Trouble ahead for closed-end funds with Swiss borrowings
The recent revaluation of the Swiss Franc versus the Euro will cause mayhem for countless German closed-end property funds, according to a new study by the Berlin-based rating agency Scope. At the very least the forecasted yields for numerous funds who took out Swiss Franc-denominated loans are heading for a disastrous plunge, the agency says.
The prospect of German closed-end funds having to force-sell many of their assets is a distinct possibility, the agency says, where fund initiators borrowed in part in the Swiss currency (CHF). The good news, says Scope, is that of the 600 closed-end funds it monitors, only 10% or 60 funds took out exposure to the Swiss currency, although using the loans for investing in assets in the eurozone.
CHF loans taken out by closed funds between 2004 and 2006 amounted to €1.3bn, and Scope estimates that the amount of debt of that outstanding is around €1bn. Given that the loans were mainly of 10-year duration, that would see most of them looking for loan extensions around about now, which Scope describes as “an extremely unfavourable starting position for imminent discussions about new loans.”
During the years 2003-2007, borrowing in CHF for closed end funds was very popular, given that interest rates on the Swiss currency were at least 150 basis points lower than in the eurozone at the time. This helped fund initiators to raise the prospects of higher dividend payouts. In the years 2003-2007 the average Euro/CHF exchange rate was 1.57, while between 2010 and 2014 it averaged 1.25. The current exchange rate is nearly parity.
As LTV covenants at many of the funds are now likely to be breached due to the strengthened Swiss currency, triggering the right of lenders to demand more security, liquidity at these funds is likely to come under severe pressure. The immediate effect of this will be to block dividend payments to investors, while potential payouts are diverted to the minimum liquidity reserves to satisfy bankers. This will cause many funds to collapse, says Scope.
Another factor threatening the viability of many funds is the parallel need to secure a new tenant lease agreement after ten years. Refinancing can then prove doubly difficult, as the security for any new lender is now further endangered. Should funds find that their liquidity reserves are not sufficient to bear the brunt of the new currency repayment burden, the result will inevitably be a wave of forced sales, concludes Scope, without naming any of the funds most likely to be negatively affected. “We are currently scrutinising the particular situation of individual funds”, say the analysts. Given that last year again saw at least a third less new closed-end property fund issues than the previous year, this latest blow comes at a tough time for German fund initiators.