Starwood European Real Estate Finance Ltd (SWEF)
26 March 2019
Starwood European Real Estate Finance Limited
Annual Report and Audited Consolidated Financial Statements
for the year ended 31 December 2018
The Company has today published its annual financial report for the year ended 31 December 2018 and has made it available online at www.starwoodeuropeanfinance.com.
Starwood European Real Estate Finance Limited is an investment company listed on the main market of the London Stock Exchange with an investment objective to provide Shareholders with regular dividends and an attractive total return while limiting downside risk, through the origination, execution, acquisition and servicing of a diversified portfolio of real estate debt investments in the UK and the wider European Union's internal market.
The Group is the largest London-listed vehicle to provide investors with pure play exposure to real estate lending.
The Group's assets are managed by Starwood European Finance Partners Limited, an indirect wholly-owned subsidiary of the Starwood Capital Group.
(1) Further explanation and definitions of the calculation is contained in the section "Alternative Performance Measures" at the end of this financial report.
For further information, please contact:
Duncan MacPherson - Starwood Capital - 020 7016 3655
Full text of annual financial report for the year ended 31 December 2018
Objective and Investment Policy
The investment objective of Starwood European Real Estate Finance Limited (the "Company"), together with its wholly owned subsidiaries Starfin Public Holdco 1 Limited, Starfin Public Holdco 2 Limited, Starfin Lux S.à.r.l, Starfin Lux 3 S.à.r.l, and Starfin Lux 4 S.à.r.l, (collectively the "Group"), is to provide its shareholders with regular dividends and an attractive total return while limiting downside risk, through the origination, execution, acquisition and servicing of a diversified portfolio of real estate debt investments (including debt instruments) in the UK and the wider European Union's internal market.
The Company invests in a diversified portfolio of real estate debt investments (including debt instruments) in the UK and the wider European Union's internal market. Whilst investment opportunities in the secondary markets will be considered from time to time, the Company's predominant focus is to be a direct primary originator of real estate debt investments on the basis that this approach is expected to deliver better pricing, structure and execution control and a client facing relationship that may lead to further investment opportunities.
The Company will attempt to limit downside risk by focusing on secured debt with both quality collateral and contractual protection.
The Company anticipates that the typical loan term will be between three and seven years. Whilst the Company retains absolute discretion to make investments for either shorter or longer periods, at least 75 per cent of total loans by value will be for a term of seven years or less.
The Company's portfolio is intended to be appropriately diversified by geography, real estate sector type, loan type and counterparty.
The Company will pursue investments across the commercial real estate debt asset class through senior loans, subordinated loans and mezzanine loans, bridge loans, selected loan-on-loan financings and other debt instruments. The split between senior, subordinated and mezzanine loans will be determined by the Investment Manager in its absolute discretion having regard to the Company's target return objectives. However, it is anticipated that whole loans will comprise approximately 40-50 per cent of the portfolio, subordinated and mezzanine loans approximately 40-50 per cent and other loans (whether whole loans or subordinated loans) between 0-20 per cent (including bridge loans, selected loan-on-loan financings and other debt instruments). Pure development loans will not, in aggregate, exceed 25 per cent of the Company's Net Asset Value ("NAV") calculated at the time of investment. The Company may originate loans which are either floating or fixed rate.
The Company may seek to enhance the returns of selected loan investments through the economic transfer of the most senior portion of such loan investments which may be by way of syndication, sale, assignment, sub-participation or other financing (including true sale securitisation) to the same maturity as the original loan (i.e. "matched funding") while retaining a significant proportion as a subordinate investment. It is anticipated that where this is undertaken it would generate a positive net interest rate spread and enhance returns for the Company. It is not anticipated that, under current market conditions, these techniques will be deployed with respect to any mezzanine or other already subordinated loan investments. The proceeds released by such strategies will be available to the Company for investment in accordance with the investment policy.
Loan to Value ("LTV")
The Company will typically seek to originate debt where the effective loan to real estate value ratio of any investment is between 60 per cent and 80 per cent at the time of origination or acquisition. In exceptional circumstances that justify it, the ratio may be increased to an absolute maximum of 85 per cent. In any event, the Company will typically seek to achieve a blended portfolio LTV of no more than 75 per cent (based on the initial valuations at the time of loan origination or participation acquisition) once fully invested.
The Company's portfolio will be originated from the larger and more established real estate markets in the European Union's internal market. UK exposure is expected to represent the majority of the Company's portfolio. Outside of the UK, investment in the European Union's internal market will mainly be focussed on Northern and Southern Europe. Northern European markets include Germany, France, Scandinavia, Netherlands, Belgium, Poland, Switzerland, Ireland, Slovakia and the Czech Republic. Southern European markets include Italy and Spain. The Company may however originate investments in other countries in the European Union's internal market to the extent that it identifies attractive investment opportunities on a risk adjusted basis.
The Company will not invest more than 50 per cent of the Company's NAV (calculated at the time of investment) in any single country save in relation to the UK, where there shall be no such limit.
When and if the UK ceases to be a member of the European Union or in the event that any other member state ceases to be a member of the European Union's internal market, it will not automatically cease to be eligible for investment.
Real Estate Sector and Property Type
The Company's portfolio will focus on lending into commercial real estate sectors including office, retail, logistics, light industrial, hospitality, student accommodation, residential for sale and multi-family rented residential. Investments in student accommodation and residential for sale are expected to be limited primarily to the UK, while multi-family investments are expected to be limited primarily to the UK, Germany and Scandinavia. Further, not more than 30 per cent, in aggregate, of the Company's NAV, calculated at the time of investment, will be invested in loans relating to residential for sale. No more than 50 per cent of the Company's NAV will be allocated to any single real estate sector of the UK, except for the UK office sector which is limited to 75 per cent of the Company's NAV.
Counterparty and Property Diversification
No more than 20 per cent of the Company's NAV, calculated at the time of investment, will be exposed to any one borrower legal entity.
No single investment, or aggregate investments secured on a single property or group of properties, will exceed 20 per cent of the Company's Net Asset Value, calculated at the time of investment.
Company or investment level recourse borrowings may be used from time-to-time on a short term basis for bridging investments, financing repurchases of shares or managing working capital requirements, including foreign exchange hedging facilities and on a longer term basis for the purpose of enhancing returns to Shareholders and/ or to facilitate the underwriting of whole loans with a view to syndication at a later point. In this regard, the Company is limited to aggregate short and long term borrowings at the time of the relevant drawdown in an amount equivalent to a maximum of 30 per cent of NAV but longer term borrowings will be limited to 20 per cent of NAV in any event.
The Company will not enter into derivative transactions for purely speculative purposes. However, the Company's investments will typically be made in the currency of the country where the underlying real estate assets are located. This will largely be in Sterling and Euros. However, investments may be considered in other European currencies, and the Company may implement measures designed to protect the investments against material movements in the exchange rate between Sterling, being the Company's reporting currency, and the currency in which certain investments are made. The analysis as to whether such measures should be implemented will take into account periodic interest, principal distributions or dividends, as well as the expected date of realisation of the investment. The Company may bear a level of currency risk that could otherwise be hedged where it considers that bearing such risk is advisable. The Company will only enter into hedging contracts, such as currency swap agreements, futures contracts, options and forward currency exchange and other derivative contracts when they are available in a timely manner and on terms acceptable to it. The Company reserves the right to terminate any hedging arrangement in its absolute discretion.
The Company may, but shall not be obliged to, engage in a variety of interest rate management techniques, particularly to the extent the underlying investments are floating rate loans which are not fully hedged at the borrower level (by way of floating to fixed rate swap, cap or other instrument). Any instruments chosen may seek on the one hand to mitigate the economic effect of interest rate changes on the values of, and returns on, some of the Company's assets, and on the other hand help the Company achieve its risk management objectives. The Company may seek to hedge its entitlement under any loan investment to receive floating rate interest.
Cash held by the Company pending investment or distribution will be held in either cash or cash equivalents, or various real estate related instruments or collateral, including but not limited to money market instruments or funds, bonds, commercial paper or other debt obligations with banks or other counterparties having a A- or higher credit rating (as determined by any reputable rating agency selected by the Company), Agency RMBS (residential mortgage backed securities issued by government-backed agencies) and AAA rated CMBS (commercial mortgage-backed securities).
Transactions with Starwood Capital Group or Other Accounts
Without prejudice to the pre-existing co-investment arrangements described below, the Company may acquire assets from,
or sell assets to, or lend to, companies within the Starwood Capital Group or any fund, company, limited partnership or other account managed or advised by any member of the Starwood Capital Group ("Other Accounts"). In order to manage the potential conflicts of interest that may arise as a result of such transactions, any such proposed transaction may only be entered into if the independent Directors of the Company have reviewed and approved the terms of the transaction, complied with the conflict of interest provisions in the Registered Collective Investment Scheme Rules 2015 issued by the Guernsey Financial Services Commission (the "Commission") under The Protection of Investors (Bailiwick of Guernsey) Law, 1987, as amended, and, where required by the Listing Rules, Shareholder approval is obtained in accordance with the listing rules issued by the UK Listing Authority. Typically, such transactions will only be approved if: (i) an independent valuation has been obtained in relation to the asset in question; and (ii) the terms are at least as favourable to the Company as would be any comparable arrangement effected on normal commercial terms negotiated at arms' length between the relevant person and an independent party, taking into account, amongst other things, the timing of the transaction.
Starwood Capital Group and certain Other Accounts are party to certain pre-existing co-investment commitments and it is anticipated that similar arrangements may be entered into in the future. As a result, the Company may invest alongside Starwood Capital Group and Other Accounts in various investments. Where the Company makes any such co-investments they will be made at the same time, and on substantially the same economic terms, as those offered to Starwood Capital Group and the Other Accounts.
UK Listing Authority Investment Restrictions
The Company currently complies with the investment restrictions set out below and will continue to do so for so long as they remain requirements of the UK Listing Authority:
* neither the Company nor any of its subsidiaries will conduct any trading activity which is significant in the context of its group as a whole;
* the Company will avoid cross-financing between businesses forming part of its investment portfolio;
* the Company will avoid the operation of common treasury functions as between the Company and investee companies;
* not more than 10 per cent, in aggregate, of the Company's NAV will be invested in other listed closed-ended investment funds; and
* the Company must, at all times, invest and manage its assets in a way which is consistent with its object of spreading investment risk and in accordance with the published investment policy. The Directors do not currently intend to propose any material changes to the Company's investment policy, save in the case of exceptional or unforeseen circumstances. As required by the Listing Rules, any material change to the investment policy of the Company will be made only with the approval of shareholders.
(1) Further explanation and definitions of the calculation is contained in the section "Alternative Performance Measures" at the end of this financial report.
SHARE PRICE PERFORMANCE
As at 31 December 2018 the NAV was 102.66 pence per Ordinary Share (2017: 102.17 pence) and the share price was 102.00 pence (2017: 109.50 pence).
Source: Thomson Reuters
STEPHEN SMITH | Chairman
25 March 2019
It is my pleasure to present the Annual Report and Audited Consolidated Financial Statements of Starwood European Real Estate Finance Limited for the year ended 31 December 2018.
The Group had another successful origination year in 2018 with £208 million of new commitments made to borrowers. With repayments and amortisation at a more typical level than in 2017, net commitments increased by £70.8 million during the year.
The Group declared an aggregate dividend for the year of 6.5 pence per Ordinary Share. The Group's NAV for the year remained stable and NAV total return (including dividends) was 7.0 per cent. The Company's share price total return across the financial year was 1.0 per cent downward, reflecting weaker equity market sentiment generally across several asset classes in late 2018.
As at 31 December 2018, the Group had investments and commitments of £477.2 million (of which £45.5 million was committed but unfunded at the end of the year). The average maturity of the Group's loan book was 2.8 years. The Group had net debt of £40.6 million leaving unused liquidity facilities of £73 million, available to fund undrawn commitments and new lending. The gross annualised levered total return of the invested loan portfolio was 8.0 per cent. The Net Asset Value ("NAV") was £385.0 million, being 102.66 pence per Ordinary Share.
The table below shows the loan commitment and repayment profile over the last five years.
The Group continues to see good opportunities to deploy capital in the target markets. The origination pipeline is healthy, with a number of transactions under review which present attractive risk adjusted returns.
The Group is cautious about raising equity until it is confident that appropriate transactions may be closed in sufficient volume to at least match an underlying repayment trend averaging 35 to 40 per cent of the loan book per annum. New loan closings and repayments tend to be irregular and are often dependent on factors outside the Group's control, though there is a trend towards greater activity pre-holidays in Easter, summer and Christmas. The Group will continue to closely monitor markets and will adjust its capital structure and its appetite for new loans consistent with the availability of suitable investment opportunities.
SHARE ISSUANCE AND SHARE PRICE PERFORMANCE
The year end share price was 102 pence reflecting a 0.7 per cent discount to NAV. The Company has typically traded at around a 4 to 8 per cent premium in the last few years. We believe this recent downward movement is a reflection of general market sentiment, particularly towards the end of the year, and we note that the share price has moved back to a premium in early 2019.
At the last Annual General Meeting ("AGM"), the Company sought and received authority to disapply Pre- Emption Rights on the allotment of equity securities for up to 10 per cent of the Ordinary Shares in issue and, at an Extraordinary General Meeting ("EGM") convened shortly thereafter, for a further 10 per cent. As at the date of this report, this authority has not been utilised.
The Company intends to seek approval to renew these authorities at the upcoming AGM and EGM. As noted above, the Company is currently £40.6 million drawn on its revolving credit facilities of £114 million (net of cash), with £45.5 million of commitments unfunded, meaning it has approximately £28 million of available capacity which is undrawn on its revolving credit facilities (absent of any repayments). If the net investment in 2019 is at a similar level to 2018 (£70.8 million) then the Company would need to issue more than 10 per cent of existing Ordinary Shares to fund the additional commitments.
The Directors believe that having access to capital within a short time frame is important to maintaining access to attractive investment opportunities while at the same time ensuring that the Company does not unnecessarily incur cash drag by raising equity in advance of deployment opportunities (which could negatively impact the Company's dividend target). The Directors believe that such access to capital will also have the following benefits for the Company and the shareholders:
* to enable the Company to pursue larger investment opportunities and hence broaden the range of lending that can be undertaken;
* to enable the Company to further increase the diversification of the Company's portfolio of investments;
* increasing the size of the Company should help to make the Company more attractive to a wider investor base;
* having a greater number of Shares in issue is likely to provide shareholders with increased secondary market liquidity; and
* the Company's fixed running costs would be spread across a larger equity capital base, thereby reducing the Company's ongoing expenses per Share.
In order to take advantage of such opportunities, the Directors believe it is appropriate for the Company to renew these existing authorities at the forthcoming AGM, in respect of issuance of up to 10 per cent of the Ordinary Shares in issue, and at a separate EGM, to be convened for shortly after the AGM, in respect of issuance of a further 10 per cent. Any new Shares issued will be issued at a minimum issue price equal to the prevailing NAV per ordinary Share at the time of allotment together with a premium intended to cover the costs and expenses of the relevant issue.
The explanation of the advantages for the Company and its shareholders of granting such authorities is set out in the Notice of the AGM and in a notice of EGM which is intended to be published shortly.
Total dividends of 6.5 pence per Ordinary Share were declared in relation to the year ended 31 December 2018.
NEW ACCOUNTING STANDARDS
IFRS 9 "Financial Instruments" became effective for annual periods beginning on or after 1 January 2018. The Group has applied IFRS 9 retrospectively which did not result in a change to the classification or measurement of financial instruments. A detailed description of IFRS 9 adoption is provided in Note 2(b)(i) of these consolidated financial statements.
BREXIT AND MACRO-ECONOMIC OUTLOOK
The United Kingdom's imminent departure from the European Union, with or without an agreement, represents a potential threat to the UK economy as well as wider Europe. On a cyclical view, national economies across Europe appear to be heading at best towards lower growth and in some cases towards recession. The potential impact of Brexit could have a further destabilising effect.
To some extent the potential impact of an unsatisfactory UK exit from the EU has already been priced into markets and forecasts, but significant headwinds could arise should there be an unstructured settlement. It is extremely difficult in the circumstances to anticipate the potential impact on markets, so your Board is keeping a particularly watchful eye on the macro position.
The strategy to incrementally grow the overall size of the Group, to minimise cash drag from repayments and to use the revolving credit facility where appropriate, will continue to be our focus during 2019.
We anticipate that we will build on the successes of the recent past and the Directors remain optimistic about the prospects and opportunities for the Group in the year ahead.
The Board will continue to inform you of progress by way of the quarterly fact sheets and investment updates as deals are signed. On behalf of the Board, I would like to close by thanking Shareholders for your commitment and I look forward to briefing you on the Group's progress later this year.
Stephen Smith | Chairman
25 March 2019
Strategic and Business Review
The Strategic Report describes the business of the Group and details the principal risks and uncertainties associated with its activities.
