ECU IN THE MEDIA
Property Week - November 2006
A novel currency for the debt-driven investor
A novel currency for the debt-driven investor
With interest rates set to rise, one outfit is helping property to manage its debt, explains Sinead Cruise.
If the Bank of England decides to raise the base rate, as was widely expected as Property Week went to press, it will force leveraged investors in every asset class to look at more efficient and innovative ways to manage their liabilities and service higher costs of borrowing.
The total amount of outstanding debt to property investors hit £155bn at the end of the third quarter, according to figures released by the bank last Friday (see graph 1 below). This represents 10.8% of the UK's overall lending activity and is the highest level on record.
One of the ways in which more intrepid investors hope to remain acquisitive in the face of rising five-year swap rates is by using multi-currency liability management.
This is a strategy in which a specially mandated manager switches the loan from one currency to another, which they hope will weaken against sterling.
Strange currencies
Picking the right currency and trading in and out of the position at the right time enables investors to shave thousands of pounds off projected interest costs. It can also help them achieve to the hitherto impossible and reduce the capital amount of the loan.
The technique has become popular among hedge fund managers and asset managers, and multi-currency loan manager ECU Group says it is starting to capture the imagination of the broader property industry.
The Mayfair-based outfit is the brainchild of City strategists Neil Mackinnon, Michael Petley and Charles Romilly, and it has pioneered the concept of reducing debt and improving cashflow by speculating on currencies.
Its philosophy is that the global debt management industry should equal the global asset management industry in both size and sophistication - a balance that becomes even more important when interest rates are rising and asset values stagnating.
Privately owned and authorised by the Financial Services Authority, the group employs 35 global economists, analysts and researchers who scrutinise the currency markets and economies of the UK, the eurozone, the US, Switzerland and Japan.
Led by ECU's investment managers, Petley and Mackinnon, the team aims to predict the relative strength of currencies. About once a month it meets up to decide whether to trade into another currency that might depreciate in value faster against the pound.
It has 24-hour access to a range of foreign exchange platforms at banks, including Citigroup and the Royal Bank of Scotland, to execute trades.
Since the group was established in 1988, its total loans under management have grown to more than £680m. Over five years, ECU says it has saved its clients an average 10.42% in interest rate costs and reduced their overall debt by 15.06% (see table, left). Over 10 years, the savings are 26.85% and 32.5% respectively (see table and graph 2 below). The figures are net of management and performance fees.
Romilly, head of corporate liability management at ECU, says: 'The vast majority of investors have always had a passive approach to their debt, but they forget that a company balance sheet has two sides.
'It shouldn't matter whether a pound has a plus or minus sign in front of it - both sides of the balance sheet should be managed proactively to maximise returns on capital.'
Despite the possible benefits, Romilly makes it clear that the high-risk, high-return strategy might not suit everyone.
Currency trading is a zero-sum game and one person's loss is another's gain. There is a chance that if the currency an investor trades into actually strengthens against the pound, the size of the loan will increase.
Romilly has perceived a reticence among multi-currency novices who are not prepared to entertain the possibility of a 15% increase in the size of their loan. It has therefore joined forces with ABN Amro to design a performance-protection option to help make it easier for companies to take the plunge.
In return for a premium, ABN Amro will underwrite any trading losses that exceed any net interest rate savings.
Down as well as up
'Of course, there are health warnings,' Romilly admits. 'We would never pretend otherwise.
'But the currency market is actually the largest and most liquid market there is.
'Yes, it is as susceptible to exceptional global shocks as any other market, but skilled managers should be able to predict long-term trends, and the wrapper we have designed with ABN Amro should give some comfort to investors and their lenders.'
Lenders that are comfortable with the ECU approach include Bank Leumi, Citibank, Coutts and HSBC. Their ranks are expected to swell following the introduction of ABN's performance protection.
If ECU is successful in increasing a client's equity, the banks' security improves. If not, ABN Amro underwrites the loss.
Romilly believes winning over the banks is crucial if more property investors are to have a chance of cutting interest costs and paying capital debt back years earlier than they might have anticipated.
'We understand that to use a concept like this involves changing the way property companies have traditionally done deals,' he says.
'One or two people we have spoken to have been blown away by the theory behind the strategy, but their existing structures already have interest-rate hedging devices built in. That's fine for historic deals, but today's transactions are being structured in a very different lending environment.
'As long as we are there from the outset, we can incorporate the debt management services. This provides the potential for the debt to reduce and interest savings to amortise.'
As a debt-management strategy, ECU's multi-currency liability management offers more than the chance to loosen the average leveraged investor from the grip of the banks. Investors can sell their property at any time in the conventional manner, unlike those for which the gearing has been securitised through commercial mortgage-backed securities.
Dicing with debt
Switching debt in and out of currencies provides investors with portfolio diversification by investing in something that has a negative correlation to property.
It can even help to enhance the returns achieved by investors that own modern properties where asset management angles are not so obvious.
The property industry has fed handsomely off the gap between the cost of borrowing and the average property yield for more than five years, but the yawning arbitrage is now little more than a chink.
The days of the no-brainer property deal might be well and truly gone, but so are the days in which property investors had no option but to sit back and slavishly pay off their loans. A more exciting opportunity to manipulate debt to make money may have arrived in its place if investors are bold enough to change the habits of a lifetime.
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