Real Est.cred Regulatory News (RECI)

19 Jun 2008 07:00



19 June 2008

Queen's Walk Investment Limited

Financial Results Announcement for the 

Fourth Quarter Ended March 2008

Queen's Walk Investment Limited maintains quarterly dividend at 15 cents per share

Queen's Walk Investment Limited (Queen's Walk), the Guernsey incorporated investment company, has reported operating income of €7.7 million or €0.25 per share for the quarter ended 31 March 2008, compared to €9.7 million or €0.28 per share in the previous quarter.  The fall in operating income reflects the expected run-off of the Company's investment portfolio, and the higher cash balances the Company maintained in the quarter. 

Cash generation for the quarter was robust with €16.6 million of cash proceeds received. This was ahead of the Company's internal forecasts and further strengthens the Company's free cash balances. As at 31 May 2008, the Company had in excess of €30 million of free cash on its balance sheet, up from €22 million as at 31 December 2007.

Fair value write downs of the Company's investment portfolio for the quarter totalled €22.1 million, compared with €8.3 million for the period ended 31 December 2007.  A significant proportion of fair value write downs are attributable to higher market discount rates and therefore do not impact the ability of the assets to generate cash.  After accounting for fair value write downs, the Company recorded a net loss of €17.1 million for the quarter compared to €1.2 million in the previous quarter. The Company's net asset value at quarter end was €6.42 per share compared to €6.90 per share in the previous quarter.

Queen's Walk's Board of Directors has declared a dividend of €0.15 per share for the quarter, resulting in full year dividends of €0.60 per share. At 31 March 2008, after allowing for all declared dividends, the Company had €0.34 cents per share in excess of this dividend still available for distribution.

Company plans fresh investments to increase NAV per share

The Company intends to boost shareholder value both through further share repurchases and by making fresh investments to exploit market dislocations.  In the coming months, the Company plans to make a further tender offer for a minimum of €10 million of Queen's Walk shares.

At this point in the credit crisis, Queen's Walk sees opportunities to generate attractive returns from dislocations in the ABS market.  Firstly, certain mezzanine ABS securities (rated from AA to BBB) trading at historical lows could offer returns of 15%-20%.  Secondly, returns of approximately 20% are on offer from re-packaging AAA-rated securities that are being deconsolidated by banks.  Thirdly, the company is looking to buy assets at substantial discounts from distressed sellers.

Following an extensive review of mortgages underlying the residual investments, the Company intends to mitigate losses on existing investments by encouraging mortgage originators to buy back certain loans that do not satisfy representations and warranties provided in the relevant securitisations.

Tom Chandos, Chairman of Queen's Walk Investments Limited, said: "The Board has been encouraged by the support our shareholders have shown in recent months. We remain committed to protecting and enhancing net asset value through the course of the next financial year.  Queen's Walk is well positioned to take advantage of opportunities in the market thanks to our strong cash position, our market expertise and the support of our shareholders."

  Highlights

Operating income of €7.7 million, equating to operating income per share of €0.25 compared to €9.7 million or €0.28 per share in the quarter ended 31 December 2007.

Net asset value at €6.42 per share, compared to €6.90 per share at the previous quarter end. 

Fair value write downs of the investment portfolio of €22.1 million in the quarter compared to €8.3 million in the previous quarter.

The Board of Directors has declared an interim dividend of €0.15 per share for the quarter. 

In the financial year ended 31 March 2008, the Company reported gross cash flows of €84.9 million.

Conference Call & Further Information

A conference call to review the Company's financial results for the quarter ended 31 March 2008 will take place at 10am London time on 19 June 2008. The conference call can be accessed by dialing +44 (0)20 7806 1958 ten minutes prior to the scheduled start of the call. A results presentation will be available on the Queen's Walk website (www.queenswalkinv.com). 

The full financial results for the year ended 2008 are available in the Company's Annual Report which is also available on the Queen's Walk website.

A webcast of the conference call will also be available on a listen-only basis at www.queenswalkinv.com. Please allow extra time prior to the call to visit the site and download the necessary software required to listen to the internet broadcast. A replay of the webcast will be available for three months following the call.