OBJECTIVE, INVESTMENT POLICY AND BUSINESS MODEL
The Objective and Investment Policy describes the Group's strategy and business model.
The Investment Manager is Starwood European Finance Partners Limited, a Company incorporated in Guernsey with registered number 55819 and regulated by the Guernsey Financial Services Commission (the "Commission"). The Investment Manager has appointed Starwood Capital Europe Advisers, LLP (the "Investment Adviser"), an English limited liability partnership authorised and regulated by the Financial Conduct Authority, to provide investment advice, pursuant to an Investment Advisory Agreement.
CURRENT AND FUTURE DEVELOPMENT
A review of the year and outlook is contained in the Investment Highlights and Portfolio Review sections of the Investment Manager's Report and within the Chairman's Statement.
A review of performance is contained in the Investment Highlights and Portfolio Review sections of the Investment Manager's Report.
A number of performance measures are considered by the Board, the Investment Manager and Investment Adviser in assessing the Company's success in achieving its objectives. The Key Performance Indicators ("KPIs") used are established industry measures to show the progress and performance of the Group and are as follows:
* The portfolio yield, both levered and unlevered;
* The payment of targeted dividends;
* The movement in NAV per Ordinary Share;
* The movement in share price and the discount / premium to NAV;
* Ongoing charges as a percentage of undiluted NAV; and
* Weighted average loan to value for the portfolio.
Details of the KPIs are shown in Financial Highlights section.
It is the role of the Board to review and manage all risks associated with the Group, both those impacting the performance and the prospects of the Group and those which threaten the ongoing viability. It is the role of the Board to mitigate these either directly or through the delegation of certain responsibilities to the Audit Committee and Investment Manager. The Board performs a review of a risk matrix at each Board meeting.
The Board considers the following principal risks could impact the performance and prospects of the Group but do not threaten its ability to continue in operation and meet its liabilities. Consequently, it has put in place mitigation plans to manage those identified risks.
Long Term Strategic Risk
The Group's targeted returns are based on estimates and assumptions that are inherently subject to significant business and economic uncertainties and contingencies and, consequently, the actual rate of return may be materially lower than the targeted returns. In addition, the pace of investment has in the past and may in the future be slower than expected or the principal on loans may be repaid earlier than anticipated, causing the return on affected investments to be less than expected. Furthermore, if repayments are not promptly re- invested this may result in cash drag, which may lower portfolio returns. As a result, the level of dividends to be paid by the Company may fluctuate and there is no guarantee that any such dividends will be paid. The shares may, therefore, trade at a discount to NAV per share and shareholders may be unable to realise their investments through the secondary market at NAV per share.
The Board monitors the level of premium or discount of share price to NAV per share. While the Directors may seek to mitigate any discount to NAV per share through the discount management mechanisms set out in this Annual Report, there can be no guarantee that they will do so or that such mechanisms will be successful. Please see Report of the Directors for further information on the discount management mechanisms.
The Investment Adviser provides the Investment Manager and the Board with a weekly report on pipeline opportunities, which includes an analysis of the strength of the pipeline and the returns available. The Directors also regularly receive information on the performance of the existing loans, including the performance of the underlying assets and the likelihood of any early repayments, which may impact returns.
The Board monitors investment strategy and performance on an ongoing basis and regularly reviews the Investment Objective and Investment Policy in light of prevailing investor sentiment to ensure the Company remains attractive to its shareholders.
Interest Rate Risk
The Group is subject to the risk that the loan income and income from the cash and cash equivalents will fluctuate due to movements in interbank rates.
The loans in place at 31 December 2018 have been structured so that 19.9 per cent of the loans are fixed rate, which provides protection from downward interest rate movements to the overall portfolio (but also prevents the Group from benefitting from any interbank rate rises on these positions). In addition, whilst the remaining 80.1 per cent is classified as floating, 93.7 per cent of these loans are subject to interbank rate floors such that the interest cannot drop below a certain level, which offers some protection against downward interest rate risk. When reviewing future investments, the Investment Manager will continue to review such opportunities to protect against downward interest rate risk.
The Board considers that the following principal risks could impact both the performance and prospects of the Group and could also threaten its ability to continue its operations and meet its liabilities but has identified the mitigating actions in place to manage them.
Foreign Exchange Risk
The majority of the Group's investments are Euro denominated. The Group is subject to the risk that the exchange rates move unfavourably and that a) foreign exchange losses on the loan principal are incurred and b) that interest payments received are lower than anticipated when converted back to Sterling and therefore returns are lower than the underwritten returns.
The Group manages this risk by entering into forward contracts to hedge the currency risk. All non-Sterling loan principal is hedged back to Sterling to the maturity date of the loan. Interest payments are hedged for the period for which prepayment protection is in place. However, the risk remains that loans are repaid earlier than anticipated and forward contracts need to be broken early. In these circumstances, the forward curve may have moved since the forward contracts were placed which can impact the rate received. In addition, if the loan repays after the prepayment protection, interest after the prepayment-protected period may be received at a lower rate than anticipated leading to lower returns for that period. Conversely, the rate could have improved and returns may increase.
As a consequence of the hedging strategy employed as outlined above, the Group is subject to the risk that it will need to post cash collateral against the mark to market on foreign exchange hedges which could lead to liquidity issues or leave the Group unable to hedge new non-Sterling investments.
The Company had approximately £264.8 million of hedged notional exposure with two UK banks at 31 December 2018 (converted at 31 December 2018 foreign exchange ("FX") rates).
As at 31 December 2018 the hedges with one of the counterparties was out of the money in an amount of £8.8 million. If at any time this mark to market exceeds £15 million, the Company is required to post collateral, subject to a minimum transfer amount of £1 million. This situation is monitored closely, however, and as at 31 December 2018, the Company had sufficient liquidity and credit available on the revolving credit facility to meet any cash collateral requirements.
Market Deterioration Risk
As mentioned earlier Brexit might have a destabilising impact on the UK economy and wider European economy as well.
The Group's investments are comprised principally of debt investments in the UK, and the wider European Union's internal market and it is therefore exposed to economic movements and changes in these markets. Any deterioration in the global, UK or European economy could have a significant adverse effect on the activities of the Group and may result in significant loan defaults or impairments.
In the event of a loan default in the portfolio, the Group is generally entitled to accelerate the loan and enforce security, but the process may be expensive and lengthy and the outcome is dependent on sufficient recoveries being made to repay the borrower's obligations and associated costs. Some of the investments held would rank behind senior debt tranches for repayment in the event that a borrower defaults, with the consequence of greater risk of partial or total loss. In addition, repayment of loans by the borrower at maturity could be subject to the availability of refinancing options, including the availability of senior and subordinated debt and is also subject to the underlying value of the real estate collateral at the date of maturity.
In mitigation, the average weighted loan to value of the portfolio is 64.1 per cent. Therefore, the portfolio should be able to withstand a significant level of deterioration before credit losses are incurred.
The Investment Adviser also mitigates the risk of credit losses by undertaking detailed due diligence on each loan. Whilst the precise scope of due diligence will depend on the proposed investment, such diligence will typically include independent valuations, building, measurement and environmental surveys, legal reviews of property title and key leases, and, where necessary, mechanical and engineering surveys, accounting and tax reviews and know your customer checks.
The Investment Adviser, Investment Manager and Board also manage these risks by ensuring a diversification of investments in terms of geography, market and type of loan. The Investment Manager and Investment Adviser operate in accordance with the guidelines, investment limits and restrictions policy determined by the Board. The Directors review the portfolio against these guidelines, limits and restrictions on a regular basis.
The Investment Adviser meets with all borrowers on a regular basis to monitor developments in respect of each loan and reports to the Investment Manager and the Board periodically and on an ad hoc basis where considered necessary.
The majority of the Group's loans are held at amortised cost with only one investment (the credit linked notes) held at fair value through profit or loss at the reporting period end. The performance of each loan is reviewed quarterly by the Investment Adviser for any indicators of significant increase in credit risk, impaired or defaulted loans. The Investment Adviser also provides their assessment of any expected credit loss for each loan advanced. The results of the performance review and allowance for expected credit losses are discussed with the Investment Manager and the Board.
Risk of Default Under the Revolving Credit Facilities
The Group is subject to the risk that a borrower could be unable or unwilling to meet a commitment that it has entered into with the Group as outlined above under market deterioration risk. As a consequence of this, the Group could breach the covenants of its revolving credit facilities, and fall into default itself.
A number of the measures the Group takes to mitigate market deterioration risk as outlined above, such as portfolio diversification and rigorous due diligence on investments and monitoring of borrowers, will also help to protect the Group from the risk of default under the revolving credit facility as this is only likely to occur as a consequence of borrower defaults or loan impairments.
The Board regularly reviews the balances drawn under the credit facility against commitments and pipeline and reviews the performance under the agreed covenants. The loan covenants are also stress tested to test how robust they are to withstand default of the Group's investments.
ASSESSMENT OF PROSPECTS
The Group's strategy is central to an understanding of its prospects. The Group's focus is particularly on managing expected repayments in order to minimise any potential for cash drag and continuing to grow the Group by sourcing investments with good risk adjusted returns. The Group's prospects are assessed primarily through its strategic review process, which the Board participates fully in. The Directors' have assessed the prospect of the Group over a period of three years which has been selected because the strategic review covers a three-year period and this is also the approximate average remaining loan term. The Group updates its plan and financial forecasts on a monthly basis and detailed financial forecasts are maintained and reviewed by the Board regularly.
ASSESSMENT OF VIABILITY
Although the strategic plan reflects the Directors' best estimate of the future prospects of the business, they have also tested the potential impact on the Group of a number of scenarios over and above those included in the plan, by quantifying their financial impact. These scenarios are based on aspects of the following selected principal risks, which are detailed in this Strategic Report, and as described below:
* Foreign exchange risk;
* Market deterioration risk (including impact of Brexit); and
* Risk of default under the revolving credit facilities.
These scenarios represent 'severe but plausible' circumstances that the Group could experience. The scenarios tested included:
* A high level of loan default meaning that the Group stopped receiving interest on a substantial part of the portfolio; and
* An analysis of the robustness of the covenants under the revolving credit facility to withstand default of the underlying investments.
The results of this stress testing showed that the Group would be able to withstand a high level of underlying loan default or impairment resulting from either of the risks identified over the period of the financial forecasts.
Based on the assessment of prospects and viability as set out above, the Directors confirm they have a reasonable expectation that the Group will continue in operation and meet its liabilities as they fall due over the three-year period ending 31 December 2021, which is also the approximate average remaining loan term.
In connection with the viability statement, the Board confirm that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity.
COMMUNITY, SOCIAL, EMPLOYEE, HUMAN RIGHTS AND ENVIRONMENTAL ISSUES
In carrying out its activities and in its relationship with the community, the Group aims to conduct itself responsibly, ethically and fairly, including in relation to social and human rights issues. The Group has no employees and the Board is composed entirely of non-executive Directors. As an investment company, the Group has no direct impact on the environment. However, the Group believes that it is in shareholders' interests to consider environmental, social and ethical factors when selecting and retaining investments.
The Directors consider that the Board is of an appropriate size and that its members have a balance of skills, qualifications and experience which are relevant to the Company. The Board supports the recommendations of the Davies Report and believes in the value and importance of diversity in the boardroom and it continues to consider the recommendations of the Davies Report which will be a key consideration as part of its succession planning.
The Company has no employees and therefore has no disclosures to make in this regard.
Stephen Smith | Chairman
25 March 2019
Investment Manager's Report - Investment Highlights
The Investment Manager and Investment Adviser are both part of the Starwood Capital Group, a leading global real estate investment group.
The Investment Manager and the Board of the Company considers that the Group is engaged in a single segment of business, being the provision of a diversified portfolio of real estate backed loans. The analysis presented in this report is presented to demonstrate the level of diversification achieved within that single segment. The Board does not believe that the Group's investments constitute separate operating segments.
As at 31 December 2018, the portfolio was invested in line with the Group's investment policy and is summarised below.
(1) Further explanation and definitions of the calculation is contained in the section "Alternative Performance Measures" at the end of this financial report.
* The currency split refers to the underlying loan currency; however, the capital and interest during protected periods on all non-sterling exposure is hedged back to sterling.
One of the key alternative performance measures of the Group is the gross levered return. A definition of how this is calculated is included in the Alternative Performance Measures section of this report. The levered return on the invested loan portfolio was 8.0 per cent per annum at the end of 31 December 2018, which has increased from 7.7 per cent at 31 December 2017. With the benefit of a few years of normalised repayment activity, the Group has assessed the impact of the repayments on the quoted annualised return and it is worth noting that the calculation of annualised returns quoted in this report and our quarterly factsheets excludes a number of potential upsides that are not incorporated in the returns figures quoted.
* In the quoted return, we amortise all one off fees (such as arrangement and exit fees) over the contractual life of the loan, which is currently at an average of four years for the portfolio. However, it has been our experience that loans tend to repay after approximately 2.5 years and as such, these fees are actually amortised over a shorter period.
* Origination fees are excluded from the annualised returns and these are accounted for within the interest line in the consolidated financial statements.
* Many loans benefit from prepayment provisions, which means that if they are repaid before the end of the protected period, additional interest or fees become due. As we quote the return based on the contractual life of the loan these returns cannot be forecast in the return.
* The quoted return excludes the benefit of any foreign exchange gains on Euro loans. We do not forecast this as the loans are often repaid early and the gain may be lower than this once hedge positions are settled.
The above three possible upsides to quoted return targets are not incorporated in the gross levered yield of 8.0 per cent as they are not guaranteed to occur, are difficult to forecast accurately and to incorporate them could overstate the expected return. However, we expect these to continue to provide an enhancement to the quoted levels of return going forward although the levels of this enhancement may vary depending on when the loans repay versus contractual maturity and prepayment protection, as well as the shape of the Sterling-Euro forward curve. Over the life of the Group to date, we have experienced on average an enhancement of 0.66 percentage points from prepayments and one off fees when loans repay and for the most recent Euro loan originated we are forecasting a pick-up of 1.3 percentage points if held to maturity.
The Group continues to recognise unrealised foreign exchange gains or losses relating to investment activity. The Group has fully hedged the principal of each individual non-Sterling denominated loan with forward contracts, together with interest receipts during the period of prepayment protection. If the loans repay at their scheduled repayment date, the Group would expect that this policy would be effective in protecting against realising FX losses on capital invested.
However, the accounting treatment for the non-Sterling denominated loans is to value the loan at the foreign exchange rate at the relevant valuation date, and to value the hedge based on the market forward rates at the valuation date to the maturity date of the relevant hedge (discounted back to present value). As a result of this accounting treatment, whilst the loan principal is economically fully hedged (if held to loan maturity), unrealised foreign exchange gains or losses are recognised in the accounts during the life of the loan due to changes in the shape of the relevant forward curves. For this reason, the Group disregards unrealised foreign exchange gains and losses when declaring dividends.
It is important to note that should any of the non-Sterling denominated loans repay early, and the Group has no alternative use for the funds repaid and therefore breaks the hedges early, foreign exchange gains or losses could be realised at that point. The size of this will depend on the shape of the relevant forward curve at the point at which the relevant hedge is broken. In general, a steeper curve would result in greater gains/losses.
The Company declared dividends of 6.5 pence per Ordinary Share in respect of the year ended 3 December 2018 (2017: 6.5 pence per Ordinary Share). These dividends are recognised in the Consolidated Statement of Changes in Equity when declared, which is usually within one month after the end of the financial period to which they relate. Dividends are usually paid within one month of the declaration date.
The Company may pay dividends out of reserves provided that the Board of Directors is satisfied on reasonable grounds that the Company will, immediately after payment, satisfy the solvency test (as defined in the Companies (Guernsey) Law, 2008, as amended), and satisfy any other requirement in its memorandum and articles.
INVESTMENT OUTLOOK AND MARKET SUMMARY
2018 numbers from Cushman and Wakefield show that the real estate market in London has been resilient despite the uncertainties of Brexit. Preliminary figures revealed a total office take-up of 12.1 million square feet which was 3 per cent higher than 2017 and 18 per cent higher than 2016. From an investment point of view, total spend reached £19.7 billion, slightly down on the £20 billion from 2017 but above the £16 billion of 2016. The latest INREV investment intentions survey shows that the UK is still high up on investors' targets with 64.6 per cent of investors in the survey looking to invest in the UK, which is behind only Germany at 66.7 per cent. Overall, the commercial real estate lending market still has a high level of liquidity, however, we have seen a repricing for UK loans by some German lenders who are affected by the uncertainties around how UK loans with be treated for Pfandbrief (covered bond financing) purposes when the UK leaves the EU. In addition, there has been a slight pullback for financing more transitional business plans in London, which may present opportunities for lending on good risk adjusted returns.
