ECU IN THE MEDIA
Niche Mortgages - June 2003
The multi-currency mortgage approach
The multi-currency mortgage approach
There are an increasing number of clients who are attracted by an interest-only mortgage where the amount owed is reduced and monthly payments are below average. This is achieved by the use of different currencies such as US dollar, yen, and even UK sterling, although this is not without risk, says John Mills.
Although a relatively unknown name in the UK mortgage industry, ECU is the largest currency mortgage manager in the UK. It manages mortgages by switching between currencies to take advantage of exchange rate movements in order to reduce the sterling value of the debt. Formed in 1988, ECU Group is the UK's largest and longest established currency debt management firm and is a wholly owned subsidiary of ED & F Man Holdings, the City trading house established in 1783.
"Since the late 1980s a number of financially sophisticated borrowers have placed their mortgages into a currency debt management programme whereby their mortgage is switched between the world's major currencies. The debt manager's objective is to manage the loan down, just as an asset manager seeks to manage an investment up in value," says Cormac Naughten, head of ECU's private client division.
According to the company, clients joining ECU's managed currency mortgage programme at its inception in 1988 are now able to pay off all loans taken out in 1988 with the benefits of the programme - without paying any more than they would have paid with a conventional sterling, interest-only mortgage.
This has enabled them to use the proceeds of any repayment vehicles originally designed to pay off their loans, as they wish - for example, paying school fees or financing their retirements.
Naughten explains how it actually works: "A multi-currency lending facility is arranged for the client with a private bank, and this facility is managed on a discretionary basis. Usually the manager is able to arrange the facility without charge. The manager uses the world's largest financial market - foreign exchange (FX) - to manage the mortgage. Some £1.2 trillion is traded daily in FX - a volume which dwarfs that of equity and bond markets combined.
As with anything in life, currency mortgages are not risk-free. According to ECU, an acid test for potential clients is that if they are unwilling to unable to withstand permanent increase of some 10 to 15 per cent in the size of their loan then they should avoid the product.
"There is also a question of temperamental suitability. This product is not for the faint hearted. Clients who feel that the currency exposure would cause them to have sleepless nights are advised to avoid the product," says Naughten.
"If you're going to be up at 3am with the remote control in your hand, looking at the exchange rates on Teletext, or on the phone checking up, the benefits of this type of mortgage are going to be outweighed by the heartache along the way."
Clients however can come out of the programme at any point without penalty.
Measures are taken to manage risk. Before a client enters the programme a conversion limit will be agreed with the lending bank. Conversion limits are typically set 15 to 25 per cent higher than the starting balance of the loan. If the sterling equivalent of the client's loan then rises to that predefined conversion limit, the bank reserves the right to convert the loan back to sterling. Clients may set their own conversion limits with their lender, providing that the conversion limit sought is in keeping with their lending criteria.
The private banks will automatically switch borrowers back to sterling if their loan increases by more than 20 per cent and this may require some clients to put up extra security to stay in the product. On average ECU switches borrowers into different currencies five to six times a year and after each switch clients are notified which currency their loans are denominated in, the exchange rate obtained and the current sterling equivalent of the loan. A detailed rationale for any switch undertaken is also supplied to clients. "ECU receives no commission or third party payments for switching currencies. This ensures that the best interests of our clients are directly aligned with those of our own," says ECU.
There is a performance fee charged by ECU, which is 15 per cent of the net profit achieved by borrowers each year. The net profit figure is calculated from the combination of debt reduction and net interest rate savings, minus any management fees and currency switching fees charged by the banks involved. Interest is paid to the lender at the rate applicable to the currency ECU moves the client's debt into plus a bank lending margin of one to two per cent over LIBOR.
ECU won't just provide their services to anyone who wants them though. It will only offer the multi-currency option to those who earn more than £75,000 per annum and require a loan of more than £100,000 with a LTV of less than 65 per cent. The group only offers the facility for residential mortgages, although this does include buy-to-let. Currency mortgages will also require additional life insurance cover of 120 percent of the value of the loan.
"Currency mortgage managers explain the product to prospective clients and screen them for suitability," explains Naughten. "This removes the compliance risk from the adviser as well as the anxiety of explaining an unfamiliar and complex product."
"Last year, the UK's largest currency mortgage manager reduced its clients' loans by nearly 11 per cent. Add to this the interest rate savings and clients on such a programme benefited by over 13 per cent. In contrast, many UK asset managers reduced their clients' portfolios by more than double in the same period," says Naughten.
The benefits are not just the sole preserve of the client, however, as advisers can share in the success. "Most currency mortgage managers pay generous procuration fees of up to 0.25 per cent of the value of the mortgage introduced. They only pay advisers a trailing percentage of the annual management fees they receive once certain thresholds have been reached for volumes of business introduced."
Of course one question that many might ask because of the current debate over Europe (or indeed EU withdrawal if some had their way) is what would indeed happen if sterling ceased to exist due to the UK's adoption of the euro. "Should sterling be replaced by the euro, the opportunities for mortgage reduction through currency management will remain unchanged, as the euro will continue to fluctuate against the other major currencies - offering continues opportunities for debt reduction. In addition, interest rates in the eurozone will most likely remain different from those prevailing elsewhere - offering continued opportunities for interest rate savings," says Naughten.
Ultimately, it comes down to taking a risk. Those prepared to do so can reap considerable benefits but of course the opposite could happen. Reputation in the marketplace is extremely vital. As Naughten says: "The two most important qualifications are a long-term track record and the quality of the foreign exchange professionals involved in the managing firm. Failure to heed this advice could mean a painful experience for both client and mortgage adviser."
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