TFIF Portfolio Update

20 July 2023

 TwentyFour Income Fund Limited

 (a non-cellular company limited by shares incorporated in the Island of Guernsey under the Companies (Guernsey) Law 2008, as amended, with registered number 56128 and registered as a Registered Closed-ended Collective Investment Scheme with the Guernsey Financial Services Commission. LEI: 549300CCEV00IH2SU369)

Re: TwentyFour Income Fund - Portfolio Update

 
Given recent press coverage on UK mortgage risk and various portfolio composition changes, the Company would like to provide more information about the junior RMBS risk that the TwentyFour Income Fund ("TFIF" or "the Company") currently has exposure to, and furthermore, what mortgage lenders can do to help support borrowers if needed.

As a result of persistently high inflation the Bank of England ("BoE") increased the UK base rate to 5% in June, with the current market expectation that they will hike rates further in August, and remain elevated in the medium term. For TFIF this means that income for the portfolio will also increase in line with this increased rate due to its investment in floating rate securities. Whilst this is positive in terms of the return for the Company's shareholders, we are mindful that higher UK interest rates also increase costs to homeowners with short term fixed rate mortgages, who will almost certainly have to refinance at higher rates. The Portfolio Manager ("TwentyFour") prefers mortgage risk over unsecured consumer risk and credit cards, where they expect performance to deteriorate more than in mortgages, but not to the extent seen during the early 1990s or the Global Financial Crisis ("GFC"), especially as inflation figures are moderating and soft landings of the UK and European economies look more likely.

The Company predominantly invests in debt securities from Residential Mortgage Backed Securities ("RMBS") and Collateralised Loan Obligations ("CLO"). Following the acquisition of the UK Mortgages Ltd ("UKML") portfolio in March 2022, TFIF also owns a number of performing junior UK RMBS investments, in addition to the Dutch junior Prime RMBS investments, acquired in 2018 to 2020. The Portfolio Manager is happy with current positioning and has a high conviction on the fundamental performance of the borrowers that the Company has exposure to, especially given the longer fixed periods and low Loan to Value ratios ("LTVs") of the underlying mortgage portfolios.

Although lenders stress-test homeowners' abilities to pay higher rates than they have been offered based on prevailing market conditions before granting mortgages, mortgage rates have increased quicker than most lenders will have expected. It is important to understand though that a mortgage is the most senior credit a consumer has and that in the UK (and in the EU) mortgage lending is done on a full recourse basis. Historically there are three main reasons for a borrower to fall into arrears; unemployment, partner separations and death. While inflation and higher resets will be problematic for some borrowers, there are typically other expenses that borrowers can and have historically cut down on in order to service their mortgages, and this is before taking into account recent wage increases that will help many borrowers manage their expenses..

There will, however, clearly be borrowers that do not have the luxury of high savings or additional disposable income, or have not seen significant salary increases. For these borrowers, mortgage servicers and lenders have tools at their disposal to help or mitigate losses, and although the regulator has guided lenders publicly on this recently, these are mostly things lenders (who have a duty of care to borrowers) have been doing for a long time, having learnt lessons  from the GFC, and more recently from the Covid pandemic. Forbearance is therefore seen as a more efficient tool than foreclosures and ultimately minimises credit losses. The main tools that lenders have to help include:

• Budget coaching
• Maturity extensions
• Temporary switches from capital repayment to interest only repayment profiles
• Partial payment holidays (the idea being it is `better to pay 80% than nothing'), followed by capitalising missed interest
• Voluntary and assisted sales, typical for professional Buy-To-Let ("BTL") especially when LTVs are low, which typically gives a better execution than a public auction
• Then if really nothing is possible, or if borrowers don't engage with lenders, a repossession and sale is the ultimate defence lenders have

This year the Portfolio Manager has successfully refinanced two UK mortgage transactions, the most recent transaction being the refinancing of a pool of legacy mortgages (the Capital Home Loans or "CHL" portfolio) that publicly priced last week. This refinancing significantly improves the economics for TFIF and it repays around two thirds of the invested capital, which can be deployed in other investment opportunities.

Following the latest refinancing, TFIF will have 11 different junior RMBS investments, making up ~17% of the NAV. These investments can be split into 5 different categories.

TFIF investment	% of NAV (as at 14th July 2023)	Lender	Investments	Current LTV2
Dutch Prime Mortgages - Junior	6.1%	Venn and Tulp	5	64%
UK Prime BTL - Junior	4.0%	Keystone	2	70%
UK Prime BTL - Vertical Risk1	4.6%	Keystone	2	71%
UK Legacy Mortgages - Junior	1.2%	CHL	1	54%
UK NC Mortgages	1.0%	The Mortgage Lender	1	54%

1 (AAA~80%, Mezzanine ~10%, Junior ~10%)

2 indexed property valuations per latest investor reports

Dutch Prime mortgages are typically 20 to 30 year fixed rate mortgages and as these investments were made in 2018-2020, the mortgage rates are very low and credit risk is therefore significantly different to UK mortgages. For UK RMBS, TFIF is invested in (professional) BTL and Owner Occupied mortgage risk. Other than the CHL investment, the rest of the RMBS are mortgage portfolios originated in recent years under strict affordability criteria. Most of these homeowners have benefitted from substantial house price increases, which ultimately reduces their risk of negative equity and the risk of potential losses for lenders and holders of junior RMBS notes, due to a reduction in Loan To Value (`LTV') ratios. Reduced LTV ratios also provide the servicers with more tools to help any borrowers who may be facing financial problems. Since the UKML acquisition, the Portfolio Manager has reduced pure equity risk in the portfolio through optimised capital structures and `vertical risk' investments where TFIF has exposure to a pro rata slice of AAA, mezzanine and junior bonds (rather than the traditional junior only investments) with a lower credit risk than the junior notes. We note that the fundamental performance of the acquired UKML securities, as well as the Dutch Prime investments (in terms of arrears and foreclosures) is substantially better than that modelled at time of acquisition.

New junior RMBS investments have not been identified at this stage, but the Portfolio Manager remains comfortable with existing investments, and will look to further optimise these investments over time as they come to fruition. Bronwyn Curtis, Chair of TFIF, shares this view and said "historically, UK mortgages have performed exceptionally well and although we recognise that the UK mortgage market is challenging, the Board is happy with the active management of the portfolio by TwentyFour, and the very low LTVs of these investments."

Aza Teeuwen, Partner and Portfolio Manager at TwentyFour comments "we believe a soft landing of the economy is the most likely scenario, supported by improving inflation figures, but we do think markets will remain volatile for a long period and our positioning reflects this. For TFIF that means a focus on senior secured assets from high quality Western European assets, increased liquidity, the lowest leverage level since the Company started employing gearing in 2020, and a relatively short credit spread duration, which ultimate gives us flexibility. We currently see best value in BBB to B rated UK and Dutch RMBS and BB rated CLOs, but we also expect to see more mezzanine and junior investment opportunities to come from some of the largest banks in the next 12 months."
 

For further information, please contact:

Numis Securities Limited:
Matt Goss        [phone]
Hugh Jonathan

TwentyFour Income Fund Limited:
John Magrath       [phone]
Alistair Wilson

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