UK retail continues to fare less well and this is clearly reflected in investment volumes and a lack of appetite from investors and lenders to take on new retail exposure. In Q4 2018, according to data from CBRE Research and Property Data, year-to-date shopping centre transaction volumes stood at £878.1 million, significantly down from a peak of £5.5 billion in 2014. We expect to see a larger number of shopping centres in distress as a result of loan maturities coming due where lenders are keen to be repaid but the owners will find it difficult to find replacement debt or liquidity to sell the property. The retail occupational market will continue to be tough in many places and it still appears to be too early to judge where the new equilibrium will settle for retail income.
In the wider credit markets, we have seen widening of spreads during 2018, which accelerated toward the end of the year. In CMBS EUR AAA and BBB pricing reached a low in Q2 2018 of 70 bps and 230 bps respectively but ended the year around 40 bps wider on each. While that has added to blended pricing of CMBS financing during the year this is not a huge move and BBB spreads were higher than this as recently as Q3 2017. There has been a larger move in the high yield market with the Markit iTraxx Europe Crossover index, which is made up of the 75 most liquid sub-investment grade entities, having started the year at 233 bps and ending at 326 bps. After similar volumes to 2017 for the first three quarters of the year, there was a sharply subdued level of new issuance of leveraged loans and high yield bonds in Q4 2018 with only EUR18 billion of new issuance versus EUR65 billion in Q4 2017. One big contrast between the commercial real estate and corporate credit markets is the growth in size of the markets since the global financial crisis. The volume of outstanding non-financial BBB corporate debt has grown by 181 per cent since 2007 whereas according to the Cass business school the total outstanding CRE debt in the UK is 35 per cent lower than the 2007 peak.
In the Group's other key markets of Spain and Ireland growth remains significantly ahead of the rest of Europe. In Dublin, there is low vacancy in prime office, hotels are running at the top occupancy of all cities in Europe and there is a shortage of residential and student stock. This year the Group has financed the development of new student accommodation in central Dublin, residential housing in commuter areas and one of the largest investments of the year for the Group was a loan made to support the acquisition of an Irish hotel. In Spain, unemployment has continued falling and GDP growth remains strong. In the Madrid market, we are seeing a similar pattern in the real estate metrics with a decreasing vacancy rate and rents increasing from a low base as a result. At this stage, we are able to lend against capital values per square metre which are significantly below the previous peak and which represents a discount to replacement cost.
Across the eight new loans the Group made in 2018, seven were in our key target markets of the UK, Ireland and Spain. We see these dynamics continuing into 2019 and a similar mix of geographical split going forward.
Investment Manager's Report - Portfolio Review
As at 31 December 2018, the Group had investments and commitments of £477.2 million (Sterling equivalent at year-end exchange rates) as follows:
(1) Euro balances translated to sterling at period end exchange rates.
During the financial year, the following significant investment activity occurred (included in the table above):
Student Accommodation, Dublin (EUR11.25 million): On 5 February 2018 the Group committed to a EUR11.25 million whole loan facility to finance a 127-bed purpose built student development scheme in central Dublin. The Dublin student market suffers from a severe structural undersupply of purpose built student accommodation, and the borrower's aim is to deliver high quality schemes in strong locations across Ireland in order to address this shortage. The initial facility advance was made on 5 February 2018, and the remaining development costs were funded monthly until completion in the summer of 2018. The facility has a term of two years.
Residential, Dublin, Ireland (EUR9 million): On 16 February 2018, the Group committed to a EUR9 million floating rate whole loan to finance the conversion of 84 apart-hotels to residential use on a site adjacent to the Hotel, Dublin (described below). The financing has been provided in the form of an initial advance along with a capex facility to fund the refurbishment works for a period of 18 months with a six-month extension option.
Hotel, Dublin, Ireland (EUR60 million): On 21 February 2018, the Group closed a EUR60 million floating rate whole loan to finance the acquisition of a 764 key hotel, 27 apart-hotel units and ancillary development land in Dublin. The financing has been provided in the form of a single advance for a four-year term with a one-year extension option.
Shopping Centre, Spain (EUR17 million): On 23 February 2018, the Group closed a EUR17 million floating rate mezzanine loan secured by a shopping centre in Spain. The property is well anchored, dominates its catchment and is positioned to benefit from the sponsors' active asset management strategy. The financing has been provided in the form of an initial advance along with a capex facility to implement further value enhancing initiatives. The Group's loan complements an existing senior facility provided by Spanish banks, a structure that the Group sees potential to replicate further in Spain. The loan term is 30 months with two one-year extension options.
Hotel, Spain (EUR55 million): On 15 March 2018, the Group closed a EUR110 million floating rate whole loan secured by a hotel in Spain with Starwood Property Trust, Inc. (through a wholly owned subsidiary) participating in 50 per cent of the loan amount, provided the Group with a net commitment of EUR55 million. The financing has been provided in the form of an initial advance along with a capex facility to support the sponsor's repositioning strategy. The loan term is five years, and the Group expects to earn an attractive risk-adjusted return in line with its stated investment strategy.
Industrial, Paris (EUR14.77 million): On 4 May 2018, the Group arranged and subscribed to a EUR14.77 million note issuance, the proceeds of which were used to finance the acquisition of a light industrial asset in the Parisian region of France.
Office & Hotel, Madrid (EUR19.5 million):
On 12 November 2018 the Group closed a EUR19.5 million fixed rate whole loan secured by a mixed-use office and hotel property located in Madrid, Spain. The financing was primarily provided in the form of an initial advance along with a smaller capex facility to support the borrower's value-enhancing, light capex initiatives. The loan term is 5 years, and the Group expects to earn an attractive risk-adjusted return in line with its stated investment strategy.
Hotel & Residential, UK (£62.5 million):
On 18th December 2018 the Group committed to fund a £62.5 million fixed rate mezzanine loan to support the development of a prime mixed-use scheme in Central London with Starwood Property Trust, Inc. (through a wholly owned subsidiary), participating in 66 per cent of the loan amount, providing the Group with a net commitment of £41.25 million. The loan term is 3 years with a one-year extension option, and the Group expects to earn an attractive risk-adjusted return in line with its stated investment strategy. The loan partially funded on 21 December 2018 with the remaining balance expected to be funded in early 2019.
Centre Point, London: The Group received full repayment on 16 February 2018 following successful completion of the borrower's business plan.
Residential Portfolio, Cork: The Group received full repayment of the loan on 13 March 2018 following successful completion of the borrower's business plan.
Hotel, Channel Islands: The Group received full repayment of the on 18 May 2018 following a refinancing by the borrower.
Residential Portfolio, Dublin: The Group received full repayment on 29 November 2018 following a sale of the portfolio.
Industrial, UK: The Group received full repayment of the on 20 December 2018 following a refinancing by the borrower.
Industrial, Paris: The Group received full repayment on 21 December 2018 following a sale of the property.
In addition to the above repayments, the Group continued to receive unscheduled amortisation on other loans as borrowers continue to execute their business plans, in particular on the Varde Partners Mixed Portfolio, the Industrial Portfolio (Europe) and Office (Paris) loans. The Group also advanced £3.6 million of proceeds to borrowers to which it has outstanding commitments from loans originated in prior years.
The average remaining term of the loans is 2.8 years, which is split as shown in the table below.
* excludes any permitted extensions. Note that borrowers may elect to repay loans before contractual maturity.
EVENTS AFTER THE REPORTING PERIOD
The following amounts have been drawn under existing commitments, up to 25 March 2019:
Subsequently to reporting date, the Company repaid EUR15 million under Morgan Stanley credit facility and £11 million under Lloyds credit facility and has drawn additional funds of EUR2 million under Lloyds facility. At 25 March 2019 the amounts drawn under each facility are:
* Morgan Stanley - EUR34 million
* Lloyds - EUR17 million
The following loan amortisation (both scheduled and unscheduled) has been received since the year-end up to 25 March 2019:
The following loans have been repaid in full since the year end:
On 23 January 2019, the Company declared a dividend of 1.625 pence per Ordinary Share payable to shareholders on the register on 22 February 2019.
Starwood European Finance Partners Limited
25 March 2019
Board of Directors
STEPHEN SMITH | Non-executive Chairman - Chairman of the Board
Stephen is Chairman of The PRS REIT which currently trades on the SFS of the London Stock Exchange. He is also Chairman of AEW UK Long Lease REIT plc which trades on the Main Market of the London Stock Exchange. Previously, he was the Chief Investment Officer of British Land Company PLC, the FTSE 100 real estate investment trust from January 2010 to March 2013 with responsibility for the group's property and investment strategy. He was formerly Global Head of Asset Management and Transactions at AXA Real Estate Investment Managers, where he was responsible for the asset management of a portfolio of more than EUR40 billion on behalf of life funds, listed property vehicles, unit linked and closed end funds. Prior to joining AXA in 1999 he was Managing Director at Sun Life Properties for five years. Stephen is a UK resident.
JONATHAN BRIDEL | Non-executive Director - Management Engagement Committee Chairman
Jonathan acts as a non-executive Chairman or Director of listed and unlisted companies comprised mainly of investment funds and investment managers. These include The Renewables Infrastructure Group Limited (FTSE 250), Alcentra European Floating Rate Income Fund Limited (until 30 June 2019), Sequoia Economic Infrastructure Income Fund Limited (FTSE 250) and Funding Circle SME Income Fund Limited which are listed on the main market of the London Stock Exchange, DP Aircraft I Limited and Fair Oaks Income Fund Limited. He was previously Managing Director of Royal Bank of Canada's investment business in the Channel Islands. Prior to this, after working at PriceWaterhouse Corporate Finance in London, Jonathan served in senior management positions in the British Isles and Australia in banking, specialising in credit and in private businesses as Chief Financial Officer. Graduating from the University of Durham with a degree of Master of Business Administration in 1988, Jonathan also holds qualifications from the Institute of Chartered Accountants in England and Wales where he is a Fellow, the Chartered Institute of Marketing and the Australian Institute of Company Directors. Jonathan is a Chartered Marketer and a member of the Chartered Institute of Marketing, a Chartered Director and Fellow of the Institute of Directors and a Chartered Fellow of the Chartered Institute for Securities and Investment. Jonathan is a resident of Guernsey.
JOHN WHITTLE | Non-executive Director - Audit Committee Chairman
John is a Fellow of the Institute of Chartered Accountants in England and Wales and holds the Institute of Directors Diploma in Company Direction. He is a non-executive Director of International Public Partnerships Limited (FTSE 250), India Capital Growth Fund which is listed on the main market of London Stock Exchange, Globalworth Real Estate Investments Limited, GLI Finance Ltd and Aberdeen Frontier Markets Investment Company Limited (all listed on AIM), Toro Limited (listed on SFM), and also acts as non-executive Director to several other Guernsey investment funds. He was previously Finance Director of Close Fund Services, a large independent fund administrator, where he successfully initiated a restructuring of client financial reporting services and was a key member of the business transition team. Prior to moving to Guernsey he was at PriceWaterhouse in London before embarking on a career in business services, predominantly telecoms. He co-led the business turnaround of Talkland International (which became Vodafone Retail) and was directly responsible for the strategic shift into retail distribution and its subsequent implementation; he subsequently worked on the private equity acquisition of Ora Telecom. John is also a resident of Guernsey.
Report of the Directors
PRINCIPAL ACTIVITIES AND INVESTMENT OBJECTIVE
The Principal Activities and Investment Objective are fully detailed in the Objective and Investment Policy.
The Company was incorporated with limited liability in Guernsey under the Companies (Guernsey) Law, 2008, as amended, on 9 November 2012 with registered number 55836, and has been authorised by the Guernsey Financial Services Commission as a registered closed-ended investment company. The Company's Ordinary Shares were admitted to the premium segment of the UK Listing Authority's Official List and to trading on the Main Market of the London Stock Exchange as part of its IPO which completed on 17 December 2012. Further issues have taken place since IPO and are listed under "Capital" below. The issued capital during the year comprises the Company's Ordinary Shares denominated in Sterling.
The Company makes its investments through Starfin Lux S.à.r.l (indirectly wholly-owned via a 100% shareholding in Starfin Public Holdco 1 Limited), Starfin Lux 3 S.à.r.l and Starfin Lux 4 S.à.r.l. (both indirectly wholly-owned via a 100% shareholding in Starfin Public Holdco 2 Limited).
References to the Group refer to the Company and its subsidiaries.
The Company has a target dividend of 6.5 pence per Ordinary Share per annum, based on quarterly dividend payments.
The Company declared dividends of 1.625 pence for each of the calendar quarters of 2018. The Company paid a total of £24,376,261 in respect of 2018 (6.5 pence per Ordinary share) (2017: £24,376,261: 6.5 pence per Ordinary Share).
The Group's performance during the year to 31 December 2018, its position at that date and the Group's future developments are detailed in the Chairman's Statement, the Strategic Report and the Investment Manager's Report.
As part of the Company's IPO completed on 17 December 2012, 228,500,000 Ordinary Shares of the Company, with an issue price of 100 pence per share, were admitted to the premium segment of the UK Listing Authority's Official List and to trading on the Main Market of the London Stock Exchange.
The following issues have been made since IPO:
Following these issues, the Company now has issued share capital consisting of 375,019,398 Ordinary Shares. There have been no further issues during 2018.
Information provided to the Company by major shareholders pursuant to the FCA's Disclosure and Transparency Rules ("DTR") is published via a Regulatory Information Service and is available on the Company's website. The Company has been notified under Rule 5 of the DTR of the following holdings of voting rights in its shares as at 31 December 2018 and as at the date of this report.
DIRECTORS' INTERESTS IN SHARES
The Directors' interests in shares are shown below:
The Directors have adopted a code of Directors' dealings in Ordinary Shares, which is based on EU Market Abuse Regulation ("MAR"). MAR came into effect across the EU (including the UK) on 3 July 2016. The Board is responsible for taking all proper and reasonable steps to ensure compliance with MAR by the Directors, and reviews such compliance on a regular basis.
EVENTS AFTER THE REPORTING PERIOD
Details of events after the reporting period are contained in note 23 to the consolidated financial statements.
The Board of Directors elected to appoint PricewaterhouseCoopers CI LLP as Auditor to the Company at the inaugural meeting of the Company on 22 November 2012 and they have been re-appointed at each AGM held since. PricewaterhouseCoopers CI LLP has indicated their willingness to continue as Auditor. The Directors will place a resolution before the AGM to re-appoint them as independent Auditor for the ensuing year, and to authorise the Directors to determine their remuneration.
Report of the Directors
INVESTMENT MANAGER AND SERVICE PROVIDERS
The Investment Manager during the year was Starwood European Finance Partners Limited (the "Investment Manager"), incorporated in Guernsey with registered number 55819 and regulated by the GFSC and Alternative Investment Fund Management Directive. The Investment Manager has appointed Starwood Capital Europe Advisers, LLP ("the Investment Adviser"), an English limited liability partnership authorised and regulated by the Financial Conduct Authority ("FCA"), to provide investment advice pursuant to an Investment Advisory Agreement.
The administration of both the Company and Investment Manager was delegated to Ipes (Guernsey) Limited (the "Administrator") during the year.
The Company maintains share repurchase powers that allow the Company to repurchase Ordinary Shares in the Market up to 14.99 per cent of the share capital, subject to annual renewal of the Shareholder authority. In addition the Company may raise fresh capital including through a placing programme (subject to the publication of a prospectus of the Company) and through opportunistic tap issues. This enables issuers such as the Company (subject to obtaining the requisite Shareholder authorities) to issue up to 20 per cent of the securities already listed by way of such issues over 12 months without any requirement to publish a prospectus.
Following the approval of the amendment to the Articles, the provisions relating to the Realisation Offer will now first apply by reference to the last six months of the financial year ending 31 December 2022 and that the Realisation Vote mechanism would apply (where the discount-triggered realisation mechanism has not been activated) by no later than 28 February 2023 and in each case on successive five year anniversaries of such dates.
In the event that the discount-triggered realisation mechanism is not activated, the Directors shall exercise their discretion under the Articles to put forward a realisation vote (as an ordinary resolution) to Shareholders by no later than 28 February 2023. If Shareholders vote in favour of this resolution then the Company will procure that a Realisation Offer on substantially the same terms as that described above is offered to Shareholders. Following the receipt of all elections, if either: (i) more than 75 per cent of the Ordinary Shares then in issue were elected for realisation; or (ii) the NAV of the Company following the realisation would be less than £100 million, the Directors may exercise their discretion not to proceed with the Realisation Offer and instead put forward alternative proposals which are no less favourable to electing Shareholders and which may include the reorganisation or winding up of the Company.
If Shareholders vote against the realisation vote then the Company will continue in existence as it is then constituted without any liquidity event for Shareholders.
At the AGM held on 15 May 2018, the Company renewed the authority received at the AGM held on 11 May 2017 to purchase in the market up to 14.99 per cent of the Ordinary Shares in issue on 15 May 2018 at a price not exceeding: (i) five per cent above the average of the mid-market values of the Ordinary Shares for the five Business Days before the purchase is made; or (ii) the higher of the last independent trade or the highest current independent bid for the Ordinary Shares.
