Source - LSE Regulatory
RNS Number : 9816P
SQN Secured Income Fund PLC
16 October 2019
 

16 October 2019

SQN Secured Income Fund plc

("SSIF" or the "Company")

 

Annual Financial Report

For the year ended 30 June 2019

 

A copy of the Company's Annual Report and Financial Statements for the year ended 30 June 2019 will shortly be available to view and download from the Company's website, http://www.sqncapital.com/managed-funds/sqn-secured-income-fund/about/.  Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into or forms part of this announcement.

 

Enquiries to:

 

Ken Hillen, Chairman

c/o finnCap Ltd.

 

SQN Asset Management Limited

Neil Roberts/Jeremiah Silkowski/Dawn Kendall

 

tel: +44 1932 575 888

 

finnCap Ltd.

Corporate Finance:

William Marle / Giles Rolls

Sales:

Mark Whitfeld

 

tel: +44 20 7220 0500

 

 

 

 

 

Kepler Partners LLP

Hugh van Cutsem

 

tel: +44 20 3384 8790

Buchanan Communications

Charles Ryland/Henry Wilson

 

tel: +44 20 7466 5000

http://www.sqncapital.com/managed-funds/sqn-secured-income-fund/about/

 

The contents of this preliminary announcement have been extracted from the Company's Annual Report, which is currently in print and will be distributed within the week. The information shown for the years ended 30 June 2019 and 30 June 2018 does not constitute statutory accounts and has been extracted from the full accounts for the years ended 30 June 2019 and 30 June 2018. The reports of the auditors on those accounts were unqualified and did not contain adverse statements under sections 498(2) or (3) of the Companies Act 2006. The accounts for the year ended 30 June 2018 have been filed with the Registrar of Companies. The accounts for the year ended 30 June 2019 will be delivered to the Registrar of Companies in due course.

 

Strategic Report

Key Points

 

30 June 2019

30 June 2018

Net assets [1]

£50,129,000

£51,539,000

NAV per Ordinary Share

95.10p

97.78p

Share price at 30 June 2019

92.00p

91.50p

Discount to NAV

3.3%

6.4%

Profit for the year

£2,236,000

£2,809,000

Dividend per share declared in respect of the year

7.00p

6.30p

Dividend cover

0.79

0.99

Total return per Ordinary Share (based on NAV)

+4.4%

+5.4%

Total return per Ordinary Share (based on share price)

+8.2%

0.0%

Ordinary Shares in issue

52,660,350

52,660,350

 

 

[1]

In addition to the Ordinary Shares in issue, 50,000 Management Shares of £1 each are in issue (see note 21).

       
 

 

Strategic Report

Overview and Investment Strategy

 

General information

SQN Secured Income Fund plc (the "Company", "Fund" or "SSIF") was incorporated in England and Wales under the Companies Act 2006 on 13 July 2015 with registered number 09682883.  It is an investment company, as defined in s833 of the Companies Act 2006.  Its shares were admitted to trading on the London Stock Exchange Specialist Fund Segment on 23 September 2015 ("Admission").

 

Investment objective

The investment objective of the Company is to provide Shareholders with attractive risk adjusted returns, principally in the form of regular, sustainable dividends, through investment predominantly in a range of secured loans and other secured loan-based instruments originated through a variety of channels and diversified by way of asset class, geography and duration.

 

Investment policy

The Company achieves its investment objective by investing in a range of secured loan assets mainly through wholesale secured lending opportunities, secured trade and receivable finance and other collateralised lending opportunities.  Loan assets include both direct loans as well as other instruments with loan-based investment characteristics (for example, but not limited to, bonds, loan participations, syndicated loans, structured notes, collateralised obligations or hybrid securities) and may include (subject to the limit set out below) other types of investment (for example, equity or revenue- or profit-linked instruments).  The Company may make investments through alternative lending platforms that present suitable investment opportunities identified by the Investment Manager (SQN Asset Management Limited ("SQN UK") and SQN Capital Management, LLC ("SQN US")).

 

The Company ensures that diversification of its portfolio is maintained, with the aim of spreading investment risk.

 

Geography

The Company invests in loan assets in a broad range of jurisdictions (although weighted towards the UK, Continental Europe and North America) in order to build a global portfolio of loan assets.

 

Asset classes

The Company invests in a wide range of loan assets, including: short-term lending such as invoice and supply chain financing; mid-term lending such as trade or short-term bridge finance; and long-term lending such as the provision of fixed term loans with standard covenants and subject to monthly or quarterly interest payments.

 

Duration

The Company holds a portfolio of loans and other loan-based instruments with a range of durations to maturity.  This is intended to provide the Company with both a liquid pool of assets ready for realisation, as well as a reliable stream of longer-term income.

 

Security

The Company invests in loan assets with a range of different types of security.  Typically, such security will be over a range of assets, including, but not limited to, property, intellectual property, tax credits, receivables, future income streams, pledges of shares or other specific assets, ownership of special purpose vehicles, personal or group company guarantees or via credit insurance, or a combination of these.  Loan assets will be unsecured only in the case of short-term lending or investment, where the perceived level of risk in respect of the particular asset is low given the quality of the counterparty, credit assessment and design of the credit contract.

 

Sector

The Company is indifferent to sector when allocating funds for investment and, instead, adheres to the investment restrictions which apply to the Company's loan portfolio as a whole in order to spread investment risk.

 

Investment restrictions

The following investment restrictions (calculated based on the Company's gross assets at the time of investment or, if earlier, the date on which the Company commits to making the relevant investment) in respect of the deployment of the Company's capital have been established in pursuit of its aim to maintain a diversified investment portfolio and thus mitigate concentration risks:

 

Investment Restriction

Investment Policy

Geography

- Exposure to UK loan assets

- Minimum exposure to non-UK loan assets

Minimum of 60%
20%

Duration to maturity

- Minimum exposure to loan assets with duration of less than 6 months

- Maximum exposure to loan assets with duration of 6 - 18 months and 18 - 36 months

- Maximum exposure to loan assets with duration of more than 36 months


None
None

50%

Maximum single investment

10%

Maximum exposure to single borrower or group

10%

Maximum exposure to loan assets sourced through single alternative lending platform or other third party originator


25%

Maximum exposure to any individual wholesale loan arrangement

25%

Maximum exposure to loan assets which are neither sterling-denominated nor hedged back to sterling


15%

Maximum exposure to unsecured loan assets

25%

Maximum exposure to assets (excluding cash and cash-equivalent investments) which are not loans or investments with loan-based investment characteristics


10%

         

The Company will not invest in other listed closed-end investment funds.

