOREIGN EXCHANGE
The Group continues to recognise unrealised foreign exchange gains or losses relating to investment activity. The Group has fully hedged the principal of each individual non-Sterling denominated loan with forward contracts, together with interest receipts during the period of prepayment protection. If the loans repay at their scheduled repayment date, the Group would expect that this policy would be effective in protecting against realising FX losses on capital invested.
However, the accounting treatment for the non-Sterling denominated loans is to value the loan at the foreign exchange rate at the relevant valuation date, and to value the hedge based on the market forward rates at the valuation date to the maturity date of the relevant hedge (discounted back to present value). As a result of this accounting treatment, whilst the loan principal is economically fully hedged (if held to loan maturity), unrealised foreign exchange gains or losses are recognised in the accounts during the life of the loan due to changes in the shape of the relevant forward curves. For this reason, the Group disregards unrealised foreign exchange gains and losses when declaring dividends.
It is important to note that should any of the non-Sterling denominated loans repay early, and the Group has no alternative use for the funds repaid and therefore breaks the hedges early, foreign exchange gains or losses could be realised at that point. The size of this will depend on the shape of the relevant forward curve at the point at which the relevant hedge is broken. In general, a steeper curve would result in greater gains/losses.
DIVIDEND POLICY
The Company declared dividends of 6.5 pence per Ordinary Share in respect of the year ended 31 December 2020 (2019: 6.5 pence per Ordinary Share). These dividends are recognised in the Consolidated Statement of Changes in Equity when declared, which is usually within one month after the end of the financial period to which they relate. Dividends are usually paid within one month of the declaration date.
The Company may pay dividends out of reserves provided that the Board of Directors is satisfied on reasonable grounds that the Company will, immediately after payment, satisfy the solvency test (as defined in the Companies (Guernsey) Law, 2008, as amended), and satisfy any other requirement in its memorandum and articles.
As announced on 24 July 2020, from 1 January 2021 the Board intends to target a dividend of 5.5 pence per annum (payable quarterly) which reflects the broader lower interest rate environment. This will provide a more sustainable level of dividend which should be fully covered by earnings whilst ensuring the Company maintains strong credit discipline. For the year ended December 2020 6.5 pence was paid out in dividends which was covered 0.9x by earnings (excluding unrealised FX gains and losses). The Company maintains a dividend reserve (within retained earnings) built up over several years which was partially utilised to ensure dividends were not paid out of capital.
INVESTMENT OUTLOOK AND MARKET SUMMARY
Many people were happy to wave good-bye to 2020's troubles as we entered 2021. While there is still some way to go dealing with COVID-19, the balance of news flow and sentiment since the beginning of 2021 has continued to be positive with better than expected vaccine timing and efficacy, an ultimately orderly handover of the US Presidency and significant continued stimulus. The vaccine roll-out in the UK has been a particular success. There are residual uncertainties including the impacts of Covid-19 mutations, the slower roll out of vaccines in Europe and the timing of easing of continuing lockdowns both in the UK and Europe. Markets are signalling that taken altogether the outlook is better than at the end of 2020 with the Dow Jones Industrial Average, the S&P 500 and Dax all hitting new all-time highs in early March.
The agreement of the trade deal with Europe was a landmark in the Brexit process which has delivered some elements of certainty, but it will take longer to understand the full impacts of the UK leaving the EU. In particular details around financial services have been delayed. While equivalence arrangements are likely to simplify matters significantly, the devil is often in the detail. Tariff free trade appears to be a success in principle but it also remains to be seen whether the red-tape introduced for trade between Europe and the UK creates its own barriers.
In the real estate markets, big box and last mile logistics and residential were the clear winners of 2020. Office and student
accommodation have been subject to more nuanced case by case effects and hospitality and retail have faced the biggest challenges.
Over recent months, the outlook has become significantly clearer for hotels. As lockdowns ease we expect a rapid rebound in domestic tourism. The population is keen to go on holidays, concerts and events and with high savings rates during lockdowns people have the cash and are ready to spend. This demand will focus first domestically and then to short haul international resorts as practicalities allow. Long haul tourism, corporate and conference business are likely to take longer to resume.
While hotel investment volumes were down sharply in 2020, we are also now seeing a marked increase in investor sentiment in both hotel equity and debt. We have already tracked over 50 hotels transacting in Europe in the first two months of 2021.
While the 2020 sector themes are likely to continue in 2021, taking the longer view there are likely to be opportunities for the right assets with well thought out and well capitalised business plans in all sectors.