The Directors will give consideration to repurchasing Shares under this authority, but are not bound to do so, where the market price of an Ordinary Share trades at more than 7.5 per cent below the Net Asset Value per Share for more than 3 months, subject to available cash not otherwise required for working capital purposes or the payment of dividends in accordance with the Company's dividend policy.
If not previously used, this authority shall expire at the conclusion of the Company's AGM in 2019. The Directors intend to seek annual renewal of this buyback authority from Shareholders each year at the Company's AGM.
John Whittle | Director
25 March 2019
Directors' Remuneration Report
REMUNERATION POLICY & COMPONENTS
The Board endeavours to ensure the remuneration policy reflects and supports the Company's strategic aims and objectives throughout the year under review. It has been agreed that, due to the small size and structure of the Company, a separate Remuneration Committee would be inefficient; therefore the Board as a whole is responsible for discussions regarding remuneration.
As per the Company's Articles of Association, all Directors are entitled to such remuneration as is stated in the Company's Prospectus or as the Company may determine by ordinary resolution; to not exceed the aggregate overall limit of £200,000. Subject to this limit, it is the Company's policy to determine the level of Directors' fees, having regard for the level of fees payable to non-executive Directors in the industry generally, the role that individual Directors fulfil in respect of responsibilities related to the Board, Management Engagement Committee and Audit Committee and the time dedicated by each Director to the Company's affairs. Base fees are set out below.
As outlined in the Articles of Association, the Directors may also be paid for all reasonable travelling, accommodation and other out-of-pocket expenses properly incurred in the attendance of Board or Committee meetings, general meetings, or meetings with shareholders or debentures of the Company or otherwise in discharge of their duties; and all reasonable expenses properly incurred by them seeking independent professional advice on any matter that concerns them in the furtherance of their duties as Directors of the Company.
No Director has any entitlement to pensions, paid bonuses or performance fees, has been granted share options or been invited to participate in long-term incentive plans. No loans have been originated by the Company for the benefit of any Director.
None of the Directors have a service contract with the Company. Each of the Directors has entered into a letter of appointment with the Company dated 22 November 2012, and then prior to the May 2019 AGM, subject to re-election every three years thereafter at the AGM. It has been decided that from the May 2019 AGM each Director is subject to annual re-election.
The Directors do not have any interests in contractual arrangements with the Company or its investments during the year under review, or subsequently. Each appointment can be terminated in accordance with the Company's Articles and without compensation. As outlined in the letters of appointment, each appointment can be terminated at the will of both parties with one month's notice either by (i) written resignation; (ii) unauthorised absences from Board meetings for 12 months or more; (iii) written request of the other Directors; or (iv) a resolution of the shareholders.
Directors' and Officers' liability insurance cover is maintained by the Company but is not considered a benefit in kind nor constitutes a part of the Directors' remuneration. The Company's Articles indemnify each Director, Secretary, agent and officer of the Company, former or present, out of assets of the Company in relation to charges, losses, liabilities, damages and expenses incurred during the course of their duties, in so far as the law allows and provided that such indemnity is not available in circumstances of fraud, wilful misconduct or negligence.
By order of the Board
John Whittle | Director
25 March 2019
Corporate Governance Statement
As a regulated Guernsey incorporated company with a Premium Listing on the Official List and admission to trading on the Main Market for Listed Securities of the London Stock Exchange, the Company is required to comply with the principles of the UK Corporate Governance Code dated April 2016 ("UK Code") (the UK Corporate Governance Code dated July 2018 will apply for the period beginning 1 January 2019).
As an AIC member, the Board has also considered the principles and recommendations of the AIC Code of Corporate Governance dated July 2016 ("AIC Code") by reference to the AIC Corporate Governance Guide for Investment Companies ("AIC Guide"). The AIC Code addresses all the principles set out in the UK Code, as well as setting out additional principles and recommendations on issues of specific relevance to the Company. The AIC Code has been endorsed by the Financial Reporting Council as ensuring investment company boards fully meet their obligations to the UK Code and LR 9.8.6 of the Listing Rules. Having adopted the AIC Code with effect from Admission (17 December 2012), the Board has therefore assessed itself, the Committees and performance of the Directors during the year.
Except as disclosed within the report, the Board is of the view that throughout the year ended 31 December 2018, the Company complied with the recommendations of the AIC Code and the relevant provisions of the UK Code. Key issues affecting the Company's corporate governance responsibilities, how they are addressed by the Board and application of the AIC Code are presented below.
The AIC Code includes provisions relating to: the role of the chief executive; executive Directors' remuneration; and the need for an internal audit function which are not considered by the Board to be relevant to the Company, being an externally managed investment company. The Company has therefore not reported further in respect of these provisions.
The Guernsey Financial Services Commission Finance Sector Code of Corporate Governance ("GFSC Code") came into force in Guernsey on 1 January 2012 and was amended in February 2016. The Company is deemed to satisfy the GFSC Code provided that it continues to conduct its governance in accordance with the requirements of the UK Code.
Appointed to the permanent position of Chairman of the Board on 22 November 2012, Stephen Smith is responsible for leading the Board in all areas, including determination of strategy, organising the Board's business and ensuring the effectiveness of the Board and individual Directors. He also endeavours to produce an open culture of debate within the Board.
Prior to the Chairman's appointment, a job specification was prepared which included an assessment of the time commitment anticipated for the role. Discussions were undertaken to ensure the Chairman was sufficiently aware of the time needed for his role, and agreed to upon signature of his letter of appointment. Other significant business commitments of the Chairman were disclosed to the Company prior to appointment to the Board, and were publicly disclosed in the Company's Prospectus dated 28 November 2012. Any subsequent changes have been declared. Certain of these commitments, and their subsequent changes, can be identified in his biography.
The effectiveness and independence of the Chairman is evaluated on an annual basis as part of the Board's performance evaluation; the Management Engagement Committee Chairman is tasked with collating feedback and discussing with the Chairman on behalf of the rest of the Board.
As per the Company's Articles, all Directors, including the Chairman, must disclose any interest in a transaction that the Board and Committees will consider. To ensure all Board decisions are independent, the said conflicted Director is not entitled to vote in respect of any arrangement connected to the interested party, but may be counted in the quorum.
STEPHEN SMITH | Chairman
Independence and Disclosure
The Board and Chairman confirm that they were selected prior to the Company's launch and were able to assume all responsibilities at an early stage, independent of the Investment Manager and Investment Adviser. The Board is composed entirely of non-executive Directors, who meet as required without the presence of the Investment Manager or service providers to scrutinise the achievement of agreed goals and objectives, and monitor performance. Through the Audit Committee and the Management Engagement Committee they are able to ascertain the integrity of financial information and confirm that all financial controls and risk management systems are robust, and analyse the performance of the Investment Manager and other service providers on a regular basis.
Following the annual performance evaluation, it was deemed that the Directors had been proven to challenge the Investment Manager throughout the year under review, as minuted and recorded, therefore for the purposes of assessing compliance with the AIC Code, the Board as a whole considers that each Director is independent of the Investment Manager and free from any business or other relationship that could materially interfere with the exercise of his independent judgment. If required, the Board is able to access independent professional advice. The Investment Manager is also requested to declare any potential conflicts surrounding votes, share dealing and soft commissions on an annual basis to the Board to help with the assessment of investments.
Open communication between the Investment Manager and the Board is facilitated by regular Board meetings, to which the Investment Manager is invited to attend and update the Board on the current status of the Company's investments, along with ad hoc meetings as required.
Coming to mutual agreement on all decisions, it was agreed the Board had acted in the best interests of the Company to the extent that, if deemed appropriate, a Director would abstain or have his objection noted, which would be reflected within the minutes.
Similar to the process outlined above for the appointment of the Chairman, a job specification was prepared for each directorship which included an assessment of the time commitment anticipated for the role to ensure each Director was aware of the time commitment needed for the role. The Directors' other significant business commitments were disclosed to the Company prior to appointment to the Board, and were publicly disclosed in the Company's Prospectus dated 28 November 2012. Any subsequent changes have been declared. Certain of these commitments can be identified in each Director's biography in Board of Directors section. Details of the skills and experience provided by each Director can also be found in their biographies, alongside identification of the role each Director currently holds in the Company.
The terms and conditions of appointment for non-executive Directors are outlined in their letters of appointment, and are available for inspection by any person at the Company's registered office during normal business hours and at the AGM for fifteen minutes prior to and during the meeting.
There is no executive Director function in the Company; all day-to-day functions are outsourced to external service providers.
The Board believes that the Company's Directors should develop their skills and knowledge through participation at relevant courses. The Chairman is responsible for reviewing and discussing the training and development of each Director according to identified needs. Upon appointment, all Directors participate in discussions with the Chairman and other Directors to understand the responsibilities of the Directors, in addition to the Company's business and procedures. The Company also provides regular opportunities for the Directors to obtain a thorough understanding of the Company's business by regularly meeting members of the senior management team from the Investment Manager, Investment Adviser and other service providers, both in person and by phone.
Balance of the Board and Diversity Policy
It is perceived that the Board is well-balanced, with a wide array of skills, experience and knowledge that ensures it functions correctly and that no single Director may dominate the Board's decisions. Having three Directors appointed ensures that during any transition period, there are at least two Directors to provide stability.
The Board's position on diversity can be seen in the Strategic Report. All Directors currently sit on all the Committees, with the exception of the Chairman, who resigned from the Audit Committee during the year (effective 12 November 2018); each Director also fills one Committee chairmanship post only.
Annual Performance Evaluation
The Board's balance is reviewed on a regular basis as part of a performance evaluation review. Using a pre- determined template based on the AIC Code's provisions as a basis for review, the Board undertook an evaluation of its performance, and in addition, an evaluation focusing on individual commitment, performance and contribution of each Director was conducted. The Chairman then met with each Director to fully understand their views of the Company's strengths and to identify potential weaknesses. If appropriate, new members are proposed to resolve any perceived issues, or a resignation is sought. Following discussions and review of the Chairman's evaluation by the other Directors, the Management Engagement Committee Chairman reviewed the Chairman's performance. Training and development needs are identified as part of this process, thereby ensuring that all Directors are able to discharge their duties effectively.
Given the Company's size and the structure of the Board, no external facilitator or independent third party was used in the performance evaluation.
Re-election and Board Tenure
There is currently no Nominations Committee for the Company as it is deemed that the size, composition and structure of the Company would mean the process would be inefficient and counter-productive. The Board therefore undertakes a thorough process of reviewing the skill set of the individual Directors, and proposes new, or renewal of current, appointments to the Board.
During the year the Board took the decision to submit all Directors for re-election annually going forward. Mr John Whittle, Mr Stephen Smith and Mr Jonathan Bridel are therefore submitting themselves for re-election at the AGM on 15 May 2019. Furthermore, beginning from the May 2019 AGM each Director is subject to annual re-election.
The Audit Committee Members and the Board confirm that all Directors have proven their ability to fulfil all legal responsibilities and to provide effective independent judgment on issues of strategy, performance, resources and conduct. The Board therefore has no hesitation in recommending to Shareholders that all Directors are re-elected.
As no new Director has been appointed since the Company's launch and the Board believes there is no gap that currently needs to be filled, no appointment process has been formalised. It is anticipated, however, that the process will involve identifying gaps and needs in the Board's composition, then reviewing the skill set of potential candidates. For renewal of current appointments, all Directors except the individual in question are entitled to vote at the meeting. Similarly, no new nominations have been made for the role of Chairman or Director of the Board since prior to launch.
The Board is mindful of the need to plan for succession and to implement in a constructive fashion that supports and builds on the cohesive Board. In view of the approaching 9th year anniversary of the Company's IPO, the retirement process for the existing Directors, as currently envisaged, is anticipated to commence at the AGM of the Company in May 2020. Replacements should be sought approximately six months before each rotation date allowing for a substantive handover period. In the Directors' opinion this would allow the Board to ensure that there is depth of knowledge, skills and experience and the right individuals are in place to lead the company into the future. Replacement Directors, in particular the exact order of retirements might vary subject to the selection of a new Chairman, which is seen as a critical appointment.
The Board will keep this succession plan under review and monitor its progress with a particular focus on ensuring over time that each new Director is equipped with the necessary skills, experience and knowledge.
BOARD AND COMMITTEES
Matters reserved for the Board include review of the Company's overall strategy and business plans; approval of the Company's half-yearly and annual report; review and approval of any alteration to the Group's accounting policies or practices and valuation of investments; approval of any alteration to the Company's capital structure; approval of dividend policy; appointments to the Board and constitution of Board Committees; observation of relevant legislation and regulatory requirements; and performance review of key service providers. The Board also retains ultimate responsibility for Committee decisions; every Committee is required to refer to the Board, who will make the final decision.
Terms of reference that contain a formal schedule of matters reserved for the Board of Directors and its duly authorised Committee for decision has been approved and can be reviewed at the Company's registered office.
The meeting attendance record is displayed in the Board and Committee Meeting Attendance sections of the Corporate Governance statement. The Directors confirm that they have devoted sufficient time and commitment to meet their board responsibilities. The Company Secretary acts as the Secretary to the Board.
The Board has established an Audit Committee composed of all the independent members of the Board. Effective 12 November 2018, the Chairman of the Board is not included as a Committee member, but may attend the meetings upon invitation by the Audit Committee Chairman. The Audit Committee, its membership and its terms of reference are kept under regular review by the Board, and it is confident all members have sufficient financial skills and experience, and competence relevant to the Company's Sector. Mr John Whittle is Audit Committee Chairman.
The Audit Committee met three times during 2018 (2017: three times); the meeting attendance record is displayed in Board and Committee Meeting Attendance section of the Corporate Governance statement. The Company Secretary acts as the Secretary to the Audit Committee.
Owing to the size and structure of the Company, there is no internal audit function. The Audit Committee has reviewed the need for an internal audit function, and perceived that the internal financial and operating control systems in place within the Company and its service providers, for example as evidenced by the Audit and Assurance Faculty Report ("AAF 01/06 Assurance Report") on the internal procedures of the Administrator, give sufficient assurance that a sound system of internal control is maintained that safeguards shareholders' investment and Company assets.
The Audit Committee is intended to assist the Board in discharging its responsibilities for the integrity of the Company's consolidated financial statements, as well as aiding the assessment of the Company's internal control effectiveness and objectivity of the external Auditors. Further information on the Audit Committee's responsibilities is given in the Report of the Audit Committee.
Formal terms of reference for the Audit Committee are available at the registered office and on the Company's website, and are reviewed on a regular basis.
Management Engagement Committee
The Company has established a Management Engagement Committee which comprises all the Directors, with Mr Jonathan Bridel as the Chairman of the Committee. The Management Engagement Committee's main function is to review and make recommendations on any proposed amendment to the Investment Management Agreement and keep under review the performance of the Investment Manager; and undertake an assessment of the Investment Manager's scope and responsibilities as outlined in the service agreement and prospectus on a formal basis every year. Discussions on the Investment Manager's performance are also conducted regularly throughout the year by the Board. Reviews of engagements with other service providers, such as the Administrator, to ensure all parties are operating satisfactorily are also undertaken by the Management Engagement Committee so as to ensure the safe and accurate management and administration of the Company's affairs and business and that they are competitive and reasonable for Shareholders.
The Management Engagement Committee met once during 2018 (2017: once) and undertook a review of the key service providers to the Group and the Company, utilising a service provider questionnaire. No material weaknesses were identified and the recommendation to the Board was that the current arrangements were appropriate and provided good quality services and advice to the Company and the Group.
Formal terms of reference for the Management Engagement Committee are available at the registered office and the Company's website, and are reviewed on a regular basis.
The Company Secretary acts as the secretary to the Management Engagement Committee.
Board and Committee Meeting Attendance
In addition to the scheduled quarterly and additional ad hoc meetings, the Directors and the Investment Manager have been provided with a number of telephone and face to face investment briefings by the Investment Adviser in order to keep the Directors and the Investment Manager fully apprised and up to date with the current investment status and progress. During the year, a committee of one Director was appointed to approve dividends.
As outlined in the Prospectus, Directors are paid in accordance with agreed principles aimed at focusing on long-term performance of the Company. Further information can be found in the Directors' Remuneration Report.
Individual attendance at Board and Committee meetings is set out below:
1 The ad hoc Board meetings are convened at short notice to deal with administrative matters. It is not therefore always logistically feasible, or a necessity, for the Chairman of the Board to attend such meetings.
Reports and papers, containing relevant, concise and clear information, are provided to the Board and Committees in a timely manner to enable review and consideration prior to both scheduled and ad-hoc specific meetings. This ensures that Directors are capable of contributing to, and validating, the development of Company strategy and management. The regular reports also provide information that enables scrutiny of the Company's Investment Manager and other service providers' performance. When required, the Board has sought further clarification of matters with the Investment Manager and other service providers, both by means of further reports and in-depth discussions, in order to make more informed decisions for the Company.
