Source - PRN


(a closed-ended investment company incorporated in Guernsey with registration number 60440)

LEI 549300388LT7VTHCIT59

Final Net Asset Value

UK Mortgages Limited £0.8059 GG00BXDZMK63 30th June 2020

UKML RNS: Commentary accompanying UK Mortgages Limited June 2020 NAV

The UKML NAV per share was calculated for June 2020 month end at 80.59 pence per share, an increase of 1.17 pence per share.

The Company’s investments continue to perform in line with current expectations, with the number of loans taking a payment holiday reducing further as more borrowers come to the end of their initial 3 month deferral period. More details on these will be available in the factsheet due to be published shortly.

Alongside the regular monthly income generated by the Company’s investments, the key drivers for the movement in the NAV for this period are the semi-annual recalculations of both the hedge effectiveness calculations and the updated IFRS 9 Expected Credit Loss (ECL) provisioning assessment.

Hedge Effectiveness:

As highlighted in NAV commentaries throughout 2020, consistently falling swap rates have so far had a negative impact on the monthly valuation levels of the interest rate swaps held in the portfolios. This, in turn, has had an ongoing negative impact on the NAV as the Company is exposed to the portion of the swap movement deemed ineffective under IFRS 9 accounting standards.

The effectiveness of the Company’s hedges are independently re-calculated each half year under current accounting policy, as referenced above. Furthermore, the Company’s forward flow portfolios have grown by almost £200m since the last calculation, increasing the value and number of hedges in place, whilst the previous hedge effectiveness parameters remained unchanged. The latest hedge effectiveness tests for June 2020 month end NAV showed improved effectiveness, thus resulting in a positive adjustment to NAV performance.

Oat Hill No1:

June was the first full month to capture the step-up in the senior note interest on the subsequently called Oat Hill No. 1 transaction, post the first optional call date in May, which resulted in a slightly higher cost of funding for the month.

IFRS 9 ECL Provisioning:

The Company’s factsheet for April 2020 included a high level estimate of the impact of payment holidays on the provision for expected credit losses under IFRS 9. The early payment holiday data available at that time showed an increased total stressed-case provision of £1.8m. Subsequently, as the payment holiday population has evolved, and with more granular data also becoming available, the high level model has been significantly refined following an extensive process with the Company’s auditors. The model now includes loan-by-loan analysis of each portfolio, capturing both initial payment holiday and ensuing extension data, employing a scaled probability of default analysis for each portfolio, coupled with stressed asset value decline assumptions, and also featuring LTV tiering plus distressed sale and interest shortfall haircuts. This therefore has resulted in a £1.1m increase in the ECL provision – £0.7m less than that indicated previously.

The positive movement from the hedge effectiveness calculations was partially offset by the increase in the IFRS 9 ECL provisioning, with the net effect of these two components contributing approximately 1.00 pence of the increase in the NAV (albeit investors should be aware that both of these figures remain subject to final audit).

Amortised Cost vs Fair Value Accounting Methodology

Amortised cost basis of accounting is a widely used methodology for valuing less liquid debt assets, where transparent pricing is not regularly and easily available (such as might be the case in a regularly traded bond market), and particularly where the assets are intended to be held to maturity. Financial institutions, such as banks and other independent lenders, typically adopt this method for the valuation of portfolios of longer-term loans such as mortgages. The methodology allows any purchase discount/premium to be released into the valuation over the life of the asset portfolio.

Fair value accounting is more typically applied to assets, which have a higher degree of market price transparency, such as exchange traded and over the counter debt instruments, where regular transactions in such instruments or comparable instruments take place.

The fair valuation of a mortgage portfolio is a highly complex process, with numerous inputs, particularly for older portfolios where the most recently available credit analysis of the borrowers and asset valuations, may be significantly outdated. As such, the fair valuation of mortgage portfolios would typically be based on the expected funding cost in public or private markets, using securitisation modelling with a number of cashflow and stress assumptions applied, tailored to each portfolio’s characteristics. Simplistically, when the funding cost of a securitisation is higher, the fair value of the portfolio will be lower and vice-versa.

The Company adopted amortised cost accounting methodology, given its widely used application for portfolios of mortgages in the banking sector and the Company’s intention to hold the portfolios to maturity.

Regardless of this, the fair valuation of the Company’s portfolios are carried out by an independent third party on a semi-annual basis using the above methodology with the quantum disclosed in the interim and year-end financial accounts for IFRS disclosure purposes. However, the above methodology assumes a single point in time valuation and therefore funding cost, whereas the Company’s portfolios are typically all term-funded for various tenors (e.g. 3 years for securitisations or 2 years for warehouses), each of which have staggered maturity dates, and so somewhat protecting the fund from the variability in funding costs over time. Therefore, whilst the fair valuations of the portfolios may introduce some volatility, the amortised cost valuation provides a smoother unwind of discount/premium over the life of the portfolios.

That said, it’s important to recognise the difference in the valuation of the Company’s portfolios between the two approaches, where typically the fair valuation has been meaningfully higher than the amortised cost. The table below, simplistically, shows the difference in the NAV between the two methodologies over the last two years, assuming all else remains the same.

Date NAV (Amortised cost) NAV (Fair Value)
Dec-18   83.65 94.54
Jun-19   82.06 99.79
Dec-19   81.06 100.38
Jun-20   80.59 94.95

More detail on the market and portfolios will be available in the factsheet due to be published shortly.

Northern Trust International Fund Administration Services (Guernsey) Limited
Andrew Bonham   44 (0)1481 745302

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