For further information please contact - 

Investor Relations: Caroline Villiers +44 (0)20 7153 1521

About the Company

Queen's Walk Investment Limited is a Guernsey-incorporated investment company listed on the London Stock Exchange.  Queen's Walk invests primarily in a diversified portfolio of subordinated tranches of asset-backed securities, including the unrated "equity" or "first loss" residual income positions typically retained by the banks or other financial institutions which have originated the loan assets that collateralise a securitisation transaction. The Company makes such investments where its investment manager, Cheyne Capital Management (UK) LLP ("Cheyne Capital"), considers the coupon or cash flows from the investment to be attractive relative to the credit exposure of the underlying asset collateral.

The content of this announcement includes statements that are, or may be deemed to be, "forward-looking statements". These forward-looking statements can be identified by the use of forward-looking terminology, including the terms "believes", "forecasts", "estimates", "anticipates", "expects", "intends", "considers", "may", "will" or "should". By their nature, forward-looking statements involve risks and uncertainties and readers are cautioned that any such forward-looking statements are not guarantees of future performance. The Company's actual results and performance may differ materially from the impression created by the forward-looking statements and should not be relied upon. The Company undertakes no obligation to publicly update or revise forward-looking statements, except as may be required by applicable law and regulation (including the Listing Rules).

  Chairman's Statement for the Financial Year Ended 31 March 2008

The past year has been dominated by the US sub-prime crisis and the knock-on effects it has had on the credit markets and the wider economy. In spite of this, the Company's diversified investment portfolio has continued to generate strong cash flows. Combined with a stable financing platform, the Company has been able to prioritise the return of capital to shareholders through a combination of share repurchases and a stable dividend.

The Company recorded an operating income of €39.1 million or €1.27 per share for the financial year ended 31 March 2008, compared to €65.5 million or €1.61 per share in the previous year. The fall in operating income is largely attributable to reduced net leverage.

The Company incurred a net loss of €22.1 million for the year, an improvement from a net loss of €67.7 million for the 2007 financial year. The Company's NAV at the end of this financial year is €6.42 per share, down from €7.24 per share as at 31 March 2007.

Not withstanding the losses in the year, the Company is able to pay dividends from income received from its investments and its distributable reserves. Through the course of the financial year, the Company has maintained a quarterly dividend of €0.15 per share. Since the IPO, the Company has paid or declared dividends of €1.74 per share. The dividend has been supported by the Company's operating income and strong cash flow profile. In the 2008 financial year, the Company reported gross cash flows of €84.9 million. The directors remain committed to seeing that the Company continues to pay, as far as possible, quarterly dividends that are in line with the Company's income generating potential.

From 31 March 2007 through to 6 June 2008, the Company has paid or declared dividends of €21.9 million and returned approximately €54.5 million to shareholders through a combination of share buy backs and tender offers. In total, €76.4 million has been returned to shareholders in this period. The repurchases of the Company's shares have been executed at significant discounts to NAV and as a consequence have been accretive to shareholders. The share buy back programme has also been important in mitigating the effect of reductions in fair value of the Company's assets.

Investment Portfolio

The past financial year has been extremely challenging for the financial markets. An excess of liquidity in the capital markets in the past few years has supported a weakening of credit standards across a number of asset classes. In relation to the asset-backed markets, and particularly the non-conforming mortgage market, investor appetite for asset-backed securities supported the emergence of "originate and distribute" lending models. This approach to lending reduced the alignment of interest between mortgage brokers, mortgage underwriters, securities firms and the end investor. While these activities took place on a massive scale in the US and resulted in the US sub-prime mortgage crisis, similar attitudes towards lending migrated to the UK and Europe in 2006 and the first half of 2007. The current credit crisis has been precipitated largely by the breakdown in the alignment of interest between different participants in the consumer lending markets.

The impact of the credit crisis will continue to spread through the economy and lead to a weakening of economic fundamentals. In the UK, the Company expects a further weakening of house prices and a contraction of available mortgage credit in the near term. Growth in the Continental European economy is expected to slow, but economic conditions should be more robust than in the UK or US.