Under the direction of the Chairman, the Company Secretary facilitates the flow of information between the Board, Committees, Investment Manager and other service providers through the development of comprehensive, detailed meeting packs, agendas and other media. These are circulated to the Board and other attendees in sufficient time to review the data.
Full access to the advice and services of the Company Secretary is available to the Board; in turn, the Company Secretary is responsible for advising on all governance matters through the Chairman. The Articles and schedule of matters reserved for the Board indicate the appointment and resignation of the Company Secretary is an item reserved for the full Board. A review of the performance of the Company Secretary is undertaken by the Board on a regular basis.
FINANCIAL AND BUSINESS INFORMATION
An explanation of the Directors' roles and responsibilities in preparing the Annual Report and Audited Consolidated Financial Statements for the year ended 31 December 2018 is provided in the Statement of Directors' Responsibilities.
For the purposes solely of the audit of the consolidated financial statements, the Auditors have reviewed the Company's compliance with certain of the AIC Code's provisions, the UK Listing Authority's Listing Rules and other applicable rules of the Financial Conduct Authority as reported in the Independent Auditor's Report.
Further information enabling shareholders to assess the Company's performance, business model and strategy can be sourced in the Chairman's Statement, the Strategic Report and the Report of the Directors.
The Directors also considered it appropriate to prepare the financial statements on the going concern basis, as explained in the Basis of preparation paragraph in Note 2 of the financial statements.
IFRS 9 ADOPTION
IFRS 9 "Financial Instruments" became effective for annual periods beginning on or after 1 January 2018. It addresses the classification, measurement and derecognition of financial assets and liabilities and replaces the multiple classification and measurement models in IAS 39. IFRS 9 has been applied retrospectively by the Group and did not result in a change to the classification or measurement of financial instruments as outlined in Note 2(b)(i) of the financial statements.
The Group's investment portfolio of credit linked notes continue to be classified as fair value through profit or loss, and other financial assets which are held for collection continue to be measured at amortised cost.
In assessing those financial assets designated as debt instruments (held for collection), no expected credit losses were deemed to be necessary because of the significant loan to value headroom and strong security packages in place at adoption, and hence there was no material impact on adoption when compared to the prior impairment policy of the Group. However, all new loans are assessed with respect to the determination of the appropriate level of expected credit loss required to be presented in the financial statements, if any, and all outstanding debt instruments held are assessed regularly with the assistance of the Investment Adviser to determine whether any are underperforming or have had a significant credit risk deterioration, which may warrant a lifetime expected credit loss being recognised.
In addition to the earlier assessment of principal risks and uncertainties contained within the Strategic Report, the Board is required annually to review the effectiveness of the Group's key internal controls such as financial, operational and compliance controls and risk management. The controls are designed to ensure that the risk of failure to achieve business objectives is minimised, and are intended to provide reasonable assurance against material misstatement or loss. This is not absolute assurance that all risks are eliminated.
Through regular meetings of the Audit Committee, the Board seeks to maintain full and effective control over all strategic, financial, regulatory and operational issues. The Board maintains an organisational and committee structure with clearly defined lines of responsibility and delegation of authorities.
As part of the compilation of the risk register for the Company, appropriate consideration has been given to the relevant control processes and that risk is considered, assessed and managed as an integral part of the business. The Company's system of internal control includes inter alia the overall control exercise, procedures for the identification and evaluation of business risk, the control procedures themselves and the review of these internal controls by the Audit Committee on behalf of the Board. Each of these elements that make up the Company's system of internal financial and operating control is explained in further detail as below.
(i) Control Environment
The Company is ultimately dependent upon the quality and integrity of the staff and management of the Investment Manager, the Investment Adviser and its Fund Administration & Company Secretarial service provider. In each case, qualified and able individuals have been selected at all levels. The staff of both the Investment Manager and Administrator are aware of the internal controls relevant to their activities and are also collectively accountable for the operation of those controls. Appropriate segregation and delegation of duties is in place.
The Audit Committee undertakes a review of the Company's internal financial and operating controls on a regular basis. The Auditors of the Company consider internal controls relevant to the Company's preparation and fair presentation of the consolidated financial statements in order to design their audit procedures, but not for the purpose of expressing an audit opinion on the effectiveness of the Company's internal controls.
In its role as a third-party fund administration services provider, Ipes (Guernsey) Limited produces an annual AAF 01/06 Assurance Report on the internal control procedures in place within Ipes (Guernsey) Limited and this is subject to review by the Audit Committee and the Board.
(ii) Identification and Evaluation of Business Risks
Another key business risk is the performance of the Company's investments. This is managed by the Investment Manager, which undertakes regular analysis and reporting of business risks in relation to the loan portfolio, and then proposes appropriate courses of action to the Board for their review.
(iii) Key Procedures
In addition to the above, the Audit Committee's key procedures include a comprehensive system for reporting financial results to the Board regularly, as well as quarterly impairment reviews of loans conducted by the Board as a whole (including reports on the underlying investment performance).
Although no system of internal control can provide absolute assurance against material misstatement or loss, the Company's system is designed to assist the Directors in obtaining reasonable assurance that problems are identified on a timely basis and dealt with appropriately. The Company, given its size, does not have an internal audit function. It is the view of the Board that the controls in relation to the Company's operating, accounting, compliance and IT risks performed robustly throughout the year. In addition, all have been in full compliance with the Company's policies and external regulations, including:
* Investment policy, as outlined in the IPO documentation, and subsequently amended by EGM's held on 2 May 2014, 9 March 2015 and 6 May 2016;
* Personal Account Dealing, as outlined in the Model Code;
* Whistleblowing Policy;
* Anti-Bribery Policy;
* Applicable Financial Conduct Authority Regulations;
* Listing Rules, and Disclosure and Transparency Rules;
* Treatment and handling of confidential information;
* Conflicts of interest;
* Compliance policies; and
* Anti-Money Laundering Regulations.
There were no protected disclosures made pursuant to the Company's whistleblowing policy, or that of service providers in relation to the Company, during the year to 31 December 2018.
In summary, the Board considers that the Company's existing internal financial and operating controls, coupled with the analysis of risks inherent in the business models of the Company and its subsidiaries, continue to provide appropriate tools for the Company to monitor, evaluate and mitigate its risks.
When and if the UK leaves Europe as a result of the referendum held on 23 June 2016 and the consequential uncertainty surrounding the UK and EU economy, the Directors considered the impact this decision will have on the Group in the short and longer term. There is still no certainty around Brexit which means that proper planning for it seems impossible.
The Directors believe Brexit is likely to have a limited effect on the Group's financial and operating prospects. The most relevant impact of Brexit since the referendum vote on 23 June 2016 was a reduction in UK interest rates and a slight devaluation of the sterling against the US Dollar and the Euro. Further implications of Brexit on the Group are not identifiable at present. This risk is beyond the control of the Group, but the Group closely monitors Brexit developments and their impact on the financial industry.
The Directors consider that the Group's main impact of Brexit would come from the below factors:
* Macro-economic uncertainty or downturn in the UK economy;
* Global political uncertainty;
* Exchange rate volatility and the devaluation of sterling; and
* Decline in the debt market and borrower ability to repay.
The above risks are already identified as principal risks to the Group which could threaten the ongoing viability of the Group. The potential impact on Group's performance and how associated principal risks are managed by the Board are described in the Strategic Report.
ALTERNATIVE INVESTMENT FUND MANAGEMENT DIRECTIVE ("AIFMD")
The AIFMD, which was implemented across the EU on 22 July 2013 with the transition period ending 22 July 2014, aims to harmonise the regulation of Alternative Investment Fund Managers ("AIFMs") and imposes obligations on managers who manage or distribute Alternative Investment Funds ("AIFs") in the EU or who market shares in such funds to EU investors.
After seeking professional regulatory and legal advice, the Company was established in Guernsey such that, upon implementation of AIFMD it would be a Non-EU AIF, with Starwood European Finance Partners Limited appointed to act as the Non-EU AIFM.
In accordance with AIFMD disclosure obligations, note 6 provides a summary of realised and unrealised gains and losses.
The Investment Manager does not receive an additional fee, to that stated in note 22, as a result of acting as the AIFM. The Board of the Investment Manager received an aggregate fee of £62,500 for the year ended 31 December 2018.
The marketing of shares in AIFs that are established outside the EU (such as the Company) to investors in an EU member state is prohibited unless certain conditions are met. Certain of these conditions are outside the Company's control as they are dependent on the regulators of the relevant third country (in this case Guernsey) and the relevant EU member state entering into regulatory co-operation agreements with one another.
The AIFM has given written notification to the United Kingdom Financial Conduct Authority ("FCA"), pursuant to Regulation 59 of the Alternative Investment Fund Managers Regulations 2013 (SI 1773/2013) (the "AIFM Regulations") of its intention to market the shares to investors in the United Kingdom in accordance with the AIFM Regulations and the rules and guidance of the FCA.
The AIFM has given written notification to the Netherlands Authority for the Financial Markets ("AFM") pursuant to Article 1:13b section 1 and 2 of the Act on the Financial Supervision (Wet op het financieel toezicht) (the "AFS") of its intention to market the shares to investors in the Netherlands in accordance with the AFS, any rules and regulations promulgated pursuant thereto and the rules and guidance of the AFM.
On 12 February 2016, the AIFM obtained a marketing licence in Sweden in accordance with Chapter 5, Section 10 of the Swedish Alternative Investment Fund Managers Act (Sw. lag (2013:561) om förvaltare av alternativa investeringsfonder). This enables shares in the Company to be marketed to professional investors in Sweden. Currently, the National Private Placement Regime ("NPPR") provides a mechanism to market Non-EU AIFs that are not allowed to be marketed under the AIFMD domestic marketing regimes. The Board is utilising NPPR in order to market the Company, specifically in the UK, Sweden and the Netherlands. The Board works with the Company's advisers to ensure the necessary conditions are met, and all required notices and disclosures are made under NPPR.
Any regulatory changes arising from implementation of the AIFMD (or otherwise) that limit the Company's ability to market future issues of its shares may adversely affect the Company's ability to carry out its investment policy successfully and to achieve its investment objective, which in turn may adversely affect the Company's business, financial condition, results of operations, NAV and/or the market price of the Ordinary Shares.
The Board, in conjunction with the Company's advisers, will continue to monitor the development of the AIFMD and its impact on the Company. The Company will continue to use NPPR pending further consultation from the European Securities and Marketing Authority ("ESMA").
The Board has considered the disclosure obligations under Articles 22 and 23 and can confirm that the Company complies with the various organisational, operational and transparency obligations.
FOREIGN ACCOUNT TAX COMPLIANCE ACT ("FATCA") AND THE OECD COMMON REPORTING STANDARDS ("CRS")
FATCA became effective on 1 January 2013 and is being gradually implemented internationally. The legislation is aimed at determining the ownership of US assets in foreign accounts and improving US Tax compliance with respect to those assets.
More than 90 jurisdictions, including all 34 member countries of the Organisation for Economic Co-operation and Development ("OECD") and the G20 members, have committed to implement the Common Reporting Standard for automatic exchange of tax information ("CRS"). Building on the model created by FATCA, the CRS creates a global standard for the annual automatic exchange of financial account information between the relevant tax authorities.
The Board in conjunction with the Company's service providers and advisers have ensured that the Company complies with FATCA and CRS's requirements to the extent relevant to the Company.
DIALOGUE WITH SHAREHOLDERS
The Directors place a great deal of importance on communication with shareholders. The Company's Chairman, Investment Manager and the Brokers, aim to meet with large shareholders at least annually, together with the Investment Adviser, and calls are undertaken on a regular basis with shareholders. The Board also receives regular reports from the Brokers on shareholder issues. Publications such as the Annual Report and Consolidated Financial Statements and quarterly factsheets are reviewed and approved by the Board prior to circulation, and are widely distributed to other parties who have an interest in the Company's performance, and are available on the Company's website.
All Directors are available for discussions with the shareholders, in particular the Chairman and the Audit Committee Chairman, as and when required.
CONSTRUCTIVE USE OF AGM
The Notice of AGM is sent out at least 20 working days in advance of the meeting. All shareholders have the opportunity to put questions to the Board or Investment Manager, either formally at the Company's AGM, informally following the meeting, or in writing at any time during the year via the Company Secretary. The Company Secretary is also available to answer general shareholder queries at any time throughout the year.
SIGNIFICANT VOTE AGAINST EGM RESOLUTIONS
As announced by the Company on 15 May 2018, the Board is aware that a significant number of votes (approximately 56.8 million shares or 21.7% of those voting) was received against Resolution 2 at the 2018 EGM. Resolution 2 at the 2018 EGM requested authority from shareholders to disapply Pre-Emption Rights on the allotment of equity securities for up to 10 per cent of the Ordinary Shares in issue, in addition to the 10% already approved at the May 2018 AGM.
The vast majority of the votes against the resolution were attributable to one institutional investor. For the purpose of good corporate governance and best practice, the Board can confirm that it has engaged with the relevant shareholder following the 2018 EGM and provided an explanation as to why the Board was of the view that the relevant resolution was in the best interests of shareholders. The Board has taken their feedback into account in considering the justification for the future related resolutions.
By order of the Board
John Whittle | Director
25 March 2019
Report of the Audit Committee
The Board is supported by the Audit Committee, which until 12 November 2018 comprised all the Directors during the year under review (the Chairman of the Board, stepped down as a committee member following the release of the 2018 UK Corporate Governance Code on 12 November 2018). The Board has considered the composition of the Audit Committee and is satisfied it has sufficient recent and relevant skills and experience, in particular the Board has considered the requirements of the UK Code that the Audit Committee should have at least one Member who has recent and relevant financial experience and that the Audit Committee as a whole has competence relevant to the sector in which the Company invests. The Board considers all of the relevant requirements to have been met.
ROLE AND RESPONSIBILITIES
The primary role and responsibilities of the Audit Committee are outlined in the Audit Committee's terms of reference, available at the registered office, including:
* Monitoring the integrity of the consolidated financial statements of the Group and any formal announcements relating to the Group's financial performance, and reviewing significant financial reporting judgements contained within said statements and announcements;
* Reviewing the Group's internal financial controls, and the Group's internal control and risk management systems;
* Monitoring the need for an internal audit function annually;
* Monitoring and reviewing the scope, independence, objectivity and effectiveness of the external Auditor, taking into consideration relevant regulatory and professional requirements;
* Making recommendations to the Board in relation to the appointment, re-appointment and removal of the external Auditor and approving their remuneration and terms of engagement, which in turn can be placed before the shareholders for their approval at the AGM;
* Development and implementation of the Group's policy on the provision of non-audit services by the external Auditor, as appropriate;
* Reviewing the arrangements in place to enable Directors and staff of service providers to, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters insofar as they may affect the Group;
* Providing advice to the Board on whether the consolidated financial statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Group's performance, business model and strategy; and
* Reporting to the Board on how the Committee discharged all relevant responsibilities at each Board meeting.
The primary role of the Audit Committee in relation to the financial reporting is to review with the Administrator, Investment Manager and the Auditor the appropriateness of the Annual Report and Audited Consolidated Financial Statements and Interim Condensed Consolidated Financial Statements, concentrating on, amongst other matters:
* The quality and acceptability of accounting policies and practices;
* The clarity of the disclosures and compliance with financial reporting standards and relevant financial and governance reporting requirements;
* Material areas in which significant judgements have been applied or there has been discussion with the Auditor;
* Whether the Annual Report and Audited Consolidated Financial Statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for the shareholders to assess the Group's performance, business model and strategy; and
* Any correspondence from regulators in relation to the Group's financial reporting.
To aid its review, the Audit Committee considers reports from the Administrator and Investment Manager and also reports from the Auditor on the outcomes of their half-year review and annual audit. The Audit Committee supports PricewaterhouseCoopers CI LLP ("PwC") in displaying the necessary professional scepticism their role requires.
The Audit Committee met three times during the year under review; individual attendance of Directors is outlined in the Board and Committee Meeting Attendance section of the Corporate Governance statement. The main matters discussed at those meetings were:
* Review and approval of the annual audit plan of the external Auditor;
* Discussion and approval of the fee for the external audit;
* Detailed review of the Annual Report and Audited Consolidated Financial Statements Accounts and recommendation for approval by the Board;
* Review and approval of the interim review plan of the external Auditor;
* Detailed review of the Interim Condensed Consolidated Financial Statements and recommendation for approval by the Board;
* Discussion of reports from the external Auditor following their interim review and annual audit;
* Adoption and impact of IFRS 9 and expected credit loss model;
* Assessment of the effectiveness of the Auditor as described below;
* Assessment of the independence of the external Auditor;
* Review of the Group's key risks and internal controls;
* Consideration of the 2016 and 2018 UK Corporate Governance Code, Guidance on Audit Committees and other regulatory guidelines, and the subsequent impact upon the Company; and
* The rotation of Group's previous Lead Audit Partner ("LAP") John Roche in line with the requirements of the FRC Ethical Standards, and replacement with a new LAP with significant experience and expertise, Roland Mills.