 

Borrowing

The Company (including, for this purpose, any special purpose vehicles that may be established by the Company in connection with obtaining leverage against any of its assets) may employ borrowings (through bank or other facilities) of up to 35% of the Company's net asset value (calculated at the time of draw down), which includes, on a look-through basis, borrowings of any investee entity.

 

Hedging

The Company intends, to the extent it is able to do so on terms that the Manager considers to be commercially acceptable, to seek to arrange suitable hedging contracts, such as currency swap agreements, futures contracts, options and forward currency exchange and other derivative contracts (including, but not limited to, interest rate swaps and credit default swaps) with the sole intention of hedging the Company's non-Sterling currency exposure back to Sterling.

 

Cash management

The Company's un-invested or surplus capital or assets may be invested in cash or cash equivalents (including government or public securities (as defined in the rules of the FCA), money market instruments, bonds, commercial paper or other debt obligations with banks or other counterparties having a "single A" (or equivalent) or higher credit rating as determined by any internationally recognised rating agency selected by the Board (which may or may not be registered in the EU)).  There is no limit to the amount of cash or cash equivalents that the Company may hold.

 

Changes to the investment policy

No material change will be made to the investment policy without the approval of Shareholders by ordinary resolution.

 

 

Strategic Report

Chairman's Statement

 

Introduction

I am pleased to update Shareholders with my Chairman's Statement, covering the period from 1 July 2018 to 30 June 2019.  Over the twelve month full financial year reporting period, the Company has continued to make excellent progress in reorganising the asset base to better reflect the secured and collateralised nature of the Investment Manager's core credit focus.  Despite continued macro uncertainty caused by Brexit and wider geopolitical issues, income and steady NAV performance have been delivered for Shareholders.

 

The Company is a UK-listed specialist investment trust with a focus on secured investments that produce regular, collateralised income from investments made in a diversified portfolio of loans to lower middle market companies in the UK and the rest of the World.

 

Performance

During the reporting period, the Company was able to maintain steady income despite some NAV volatility resulting from legacy portfolio impairments.  This income stability is a testament to the uncorrelated nature of the assets that the Company targets and the strong foundation the security associated with the direct lending strategy of the Investment Manager.   All loans underwritten since April 2017 are performing in line with expectations and have met all their capital and interest commitments.  The Investment Manager has also been moderately successful in limiting impairment risk from legacy loans via platforms within the portfolio by reducing this portion of the overall portfolio to £15.2 million of the total.  This is in line with guidance given by the Investment Manager but it is noted that progress in reducing peer to peer loan exposure has slowed as the rump of the segment takes more resource and time to manage out.

 

For the reporting period ending 30 June 2019, the Company has generated a net profit of £2.2 million comprising of earnings per Ordinary Share of 4.25p.  The Company's NAV at 30 June was £50.1 million (95.10p (cum income) per Ordinary Share) compared to £51.5 million (97.78p per Ordinary Share) as at 30 June 2018.  The total return for the reporting period was 4.4%.

 

Foreign exchange exposure on the 16.9% of the total loans allocated to non-Sterling loans is fully hedged and any liquidity calls arising from the hedging strategy are considered manageable within the Company's cash flow even with increased volatility assigned to Brexit uncertainty.

 

Note that all returns are net of all fees and no gearing was applied to the portfolio during the reporting period.

 

Corporate Activity

As previously reported, during the first half of the year the Company appointed new corporate and legal advisors.  From December 2018, FinnCap, Kepler Partners and Dickson Minto were duly appointed in their respective roles.

 

These counterparties have had a constructive and positive impact on Shareholder interaction and the second half of the reporting period was spent actively engaging with existing and potential new investors in the UK and further afield.  It has been noted that there has been increased activity in stock acquisition from the retail sector of the market which has helped to maintain a consistent share price with very low volatility compared to other trusts of similar nature in the sector.

 

Despite retail interest, the Company has been unable to encourage large scale purchasing interest from the larger corporate sector and in particular discretionary wealth managers, to narrow the discount to NAV.  In the main, this is due to increased concern regarding the sector and as investors made strategic decisions to divest from the UK.  A reduction in the discount is essential to allow for further capital to be raised and so it is disappointing given the positive transformation the Company has undergone.  On the other hand, it is unsurprising given increased uncertainty regarding the economic well-being of the UK should we leave the European Union.

 

Earnings and Dividends

Total earnings per Ordinary share for the reporting period were 4.25p.

 

The Company elected to designate all dividends for the period ended 30 June 2019 as interest distributions to its Shareholders.  In doing so, the Company took advantage of UK tax treatment by "streaming" income from interest-bearing investments into dividends that will be taxed in the hands of Shareholders as interest income.

 

As set out in the Prospectus, the Company intends to distribute at least 85% of its distributable income by way of dividends on a monthly basis.  During any year the Company may retain some of the distributable income as a loss reserve to smooth future dividend flows.

 

The Company reached its dividend target of 7.00p per annum in July 2019 and is on target to deliver a total return of at least 8.00% based on the portfolio as it stands today.  During the reporting period, dividend cover has fluctuated due to specific transaction flows and the decision not to apply leverage until more platform and peer to peer investments had been removed from the portfolio.  At the end of the reporting period, the Company can again report that income flow from new underwriting and committed deals has stabilised with dividend cover at sustainable levels for the second half of the year.

 

Application of IFRS 9 Accounting Standards

In July 2018, the Company adopted new accounting standards that came into force during that year.  As Shareholders will note, this standard requires the Company to quantify future expected losses.  Due to changes in the circumstances of the legacy peer to peer businesses, the Company has made the decision that some impairment provisions should increase relating to these investments.  The Board considers this to be a prudent approach.  The Board notes that the Investment Manager has made strident efforts to mitigate risk associated with these legacy positions and will continue to monitor developments within these platforms.

 

Discount

During the reporting period, the Company traded at an average discount to NAV of 5.85%.

 

In normal market conditions, stabilisation of dividend cover and stable NAV performance would have resulted in a narrowing of discount to NAV.  However, sector volatility and the sale of shares by two significant holders creating a stock overhang during most of the reporting period has led to a modest widening of the discount.

