SWEF: Portfolio Update

Starwood European Real Estate Finance Limited

Quarterly Portfolio Update

Annualised dividend yield of 6.3 per cent, fully covered by income;

two capital redemptions undertaken year to date and more expected in next few quarters

Starwood European Real Estate Finance Limited (“SEREF” or the “Group”), a leading investor managing and realising a diverse portfolio of high quality senior and mezzanine real estate debt in the UK and Europe, is pleased to present its performance for the quarter ended 30 September 2023.

Highlights

•  Further realisation progress - during the quarter:
  • A total of £74.6 million, 19.6 per cent of the Group’s 30 June 2023 total funded loan portfolio, has been repaid across seven investments
  • This included the full repayment of two loans and five partial repayments
  • Proceeds were used in the quarter to fund the second return of capital to shareholders of £30.0 million and to create a cash reserve for unfunded loan cash commitments which amount to £44.5 million as at 30 September 2023
• The average remaining loan term of the portfolio is 1.4 years
• Strong cash generation - the portfolio continues to support annual dividend payments of 5.5 pence per Ordinary Share, paid quarterly, and generates an annual dividend yield of 6.3 per cent on the share price as at 30 September 2023
• Inflation protection – 86.6 per cent of the portfolio is contracted at floating interest rates (with floors)
• Robust portfolio - the loan book is performing broadly in line with expectations with its defensive qualities reflected in the Group’s continued NAV stability in a challenging macro environment
• Significant equity cushion - the weighted average Loan to Value for the portfolio is 58.3 per cent

John Whittle, Chairman of SEREF, said:

“Our real estate debt portfolio has continued to deliver results against a difficult market backdrop, providing a regular, consistent and fully covered dividend and substantial inflation protection. Our high quality loan book has performed broadly in line with expectations and there have been no changes to the credit risk levels applied to any of the loan investments during the quarter.

In accordance with the amendments to the Company’s articles of incorporation approved by shareholders at the EGM on 27 January 2023, we are working to return cash to shareholders in an orderly manner as soon as reasonably practicable following the repayment of loans, while retaining sufficient working capital for ongoing operations and the funding of committed but currently unfunded loan commitments. We have made good progress on this objective so far this year with £40.0 million being returned to shareholders and a cash reserve of £44.5 million being created to fund the currently unfunded loan cash commitments. The average remaining loan term of the portfolio has now reduced to 1.4 years and as such we look forward to updating shareholders on this objective in due course.”

The factsheet for the period is available at: www.starwoodeuropeanfinance.com

Share Price / NAV at 30 September 2023

Key Portfolio Statistics at 30 September 2023

*excludes any permitted extensions.  Note that borrowers may elect to repay loans before contractual maturity.

*the currency split refers to the underlying loan currency, however the capital on all non-sterling exposure is hedged back to sterling.

(1) The unlevered annualised total return is calculated on amounts outstanding at the reporting date, excluding undrawn commitments, and assuming all drawn loans are outstanding for the full contractual term.  13 of the loans are floating rate (partially or in whole and all with floors) and returns are based on an assumed profile for future interbank rates, but the actual rate received may be higher or lower.  Calculated only on amounts funded at the reporting date and excluding committed amounts (but including commitment fees) and excluding cash uninvested.  The calculation also excludes the origination fee payable to the Investment Manager.

(2) LTV to Group last £ means the percentage which the total loan drawn less any deductible lender controlled cash reserves and less any amortisation received to date (when aggregated with any other indebtedness ranking alongside and/or senior to it) bears to the market value determined by the last formal lender valuation received by the reporting date.  LTV to first Group £ means the starting point of the loan to value range of the loans drawn (when aggregated with any other indebtedness ranking senior to it). For development projects the calculation includes the total facility available and is calculated against the assumed market value on completion of the relevant project.  

Orderly Realisation and Return of Capital

On 31 October 2022, the Board announced the Company’s Proposed Orderly Realisation and Return of Capital to Shareholders. A Circular setting out the Proposed Orderly Realisation, containing a Notice of Extraordinary General Meeting (EGM) was published on 28 December 2022. The proposals were approved by Shareholders at the EGM in January 2023 and the Company is now seeking to return cash to Shareholders in an orderly manner as soon as reasonably practicable following the repayment of loans, while retaining sufficient working capital for ongoing operations and the funding of committed but currently unfunded loan commitments.

In August 2023, the Company announced its second capital distribution, returning circa £30.0 million to shareholders through the compulsory redemption of 29,092,218 shares at a price of £1.0312 per share.  The first redemption, in June 2023, returned circa £10.0 million to shareholders through the compulsory redemption of 9,652,350 shares at a price of £1.0363 per share. 

Dividend

On 20 October 2023, the Directors declared a dividend, to be paid in November, in respect of the third quarter of 2023 of 1.375 pence per Ordinary Share, equating to an annualised income of 5.5 pence per annum. 

Portfolio Update

The Group continues to closely monitor its loan exposures, underlying collateral performance and repayments. Despite continued heightened risk around high interest rates, economic conditions and lower transaction volumes, the portfolio has continued to perform well.

Significant loan repayments totalling £74.6 million, equivalent to 19.6 per cent of the 30 June 2023 total funded loan balances were received during the quarter to 30 September 2023. This included full repayment of two loan investments; the £49.9 million Hotel & Residential UK loan and the €12.7 million Mixed Use, Dublin loan. These investments were ground up construction projects which had reached substantial construction completion and were successfully refinanced. As a result of this, the Group has no remaining exposure to ground up construction risk and the Group’s exposure to the residential sector has dropped to 1.1 per cent.

The Group’s remaining exposure is spread across 15 investments. Four asset classes represent 84 per cent of the total funded loan portfolio as at 30 September 2023; these are hospitality (38 per cent), office (23 per cent), retail (14 per cent) and light industrial & logistics (9 per cent).