The Committee has also reviewed and considered the whistleblowing policy in place for the Administrator and other service providers, and is satisfied the relevant staff can raise concerns in confidence about possible improprieties in matters of financial reporting or other matters insofar as they may affect the Company.
Annual General Meeting
The Audit Committee Chairman, or other members of the Audit Committee appointed for the purpose, shall attend each AGM of the Company, prepared to respond to any shareholder questions on the Audit Committee's activities.
The Audit Committee considers at least once a year whether or not there is a need for an internal audit function. Currently, the Audit committee does not consider there to be a need for an internal audit function, given that there are no employees in the Group and all outsourced functions are with parties / administrators who have their own internal controls and procedures. This is evidenced by the annual 01/06 AAF Assurance Report provided by the Administrator, which gives sufficient assurance that a sound system of internal control is maintained at the Administrator.
SIGNIFICANT ISSUES IN RELATION TO THE CONSOLIDATED FINANCIAL STATEMENTS
During the year, the Audit Committee considered a number of significant issues in respect of the Annual Report and Audited Consolidated Financial Statements. The Audit Committee reviewed the external audit plan at an early stage and concluded that the appropriate areas of audit risk relevant to the Group had been identified and that suitable audit procedures had been put in place to obtain reasonable assurance that the consolidated financial statements as a whole would be free of material misstatements. The table below sets out the Audit Committee's view of the key areas of risk and how they have addressed the issues.
REVIEW OF EXTERNAL AUDIT PROCESS EFFECTIVENESS
The Audit Committee communicated regularly with the Investment Manager, Investment Adviser and Administrator to obtain a good understanding of the progress and efficiency of the audit process. Similarly, feedback in relation to the efficiency of the Investment Manager, Investment Adviser and other service providers in performing their relevant roles was sought from relevant involved parties, including the audit partner and team. The external Auditor is invited to attend the Audit Committee meetings at which the semi-annual and annual consolidated financial statements are considered, also enabling the Auditor to meet and discuss any matters with the Audit Committee without the presence of the Investment Manager or the Administrator.
During the year, the Audit Committee reviewed the external Auditor's performance, considering a wide variety of factors including:
* The quality of service, the Auditor's specialist expertise, the level of audit fee, identification and resolution of any areas of accounting judgement, and quality and timeliness of papers analysing these judgements;
* Review of the audit plan presented by the Auditor, and when tabled, the final audit findings report;
* Meeting with the Auditor regularly to discuss the various papers and reports in detail;
* Furthermore, interviews of appropriate staff in the Investment Manager, Investment Adviser and Administrator to receive feedback on the effectiveness of the audit process from their perspective; and
* Compilation of a checklist with which to provide a means to objectively assess the Auditor's performance.
The Audit Committee is satisfied with the effectiveness of the audit process and therefore does not consider it necessary to require the Auditor to tender for the audit work.
AUDITOR'S TENURE AND OBJECTIVITY
The Group has developed an audit tender policy which the Board will re-consider after five years from the appointment date of the current Auditor. The Board re-considered this during 2017 and it was deemed to still be applicable.
The Group's current Auditor, PwC, have acted in this capacity since the Company's inaugural meeting on 22 November 2012. The Committee reviews the Auditor's performance on a regular basis to ensure the Group receives an optimal service. Subject to annual appointment by shareholder approval at the AGM, the appointment of the Auditor is formally reviewed by the Audit Committee on an annual basis. PwC follows the FRC Ethical Standards and their rotation rules now require the lead audit partner to rotate every 5 years, key partners involved in an audit every 7 years and PwC's own internal policy would generally expect senior staff to rotate after 10 years. Rotation ensures a fresh look without sacrificing institutional knowledge.
Rotation of audit engagement partners, key partners involved in the audit and other staff in senior positions is reviewed on a regular basis by the lead audit engagement partner. During the year, John Roche rotated from the position of audit engagement partner to be replaced by Roland Mills.
PwC regularly updates the Audit Committee on the rotation of audit partners, staff, level of fees, details of any relationships between the Auditor and the Group, and also provides overall confirmation of its independence and objectivity. There are no contractual obligations that restrict the Group's choice of Auditor. Any non-audit work would be reviewed by the Audit Committee and approved by the Audit Committee Chairman prior to the Auditor undertaking any work, if the fees are over £12,500. This threshold is reviewed periodically to ensure it is set at an appropriate value.
As a result of its review, the Audit Committee is satisfied that PwC remains independent of the Group, the Investment Manager and other service providers and the Audit Committee has no current plans for re-tendering for the position of auditor to the Company. The Audit Committee therefore recommends the continuing appointment of PwC by the Board.
CONCLUSIONS IN RESPECT OF THE CONSOLIDATED FINANCIAL STATEMENTS
The production and the audit of the Annual Report and Audited Consolidated Financial Statements is a comprehensive process requiring input from a number of different contributors. In order to reach a conclusion on whether the Group's consolidated financial statements are fair, balanced and understandable, as required under the UK Code and the AIC Code, the Board has requested that the Audit Committee advise on whether it considers that the Annual Report and Consolidated Financial Statements fulfils these requirements. In outlining its advice, the Audit Committee has considered the following:
* The comprehensive documentation that is in place outlining the controls in place for the production of the Annual Report and Audited Consolidated Financial Statements, including the verification processes in place to confirm the factual content;
* The detailed reviews undertaken at various stages of the production process by the Investment Manager, Investment Adviser, Administrator, Auditor and the Audit Committee that are intended to ensure consistency and overall balance;
* Controls enforced by the Investment Manager, Investment Adviser, Administrator and other third party service providers to ensure complete and accurate financial records and security of the Group's assets; and
* The existence and content of a satisfactory control report produced by the Ipes Group that has been reviewed and reported upon by the Administrator's service Auditor to verify the effectiveness of the internal controls of the Administrator, such as the AAF 01/06 Assurance Report.
As a result of the work performed, the Audit Committee has concluded that it has acted in accordance with its' terms of reference and has ensured the independence and objectivity of the external Auditor. It has reported to the Board that the Annual Report for the year ended 31 December 2018, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group's performance, business model and strategy. The Board's conclusions in this respect are set out in the Statement of Directors' Responsibilities.
The Audit Committee has recommended to the Board that the external auditor is re-appointed.
John Whittle | Audit Committee Chairman
25 March 2019
Statement of Directors' Responsibilities
The Directors are responsible for preparing consolidated financial statements for each financial year which give a true and fair view, in accordance with applicable laws and regulations, of the state of affairs of the Company and of the profit or loss of the Company for that year.
Company law requires the Directors to prepare financial statements for each financial year. The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union ("IFRS"). In preparing the consolidated financial statements, the Directors are required to:
* Select suitable accounting policies and apply them consistently;
* Make judgments and estimates that are reasonable and prudent;
* State whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the consolidated financial statements; and
* Prepare the consolidated financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.
The maintenance and integrity of the Company's website is the responsibility of the Directors; the work conducted by the Auditor does not involve consideration of the maintenance and integrity of the website and, accordingly, the Auditor accepts no responsibility for any changes that may have occurred to the consolidated financial statements since they are initially presented on the website. Legislation in Guernsey governing the preparation and dissemination of the consolidated financial statements may differ from legislation in other jurisdictions.
The Directors are responsible for keeping proper accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the consolidated financial statements comply with the Companies (Guernsey) Law, 2008, as amended. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Each of the Directors confirms that, to the best of their knowledge:
* They have complied with the above requirements in preparing the consolidated financial statements;
* There is no relevant audit information of which the Company's Auditor is unaware;
* All Directors have taken the necessary steps that they ought to have taken to make themselves aware of any relevant audit information and to establish that the Auditor is aware of said information;
* The consolidated financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and
* The Chairman's Statement, Strategic Report, Investment Manager's Report, Report of the Directors and Corporate Governance Statement include a fair review of the development and the position of the Company and the Group, together with a description of the principal risks and uncertainties that they face.
The UK Code, as adopted through the AIC Code by the Company, also requires Directors to ensure that the Annual Report and Consolidated Financial Statements are fair, balanced and understandable. In order to reach a conclusion on this matter, the Board has requested that the Audit Committee advise on whether it considers that the Annual Report and Consolidated Financial Statements fulfil these requirements. The process by which the Committee has reached these conclusions is set out in the report of the Audit Committee. Furthermore, the Board believes that the disclosures set out in Financial Highlights, Chairman's Statement, Strategic Report and Investment Manager's Report of the Annual Report provide the information necessary for shareholders to assess the Company's performance, business model and strategy.
Having taken into account all the matters considered by the Board and brought to the attention of the Board during the year ended 31 December 2018, as outlined in the Chairman Statement, Investment Manager's Report, Corporate Governance Statement, Strategic Report and the Report of the Audit Committee, the Board has concluded that the Annual Report and Audited Consolidated Financial Statements for the year ended 31 December 2018, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's performance, business model and strategy.
For Starwood European Real Estate Finance Limited
Stephen Smith | Chairman
25 March 2019
Independent Auditor's Report to the Members of Starwood European Real Estate Finance Limited
Report on the audit of the consolidated financial statements
In our opinion, the consolidated financial statements give a true and fair view of the consolidated financial position of Starwood European Real Estate Finance Limited (the "Company") and its subsidiaries (together "the Group") as at 31 December 2018, and of their consolidated financial performance and their consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union and have been properly prepared in accordance with the requirements of The Companies (Guernsey) Law, 2008.
WHAT WE HAVE AUDITED
The Group's consolidated financial statements comprise:
* the Consolidated Statement of Financial Position as at 31 December 2018;
* the Consolidated Statement of Comprehensive Income for the year then ended;
* the Consolidated Statement of Changes in Equity for the year then ended;
* the Consolidated Statement of Cash Flows for the year then ended; and
* the notes to the consolidated financial statements, which include a summary of significant accounting policies.
BASIS FOR OPINION
We conducted our audit in accordance with International Standards on Auditing ("ISAs"). Our responsibilities under those standards are further described in the Auditor's responsibilities for the audit of the consolidated financial statements section of our report.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.
We are independent of the Group in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements of the Group, as required by the Crown Dependencies' Audit Rules and Guidance, and at the request of the directors with SEC Independence Rules. We have fulfilled our other ethical responsibilities in accordance with these requirements.
OUR AUDIT APPROACH
* Overall Group materiality was £7.7 million which represents 2.0% of consolidated net assets.
* The Company is based in Guernsey, has underlying subsidiaries located in Guernsey and Luxembourg and engages Starwood European Finance Partners Limited (the "Investment Manager") to manage its assets. The consolidated financial statements are a consolidation of the Company and all of the underlying subsidiaries.
* We conducted our audit of the consolidated financial statements from information provided by Ipes (Guernsey) Limited (the "Administrator") to whom the board of directors has delegated the provision of certain functions. We also had significant interaction with Starwood Capital Europe Advisers, LLP (the "Investment Adviser") in completing aspects of our overall audit work.
* We conducted our audit work in Guernsey and we tailored the scope of our audit taking into account the types of investments within the Group, the involvement of the third parties referred to above, and the industry in which the Group operates.
* We performed an audit of the complete financial information of the Guernsey and Luxembourg components of the Group.
* The components of the Group where we performed full scope audit procedures accounted for 100% of total net assets and total operating profit.
KEY AUDIT MATTERS
* Carrying amount and impairment/expected credit losses of loans advanced
* Valuation of credit linked notes
* Risk of fraud in income from loans advanced
As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the consolidated financial statements. In particular, we considered where the directors made subjective judgments; for example, in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, including among other matters, consideration of whether there was evidence of bias that represented a risk of material misstatement due to fraud.
We tailored the scope of our audit in order to perform sufficient work to enable us to provide an opinion on the consolidated financial statements as a whole, taking into account the structure of the Group, the accounting processes and controls, and the industry in which the Group operates.
The Company is based in Guernsey with two subsidiaries located in Guernsey and three underlying subsidiaries located in Luxembourg. The consolidated financial statements are a consolidation of the Company and all of the underlying subsidiaries.
Scoping was performed at the Group level, irrespective of whether the underlying transactions took place within the Company or within the subsidiaries. The Group audit was led, directed and controlled by PricewaterhouseCoopers CI LLP and all audit work for material items within the consolidated financial statements was performed in Guernsey by PricewaterhouseCoopers CI LLP.
The transactions relating to the Company and the subsidiaries are maintained by the Administrator and therefore we were not required to engage with component auditors from another PwC global network firm operating under our instructions. Our testing was therefore performed on a consolidated basis using thresholds which are determined with reference to the overall Group materiality and the risks of material misstatement identified.
As noted in the overview, the components of the Group for which we performed full scope audit procedures accounted for 100% of total net assets and total operating profit.
The scope of our audit was influenced by our application of materiality. An audit is designed to obtain reasonable assurance whether the consolidated financial statements are free from material misstatement. Misstatements may arise due to fraud or error. They are considered material if individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the consolidated financial statements.
Based on our professional judgment, we determined certain quantitative thresholds for materiality, including the overall Group materiality for the consolidated financial statements as a whole as set out in the table below. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures and to evaluate the effect of misstatements, both individually and in aggregate on the consolidated financial statements as a whole.
We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £0.4 million, as well as misstatements below that amount that, in our view, warranted reporting for qualitative reasons.
KEY AUDIT MATTERS
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.
The directors are responsible for the other information. The other information comprises all the information included in the Annual Report and Audited Consolidated Financial Statements but does not include the consolidated financial statements and our auditor's reports thereon.
Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.
In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.
RESPONSIBILITIES OF DIRECTORS FOR THE CONSOLIDATED FINANCIAL STATEMENTS
The directors are responsible for the preparation of the consolidated financial statements that give a true and fair view in accordance with International Financial Reporting Standards as adopted by the European Union, the requirements of Guernsey law and for such internal control as the directors determine is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the consolidated financial statements, the directors are responsible for assessing the Group's ability to continue as a going concern, disclosing, as applicable, matters relating to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or to cease operations, or have no realistic alternative but to do so.
AUDITOR'S RESPONSIBILITIES FOR THE AUDIT OF THE CONSOLIDATED FINANCIAL STATEMENTS
Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional scepticism throughout the audit. We also:
* Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
* Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group's internal control.
* Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by the directors.
* Conclude on the appropriateness of the directors' use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor's report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor's report. However, future events or conditions may cause the Group to cease to continue as a going concern. For example, the terms on which the United Kingdom may withdraw from the European Union are not clear, and it is difficult to evaluate all of the potential implications on the Group and the wider economy.
* Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
* Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the Group audit. We remain solely responsible for our audit opinion.
We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.
We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor's report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.
REPORT ON OTHER LEGAL AND REGULATORY REQUIREMENTS
Under The Companies (Guernsey) Law, 2008 we are required to report to you if, in our opinion:
* we have not received all the information and explanations we require for our audit;
* proper accounting records have not been kept; or
* the consolidated financial statements are not in agreement with the accounting records.
We have no exceptions to report arising from this responsibility.
We have nothing to report in respect of the following matters which we have reviewed:
* the directors' statement set out in Corporate Governance statement in relation to going concern. As noted in the directors' statement, the directors have concluded that it is appropriate to adopt the going concern basis in preparing the consolidated financial statements. The going concern basis presumes that the Group has adequate resources to remain in operation, and that the directors intend it to do so, for at least one year from the date the consolidated financial statements were signed. As part of our audit we have concluded that the directors' use of the going concern basis is appropriate. However, because not all future events or conditions can be predicted, these statements are not a guarantee as to the Group's ability to continue as a going concern;
* the directors' statement that they have carried out a robust assessment of the principal risks facing the Group and the directors' statement in relation to the longer-term viability of the Group. Our review was substantially less in scope than an audit and only consisted of making inquiries and considering the directors' process supporting their statements; checking that the statements are in alignment with the relevant provisions of the UK Corporate Governance Code; and considering whether the statements are consistent with the knowledge acquired by us in the course of performing our audit; and
* the part of the Corporate Governance Statement relating to the parent Company's compliance with the ten further provisions of the UK Corporate Governance Code specified for our review.
This report, including the opinion, has been prepared for and only for the members as a body in accordance with Section 262 of The Companies (Guernsey) Law, 2008 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
As explained in note 21 to the consolidated financial statements, in addition to our responsibility to audit and express an opinion on the consolidated financial statements in accordance with ISAs and Guernsey law, we have been requested by the directors to express an opinion on the financial statements in accordance with auditing standards generally accepted in the United States of America as issued by the AICPA, in order to meet the requirements of Rule 206(4)-2 under the Investment Advisers Act (the "Custody Rule"). We have reported separately in this respect below.