Over the course of the past financial year, the Company has repositioned its portfolio to take into account weakening market and economic conditions. In the first quarter of the financial year, the Company reduced its exposure to the US sub-prime market by selling three out of four of its residual investments. Net leverage has also been reduced from 25.9% as at 31 March 2007 to 6.2% (1) as at 31 March 2008. In addition the Company replaced its short-term financing facilities with a four-year term financing facility. Lastly, in September 2007, the Company purchased €28 million notional of two year put options set at a strike price of 90% of the September value of the UK Halifax house price index. The April 2008 value of this index is 93% of the September 2007 value.

(1) Net of cash proceeds required to pay the 31 March 2008 dividend.

The Company's UK investment portfolio continues to generate strong cash flows and performance is generally in line with revised pricing assumptions. Available mortgage credit has contracted dramatically since the credit crisis began and is expected to remain tight in the near term. Tighter lending conditions will likely result in higher defaults and arrears rates in the underlying mortgage portfolios. The potential loss in value as a result of weaker credit performance should be mitigated by slower pre-payment rates and the Company's UK house price hedge.

In the coming quarters, the Company will be engaging with mortgage originators and the securitisation underwriters to establish whether the mortgage loans to which the Company has exposure were originated in accordance with the various representation and warranties provided in the relevant securitisation.

In general, the Company's portfolio of European mortgage residual investments performed satisfactorily during the course of the year. However, the increase in Euribor rates has started to have a negative impact on mortgage affordability for some borrowers. Since the end of the last financial year, the three-month Euribor rate has increased from 3.93% to 4.96%. The Company has adopted a conservative view in relation to Euribor rates, and as such increased its assumptions in relation to arrears and defaults of the underlying mortgage loans.

The Company's portfolio of SME residuals continues to perform better than or in line with expectations. The SME portfolio accounts for approximately 25% of the Company's investment portfolio and has proved to have a positive diversification benefit in relation to the mortgage investments.

The Company's direct and indirect exposure to the US subprime mortgage market currently accounts for approximately 0.1% of the investment portfolio.

Outlook

The 2009 financial year will bring both challenges and opportunities. Market participants remain divided as to the depth and duration of economic slow-downs in the developed world. Moreover, in both the commercial and residential property markets, there has been a decline in asset values. In the credit markets, spreads have widened substantially in the last nine months, and specifically in the ABS sector, spreads appear to have over shot fundamental valuations.

In previous quarters, the Company has prioritised the return of capital to shareholders. However, the Company now believes that the returns achievable in the current market dislocation are more beneficial to shareholders than returning all available capital. As at 31 March 2008, the Company had cash and cash equivalent balances of €32.9 million. In addition, the Company expects to receive strong cash flows from the residual investments in 2008. For the financial year ending 31 March 2009, the Company intends to balance the return of capital with the reinvestment of capital.

In the coming months, the Company expects to make a further tender offer to repurchase shares. The proceeds for the tender offer will be available from the Company's cash balances. The tender offer is expected to be for not less than €10 million.

In addition to the return of capital, the Board will work with the Investment Manager to identify investment areas that can achieve the Company's risk adjusted returns targets. The Company will continue to focus on the asset-backed markets though it will consider taking positions higher up the capital structure. The Company's long term capital and termed financing leaves it well positioned to invest in the sector and will provide a competitive advantage.

The Investment Manager's long record in the residual markets has allowed it to accumulate substantial amounts of data on the underlying performance of mortgage and SME loans. Moreover, with more originators now providing loan level data, the Investment Manager is able to accumulate more data on loan performance across originators and loan types. The quantity of data combined with proprietary analytics allows the Investment Manager to take a fundamental view on the expected performance of the loan markets and gain an advantage in the current market dislocation.

The Board has been encouraged by the support our shareholders have shown in recent months. We remain committed to protecting and enhancing net asset value through the course of the next financial year.  Queen's Walk is well positioned to take advantage of opportunities in the market thanks to our strong cash position, our market expertise and the support of our shareholders.