Interest rates remain stable with Sterling Libor at 0.08% per cent and the curve remaining extremely flat with the Sterling 5-year swap rate at only 0.52% per cent. With rates so low investors are keen to find yield which has supported record European issuance in both investment grade and non-investment grade credit in 2020. Yields in the high yield market have been near or around all-time lows.
In real estate lending, 2020 volumes were down significantly. As we move in to 2021 we expect market conditions to become more liquid as the market adjusts to the COVID-19 and post COVID-19 environments. While we expect dislocations to remain in the market during 2021, we are seeing willingness from the market to engage on all asset classes also including hotels and retail. The lending appetite is coming from diverse sources reflecting an increasingly fragmented market. There continues to be a significantly lower participation from balance sheet bank lenders particularly for development financing and for financing other non-vanilla business plans and asset classes. We see this pattern persisting as a long-term theme that will support the Group's strategy of sourcing attractive new investment opportunities in 2021 and beyond.
INVESTMENT DEPLOYMENT
As at 31 December 2020, the Group had investments (excluding accrued interest) and commitments of GBP490.1 million (Sterling equivalent at year-end exchange rates) as follows:
Sterling Sterling
Sterling Total (Drawn
Transaction equivalent equivalent unfunded
and Unfunded)
balance (1) commitment (1)
Hospitals, UK GBP25.0 m - GBP25.0 m
Hotel & Residential, UK GBP49.9 m - GBP49.9 m
Office Scotland GBP4.8 m GBP0.2 m GBP5.0 m
Office, London GBP13.3 m GBP7.3 m GBP20.6 m
Residential, London GBP24.5 m GBP1.1 m GBP25.6 m
Hotel, Oxford GBP16.7 m GBP6.3 m GBP23.0 m
Hotel, Scotland GBP27.2 m GBP15.5 m GBP42.7 m
Hotel, North Berwick GBP10.5 m GBP4.5 m GBP15.0 m
Logistics Portfolio, UK (2) GBP12.0 m - GBP12.0 m
Total Sterling Loans GBP183.9 m GBP34.9 m GBP218.8 m
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Three Shopping Centres, Spain GBP33.3 m - GBP33.3 m Shopping Centre, Spain GBP15.4 m - GBP15.4 m Hotel, Dublin GBP54.2 m - GBP54.2 m Hotel, Spain GBP47.7 m GBP1.3 m GBP49.0 m Office & Hotel, Madrid, Spain GBP16.7 m GBP0.9 m GBP17.6 m Mixed Portfolio, Europe GBP29.5 m - GBP29.5 m Mixed Use, Dublin GBP3.2 m GBP10.1 m GBP13.3 m Office Portfolio, Spain GBP19.3 m GBP2.0 m GBP21.3 m Office Portfolio, Ireland GBP31.8 m - GBP31.8 m Logistics Portfolio, Germany (2) GBP5.9 m - GBP5.9 m Total Euro Loans GBP257.0 m GBP14.3 m GBP271.3 m Total Portfolio GBP440.9 m GBP49.2 m GBP490.1 m
(1) Euro balances translated to sterling at period end exchange rates.
(2) Logistics Portfolio, UK and Logistics Portfolio, Germany is one single loan agreement with Sterling and Euro tranches.
During the financial year, the following significant investment activity occurred (included in the table above):
New Loans
The table below shows new commitments made in 2020 together with amounts funded under both the new commitments and under the existing commitments.
Period of New Funded
Commitment
Commitments (1) in 2020 (2)
Office Portfolio, Ireland January 2020 GBP29.9 m GBP29.9 m
Hotel, Berwick February 2020 GBP15.0 m GBP10.5 m
Residental, London (extension) February 2020 GBP10.0 m GBP10.0 m
Logistics Portfolio, UK June 2020 GBP12.0 m GBP12.0 m
Logistics Portfolio, Germany June 2020 GBP5.9 m GBP5.9 m
Hotel, Scotland Pre 2020 (extended in 2020) GBP1.3 m GBP1.3 m
Hotel, Spain Pre 2020 - GBP19.9 m
Office, Scotland Pre 2020 - GBP0.3 m
Office, London Pre 2020 - GBP0.7 m
Residential, London Pre 2020 - GBP4.6 m
Mixed use, Dublin Pre 2020 - GBP2.4 m
Office Portfolio, Spain Pre 2020 - GBP0.4 m
Total GBP74.1 m GBP97.8 m
(1) Euro amounts converted at rate on date of first loan drawdown.
(2) Euro amounts converted at rate of each drawdown.
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 net commitment of GBP10.0 million. The remaining loan term at the date of the extension was 1.75 years with a 1 year extension option.
New Loan: Logistics, UK and Germany:
On 17 June 2020, the Group closed an investment in the funding of a EUR71.9 million, 36 month floating rate senior loan secured by a portfolio of industrial/logistics assets in the UK and Germany. The investment has been made alongside Starwood Property Trust, Inc (through a wholly owned subsidiary) with the Group participating in EUR20 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.
Extension: Hotel, Scotland: In August 2020, the Group increased (and funded) the total commitment to this loan by an additional GBP1.3 million to allow the borrowers to acquire three additional assets in the same perimeter as the hotel which will add 9 keys when refurbished.
New Loan, Office Portfolio, Ireland: 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 net commitment of EUR35.15 million. The portfolio consists of 12 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 total commitment of GBP15.0 million. The sponsor is a repeat borrower for the Group. The financing, which has been 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.
Repayments
The following loans were repaid in full during the year:
Month Amount (1) Reason Office, Paris February GBP13.4 m Repayment from borrower equity Mixed use Development, South East UK March GBP0.7 m Completion of sales Credit Linked Notes June GBP21.8 m Repayment by issuers Total GBP35.9 m
(1) Sterling equivalent for Euro loans using the spot rate on date of repayment.
The repayment of the Credit Linked Notes in the above table 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.
In addition to the above full repayments, the Group continued to receive scheduled (i.e. contractual) and unscheduled amortisation on other loans as borrowers continue to execute their business plans in the amounts shown in the table below.
Amount(1) Reason Residential, London GBP29.1 m Sale of selected assets in line with business plan Mixed Portfolio, Europe GBP15.4 m Sale of selected assets in line with business plan Office Portfolio, Spain GBP0.4 m Sale of small asset Three Shopping Centres, Spain GBP0.6 m Scheduled amortisation Total GBP45.5 m
(1) Sterling equivalent for Euro loans using the spot rate on date of repayment.
The average remaining term of the loans is 2.4 years, which is split as shown in the table below.
Remaining years to contractual maturity (1) Funded loans % of invested
(GBPm)(2) portfolio
0 to 1 years 79.2 18.0%
1 to 2 years 94.7 21.5%
2 to 3 years 155.8 35.3%
3 to 5 years 111.2 25.2%
Total 440.9 100.0%
(1) excludes any permitted extensions. Note that borrowers may elect to repay loans before contractual maturity.
(2) excluding accrued interest.
PORTFOLIO PERFORMANCE UPDATE
All loan interest and scheduled amortisation payments up to 31 December 2020 have been paid in full and on time, either in accordance with the original or the revised contractual terms of the loans.
Notwithstanding the Covid 19 pandemic-related disruption continuing to be experienced, the portfolio continues to be robust and portfolio performance is in line with current expectations. In the sectors that are most impacted, hospitality and retail, borrowers continue to pay loan interest and capital repayments despite the latest lockdown measures.
Key updates up to 31 December 2020 are outlined below. Further updates throughout the year will be provided via the quarterly factsheets in order to keep shareholders informed.
Hospitality (35.7 per cent of Investment Portfolio) - The largest hotel exposure (Hotel, Dublin), at 27 per cent of hospitality exposure has benefitted from a licence in
place to the Irish Government's Health Service Executive since early in the pandemic and continues to benefit. This
has de-risked the impact of the pandemic in the medium term. In addition, the sponsor has continued to work on
their wider business plan in relation to the extensive land adjacent to the hotel that also forms part of the
loan's collateral. In the last quarter, the sponsor has been successful in achieving planning permission for a
residential scheme of over 220 apartments on a small site that forms part of the wider land collateral. This has
enhanced the value and future liquidity of this site. - The UK hotel exposures (Hotel Oxford, Scotland and North Berwick, accounting for 35 per cent of hotels in the
portfolio) all successfully re-opened during the summer following the lifting of domestic travel restrictions.
Trading was generally positive despite the backdrop of the wider market uncertainty. This reflected the domestic
demand for staycation breaks in the UK, particularly for leisure destinations with nearby outdoor facilities such
as golf which is offered by the Hotel Scotland and North Berwick. This trend is expected to continue into 2021 with
market commentators such as VisitBritain.org forecasting that the recovery of domestic tourism in 2021 will be
significantly stronger than inbound tourism. While 2021 is not expected to recover to pre-Covid-19 levels and
international visitor numbers will be down materially, VisitBritain.org (as of mid December 2020) forecast that the
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