For and on behalf of
25 March 2019
Independent Auditor's Report to the Members of Starwood European Real Estate Finance Limited (US GAAS)
We have audited the accompanying consolidated financial statements of Starwood European Real Estate Finance Limited and its subsidiaries (the "Group"), which comprise the Consolidated Statements of Financial Position as of 31 December 2018 and 2017, and the related Consolidated Statements of Comprehensive Income, the Consolidated Statements of Changes in Equity, the Consolidated Statements of Cash Flows for the years then ended, and the notes to the consolidated financial statements, which include a summary of significant accounting policies.
MANAGEMENT'S RESPONSIBILITY FOR THE CONSOLIDATED FINANCIAL STATEMENTS
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Our responsibility is to express an opinion on the consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Group's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Starwood European Real Estate Finance Limited and its subsidiaries as of 31 December 2018 and 2017, and the results of their operations, changes in their net assets, and their cash flows for the year then ended, in accordance with International Financial Reporting Standards as adopted by the European Union.
Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole.
The other items listed in the Index to the Annual Report and Audited Consolidated Financial Statements, other than the consolidated financial statements and our auditor's reports thereon are presented for purposes of additional analysis and are not a required part of the consolidated financial statements. The information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves and other additional procedures, in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the consolidated financial statements taken as a whole.
This report, including the opinion, has been prepared for and only for the members as a body and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
PricewaterhouseCoopers CI LLP
Guernsey, Channel Islands
25 March 2019
Consolidated Statement of Comprehensive Income
for the year ended 31 December 2018
The accompanying notes form an integral part of these consolidated financial statements.
Consolidated Statement of Financial Position
as at 31 December 2018
These consolidated financial statements were approved and authorised for issue by the Board of Directors on 25 March 2019, and signed on its behalf by:
The accompanying notes form an integral part of these consolidated financial statements.
Consolidated Statement of Changes in Equity
for the year ended 31 December 2018
Year ended 31 December 2018
Year ended 31 December 2017
The accompanying notes form an integral part of these consolidated financial statements.
Consolidated Statement of Cash Flows
for the year ended 31 December 2018
1 Net of arrangement fees of £2,396,173 (2017: £2,679,765) withheld.
2 Including CLNs origination fees of £nil (2017: £288,150).
The accompanying notes form an integral part of these consolidated financial statements.
Notes to the Consolidated Financial Statements
for the year ended 31 December 2018
1. GENERAL INFORMATION
Starwood European Real Estate Finance Limited (the "Company") was incorporated with limited liability in Guernsey under the Companies (Guernsey) Law, 2008, as amended, on 9 November 2012 with registered number 55836, and has been authorised by the Guernsey Financial Services Commission as an authorised closed-ended investment company. The registered office and principal place of business of the Company is 1, Royal Plaza, Royal Avenue, St Peter Port, Guernsey, Channel Islands, GY1 2HL.
On 12 December 2012, the Company announced the results of its IPO, which raised net proceeds of £223.9 million. The Company's Ordinary Shares were admitted to the premium segment of the UK Listing Authority's Official List and to trading on the Main Market of the London Stock Exchange as part of its IPO which completed on 17 December 2012. A further £9.9 million of net proceeds was raised via tap issues throughout the period ended 31 December 2013 and £66.6 million for the year ended 31 December 2015. On 10 August 2016 the Company issued a further 70,839,398 Ordinary Shares raising net proceeds of £71.5 million.
The consolidated financial statements comprise the financial statements of the Company, Starfin Public Holdco 1 Limited (the "Holdco 1"), Starfin Public Holdco 2 Limited (the "Holdco 2"), Starfin Lux S.à.r.l ("Luxco"), Starfin Lux 3 S.à.r.l ("Luxco 3") and Starfin Lux 4 S.à.r.l ("Luxco 4") (together the "Group") as at 31 December 2018.
The Company's investment objective is to provide its shareholders with regular dividends and an attractive total return while limiting downside risk, through the origination, execution, acquisition and servicing of a diversified portfolio of real estate debt investments (including debt instruments) in the UK and wider European Union's internal market. To pursue its investment objective, the Company, through the Holdco 1 and Holdco 2 (the "Holdcos"), invests in the Luxco, Luxco 3 and Luxco 4 (the "Luxcos") through both equity and profit participation instruments or other funding instruments. The Luxcos then grant or acquire loans (or other debt instruments) to borrowers in accordance with the Group's investment policy. The Group expects all of its investments to be debt obligations of corporate entities domiciled or with significant operations in the United Kingdom and wider European Union's internal market.
The Company has appointed Starwood European Finance Partners Limited as the Investment Manager (the "Investment Manager"), a company incorporated in Guernsey and regulated by the GFSC. The Investment Manager has appointed Starwood Capital Europe Advisers, LLP (the "Investment Adviser"), an English limited liability partnership authorised and regulated by the Financial Conduct Authority, to provide investment advice pursuant to an Investment Advisory Agreement. The administration of the Company is delegated to Ipes (Guernsey) Limited (the "Administrator").
2. BASIS OF PREPARATION AND PRINCIPAL ACCOUNTING POLICIES
The principal accounting policies applied in the preparation of these financial statements are set out below. These policies have been consistently applied to the years presented, unless otherwise stated.
a) Going Concern
Note 17 includes the Group's objectives, policies and processes for managing its capital, its financial risk management objectives, details of financial instruments and exposure to credit risk and liquidity risk. The Directors have undertaken a rigorous review of the Group's ability to continue as a going concern including reviewing the ongoing cash flows and the level of cash balances and available liquidity facilities as of the reporting date as well as taking forecasts of future cash flows into consideration.
After making enquiries of the Investment Manager and the Administrator, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for at least one year from the date the consolidated financial statements were signed. Accordingly, the Directors continue to adopt a going concern basis in preparing these consolidated financial statements.
b) Statement of compliance
The Company has prepared its consolidated financial statements in accordance with the Companies (Guernsey) Law, 2008 (as amended) and International Financial Reporting Standards as adopted by the European Union ("IFRS"), which comprise standards and interpretations approved by the International Accounting Standards Boards ("IASB") together with the interpretations of the IFRS Interpretations Committee ("IFRIC") as approved by the International Accounting Standards Committee ("IASC") which remain in effect. The Directors of the Company have taken the exemption in Section 244 of The Companies (Guernsey) Law, 2008 (as amended) and have therefore elected to only prepare consolidated and not separate financial statements for the year.
(i) Standards and amendments to existing standards effective 1 January 2018
IFRS 15 "Revenue from Contracts with Customers" became effective for annual periods beginning on or after 1 January 2018. The new standard is based on the principle that revenue is recognised when control of a good or service transfers to a customer, so the notion of control replaces the existing notion of risks and rewards. Also, the revenue from financial instruments and other contractual rights or obligations within the scope of IFRS 9 "Financial Instruments" are scoped out from IFRS 15. Adoption of this standard did not have a material impact on the Group's consolidated financial statements.
IFRS 9 "Financial Instruments" became effective for annual periods beginning on or after 1 January 2018. It addresses the classification, measurement and derecognition of financial assets and liabilities and replaces the multiple classification and measurement models in IAS 39.
IFRS 9 has been applied retrospectively by the Group and did not result in a change to the classification or measurement of financial instruments as outlined in note 2(g). The Group's investment portfolio continues to be classified as fair value through profit or loss and other financial assets which are held for collection continue to be measured at amortised cost. In assessing those financial assets designated as debt instruments (held for collection), no expected credit losses were deemed to be necessary because of the loan to value ratios and strong collateral packages in place at adoption, and hence there was no material impact on adoption when compared to the prior impairment policy of the Group. However, all new loans are assessed with respect to the determination of the appropriate level of expected credit losses required to be presented in the financial statements, if any, and all outstanding debt instruments held are assessed regularly with the assistance of the Investment Adviser to determine whether any are under performing or have had a significant credit risk deterioration, which may warrant a lifetime expected credit loss being recognised.
There are no other standards, amendments to standards or interpretations that are effective for annual periods beginning on 1 January 2018 that have a material effect on the financial statements of the Group.
(ii) New standards, amendments and interpretations effective after 1 January 2018 and have not been early adopted
A number of new standards, amendments to standards and interpretations are effective for annual periods beginning after 1 January 2018, and have not been early adopted in preparing Group's consolidated financial statements. None of these are expected to have a material effect on the consolidated financial statements of the Group.
c) Basis of preparation
These consolidated financial statements have been prepared on a going concern basis and under the historical cost convention as modified by the revaluation of certain assets and liabilities to fair value.
Critical accounting judgements and key sources of estimation uncertainty
The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group's accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements relate to:
(i) Critical accounting estimates and assumptions
* Models used for loans accounted at amortised cost use as assumptions and estimate the receipt of and expected timing of scheduled and unscheduled pre-payments of loans advanced. Changes in these assumptions and estimates could impact on liquidity risk and the interest income (see note 17).
* The discounted cash flow models used to calculate the fair value of the credit linked notes involves approximates and estimates of the timing of cash flows and uses significant unobservable inputs that will directly impact the valuation of financial assets at fair value through profit or loss (see note 11).
* The measurement of both the initial and ongoing expected credit loss allowance for financial assets measured at amortised cost is an area that requires the use of significant assumptions about credit behaviour such as likelihood of borrowers defaulting and the resulting losses (see note 2(h)).
(ii) Critical judgements
* The functional currency of each of the Group's entities, which is considered by the Directors to be Euro for Luxco 3; Sterling for all other Group's entities (see notes 2(e) and 2(k)).
* The operating segments, of which the Directors are currently of the opinion that the Company and its subsidiaries are engaged in a single segment of business, being the provision of a diversified portfolio of real estate backed loans (see note 2(f)).
* The valuation of the credit linked notes is derived from a model prepared by the Investment Adviser. The main inputs into the valuation model for the CLNs are discount rates, market risk factors, probabilities of default, expected credit loss levels and cash flow forecasts. The key areas of judgement are the methodology and approach to model the fair value of credit linked notes.
* A number of significant judgements are also required in applying the accounting requirements for measuring ECL, such as determining the criteria for significant increase in credit risk, choosing the appropriate model and assumptions for the measurement of ECL, determining the probabilities of default and loss given default.
d) Basis of consolidation
The consolidated financial statements incorporate the financial statements of the Company and entities controlled by the Company (its subsidiary undertakings) made up to the end of the reporting period. Control is achieved where the Company has the power to govern the financial and operating policies of an investee entity so as to obtain benefits directly from its activities. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Company controls another entity. The Company also assesses existence of control where it does not have more than 50 per cent of the voting power but is able to govern the financial and operating policies by virtue of de-facto control.
Subsidiary undertakings are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases.
The Group applies the acquisition method to account for business combinations.
Acquisition-related costs are expensed as incurred unless directly attributable to the acquisition. No consideration, other than for the par value of any share capital or capital contributions, has been paid in respect of the acquisition of subsidiary undertakings. The Company acquired the subsidiaries at the time of their initial establishment and hence they had no net assets at the date of the acquisition.
Intercompany transactions, balances, income and expenses on transactions between Group companies are eliminated on consolidation. Profits and losses resulting from intercompany transactions that are recognised in assets are also eliminated.
e) Functional and presentation currency
Items included in the financial statements of each of the Group's entities are measured using the currency of the primary economic environment in which the entity operates (the "functional currency"). Therefore, the Directors have considered in assessing the functional currency of each of the Group's entities:
* the share capital of all members of the Group is denominated in Sterling except for Lux 3 share capital which is denominated in Euro;
* the dividends are paid in Sterling;
* Euro non-investment transactions represent only a small proportion of transactions in the Luxembourg entities; and
* proportion of non Sterling investments in each portfolio of Luxembourg entities.
The functional and presentation currency of each Group entity is Sterling, apart from Starfin Lux 3 S.à.r.l for which the functional currency is Euro. Starfin Lux 3 S.à.r.l holds loans and investments in Euro currencies. The Directors have also adopted Sterling as the Group's presentation currency and, therefore, the consolidated financial statements for the Company are presented in Sterling.
f) Segment reporting
Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identified as the Board, as the Board makes strategic decisions. The Directors, after having considered the way in which internal reporting is provided to them, are of the opinion that the Company and its subsidiaries are engaged in a single segment of business, being the provision of a diversified portfolio of real estate backed loans. Equally, based on the internal reporting provided, the Directors do not analyse the portfolio based on geographical segments.
g) Financial assets and liabilities
Classification and subsequent measurement
From 1 January 2018, the Group classifies its financial assets into the following measurement categories: at amortised cost, at fair value through profit or loss and at fair value through other comprehensive income. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition.
Financial assets measured at amortised cost
A financial asset is measured at amortised cost if both of the following conditions are met: (a) the financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows and (b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. The carrying amount of these assets is adjusted by any expected credit loss allowance recognised and measured as described in note 2(h). Interest income from these financial assets is included in "Income from loans advanced" using the effective interest rate method.
Financial assets at fair value through other comprehensive income
A financial asset is measured at fair value through other comprehensive income if both of the following conditions are met: (a) the financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and (b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Movements in the carrying amount are taken through other comprehensive income, except for the recognition of impairment gains and losses, interest revenue and foreign exchange gains and losses on the instrument's amortised cost which are recognised in profit or loss.
Financial assets at fair value through profit or loss
Financial assets at fair value through profit or loss are non-derivatives that are (a) either designated in this category upon initial recognition or subsequently or (b) not classified in any of the other categories. Gains or losses on a financial assets subsequently measured at fair value through profit or loss are recognised in profit or loss net of interest income received from these financial assets and presented in the profit or loss statement within "Net changes in fair value of financial assets at fair value through profit or loss" in the period in which in arises.
Financial liabilities at fair value through profit or loss
Financial liabilities at fair value through profit or loss are carried in the statement of financial position at fair value with net changes in fair value recognised in profit or loss. These comprise currency forward contracts which represent contractual obligations to purchase domestic currency and sell foreign currency on a future date.
Financial liabilities measured at amortised cost
Financial liabilities that are not classified through profit or loss, including bank loans, are measured at amortised cost.
Recognition and measurement
Regular purchases and sales of financial assets are recognised on the trade date, the date on which the Group commits to purchase or sell the asset. Financial assets not carried at fair value through profit or loss are initially recognised at fair value plus transaction costs. Financial assets carried at fair value through profit or loss are initially recognised at fair value, and transaction costs are expensed in the Consolidated Statement of Comprehensive Income. Financial assets at fair value through profit or loss and financial assets at fair value through other comprehensive income are subsequently carried at fair value. Financial assets at amortised cost are subsequently measured using the effective interest method and are subject to impairment using the expected credit loss model. Gains and losses are recognised in profit or loss when the asset is derecognised, modified or impaired.
Financial assets are derecognised when the rights to receive cash flows from the investments have expired or have been transferred and the Group has transferred substantially all risks and rewards of ownership. Financial liabilities are derecognised when they are extinguished, that is, when the obligation specified in the contract is discharged or cancelled or expires.
Amortised cost and effective interest rate
The amortised cost is the amount at which the financial asset or or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance.
The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of financial assets or financial liability to the gross carrying amount of a financial asset (i.e., its amortised cost before any loss allowance) or to the amortised cost of a financial liability. The calculation does not consider expected credit losses and includes transaction costs and all fees paid or received that are integral to the effective interest rate.
Fair value estimation
The fair value of financial assets and liabilities, which comprise financial instruments such as debt securities, not traded in an active market, is determined using valuation techniques. The fair value of the CLNs will be determined by the Investment Adviser using a valuation model. The main inputs into the valuation model for the CLNs are discount rates, market risk premium adjustments to the discount rate, probabilities of default and cash flow forecasts. The Investment Adviser also performs a full analysis of the performance of each underlying loan and with reference to other inputs such as third party valuations of the underlying collateral.
The fair value of financial assets and liabilities, which comprise derivatives not designated as hedges, are valued based on the difference between the agreed price of selling or buying the financial instruments on a future date and the price quoted on the year end date for selling or buying the same or similar financial instruments.
h) Expected credit loss measurement
The Group follows a three-stage model for impairment based on changes in credit quality since initial recognition as summarised below:
* A financial instrument that is not credit-impaired on initial recognition is classified as Stage 1 and has its credit risk continuously monitored by the Group. The expected credit loss ("ECL") is measured over a 12 month period of time.
* If a significant increase in credit risk since initial recognition is identified, the financial instrument is moved to Stage 2 but is not yet deemed to be credit-impaired. The ECL is measured on a lifetime basis.
* If the financial instrument is credit-impaired it is then moved to Stage 3. The ECL is measured on a lifetime basis.