 

Board of Directors

No changes to the Board composition were made during the reporting period and there are no future plans to increase the number of directors until such time that we have sufficient funds under management to warrant such appointments.

 

The Board continues to engage with the Investment Manager and has regular communications in line with governance guidelines.

 

Outlook

The Company has delivered income in line with its mandate and continues to make progress in reassigning available cash to loans underwritten directly by the management team.  The focus on risk management of legacy positions has been a particular focus of the Board and the Investment Manager has reduced further allocations to platform investments.

 

As the Company approaches 31 December 2019 when a Continuation Vote is required as total assets are less than £250 million, the Board has been considering three paths forward. The Company can continue as it is, it may also use as yet, unutilised gearing to achieve higher dividends in a range of 9.5% - 10.5%.  The Board considers this to be manageable without an increase in overall risk to the portfolio as more of the legacy portfolio is replaced with underwriting conducted by the Investment Manager.  Secondly, the Board can present investors with a wind down plan that will likely take two or three years to execute with the objective of delivering investors total proceeds as close to NAV as possible less the unavoidable expenses required in the process.  A third option has been considered, to propose that a new share class be issued to raise external capital to invest into a single segment of the investment strategy and enter into a share and asset swap on the current portfolio to provide liquidity to existing shareholders who wish to exit.  However, after further consideration and consultation with several key shareholders, the Board has resolved not to pursue this option.

 

We thank investors for their continued support during this period of ongoing transformation for the Company and hope that the consistent high level of income has been welcome as the Board and the Investment Manager have successfully worked to rebalance the portfolio away from inherited asset classes that have proven so much more problematic to other portfolios and sought to improve liquidity with continuing campaigns to raise new capital.

 

Ken Hillen

Chairman

15 October 2019

 

Investment Manager's Report

 

Overview

We are pleased to report continued steady progress in delivering a 7.00p dividend and containment of NAV deterioration from legacy portfolio impairments.  Despite these difficulties, the NAV performance remained relatively stable throughout the reporting period.  Our investment approach has been to focus on collateral and seniority of position in the debt stack for all new investments, creating a firmer foundation for the portfolio than had previously been the case.  This higher allocation to traditional underwriting has been undertaken alongside a considerable project to achieve stabilisation of the legacy portfolio inherited in April 2017.

 

The Company has successfully reduced peer to peer lending to only 7% of the portfolio and has reduced overall legacy exposure to £15.2 million.  This continues to fall and will be accelerated by the run-off of our single biggest position in a co-invested venture debt book where we have started to receive cash sums as debt is refinanced.  Impairments have been very low under IFRS 9 provisions, with a combined forward looking impairment provision of 2.22% including our recent reassessment of risks to platform investments.  All developments for the portfolio have been achieved without the use of leverage for investment or working capital purposes.  With Brexit uncertainty remaining a core theme for investors, we have analysed our direct loans and are comfortable that we have suitable downside protection embedded within the portfolio to sustain impact of a recession in the UK and mainland Europe. By contrast, the legacy peer to peer segment of the portfolio does present a continued risk of impairment, as this exposure continues to amortise down, we expect that the rump of the portfolio will remain a challenge.

 

Background

SQN is a credit focussed alternative investment manager with a successful track record in managing loans and asset backed financing to the lower mid-market, non-sponsored segment of the market.  For our borrowers we provide transformational funding on a senior secured basis using a traditional merchant banking model.  For our investors, we provide regular, covered income with a focus on risk mitigation and returns uncorrelated to other asset classes.  As at June 2019, SQN had over a billion dollars of active unlevered investments across the SQN group, including SSIF.  We manage ten funds in five jurisdictions and during the reporting period, achieved investment manager approval from the Central Bank of Ireland.  We remain suitably resourced to deliver income and total return in line with the expectation we have set for SSIF.  However, we are now fully invested to the capacity allowable given the run-off of legacy positions and need to consider imaginative options for future growth of Shareholder capital ahead of a continuation vote scheduled for December 2019.

 

Portfolio

We are focussed on underwriting of the highest quality in the lower middle market segment of the market with thirteen loans now underwritten by SQN, with an average of £2.6 million deployed per loan and at an average rate of 10.9%.  Each loan has bespoke legal documentation and is designed to fit to the Company's and the borrower's requirements.  There have been no late or missed payments in this portion of the portfolio underwritten by SQN and our covenant monitoring data is up to date. The outlook for the performance of these loans remains very good.

 

We have made a change to the way in which we categorise the legacy portfolio.  With £15.2 million now held in this part of the portfolio, we have differentiated between peer to peer loans and those that are held in loan note structures with professional counterparties.  These loans are larger in quantum and we have a closer relationship with the underlying companies. We have provided further details relating to these investments later in the report. The total number of loans via third parties have been reduced from 213 to 55 with a small number of loans amortising out of the portfolio each month. As mentioned above, peer to peer lending now represents only 7% of the portfolio.

 

No leverage was used throughout the reporting period.  Given the nature of the investments and the less predictable nature of repayments from legacy positions, we continue to see this as a challenge with regard to timing of reinvestments.  Despite this, we have paid close attention to delivering a covered dividend and can confirm that this is now stable, with expectation that it will remain so for the next year.  We have provided a history of progress below:

 

 

 

 

Gross Portfolio Yield

Portfolio Yield Including projected pipeline investments

 

 

Dividend Cover

 

 

Portfolio Cash %

July 2018

10.32%

10.32%

0.97

9.92%

August 2018

10.07%

10.07%

0.78

12.55%

September 2018

8.54%

8.54%

0.82

23.65%

October 2018

7.26%

7.63%

0.65

32.95%

November 2018

7.64%

9.35%

0.72

30.25%

December 2018

8.52%

9.28%

0.73

21.29%

January 2019

8.55%

9.32%

0.79

20.62%

February 2019

8.75%

9.52%

0.84

17.89%

March 2019

9.23%

9.62%

0.81

12.64%

April 2019

10.41%

10.50%

0.84

2.22%

May 2019

10.46%

10.80%

0.97

5.76%

June 2019

10.38%

10.84%

0.82

6.42%

July 2019

9.76%

9.76%

0.92

5.24%

August 2019

9.77%

9.77%

1.01

5.22%

Source: SQN

 

There were no breaches of investment restrictions without prior approval from the Board during the reporting period and all non-Sterling capital and income has been fully hedged.  Fluctuations in the value of Sterling during the reporting period has made for some significant moves in the cost of this hedging and this has been mitigated by reducing brokerage costs and careful monitoring of timing of hedge rolls.

