ECU IN THE MEDIA
Foreign Interest
Multi-currency mortgages could potentially save high net worth borrowers' money and they could pay off their loans early. But they are not for everyone, Laverne Hadaway discovers
What they had not reckoned on were the currency fluctuations. Figures from currency manager, the ECU Group show that a £1m loan taken out in yen in 1988 would have risen to £1.7m by November 1994. A £1m loan in yen taken out in 1980 would have ballooned to £4.3m by 1995.
Unfortunately, at the time, there were many mortgage brokers and banks pushing foreign currency loans. They were recommended to people who knew little or nothing about currency speculation. When their loans began to rise in the line with currency fluctuations, they could not take any avoiding action.
Lessons Learned
Today, most advisers would strongly discourage UK borrowers from taking foreign currency mortgages unless they had a very good reason. Simon Jones, director of Savills Private Finance, says that the firm would advise someone to take out a euro or dollar loan if their income stream was in euros or dollars. "If someone came to us for advice and they were simply looking at the interest rates, we'd just say no", says Jones.
So if foreign currency mortgages are so risky, why should multi-currency mortgages fare any better? Although there are a few small operators in the arena, the biggest and probably longest established is ECU. The big difference, it would argue, is that it does actually manage the multi-currency loans, analysing currency movements carefully and taking short to medium term considered positions.
Multiple currencies at least provide more options and flexibility should there be a need to switch out of a currency quickly. Also, there is no gearing; the traders are strictly one for one.
So how does it work? An interest only mortgage is borrowed from a private bank and handed over to the currency manager. Say, for example, that ECU converts £1m into yen at the rate of 180m yen to the pound. The loan is now worth 180m yen. The yen weakens to a rate of 200 to the pound. ECU makes the decision to take a profit. 180m yen converts back to £900,000, thus reducing the loan by £100,000.
The interest rate savings are effectively a secondary consideration. However, historically, UK borrowers have endured some of the highest interest rates compared to other established economies. ECU calculates that the cost of servicing loans denominated in Swiss francs and yen have been between 40% and 75% cheaper than the costs of loans in sterling.
For example, if the interbank rate for borrowing sterling were 5% and for borrowing yen, 0.25% a considerable saving could be made. The monthly interest on a loan denominated in yen would be £1,250, allowing for a bank margin of 1.25%.
ECU suggests that borrowers can benefit from reductions in the loans of around 5% or 6% a year. Over time, that can have a very significant effect on the size of the mortgage.
Another benefit, Robert Guy, director of Timothy James & Partners, an IFA firm specialising in private clients introduced by accountants, solicitors and actuaries, points out, is that it is a tax efficient way of investing. If the currency manager gets it right and the loan is reduced, any reduction is free of tax; the Revenue does not recognise it as a capital gain.
Perhaps the biggest difference between what happened in the '90s and multi-currency mortgages now, is that advisers and lenders do their level best to put would be borrowers off because it is not a mass market and definitely not for every one.
Know your client
"If somebody ran in off the street and said, 'I'm interested in a currency mortgage', I would say no thank you', because I don't know them well enough," Says Guy.
He will recommend a multi-currency mortgage only to private clients for whom he already manages investment portfolios, because it means that he knows their attitude to risk and all their other circumstances. ECU's minimum lending criteria are minimum loans of £100,000, 65% loan to value, income multiples of three times salary or 2.5 times joint incomes and a maximum term of 20 years.
Guy is even more cautious and his minimum criteria for his clients is a maximum LTV of 50%, and a minimum mortgage of £250,000 or more. Normally, he would recommend £500,000, but in certain circumstances he has allowed a smaller minimum.
However, his caution does not end there. Guy says he also tells clients that having budgeted their mortgages at sterling rates, they should continue to pay sterling rates. That way they build up a cash reserve that can be used at the end of the year to cushion any loss if the currency markets went against them and their loan increased or to pay an additional lump sum off the mortgage. "I strongly suggest they just carry on and treat it as though it were a sterling mortgage," he says.
