Results analysis: Starwood European Real Estate Finance

• Starwood European Real Estate Finance (SWEF) has delivered strong performance through a volatile economic environment, and paid two quarterly dividends in the half in line with its 5.5p target. These dividends were covered by net income (with some adjustments made for currency movements which are not expected to persist). They amount to an annualised yield of 5.6% on the share price at the time of writing.
• Cover has been boosted by a rise in interest rates which has fed through into SWEF’s majority floating rate portfolio (78% floating as of 30/06/2022). The unlevered portfolio return rose from 6.6% to 7.1% during the first half of 2022 thanks to this dynamic.
• Meanwhile the loan portfolio has displayed resilience, with all loan interest and scheduled amortization paid in full and on time. SWEF’s NAV has been stable, moving from 103.1p to 103.4p over the half. The loan to value position of the whole portfolio has improved from 61.9% to 60.5%.
• Despite the strong performance, the discount widened over the period, moving from 8.8% to 11.4% as of 30/06/2022. The board has reinitiated a buyback programme since the period end, and this has helped bring the discount in to 4.2% at the time of writing.
• In the event that the discount is 5% or wider in the six months to 31/12/2022, the board, “May put forward a realisation offer to Shareholders (‘Realisation Offer’). The terms of such Realisation Offer would provide, broadly, that Shareholders may request for up to 75% of the Ordinary Shares in issue to be realised for cash. If this mechanism is not activated, the Directors shall exercise the discretion afforded to them under the Articles to put forward a realisation vote (as an ordinary resolution) (“Realisation Vote”) to Shareholders by no later than 28 February 2023. The Board is actively investigating and considering the options available to them in the best interests of Shareholders. This process is ongoing and the outcome uncertain at the current time.”
• SWEF’s managers continue to highlight a strong investment pipeline which represents attractive risk adjusted returns. In the first half they made a new loan against a portfolio of offices and industrial property in the Netherlands and the UK. This was facilitated by a number of disposals and partial repayments.
• As of 30/06/2022, 34% of the book was to mature in less than one year. The managers have £70.7m of available funds to put to work, accounting for undrawn commitments.
• Chairman of the board John Whittle said: “[SWEF’s]’s NAV stability demonstrates the positive fundamentals of the … portfolio as an exceptionally attractive risk-adjusted source of alternative income tested in the harshest of market environments.”

Kepler View

This is another set of strong results for Starwood European Real Estate Finance (SWEF). The loans have performed well and income has been boosted by rising base rates feeding through into the coupons received. Given market expectations of further rate rises to come, this should improve the income cover situation further and in due time, if sustained, maybe lead the board to consider an increased payout. We think the discount narrowing is likely to reflect the market recognising the uncertainty stemming from the pandemic is now in the past, as well as the active buyback programme. With the discount window now open for triggering a tender offer or continuation vote, this should provide strong support for the share price adding to the attractions of the shares in a troubled market.

We note the disposals achieved during the period have contributed to an improvement in quality in the portfolio, with a lower LTV. Meanwhile one of the three loans classified as stage 2 for IFRS purposes (reflecting an increased risk of impairment) has been upgraded, reflecting strong trading after the completion of a refurbishment programme. The managers report the pipeline for new investments is strong, and we note they will need to reinvest around 1/3 of the portfolio over the next twelve months. We think widening credit spreads mean this could be a good time to make new loans, although the current economic uncertainty does seem likely to lead to a recession which means stock selection and diligent fundamental analysis will remain highly important.

SWEF’s dividend yield of 5.6% is on offer without the substantial interest rate risk which high yield bonds bring. Loans typically sit high up the capital structure, and the LTV of 60.5% provides a substantial margin of safety. As the share price is supported by the potential tender or continuation vote, we think this is likely to reduce discount risk too, and so SWEF looks like an interesting source of stable returns in a highly uncertain environment.

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