 

Risk Management

Brexit continues to dominate the investment landscape as delay in the exit of the UK from the European Union extended from March 2019 to October 2019.  As previously reported, we have considered the risk associated with our current and future investments with great care and have approached this work from four dimensions; underwriting, currency, interest rates and duration. 

 

·      Underwriting is stress tested for a 10% fall in cash flows with little impact.  Our loans are senior, collateralised and we focus on debt service ratios.  We use bespoke legal structures allowing us to take control of bank accounts in extremis.  Covenants remain in keeping with expectations but as a lender of over two decades' experience, we have never seen a default result from a non-financial breached covenant; cash management is the prerequisite factor we consider.

·      All non-Sterling currency exposures are hedged.  The Company has a Sterling base and Shareholders should expect to be hedged against adverse movements and we fulfil this requirement.

·      All loans are fixed rate and our borrowers have a very low sensitivity to interest rate movements.  The overall portfolio has no gearing and so has nil sensitivity to rates as a whole.

·      As a fixed income manager, we monitor duration regularly.  We have made great efforts to reduce duration and this has been successful.  The single biggest duration contributor is our investment with BMS UK.  However, as this fund is now in run-off, we expect the weighted average duration of the portfolio to diminish further over the following year.

 

SQN Underwritten Direct Loans

The following provides a narrative relating to some of our direct loan investments.  Names of counterparties have been omitted for commercial and business sensitive reasons for our borrowers.  All borrowers have made capital and interest payments during the reporting period and we are pleased to report that all interest and capital has been paid in accordance with our borrowers' loan agreements.

 

·      Medical Services Provider in UK - the business is well managed and provides an essential medical service to the NHS and private practices in London and the north of England.  Patient numbers weakened for part of the year but the average has met target expectations with Summer 2019 delivering the highest patient treatments since 2017.  The business is in a sale process and we have covenants requiring the loan to be repaid in the event of change of control with penalty costs applied.

·      Wholesale Lending Group - the business remains stable and has delivered expected returns to the Company.  All loan-to-value investments have remained within their limit and all indicators are "green" status under our monitoring regime.  We also receive a quarterly external audit of the performance of the business.  There were some management changes during the reporting period that we were concerned about, including a new FD and origination manager, to replace retiring personnel.  After a short period, where it became clear that these new hires were not a good cultural fit, the executive management have quickly addressed these decisions and re-established a stable team.

·      Leasing Group - strong performance from a very good management team based in the north of England.  The Company provides a facility to fund a number of transactions which are then refinanced via block discounters at cheaper rates.

·      Laser and LED manufacturer - weaker performance compared to last year but this is due to a one off cost of relocation of the entire business from UK to Ireland.  We are comfortable that interest and capital is all being repaid on time and that the business has suitable sales pipeline to meet their debt commitments.

·      Marine Servicing Company - a service company specialising in renewable energy build and maintenance contracts as well as bridge and oil field service maintenance.  The company expanded during the reporting period acquiring a significant fleet in the US as this was part of a strategic expansion plan implemented in 2018.  They have equity support from a number of infrastructure investors.  With this larger asset base and backed by strong and experienced shareholders, this company is well positioned to keep increasing its utilisation rates and to improve its profitability.

·      Film Production Financing - Pre-sales and tax rebates plus completion insurance make these transactions offer the most balanced of risks for the rate of return and we have added comfort via a cross-collateralisation mechanism across all deals, providing healthy diversification. All assets are performing to expectation and within our monitoring guidelines.  We keep a close business relationship with the principals and advise on SPV structuring and currency hedging.

All in all, this book of loans is performing to expectations and we consider that each company has suitable cash reserves and capacity for growth to sustain hard economic shocks.  In volatile times, cash is the prevailing metric by which we judge our exposures.  This is quite different to the obsession with strength of covenants that is so often the focus of high yield and leveraged loan investors.  This was recently demonstrated when Wrightbus, the manufacturer of public transport vehicles, was placed into administration due to cash shortfall despite having a healthy order book.

 

Legacy portfolio

 

Co-Investments

During the reporting period, SQN decided to reclassify the way in which the legacy portfolio is denoted.  This reflects the specific difference between pure peer to peer, technology platform based lending and three investments that are characterised by professional co-investment alongside the British Business Bank and GLI.  There has been some significant corporate change for all three of these investments and we provide the following narrative:

 

UK Venture Debt - two of the three principals of this company resigned during the reporting period.  This triggered a clause in the Loan Note agreement that allowed us to take closer control of the process of managing the portfolio.  In reality, this means that any investment decision needs to be agreed by shareholders and gives us flexibility in guiding assets therein.  The remaining principal remains committed to the successful run-off of the portfolio and have recruited suitable colleagues as replacements.  As the portfolio runs off, we will receive cash earlier than the original maturity of the Loan Note, allowing for accelerated reinvestment into traditionally underwritten direct loans. In September, this platform has made the Company aware of a post Balance Sheet event that whereby a loan recipient is to be sold at a discount to the price originally expected due to a series of potential acquirers falling away.  This has resulted in an impairment provision.  If the sale does not take place, then the business concerned will be placed under administration. We believe this would result in a lengthy and uncertain recovery, as there is a large creditor book skewed to 85% with one counterparty and difficult to liquidate assets.  The assessment made is that a sale at a lower rate is the safest option for return of capital and we have reflected this scenario of a $5m sale in our assessment of the potential for impairment, informed by the guidance provided by the platform.

 

Irish Venture Debt - this company was sold to Beach Point Capital, "BPC", a US Private Equity company. We made a decision to follow the manager and reinvest under this new entity.  Although we have limited bandwidth to invest in the segment in which BPC specialises, we have a high degree of confidence in their capability to deliver risk managed returns of 10-14%.  This investment is now categorised as a direct investment and will not exceed more than 10% of the portfolio.