Annual General Meeting

The Company's Annual General Meeting will be held at the registered offices of the Company on 4 September 2008. The notice of the Annual General Meeting and a form of proxy will accompany the annual report to be distributed to shareholders in the Company.

  Financial Highlights

(1.) Net profit from investments before deduction of net fair value losses through profit or loss.  For the quarter ended 31 December 2007, the distributable income includes €197,984 of losses due to interest rate swaps, options and F/X transactions.  For the quarter ended 31 March 2008, the distributable income includes €471,273 of losses due to interest rate swaps, options and F/X transactions.

Fourth Quarter Dividend Details

The Board of Directors has declared an interim dividend for the quarter ended 31 March 2008 of €0.15 per share payable on 18 July 2008 to shareholders of record on 27 June 2008.

Portfolio Review - Rate of cash flow from assets exceeds expectations

The portfolio's ability to generate cash remains strong with total cash proceeds of approximately €16.6 million received in the quarter ended 31 March 2008 compared to €20.2 (2) million received in the previous quarter. Cash flows from the UK, European and SME investments were ahead of expectations. The absolute fall in the total cash received, reflects a smaller overall portfolio due to the expected amortisation of the Company's assets, the weakening Sterling-Euro exchange rate and the expected fluctuation in the timing of cash flows generated by the assets. The cash flow performance of the Company's US sub-prime related assets was compromised by continued deterioration in the US mortgage market.

The Company's investment portfolio consists largely of investments with exposure to the UK and European mortgage markets and to the European SME sector. Assets with exposure to the US sub-prime market account for approximately 0.1% of the investment portfolio. The Company also has exposure to the US leveraged loan market through a residual investment in a CLO ("Collateralised Loan Obligation") which accounts for 1.1% of the investment portfolio. All the securitisations to which the Company has exposure are term financed and have no risk of additional margin calls or refinancing risk.

The Company's net leverage has decreased to 6.2 % (3) as at 31 March 2008 from 9.5% (4) as at 31 December 2007. The Company's net indebtedness as at 31 March 2008 was €12.2 million compared to net indebtedness of €23.5 million as at 31 December 2007. On 14 February 2008, the Company repaid €4.5 million of its financing facility. As at 31 May 2008, the Company had total borrowings of €40.5 million.

(2) Cash flows in the quarter ended 31 December 2007 expressed using 31 March 2008 f/x rates.

(3) Net of cash proceeds required to pay the 31 March 2008 dividend.

(4) Net of cash proceeds required to settle the tender offer and pay the 31 December 2007 dividend.

A breakdown of the Company's investment portfolio by jurisdiction (by reference to underlying asset originator) is set out below. Percentages for each asset class are in relation to the value of the Company's investment portfolio excluding cash.

A breakdown of the Company's investment portfolio by asset type (by reference to underlying asset collateral) is set out below. Percentages for each asset class are in relation to the value of the Company's investment portfolio excluding cash.

A summary of the Company's 10 largest positions as at 31 March 2008 is set out the in following table:

Investment Portfolio 

UK Mortgage Investments (26.0% of GAV)

The company's UK mortgage portfolio continued to be highly cash generative, contributing €9.9 million of gross cash flows in the quarter.  

Market discount rates have increased for UK residual investments, which has had a negative impact on the fair value of the Company's mortgage residuals. The Company also recorded a write down of €5.8 million in relation to the Newgate 06-1 residual, which is a result of the anticipated poor performance of the underlying mortgage loans.

In the past quarter, prepayment rates have fallen among loans that have been in their full margin interest period for at least six months. On balance this will increase the duration of the assets which is accretive to the value of the assets. Currently the cash flow forecasts do not incorporate the new observations concerning the prepayment behaviour of seasoned loans. The cash flow forecasts will be updated next quarter once a sustained trend in the prepayment rate can be established.

The Company has incorporated higher arrears and default rates in the current pricing assumptions, reflecting how borrowers have found it difficult to refinance their loans once they are in arrears on their mortgage payments. As such, the current cash flow forecasts reflect a higher default rate assumption on the mortgage loans.