The client must have other assets as well and be comfortable able to afford the mortgage in sterling.
Guy insists that the prospective borrower has meeting with the private bank from whom they are borrowing the money and with the currency manager to ensure that they understand the investment process, how the currencies are picked, dealing with stop losses and so on. He says that he would not allow any client who refused to come to the meeting to go ahead with the transaction. He wants to ensure that everyone goes into it with their eyes open.
If the worst happens
From a risk perspective he also explains the worst case scenario. If the loan rises from its starting point by 15%, that is the trigger limit at which point the bank reserves the right to take the borrower out of the programme and convert the loan back to sterling. That is a 15% permanent increase in the loan. Again, Guy says he would only allow a client to enter into the mortgage for whom the worst scenario would have a minimal effect on their lifestyle. "It wouldn't impact them in terms of their children having to change schools, for example. If their lifestyle would be unduly affected, then clearly this is not the programme for them."
He says that having gone through all those hoops, about one in three clients gets through the meeting stage and decides that a multi currency mortgage is not for him or her. He says that it is unsuitable for anyone who is likely to lose sleep at night thinking about it or likely to keep checking currency movements on teletext. "If they're the sort of person they shouldn't do it. I'm very strict with who I put into it and it's certainly not a mass market product."
Of course, the process is not without risk. World events and cries can suddenly erupt to upset the equilibrium. Ecu readily admits that its customers sufferer losses in the '90s, however, the loses were small compared to what borrowers in single currency suffered. Also since 1995, when its last stop loss was triggered, is has put in place risk-management processes. So the movement to and from currencies is managed with the help of experts and analysis. During crises such as September 11 and the Iraq war, for example, Ecu remained in sterling.
Today, it deals only in the five major currencies: sterling, dollars, yen, euros and Swiss francs. It has with currencies that trade in large volumes every day so that in the event of a sudden crises or change where the company needs to move out of a particular position, it has room for manoeuvre. Also, these are currencies of countries with well established central banks and well established economies. They are unlikely to suffer from interest rates suddenly rising over night as the government tries to protect its local currency.
Depreciation
The aim is to pick the currency that the company believes will depreciate the most against sterling. Typically it trades five or six times a year, switching from one currency to another. Ecu can take advantage of the interbank lending rates that prevail for each currency. It trades at interbank spot rates, which are the best possible rates and the benefits are gained instantly. A client attempting to trade on his or her own could not possibly achieve those rates. Currently the interest rate for borrowing yen is 0.1% the rate for Swiss franc is 0.25%, dollars is 1%, euros 2% and sterling 4.25%. The lenders add on a margin of between 1.25% and 1.75%.
Charges
Apart from the margins paid to the lenders, Ecu charges an annual fee of £2,500 for the first 250,000 loan, with a band of rates from 1% for loans between £250,001 and £500,000, dropping to 0.5% for loans above £5m. The fee is payable by standing order monthly in advance.
In addition, it charges a performance fee equal to 20% of the net profit made by the client. It defines net profit as "the aggregate of any debt reduction and net interest rate savings achieved" during the year. It is payable on each anniversary of the commencement of the loan.
Although Ecu is regulated by the Financial Services Authority, transactions for multi-currency mortgages are not covered and borrowers therefore are not covered by the Financial Services Compensation Scheme. "Really it's for financially sophisticated borrowers," says Cormac Naughten, head of private clients at Ecu. sCaveat emptor has to be the basic principle." He goes on to explain that with typical loans of £0.5m, it is not a product that is accessible to all and sundry. Nevertheless, he says Ecu conducts its business as if the product were regulated. The FSAss unwillingness to get involved, however, gives a good indication of how far multi currency mortgages are from being mass market products. Not only are they unsuitable for the average UK borrower, they are also unsuitable for anyone of a nervous disposition with a cautious attitude towards risk.