 

Small Company Bond Platform - this was a UK based debt platform for very small businesses requiring circa £1 million loans.  In October 2018, we noted an alert from the Companies House service that all the original directors had resigned.  In December, we received a no-reply notification via email that administration of our investment had transferred to a third party.  We have since discovered that the company has now re-emerged as a crypto-currency brokerage.  Prior to these events, we had assessed this relationship to be of the highest risk to the portfolio and had engaged in a direct dialogue with all three counterparties with whom we had outstanding loans.  This action proved to be prescient and has ensured that we have been able to negotiate refinance of two of the three loans which will roll-off our loan book in Q3, 2019.  The final loan is due to mature in 2020 and we are in dialogue with the parent company to facilitate early repayment in Q4, 2019.  We have also had good interactions with the new administration agent and have been receiving interest and capital payments without concern.  The final loan exposure to this platform is a bankruptcy case and had already been impaired within our own exposure reports and have regular reports on progress from the liquidation agents.  This case involves a suspected fraud, is making slow progress but there is a possibility of receiving some assets under proceeds of crime procedures and we will remain persistent in our endeavour to recoup as much capital as possible for Shareholders.

 

So, despite disappointment at the provision for transitional arrangements, we are pleased to report that further to our careful actions, loan capital has been secured for our Shareholders.

 

We classify this segment of the portfolio as less of a risk than peer to peer given the close interaction with the managers and the quality of the companies underwritten.  However, as demonstrated, they are still exposed to unorthodox management standards and changes in focus of parent companies and personnel change which requires us to be vigilant.

 

Peer to Peer

Throughout SQN's tenure as manager of this portfolio, we have consistently warned of the risks associated with peer to peer lending and have endeavoured to diminish risk associated with this asset class for our Shareholders.  As a reminder, it is our view that weak underwriting standards, volume driven lending decisions and the second derivative aspects of control makes this sector of the market too volatile for a vehicle associated with senior, secured lending. To this end, it is our intention to reduce risk exposure to this asset class as quickly as practicable.  We assess the probability of repayment on a continuous basis, making impairment adjustments as appropriate.  We have continued to mitigate these risks during the reporting period by reducing overall exposure and keeping close relationships with the platform providers.

 

Having inherited six lending platforms with these characteristics from the previous manager, our strategy has been to divest as rapidly as possible. Since assuming management of the Fund, we have removed three of these investments from the portfolio by selling the exposure or encouraging early repayment. However, as these positions continue to mature, corporate change has occurred which means they remain a time-consuming challenge.  Three such investments remain within the portfolio and we have given commentary on our assessment of these platforms as follows:

 

UK Peer to Peer lender - the owner changed the name of the company and merged it with other property-based lending businesses held under their corporate structure. The parent company has stated their intention to withdraw from this segment of the market and is managing a run-off portfolio.  We monitor carefully and intervene when we consider them to be too lenient with borrowers.  It would be far too easy for an intermediary to write-down debt, allowing borrowers to walk away from their liabilities, leaving not only us but a minority of retail investors with losses.  Therefore, we apply maximum pressure to construct manageable repayment plans and, in some cases, liens on property or other assets, allowing for additional recoup of value for our Shareholders.

 

US Peer to Peer lender - this remains our largest peer to peer investment and although the relationship remains genial, this position is junior and represents a risk of write-down.  In March 2019, we met with the owner/ founder and agreed an incentive plan for them to work harder on collections and agreed a quarter year for improvement.  They informed us that they had written down 100% of this portfolio in their accounts and we found it perplexing given previous reporting, although not surprising given that they were in negotiations to sell their business and that this portfolio was their first with senior debt held by an aggressive hedge fund financier.  A sale would leave the business in a stronger position financially and give added comfort for the addition promissory note held against the parent company, so we did not want to thwart this process by sapping resources.

 

We also advised that if no improvement was forthcoming, we would take over collections and explained that we have a good track record, together with our partners, in achieving better returns.  Our work-out rate for transactions can be demonstrated by our performance in our asset finance strategy and direct loan strategy over the last twenty years.

 

In June, having observed slow progress, we began a series of meetings to agree interaction mooted in the previous quarter.  Two executives from SQN visited New York in July and August to agree a process for the way forward and to have an update on the sale of the business.  At the time, they were in the middle of a two stage Due Diligence conducted by the potential buyer and KPMG.  Due to the resource drag for this work, they requested until the end of August to commence sending files to us.

 

At the time of writing, we are waiting for the platform to transfer all borrower files to us.  Thereafter, we will begin the process of making our own assessment of the probability of recovery and engage with attorneys and collection agencies.  Again, this represents a significant resource commitment for SQN and we will remain uncompromising in our pursuit of this endeavour even as it is just a small portion of the overall portfolio. We also intend to engage a debt collector who has an aggressive reputation for collections.  Given the time that has passed and speed at which information is received, we have decided to impair this platform exposure by 25%. This is a pre-emptive move and takes into account our own assessment of individual loans that are now being managed out by attorneys.

 

Spanish Peer to Peer lender - this company has now obtained government support for their lending strategy and are able to offer loans at lower rates than our criteria, so this tranche is in run-off.  We have already reflected a significant write-down of these assets in the NAV, so this exposure is now de minimus at 0.7%.  However, we have two Spanish speaking colleagues who engage on a bi-weekly basis with them and have quiet confidence that we will be able to recover some of these write-downs to the benefit of the Company.

 

Throughout the process of restructuring this Fund, the peer to peer exposure has been the biggest test and the greatest draw on resource when compared to the expected return.

 

IFRS 9

Since July 2018, the Company has adopted IFRS 9 methodology to provide information regarding forward expectations of impairment.  This was a change in the accounting policy whereby loans previously had an impairment assigned to them reflecting current information only.  We consider it appropriate to provide Shareholders with a description of our approach to the new standards in this regard.  We use a three stage risk assessment as follows:

 

---------------------- Change in credit risk ----------------------

Stage 1

 

Stage 2

 

Stage 3

 

No significant increase in Credit Risk since Initial Recognition

 

Significant increase in Credit Risk since Initial Recognition

 

Credit Impaired

 

 

 

 

 

 

 

12-month ECL

 

---------------------- Lifetime ECL ----------------------

 

 

 

 

 

 

 

---------------------- Interest: Gross Basis ----------------------

 

Interest: Net Basis

 

 

In July 2018, the Company chose to distinguish between SQN's direct loans and legacy platform loans, making a higher average portfolio provision for legacy positions.  The rates of impairment were as follows:

 

 

Probability of Default (Platforms)

Stage 1

2%

Stage 2

15%

Stage 3

25%

 

One year on, we have revisited this approach and have revised the range of provisioning allocated to legacy loans as follows and have now taken account of explicit individual risks to loans:

 

 

Probability of Default (Platforms)

Stage 1

2%

Stage 2

15%-100%

Stage 3

25%-100%

 

With these explicit individual risks to loans now applied, this has meant an increase in the IFRS 9 provisioning to 2.22% by the financial year end of June 2019.  As described above, the increase in this provision is attributable to the UK and US peer to peer lenders representing 0.71% and 1.1% respectively.