The Group's financial assets at amortised cost are classified within Stage 1 for the following reasons:
* All loans are the subject of very detailed underwriting, including the testing of resilience to aggressive downside scenarios with respect to the loan specifics, the market and general macro economic changes, and therefore the Group considers that value of losses given default ("LGD") currently have a nil value for all loans;
* Loans have very robust covenants in place which trigger as an early warning (long before there would be any indicators of significant increase in credit risk) and this enables the Investment Adviser to become highly involved in the execution of business plans to avoid ECL;
* Loans have strong security packages and many are amortising with relatively short terms which further reduces the risk; and
* All loans have significant loan-to-value headroom which further mitigates the risk of ECL.
No loans in the portfolio to date have had an increase in credit risk that would have required them to be classified within Stage 2. The paragraph below describes how the Group determines when a significant increase in credit risk has occurred. However, even if this were to occur, the Group would not anticipate the recognition of material credit losses for the reasons outlined above - the value of ECL would still be expected to be nil.
The Group considers that for prepayments and capitalised costs, the ECL is by default nil as these are non- monetary items with no credit risks. For trade and other receivables the Group applies the simplified approach which requires expected lifetime losses to be recognised from initial recognition of the receivables.
Significant increase in credit risk
The Group uses both quantitative and qualitative criteria which is monitored no less than quarterly in order to assess whether an increase in credit risk has occurred. Increased credit risk would be considered if, for example, all or a combination of the following has occurred:
* underlying income performance is at a greater than 10 per cent variance to the underwritten loan metrics;
* Loan to Value is greater than 75-80 per cent;
* Loan to Value or income covenant test results are at a variance of greater than 5-10 per cent of loan default covenant level (note that loan default covenant levels are set tightly to ensure that an early cure is required by the borrower should they breach which usually involves decreasing the loan amount until covenant tests are passed);
* late payments have occurred and not been cured within 3 days;
* loan maturity date is within six months and the borrower has not presented an achievable refinance or repayment plan;
* covenant and performance milestones criteria under the loan have required more than two waivers;
* increased credit risk has been identified on tenants representing greater than 25 per cent of underlying asset income;
* income rollover / tenant break options exist such that a lease up of more than 30 per cent of underlying property will be required within 12 months in order to meet loan covenants and interest payments; and
* borrower management team quality has adversely changed.
Under-performing assets - Stage 3
Non-performing financial assets would be classified with Stage 3, which is fully aligned with the definition of credit- impaired, when one or more of the following has occurred:
* the borrower is in breach of all financial covenants;
* the borrower is in significant financial difficulty; and
* it is becoming probable that the borrower will enter bankruptcy.
An instrument is considered to have been cured, that is no longer in default, when it no longer meets any of the default criteria for a sufficient period of time.
The Group writes off financial assets, in whole or in part, when it has exhausted all practically recovery efforts and has concluded there is no reasonable expectation of recovery. Indicators that there is no reasonable expectation of recovery include:
* ceasing enforcement activity; and
* where the Group's recovery method is foreclosing on collateral and the value of the collateral is such that there is no reasonable expectation of recovering in full.
The most significant period-end assumptions used for the expected credit loss estimates are the LGD and probability of default ("PD") as described above.
The default probabilities are based on initial loan-to-value ("LTV") headroom which the Investment Adviser believes to be a good predictor of the PD, in accordance with recent market studies of European commercial real estate loans.
In measuring the LGD for this sensitivity analysis, the loans advanced have been assessed on a collective basis as they possess similar covenants and security package characteristics. The selected LGD of 0.30% is based on the aggregate losses of all AAA rated notes issued in Europe from 1995 to 2017 (totalling EUR177 billions), accordingly to recent market studies of European commercial real estate loans. The Investment Adviser considers this to be a reasonable estimate for loss given default parameter.
As explained on Note 2 (b)(i), the year-end ECL are nil. Set out below is the sensitivity to the ECL as at 31 December 2018 and 31 December 2017 that could result from reasonable possible changes in the LTV and LGD actual assumptions used for calculation of ECL as at the respective year-end. On an individual loan basis, the LTV was increased by 5%, and a new PD determined, which was multiplied by a constant LGD of 0.30% for all loans and the loan exposure as at each year-end. All other variables are held constant.
Change in ECL allowance (+)
i) Cash and cash equivalents
In the Consolidated Statement of Cash Flows, cash and cash equivalents includes cash in hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less.
j) Share capital
Ordinary Shares are classified as equity. Incremental costs directly attributable to the issue of new Ordinary Shares are shown in equity as a deduction, net of tax, from the proceeds.
k) Foreign currency translation
Transactions and balances
Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions or valuation where items are re-measured. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the Consolidated Statement of Comprehensive Income. Foreign exchange gains and losses that relate to borrowings and cash and cash equivalents and all other foreign exchange gains and losses are presented in the Consolidated Statement of Comprehensive Income within "net foreign exchange losses/(gains)".
The results and financial position of all the Group entities that have a functional currency different from the presentation currency of the Group are translated into the presentation currency of the Group as follows:
i. assets and liabilities for each Statement of Financial Position presented are translated at the closing rate at the end of the reporting period;
ii. income and expenses for each Statement of Comprehensive Income are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the rate on the dates of the transactions);
iii. share capital is translated at historical cost (translated using the exchange rates at the transaction date); and
iv. all resulting exchange differences are recognised in other comprehensive income.
The cumulative amount of translation exchange differences is presented in a separate component of equity until disposal of the entity.
Starfin Lux 3 S.à.r.l has Euro as its functional currency.
l) Interest income
Interest income on financial assets within Stage 1 and 2 is recognised by applying the effective interest rate to the gross carrying amount of financial assets. For financial assets that are classified within Stage 3, interest revenue is calculated by applying the effective interest rate to their amortised cost (that is net of expected credit loss provision). Interest income on non-performing financial assets at amortised cost is recognised to the extent the Group expects to recover the interest receivable.
Interest on cash and cash equivalents is recognised on an accruals basis.
m) Origination, exit and loan arrangement fees
Origination fees paid to the Investment Manager and exit and direct loan arrangement fees received will be recognised using the effective interest rate method under loans advanced and amortised over the lifetime of the related financial asset through income from loans advanced in the Consolidated Statement of Comprehensive Income. Syndication costs are recognised in the Consolidated Statement of Comprehensive Income when incurred.
All other expenses are included in the Consolidated Statement of Comprehensive Income on an accruals basis.
The Company is a tax-exempt Guernsey limited liability company as it is domiciled and registered for taxation purposes in Guernsey where it pays an annual exempt status fee under The Income Tax (Exempt Bodies) (Guernsey) Ordinances 1989 (as amended). Accordingly, no provision for Guernsey tax is made.
The Holdcos are exempted for Guernsey tax purposes, and therefore no provision for taxes has been made.
The Luxcos are subject to the applicable general tax regulations in Luxembourg and taxation is provided based on the results for the year (see note 20).
p) Other receivables
Trade and other receivables are amounts due in the ordinary course of business. They are classified as assets. Trade and other receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less allowance for ECL.
q) Other payables
Trade and other payables are obligations to pay for services that have been acquired in the ordinary course of business. They are classified as liabilities. Trade and other payables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest rate method.
r) Dividend distributions
Dividend distributions to the Company's shareholders are recognised as a liability in the Company's financial statements in the period in which the dividends are declared by the Board of Directors.
s) Offsetting financial assets and liabilities
Financial assets and liabilities are offset and the net amount reported on the Consolidated Statement of Financial Position when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis or realise the asset and settle the liability simultaneously.
t) Financial liabilities at amortised cost
Financial liabilities at amortised cost, including bank loans are initially recognised at fair value and subsequently measured at amortised cost using the effective interest method. Financial liabilities are derecognised when the contractual obligation is discharged, cancelled or expires.
u) Capitalised expenses on credit facilities
Expenses in connection with the process of originating, prolongation, or restructuring of a credit facility, such as application and underwriting fees, are capitalised and subsequently amortised over the period of the relevant credit facility in the Consolidated Statement of Comprehensive Income within "credit facility amortisation of fees".
3. MATERIAL AGREEMENTS
a) Investment management agreement
The Company and the Investment Manager have entered into an investment management agreement, dated 28 November 2012 (the "Investment Management Agreement"), (which was amended on 7 March 2014, 14 May 2014, 7 September 2015 and
The Investment Manager is entitled to a management fee which is calculated and accrued monthly at a rate equivalent to 0.75 per cent per annum of NAV. In calculating such fee, there shall be excluded from the Net Asset Value attributable to the Ordinary Shares the uninvested portion of the cash proceeds of any new issue of Shares (or C Shares) until at least 90 per cent of such proceeds are invested in accordance with the Company's investment policy (or deployed to repay borrowings under any credit facility of the Group or other liabilities of the Group) for the first time. The management fee is payable quarterly in arrears.
In addition, the Investment Manager is entitled to an asset origination fee of 0.75 per cent of the value of all new loan investments made or acquired by the Group (see note 22). The asset origination fee to be paid by the Group is expected to be paid upon receipt by the Group of loan arrangement fees received on the deployment of the Group's funds.
The Investment Management Agreement is terminable by either the Investment Manager or the Company giving to the other not less than 12 months' written notice. The Company is also able to terminate the appointment of the Investment Manager in the event of a change of control of the Investment Manager. A change of control shall be deemed to occur where a person acquires a direct or indirect interest in the Investment Manager, which is calculated by reference to 15 per cent or more of the voting rights. In addition the Investment Management Agreement can be terminated by the Company for any failure to act in good faith with the due skill, care and diligence which would reasonably be expected from an experienced manager in the sector and to exercise appropriate prudence in the management of the Group's portfolio.
Pursuant to the Investment Management Agreement's provisions, a performance fee would apply from 1 January 2018. The amount of such Performance Fee is 20 per cent of the excess (if any) of the returns generated by the Group over the Hurdle Total Return (described below). The measurement period over which the Performance Fee is calculated is two years, with the payment of any performance fee earned being made at the end of each such two year period.
The Hurdle Total Return will be achieved when the NAV of the Company at the end of the two year period, plus the total of all dividends declared and paid to Ordinary Shareholders in that two year period, is equal to the NAV of the Company at the start of each two year measurement period, as increased by 8 per cent per annum, on a simple interest basis (but excluding performance fees accrued and deemed as a creditor on the balance sheet at the start of the two year measurement period). No performance fee will be payable in relation to performance that recoups previous losses (if any).
To the extent that the Company makes further issues of Ordinary Shares and/or repurchases or redeems Ordinary Shares, the Hurdle Total Return will be adjusted accordingly, by reference to the issue proceeds of such further issues and dividends declared subsequent to such issues. Other corporate actions will also be refllected as appropriate in the calculation of the Hurdle Total Return.
The Investment Manager has appointed Starwood Capital Europe Advisers, LLP (the "Investment Adviser"), an English limited liability partnership authorised and regulated by the Financial Conduct Authority, to provide investment advice pursuant to an Investment Advisory Agreement.
b) Administration agreement
The Company has engaged the services of Ipes (Guernsey) Limited (the "Administrator") to act as Administrator and Company Secretary. Under the terms of the service agreement dated 25 September 2018, the Administrator is entitled to a fee of no less than £225,000 per annum for Guernsey registered companies of the Group, EUR96,000 for Luxembourg registered subsidiaries and further amounts as may be agreed in relation to any additional services provided by the Administrator. The Administrator is, in addition, entitled to recover third party expenses and disbursements.
c) Registrar's agreement
The Company and Computershare Investor Services (Guernsey) Limited (the "Registrar") entered into a Registrar agreement dated 28 November 2012, pursuant to which the Company appointed the Registrar to act as Registrar of the Company for a minimum annual fee payable by the Company of £7,500 in respect of basic registration.
d) Brokerage agreement
On 21 March 2018, the Company appointed Stifel Nicolaus Europe Limited ("Stifel") to act as Broker to the Group. Stifel is entitled to receive a fee of £50,000 per annum plus expenses. The previous brokerage agreement with Fidante Partners Europe Limited was terminated on 19 March 2018.
e) Licence agreement
The Company and Starwood Capital Group Management, LLC (the "Licensor") have entered into a trade mark licence agreement dated 28 November 2012 (the "Licence Agreement"), pursuant to which the Licensor has agreed to grant to the Company a royalty-free, non-exclusive worldwide licence for the use of the "Starwood" name for the purposes of the Company's business.
Under the terms of the Licence Agreement, it may be terminated by the Licensor; (i) if the Investment Management Agreement or any other similar agreement between the Company and the Investment Manager (or either of their respective affiliates) is terminated for any reason whatsoever or expires; (ii) if the Company suffers an insolvency event or breaches any court order relating to the Licence Agreement; or (iii) upon two months' written notice without cause.
f) Hedging agreements
The Company and Lloyds Bank plc entered into an international forward exchange master agreement dated 5 April 2013 and on 7 February 2014 the Company entered into a Professional Client Agreement with Goldman Sachs, pursuant to which the parties can enter into foreign exchange transactions with the intention of hedging against fluctuations in the exchange rate between Sterling and other currencies. Both agreements are governed by the laws of England and Wales.
g) Revolving credit facilities
Under its investment policy, the Company is limited to borrowing an amount equivalent to a maximum of 30 per cent of its NAV at the time of drawdown, of which a maximum of 20 per cent can be longer term borrowings. In calculating the Company's borrowings for this purpose, any liabilities incurred under the Company's foreign exchange hedging arrangements shall be disregarded.
On 4 December 2014, the Company entered into a £50 million revolving credit facility with Lloyds Bank plc (the "Lloyds Facility") which is intended for short-term liquidity. This facility was amended and extended on 8 October 2018. The current maturity date is 8 May 2020. The facility is secured by a pledge over the bank accounts of the Company, its interests in Starfin Public Holdco 1 Limited and the intercompany funding provided by the Company to Starfin Public Holdco 1 Limited. Starfin Public Holdco 1 Limited also acts as guarantor of the facility and has pledged its bank accounts as collateral. The undertakings and events of default are customary for a transaction of this nature.
On 18 December 2017, the Group entered into a separate £64 million secured borrowing facility with Morgan Stanley (the "MS Facility"). The debt can be drawn in respect of underlying loans which are eligible under the facility. Certain loans will not be eligible, for example mezzanine loans and loans above 75 per cent loan to value. It is secured by a customary security package of bank account pledges, intercompany receivables security, share security over the two borrower entities (Starfin Lux 3 S.à.r.l and Starfin Lux 4 S.à.r.l) and their shares. The MS Facility does not have recourse to the Company. The undertakings and events of default are customary for a facility of this nature.
4. DIRECTORS' FEES
5. AUDIT AND NON-AUDIT FEES
There were £nil other assurance expenses incurred during the year (2017: £18,000 which related to Auditor's work on Investment Circular). There were £nil non-audit fees not expensed in the consolidated statement of comprehensive income (2017: £150,000 which related to the Group's restructuring and refinancing and these were capitalised to credit facility costs). Other non-audit services totalling £35,416 were expensed in the consolidated statement of comprehensive income relate to tax advisory, valuations and other disbursements (2017: £15,721).
6. NET FOREIGN EXCHANGE GAINS / (LOSSES)
7. EARNINGS PER SHARE AND NET ASSET VALUE PER SHARE
The calculation of basic earnings per Ordinary Share is based on the operating profit of £26,175,567 (2017: £26,562,287) and on the weighted average number of Ordinary Shares in issue during the year of 375,019,398 (2017: 375,019,398) Ordinary Shares.
The calculation of NAV per Ordinary Share is based on a NAV of £384,993,582 (2017: £383,139,536) and the actual number of Ordinary Shares in issue at 31 December 2018 of 375,019,398 (2017: 375,019,398).
8. CASH AND CASH EQUIVALENTS
Cash and cash equivalents comprise the following:
Cash and cash equivalents comprises cash held by the Group and short term deposits held with various banking institutions with original maturities of three months or less. The carrying amount of these assets approximates their fair value. For further information and the associated risks refer to note 17.
9. OTHER RECEIVABLES AND PREPAYMENTS
10. LOANS ADVANCED
The Group's accounting policy on the measurement of financial assets is discussed in note 2(g).
No element of loans advanced are past due or impaired. For further information and the associated risks see the Investment Manager's Report.
The table below reconciles the movement of the carrying value of loans advanced in the year:
For further information on the fair value of loans advanced, refer to note 18.
11. FINANCIAL ASSETS AND LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Financial assets at fair value through profit or loss comprise currency forward contracts which represent contractual obligations to purchase domestic currency and sell foreign currency on a future date at a specified price and financial instruments designated at fair value through profit or loss which are debt securities that are managed by the Group and their performance is evaluated on a fair value basis.
The underlying instruments of currency forwards become favourable (assets) or unfavourable (liabilities) as a result of fluctuations of foreign exchange rates relative to their terms. The aggregate contractual or notional amount of derivative financial instruments, the extent to which instruments are favourable or unfavourable, and thus the aggregate fair values of derivative financial assets and liabilities, can fluctuate significantly from time to time. The foreign exchange derivatives are subject to offsetting, enforceable master netting agreements for each counterparty.
The fair value of financial assets and liabilities at fair value through profit or loss are set out below: