CITY of London bankers are finding ingenious ways of servicing the huge mortgages that come with those Notting Hill flats and Chelsea townhouses, writes Phil Davis.
Paying down the capital over 25 years and the interest at standard variable rates is not for the financial elite.
To achieve this they are turning to currency mortgages, which aim to borrow in currencies with low interest rates and ones that are likely to fall most against sterling.
This may sound familiar to older hands who took a beating from foreign currency mortgages in the 1980s. A borrower with a yen loan of £1m in 1980 would have owed £4.3m 15 years later as the Japanese currency soared.
But the tide has turned: The ECU Group plc, the biggest currency mortgage company, runs about £800m worth of them for more than 700 City homeowners, a 10-fold increase in 10 years. ECU switches the loan regularly between the pound, dollar, Canadian dollar, Swiss Franc and euro based on its macroeconomic views. In effect, it's a macro hedge fund.
ECU's record shows that taking a medium-term view, of months or even years, can beat the odds (and the City's short-term currency traders). Someone taking out a £1m, 17-year mortgage with ECU in 1988 would have paid an average interest rate of 5.4% instead of the variable rate of 8.94%. Even better, the loan would have reduced to £545,561 without a single capital repayment.
The trick is low turnover - ECU switches currencies on average 15 times a year - and taking long views so positions are exited ahead of the herd. ECU's greatest coup came in 1992 when it viewed the Finnish mark decoupling from the German Deutschmark as a prelude to sterling suffering a similar fate. It switched the debt into sterling weeks before Britain was ejected from the Exchange Rate Mechanism and the pound plummeted.
Other attractions are that debt reduction is not subject to tax, whereas investing in a currency would be. And with British interest rates the highest in the western world over the past 20 years, it is unsurprising that City types are looking to bypass them.
It requires deep pockets and strong nerves. Mortgagees must be able to tolerate the volatility of forex markets and put up more money if the debt increases by more than 20%. And the service does not come cheap: managers levy an annual charge of about 1% of the loan and a performance fee of 20% of the debt reduction.
Foreign exchange movements can be sudden and substantial. At no stage should you expose yourself to the high risks of foreign currency exposures if you are not able to afford the potential losses that could result from sizeable adverse currency movements and the higher interest rate servicing costs that would be required of you in the event of your having a larger debt.
Denominating debt in foreign currencies may not be suitable for you. Changes in the exchange rate may increase the sterling equivalent of your debt. Your lender will not tolerate too great an increase in the sterling equivalent of your debt as a result of currency losses and may opt to convert your debt back into sterling at a predetermined level. This may result in a permanent increase in the sterling equivalent of your debt which is not fully compensated for by any other benefits derived during the course of The ECU Group plc's discretionary currency debt management services. In this event, you could be left paying UK interest rates on a larger amount of sterling debt than that you originally borrowed. Your home may be repossessed if you do not keep up repayments on your mortgage.
Your lending bank sets a 'Conversion Limit' at which level they have the right to convert your managed multi-currency mortgage back into sterling to prevent further currency losses. It is important to understand that this is a right of your lending bank and not an obligation and that if they do not act promptly to convert your loan back into sterling when your Conversion Limit is reached, your loan could increase by more than that specified by your Conversion Limit.
ECU may from time to time transfer your loan into foreign currencies with higher interest rates than sterling with the objective of achieving a debt reduction in that currency.
Sterling interest rates are subject to change and the differential between sterling interest rates and the interest rates of other foreign currencies will fluctuate.
Suitability
The markets or financial instruments discussed herein may not be suitable for all investors and investors must make their own investment or participation decisions using their own independent advisors as they believe necessary and based upon their specific financial situation and investment objectives. Past performance is not a reliable indicator of future performance, and should not therefore form the basis of a decision whether or not to buy or sell any investments or financial instruments or to participate in any particular trading strategy mentioned herein.
The UK Regulatory System
The ECU Group plc ("ECU") is authorised and regulated by the Financial Services Authority.
In respect of managing physical liabilities in foreign currencies, ECU trades the foreign exchange markets on a spot basis and issues switch instructions to lending banks on a spot basis. Neither of these activities is currently regulated by the Financial Services & Markets Act 2000 as they meet the "Commercial Purposes" test. Therefore you will not benefit from the protection of the Financial Services and Markets Act 2000.
However, if ECU instructs the Lender, or any prime broker or counterparty with whom ECU effects foreign exchange transactions, to conduct a switch by way of effecting an “option” or “futures” transaction for the Client’s account, such transactions may be considered to be an “investment of a specified kind” under the Financial Services and Markets Act 2000. Consequently, both the execution process provided by the Lender, or any prime broker or counterparty with whom ECU effects foreign exchange transactions, and the currency management services provided by ECU, as envisaged under this Agreement, may be considered to be regulated activities. In such instances, the Client may be required to sign additional risk warnings and the rules for the protection of investors under the Financial Services and Markets Act 2000 will apply.
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CITY of London bankers are finding ingenious ways of servicing the huge mortgages that come with those Notting Hill flats and Chelsea townhouses, writes Phil Davis.