 

The reasons for this change are as follows:

 

·      There have been some significant changes in ownership and focus of the businesses in the legacy portfolio that has increased risk to the capital deployed.

·      The platforms are no longer underwriting new business and are treating these loans as legacy portfolio positions themselves.  This has resulted in their diminished attention to the task of collections resulting in a slower recoup of loan capital.

·      One of the platforms was in sale negotiations and was at an advanced stage in Due Diligence that would have meant a stabilisation of the outlook for the assets.  This corporate action has now been placed on hold.

·      As the legacy portfolio becomes a smaller percentage of the total portfolio, the impaired loans will represent a greater proportion in percentage terms of the remainder.  Over the year, the total sum invested in platform loans has reduced from 53.6% to 29.7%.

 

IFRS 9 doesn't prescribe a specific measuring method for expected credit loss ("ECL") - it acknowledges the varying nature of financial instruments and available information. However, as a minimum, any measurement of ECL under IFRS 9 must reflect:

 

·      An unbiased evaluation of a range of possible outcomes and their probabilities of occurrence;

·      Discounting for the time value of money; and

·      Reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.

 

While the presence of collateral is not a key element in the assessment of whether there has been a significant increase in credit risk, it is of great importance in the measurement of ECL. IFRS 9 states that estimates of cash shortfalls reflect the cash flows expected from collateral and other credit enhancements that are integral to the contractual terms. Due to the business nature of SQN, this is a key component of its ECL measurement and interpretation of IFRS 9, as any investment would include elements of (if not all): a fully collateralised position, fixed and floating charges, a corporate guarantee, a personal guarantee, coverage ratios between 130% to 150%, and an average LTV of 85%.

 

An IFRS 9 provision needs to be applied to all investments, regardless of our level of comfort regarding repayment.  Therefore, we have applied a 2% minimum impairment provision for all Stage 1 loans across the portfolio.

 

Should an investment move to Stage 2, then it will be assessed individually until it moves back to Stage 1. The use of collectives, and individual assessments from Stage 2, will enable correlations to be isolated at a micro level without detriment to the wider portfolio, providing a framework that incorporates growth and diversification.

 

IFRS 9 confirms that a Probability of Default ("PD") must never be zero as everything is deemed to have a risk of default; this has been incorporated by SQN. All PDs will be assessed against historic data as well as the prevailing economic conditions at the reporting date, adjusted to account for estimates of future economic conditions that are likely to impact the risk of default. 12-month PD will be applied across the collective as a cumulative in Stage 1, currently set at 2% in line with investment data held by SQN, market knowledge, and credit enhancements (this is equivalent to there being 1 default for an average portfolio of 50 unique borrowers. Once an investment moves to Stage 2 then PD will be calculated on an individual basis (and adjusted for Stage 3 if appropriate). All assessment is based on reasonable and supportive information available at the time.

 

Lifetime ECL will be applied across the collective as a cumulative in Stage 1, split according to the investment's classification. For direct loan investments this is calculated as 2% of the individual investment's Contracted Cash Flows ("CCF"), and 2% of the investment's CCF for platform investments. These Stage 1 Lifetime ECL amounts are taken to be the investments' floor amounts- the Lifetime ECL for any investment can never be less than its floor amount. Once an investment moves to Stage 2 then Lifetime ECL will be calculated on an individual basis. Lifetime ECL will be reviewed at each reporting date based on reasonable and supportive information available at the time.

 

Should the expected cashflows (when all credit enhancements are incorporated) be greater than the CCF (irrespective of the stage it is assigned to), then Lifetime ECL will be recorded as the floor value calculated above. Given the business model of SQN, it is expected that individual loss allowances (PD multiplied by Lifetime ECL) will be minimal for a large proportion of the direct loan portfolio as every investment is structured with multiple credit enhancements at origination. This ensures there will be minimal impact to the Company from IFRS 9 going forward given its collateralised business model, irrespective of any increase in credit risk. It is noted that a situation could arise where the collateral base falls to a material level below the CCF and should such a situation arise then SQN would adjust the ECL accordingly.

 

The increase in credit risk, and movement between Stage 1 to Stage 2, is one of judgement and subjectivity. The Company does not employ the generic presumptions recommended under IFRS 9 (30-day significant increase in credit risk and the 90-day default) given the idiosyncratic nature of its investments and credit enhancements built in at origination. Accelerating the recognition of default would decrease asset value (and ultimate recovery), over-value losses, and have no precedent given historic information and the nature of long-term asset investments. Default is driven by collateral, guarantees and LTV, not by days passed, with an emphasis on the deterioration of the individual collateralised position. Therefore, any investment that moves from Stage 1 is assessed on an individual basis.

 

So, despite reducing the overall exposure in platforms to 29.7% of the overall portfolio, we consider it prudent to reflect these changes in conditions as they now present themselves and have adopted a methodology that reflects these specific circumstances.

 

Even with these impairment provisions, dividend cover remains consistent and we have confidence that an 8% total return on the portfolio in the medium term is achievable.

 

Investment Outlook

After a troubled start, SQN assumed management of the Company in April 2017.  Since then, the Company has stabilised and is now delivering steady dividend cover and the net asset value has reflected the careful management of direct loans and legacy third party investments.

 

As we consider risks, as demonstrated in our candid assessment above, SQN has carefully managed the relationships with legacy counterparties but as this part of the portfolio matures, it is unsurprising that the remainder will represent a significant challenge.

 

Without further Shareholder capital and without an adjustment to the investment mandate, whilst we will be able to maintain dividend cover it will be a challenge to make further improvements in NAV, nor will we be able to control potential impact of impairments from legacy investments having an affect.  We have always advised that the best way to manage these risks is to grow the assets to diminish this impact.  If the Company were to be placed into wind down, we would be able to liquidate assets at a reasonable pace, given the now shorter, though still extended, duration profile, allowing us to return capital efficiently.  During this time, investors will continue to receive their income return on a monthly basis.