Hospitality exposure is diversified across five loan investments. Two loans (23 per cent of hospitality exposure) benefit from State/Government licences in place at the properties and benefit from significant structural amortisation that continues to decrease these loan exposures. The other trading hotel exposures have either been recently refurbished or are currently under refurbishment. Refurbished assets are expected to be more defensive should consumer spending on leisure decrease in the future. All trading assets currently continue to have strong revenue performance. The weighted average loan to value of the hospitality exposure is 51 per cent.

The office exposure (23 per cent) is spread across six loan investments. This exposure is expected to further reduce during the fourth quarter as the Office London loan (29 per cent of office exposure) is under contract to sell. Occupancy across the leased office portfolio has held up well, with the vast majority of the underlying tenants renewing leases and staying in occupation. The Group’s office exposure is predominantly weighted towards substantially Grade A product (52 per cent of office exposure) and well-located city centre Grade B product (34 per cent). Only 13 per cent of office exposure or 3 per cent of the total invested portfolio is Grade B located in city periphery sub-markets. The weighted average loan to value of loans with office exposure is 60 per cent. The average age of these independently instructed valuation reports is less than one year and hence there continues to be significant headroom to the Group’s loan basis on these loans.

The retail exposure (14 per cent) is spread over three investments and has continued to perform strongly from an operational perspective, with occupancies across the shopping centre exposures fully recovered to pre-pandemic levels and in the high eighties or nineties per cent. The sponsor of the shopping centre loans has granted exclusivity to a credible potential purchaser who is currently conducting due diligence. The sponsor is targeting a sale by year end. The weighted average loan to value of the Retail exposure is 76 per cent.

Light industrial & logistics exposure comprises 9 per cent of the total funded portfolio (in two investments) and provides good diversification into an asset class that continues to have very strong occupational and investor demand. Weighted average loan to value of this asset class is 65 per cent.

On a portfolio level we continue to benefit from material headroom in underlying collateral value against the loan basis, with a current weighted average loan to value of 58 per cent. These metrics are based on independent third party appraisals (with the exception of two loans that have been marked against a sale process bid level). These appraisals are typically updated annually for income producing assets. The weighted average age of valuations is just under ten months.

Credit Risk Analysis

All loans within the portfolio are classified and measured at amortised cost less impairment. 

During the quarter there have been no changes to the existing credit risk levels for any of the loans in the portfolio.

The Group follows a three-stage model for impairment based on changes in credit quality since initial recognition as summarised below:

• A financial instrument that is not credit-impaired on initial recognition is classified as Stage 1 and has its credit risk continuously monitored by the Group. The expected credit loss (“ECL”) is measured over a 12-month period of time.
• If a significant increase in credit risk since initial recognition is identified, the financial instrument is moved to Stage 2 but is not yet deemed to be credit-impaired. The ECL is measured on a lifetime basis.
• If the financial instrument is credit-impaired it is then moved to Stage 3. The ECL is measured on a lifetime basis.

The Group closely monitors all loans in the portfolio for any deterioration in credit risk. As at the date of this factsheet, no additional downgrades or impairments have been recognised since the prior quarter end. As at 30 September 2023, assigned classifications are:

• Stage 1 loans – nine loan investments equivalent to 63% of the funded portfolio are classified in the lowest risk profile, Stage 1.
• Stage 2 loans – five loan investments equivalent to 33% of the funded portfolio have remained in Stage 2. The average loan to value of these exposures is 68 per cent. The average age of valuation report dates used in the loan to value calculation is eight months old. While these loans are considered to be higher risk than at initial recognition, no loss has been recognised on a 12-month and lifetime expected credit losses basis. Therefore, no impairment in the value of these loans has been recognised. The drivers for classifying these deals as Stage 2 are typically either one or a combination of the below factors:
  • lower underlying property values following receipt of updated formal appraisals by independent valuers or agreed and in exclusivity sale values;
  • sponsor business plans progressing more slowly than originally underwritten meaning that trading performance has lagged expectation and operating financial covenants under the facility agreements have breached; and
  • additional equity support is required to cover interest or operating shortfalls as a result of slower lease up or operations taking longer to ramp up.

The Stage 2 loans continue to benefit from headroom to the Group’s investment basis. The Group has a strategy for each of these deals which targets full loan repayment over a defined period of time. Timing of repayment will vary depending on the level of equity support from sponsors. Typically, where sponsors are willing to inject additional equity to partially pay down the loans and support their business plan execution, then the Group will grant some temporary financial covenant headroom. Otherwise, sponsors are running sale processes to sell assets and repay their loans. 

• Stage 3 loan – one loan equivalent to 4 per cent of the funded portfolio is classified as Stage 3. This investment has a loan to value of 92 per cent. This value is based on the projected net proceeds which are expected to be available for loan repayment upon sale of the underlying loan collateral. The sponsor has run a comprehensive competitive sale process through a global advisory firm with oversight by the lenders and the bidder has a proven execution track record in the same asset class and deal size and intends to close with all equity with no reliance on debt. Given continued capital markets volatility, materially lower transaction volumes and uncertainty regarding interest rates, the Group has approved the sale and the buyer is in exclusivity while undertaking standard purchaser due diligence.

While the current projected net sale proceeds on the stage 3 loan would fully pay down the Group’s loan balance, the Group has applied sensitivities to the expected net proceeds and, on that basis, has accounted for a credit impairment of £1.7 million / circa 0.5 per cent of total funded loan portfolio as at 30 September 2023. We note that despite the impairment, this loan investment is projected to achieve local currency returns of over 1.4 times the Group’s capital invested.

This assessment has been made based on 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.