Following an extensive review of mortgage loans that act as collateral for some of the Company's UK residential investments, the Company has identified certain loans whose quality fell short of the descriptions and warranties in documents accompanying the actual securitisation. The Company has decided to take action on behalf of shareholders in order to mitigate losses in the future.  Queen's Walk has entered negotiations with the mortgage originators with the purpose that they buy back the loans that did not satisfy representations and warranties in the underlying securitisation. 

In October 2007, to help to hedge the portfolio against a drop in UK house prices, the company entered into a two-year €28 million put option, with a strike price of 90% of the 30 September 2007 Halifax House Price Non-Seasonally Adjusted Index level. In the event that house prices do not fall below 10%, the fair value of this put option will fall to zero over the next two years. The 10% threshold reflects the approximate gain in house prices for the least seasoned UK residual in the portfolio.  If house prices fall by more than 10% from the September 2007 level, the put option will act as a partial hedge against higher credit losses in the portfolio. Since September 2007, house prices, as measured by this index, have fallen by approximately 6.8%.

European Mortgage Investments (37.1% of GAV)

In general the portfolio of European mortgage residuals has performed well despite the credit crisis. The credit quality of most underlying mortgage loans remains high, however continued high levels of Euribor over the past nine months have led to problems for certain borrowers.  Borrowers with mortgages indexed to Euribor have been facing increased mortgage payments. As a result, the Company has observed increases in both the arrears and default rates in the underlying portfolios.

The Company is applying a conservative view in estimating the cash flows from the portfolio. The cash flow forecast for the European portfolio reflects the assumption that Euribor rates remain high, resulting in higher arrears and default rates.

The fair value of the European mortgage residuals reflects changes made to the default expectations in relation to these residuals. The arrears and default assumptions assume no improvement in the Euribor rates going forward. The fair value of the European mortgage residuals has also been reduced as a result of widening market discount rates on the assets.

We believe, however, that this increase in arrears is temporary. Euribor is currently about 85bps greater than the ECB target rate. This spread is substantially greater than historic levels. The Company believes that this spread should reduce when liquidity increases in the credit markets.

SME Investments (20.9% of GAV)

SME assets continued to perform well with cumulative default rates on the underlying asset pools better than or inline with expectations.

In the last quarter, the Company identified the Eirles Three Limited (236B) residual as having exposure to the Spanish construction and buildings industries. The Investment Manager has investigated the Spanish exposures in the portfolio and has not increased the default rate for the residual. To date, the Company has expected cumulative defaults of 175bps, with actual defaults significantly lower at 114bps.

CDO Investments (1.0% of GAV)

The Company holds residual positions in three CDOs, two of which are exposed to US mortgage assets. While the High Grade CDO and ABS Investments I have weakened, CLO Investments I has performed better than expected.

The High Grade CDO is backed by AAA to A-rated ABS bonds. ABS Investments I is a CDO backed by the mezzanine tranches of US ABS CDOs (including US RMBS CDOs).  As at 31 March 2008, the performance of High Grade CDO had weakened materially as a result of more downgrades of higher rated ABS bonds. The performance of ABS Investments I has also deteriorated significantly following the substantial downgrades of US mezzanine ABS bonds. The Company expects to receive no further cash flows with respect to either of these assets.

CLO Investments I is backed by AA- to BBB- rated US CLO bonds. The performance of this collateral has exceeded original pricing assumptions and two of the bonds in the portfolio have been upgraded from BBB to A and AA, respectively. There have been no downgrades or negative watch warnings on any of the bonds in the portfolio. The cash generative ability of this residual investment remains positive and is in line with expectations. However, the fair value of the asset has been reduced as a result of wider discount rates being applied in the quarter.

US Mortgage Investment (0.04% of GAV)

The Company has one remaining US mortgage residual, RASC 2006-KS2.  Actual loss performance over the past quarter has not deviated significantly from our previous projections. However, with an increase in the arrears pipeline the forecast cumulative loss has been increased in the quarter. 

Portfolio Valuation 

In accordance with the Company's valuation procedures, the fair value of the Company's investments has been evaluated on the basis of observable market data, market discount rates and the Investment Manager's expectations regarding future trends. The market discount rate of the Company's residual portfolio has increased in the quarter. On average, discount rates have widened by approximately 20% to 40%. This increase has reduced the fair value of the Company's portfolio.

After giving effect to fair value write downs of €22.5 million in the quarter, the NAV of the Company was €6.42 per share as at 31 March 2008 (€6.90 per share as at 31 December 2007).

The Company's long-standing policy is to account for assets and liabilities using different accounting treatments.  The Company's investments are evaluated at fair value, whereas liabilities are held at amortised cost.

The table below summarises the changes in fair values of the Company's investment portfolio by asset class:

(1) Fair values as at 31 December 2007 are expressed using 31 March 2008 F/X rates.

(2) The fair value figures for 31 December 2007 and 31 March 2008 include accrued income and, in the case of the UK mortgage residuals, the value of the interest rate swaps.

(3) Cash flows for 31 December 2007 are expressed using 31 March 2008 F/X rates.

(4) The values for each column may not sum to the total due to rounding differences.

Fair value changes since 31 December 2007 include principal amortisations of the residuals as a result of cash flows received in the quarter as well as fair value write downs related to the investment portfolio. 

Share Repurchase Programme 

On 8 January 2008, shareholders approved the Company's latest tender offer and on 15 January 2008, the Company repurchased 2,777,771 shares for cancellation at a price of €5.40 per share. 

As at 31 March 2008, the Company had purchased 9,914,708 shares through its buy back programme and previous tender offers at an average price of €5.34 per share. During the period from 31 March 2008 until 6 June 2008, the Company purchased 318,150 shares through its buy back programme at an average price of €4.72 per share. Although the share buybacks have been accretive to NAV, the number of shares which the Company repurchases has been constrained by limits on the volume of shares that can be purchased on any particular day, and by the price at which the Company can repurchase shares.

Strategy and Market Outlook

The credit crisis in the financial markets should ease following the coordinated action by financial regulators to restore liquidity to the system. The securitisation markets have started to recover as spreads on prime AAA-rated ABS have tightened significantly in the last few months. However, we do not expect the sub-prime securitisation markets to re-open in the near term and appetite for assets in the ABS sector will remain limited, especially so at the mezzanine level (bonds rated AA to BBB-).

We expect the weakening of the real economy to lead to increased tiering, in both performance and price, between different loan types and transactions. To identify value between these transactions requires considerable amounts of data, analytical modelling and structural analysis. As a consequence of the lack of liquidity in the ABS markets, combined with a high hurdle to entry, spreads of mezzanine ABS bonds are trading at historical wides. From an absolute return perspective, investments in A-rated ABS assets have an expected total return of 15-20% per year. In addition, there are an increasing number of long-short strategies that take advantage of distinctions in asset performance between originators and transaction structures. Given the continued illiquidity in the ABS sector, these investments are better suited for investors with a longer term investment horizon.

The Company has also been approached to facilitate transactions that allow banks to deconsolidate a significant portion of their AAA-rated ABS risk and release balance sheet as well as regulatory capital. These investments are typically structured as equity investments in a term funded portfolio of AAA-rated bonds. The Company's return targets for these types of assets are in excess of 20%.

The Investment Manager is also exploring the purchase of fundamentally credit sound assets at substantial discounts from distressed sellers in order to realise their fair value over time. 

The Company is in a strong position to take advantage of these market opportunities, and believes that now is the right time to commit capital. The Company's analytical infrastructure combined with extensive loan level data, allows for detailed analysis of portfolios and identification of relative value. The Company has already identified pricing and structural anomalies that it is able to exploit. The current dislocations in the ABS markets offer investors a superior risk return profile without significant leverage requirements. Exploiting these opportunities will help the Company to achieve its return targets with a reduced risk profile.

Over the coming months, the Company expects to use some of its available cash and cash received from its assets to purchase new assets. In addition, in the coming months the Company intends to conduct a further tender offer for its shares. We expect both these strategies to increase NAV in the coming quarters.