 

However, it would be very disappointing for this to be the outcome for a fund that we have considerable pride in restructuring and returning to its original goal of income generation.  A more constructive approach would be to allow the Company to continue and to make use of as yet, unutilised gearing capacity to invest in our underwritten loans.  This would allow the Company to generate an enhanced dividend of approximately 9.45p for every pound Sterling invested, and reduce the gross impact of the peer to peer exposure to 3.70%.  Even with peer to peer impairments, this would allow for a net yield of approximately 10.6%.  We look forward to a dialogue with our Shareholders over the coming months to agree a satisfactory way forward.

 

We consider that the Company has reached a pivotal point in its history, we would be very happy to continue to provide income for our Shareholders and we have been humbled by the support and encouragement given to us by our clients and I would like to thank them personally for their patronage.  However, we are realistic that a Company with a small capital base tends to trade at a discount and so makes it difficult to raise new capital.  We have made proposals to the Board and are committed to delivering a satisfactory outcome for Shareholders who seek regular, higher income from a stable, alternative investment base.  If the Company is wound up, we will honour that decision and return proceeds to our Shareholders in as expeditious fashion as circumstances will allow.

 

Dawn Kendall

Portfolio Manager

SQN Asset Management Limited

15 October 2019

 

 

Principal Risks

 

Risk is inherent in the Company's activities, but it is managed through an ongoing process of identifying and assessing risks and ensuring that appropriate controls are in place.  The key risks faced by the Company, along with controls employed to mitigate those risks, are set out below.

 

Macroeconomic risk

Adverse macroeconomic conditions may have a material adverse effect on the Company's yield on investments, default rate and cash flows.  The Board and the Investment Manager keep abreast of market trends and information to try to prepare for any adverse impact.

 

The Company's assets are diversified by geography, asset class, and duration, thereby reducing the impact that macroeconomic risk may have on the overall portfolio.

 

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows and/or fair values of the Company's investments.  Exposure to interest rate risk is limited by the use of fixed rate interest on the majority of the Company's loans, thereby giving security over future loan interest cash flows.

 

Currency risk is the risk that changes in foreign exchange rates will impact future profits and net assets.  Currency risk is mitigated to a certain extent through the use of forward foreign exchange contracts to hedge movements in foreign currency exchange rates.

 

Credit risk

The Company invests in a range of secured loan assets mainly through wholesale secured lending opportunities, secured trade and receivable finance and other collateralised lending opportunities.  The Company is also exposed to direct loans.  Significant due diligence is undertaken on the borrowers of these loans and security taken to cover the loans and to mitigate the credit risk on such loans.

 

The key factor in underwriting secured loans is the predictability of cash flows to allow the borrower to perform as per the terms of the contract.

 

The Company has investment restrictions in place.  Therefore, as mentioned above, the Company's assets are diversified by geography, asset class, and duration, thereby reducing the impact that investment risk may have on the overall portfolio.

 

The credit risk associated with the investments is reduced not only by diversification but also by the use of security.  Despite the use of security, credit risk is not reduced entirely and so the Investment Manager monitors the recoverability of the loans (on an individual loan basis) each month and impairs loans in accordance with IFRS 9 Financial Instruments

 

Platform risk

The Company is dependent on platforms, albeit to a lesser extent for that reducing part of the loan portfolio originated through platforms than was the case prior to the change of Investment Manager in April 2017, to operate the loan portfolio (to bring new loans to the Company's attention; to effectively monitor those loans; and to pay and receive monies as necessary).  If a platform were no longer able to operate effectively this could put at risk loans made with/through such a platform and increase credit risk.

 

The Investment Manager undertakes due diligence on all the platforms and part of this work is to confirm that the platforms have disaster recovery policies in place whereby a third party administrator would step in to manage the loans in the event the platform could no longer do so.  If such an event were to occur, the Company's approach would vary depending on the platform and the circumstances, and would be determined by the Board after discussion with the Investment Manager and other advisers.

 

The Company's exposure to platform risk is decreasing as it realises platform loans and exits positions on certain platforms entirely.

 

Regulatory risk

The Company's operations are subject to wide ranging regulations, which continue to evolve and change.  Failure to comply with these regulations could result in losses and damage to the Company's reputation.

 

The Company employs third party service providers to ensure that regulations are complied with.

 

Reputational risk

The Company has been incorporated with an unlimited life.  However, in the event that the Ordinary Shares have been trading at a discount to NAV of greater than 10% for three consecutive months (calculated on a rolling three monthly average of daily numbers), the Company shall convene a general meeting to propose a continuation resolution.  If such a continuation resolution is not passed, the Board will draw up proposals for the winding-up or reconstruction of the Company for submission to Shareholders.  Any adverse impact on the Company's reputation would likely result in a fall in its share price, thereby increasing the possibility of a continuation vote being proposed.

 

The Company's Articles of Association require the Directors to convene a general meeting to propose to Shareholders a NAV Continuation Resolution if the Company does not have a NAV of at least £250 million as at 31 December 2019.  Any adverse impact on the Company's reputation would increase the possibility of a NAV Continuation Resolution not being passed.  Although it appears unlikely that the Company's NAV will be greater than £250 million as at 31 December 2019, the outcome of a NAV Continuation Resolution (if required) is not known.  Given that Shareholders have generally been supportive of the Company's plans to date, the Directors do not consider that this adversely affects the Company's going concern at this stage.  Should the NAV Continuation Resolution not be passed, the financial statements will have to be prepared on a break-up basis. Directors do not consider the impact of this to be material.

 

Environment, Employee, Social and Community Issues

 

As an investment company, the Company does not have any employees or physical property, and most of its activities are performed by other organisations.  Therefore, the Company does not combust fuel and does not have any greenhouse gas emissions to report from its operations, nor does it have responsibility for any other emissions producing sources under the Companies Act 2006 (Strategic Report and Directors' Report) Regulations 2013.

 

When making investment decisions, the Investment Manager does not consider the impact that an entity in which the Company invests may have on the community. However, the Board believes that all companies have a duty to consider their impact on the community and the environment but the Company does not have a direct impact on the community or environment and, as a result, does not maintain policies in relation to these matters.

 

Gender Diversity

 

The Board of Directors of the Company currently comprises two male Directors and one female Director.  Further information in relation to the Board's policy on diversity can be found in the Directors' Remuneration Report.

 

Key Performance Indicators

 

The Board uses the following key performance indicators ("KPIs") to help to assess the Company's performance against its objectives.  Further information on the Company's performance is provided in the Chairman's Statement and the Investment Manager's Report.

 

Dividend yield

The Company distributes at least 85% of its distributable income by way of dividends on a monthly basis.  During any year the Company may retain some of the distributable income and use these to smooth future dividend flows.  The Company's annual dividend target for the period under review was 7.00p per Share.

 

The Company has announced dividends of £3,684,000 (7.00p per Ordinary Share) for the year ended 30 June 2019, being 128.9% of distributable profit for the year (see notes 5 and 22 for further details).  To ensure the tax efficient streaming of qualifying interest income, the Company may announce an additional dividend out of the profits for the year ended 2019, once the tax advisers have finalised the tax computations.

 

NAV and total return

The Directors regard the Company's NAV as a key component to delivering value to Shareholders, but believe that total return (which includes dividends) is the best measure for shareholder value.

 

Premium/discount of share price to NAV

The Board regularly monitors the premium/discount of the price of the Ordinary Shares to the NAV per share.  As mentioned in Principal Risks above, in the event that the Ordinary Shares have been trading at a daily discount to NAV of greater than 10% for three consecutive months (calculated on a rolling three monthly average of daily numbers), the Board will convene a general meeting to propose a continuation resolution.  If such a continuation resolution is not passed, the Board will draw up proposals for the winding-up or reconstruction of the Company for submission to Shareholders.  The adoption of the new Articles of Association in the year include, amongst other things, a provision for the continuation resolution (by way of an ordinary resolution) if the Company's net assets at 31 December 2019 are less than £250 million.

 

At 30 June 2019 the shares were trading at 92.00p, a 3.26% discount to NAV.  However, the three month average share price was a 3.76% discount to NAV.

 

Ken Hillen

Chairman

15 October 2019

 

 

Statement of Comprehensive Income

for the year ended 30 June 2019

 

Note

Year ended

30 June 2019

Year ended

30 June 2018

 

 

£'000

£'000

Revenue

 

 

 

Interest income

3f

4,026

4,466

Other income

 

30

1

 

 

------------

------------

Total revenue

 

4,056

4,467

 

 

------------

------------

Operating expenses

 

 

 

Management fees

7a

(513)

(518)

Other expenses

11

(169)

(154)

Administration fees

7b

(117)

(116)

Directors' remuneration

8

(108)

(114)

Transaction fees

 

(81)

(59)

Broker fee

 

(79)

(123)

Legal and professional fees

 

(51)

(72)

 

 

------------

------------

Total operating expenses

 

(1,118)

(1,156)

 

 

------------

------------

Investment gains and losses

 

 

 

Movement in unrealised gains and losses on loans due to movement in foreign exchange on non-Sterling loans

14

110

(46)

Movement in unrealised gains and losses on loans due to movement in impairments

14

(415)

(269)

Movement in unrealised gain on investments at fair value through profit or loss

15

1

22

Movement in unrealised loss on derivative financial instruments

17

(319)

(182)

Realised gain/(loss) on disposal of loans

 

16

(40)

Realised gain on disposal of investments at fair value through profit or loss

15

3

-

Realised loss on disposal of investments held for sale

 

(51)

-

Realised (loss)/gain on derivative financial instruments

17

(206)

21

 

 

------------

------------

Total investment gains and losses

 

(861)

(494)

 

 

------------

------------

Net profit from operating activities before loss on foreign currency exchange

 

2,077

2,817

 

 

 

 

Net foreign exchange gain/(loss)

 

159

(8)

 

 

------------

------------

Profit and total comprehensive income for the year attributable to the owners of the Company

 

2,236

2,809

 

 

------------

------------

 

 

 

 

Earnings per Ordinary Share (basic and diluted)

13

4.25p

5.33p

 

 

------------

------------

 

All of the items in the above statement are derived from continuing operations.

There were no other comprehensive income items in the year.

Except for unrealised investment gains and losses, all of the Company's profit and loss items are distributable.

The accompanying notes form an integral part of the financial statements.

 

 

Statement of Changes in Equity

for the year ended 30 June 2019

 

 

 

 

Note

Called up share capital

Special distributable reserve

Profit and loss account

Total

 

 

£'000

£'000

£'000

£'000

 

 

 

 

 

 

At 1 July 2017

 

577

50,942

529

52,048

 

 

 

 

 

 

Profit for the year

22

-

-

2,809

2,809

 

 

 

 

 

 

Transactions with Owners in their capacity as owners:

Dividends paid

5,22

-

-

(3,318)

(3,318)

 

 

------------

------------

------------

------------

Total transactions with Owners in their capacity as owners

-

-

(3,318)

(3,318)

 

 

 

 

 

 

 

 

------------

------------

------------

------------

At 30 June 2018

 

577

50,942

20

51,539

 

 

 

 

 

 

Impact of transition to IFRS 9

3h

-

-

(23)

(23)

 

 

 

 

 

 

 

 

------------

------------

------------

------------

At 1 July 2018 - revised for the application of IFRS 9

577

50,942

(3)

51,516

 

 

 

 

 

 

Profit for the year

22

-

-

2,236

2,236

 

 

 

 

 

 

Transactions with Owners in their capacity as owners:

Dividends paid

5,22

-

(689)

(2,934)

(3,623)

 

 

------------

------------

------------

------------

Total transactions with Owners in their capacity as owners

-

(689)

(2,934)

(3,623)

 

 

 

 

 

 

 

 

------------

------------

------------

------------

At 30 June 2019

 

577

50,253

(701)

50,129

 

 

------------

------------

------------

------------

 

There were no other comprehensive income items in the year.

The above amounts are all attributable to the owners of the Company.

The accompanying notes form an integral part of the financial statements.

 

 

 Statement of Financial Position

as at 30 June 2019

 

 

Note

30 June 2019

30 June 2018

 

 

£'000

£'000

Non-current assets

 

 

 

Loans at amortised cost

14

36,614

31,918

Investments at fair value through profit or loss

15,16

232

280

 

 

------------

------------

Total non-current assets

 

36,846

32,198

 

 

------------

------------

Current assets

 

 

 

Loans at amortised cost

14

10,642

12,445

Cash held on client accounts with platforms

14

48

196

Other receivables and prepayments

18

1,141

772

Cash and cash equivalents

 

1,987

6,125

 

 

------------

------------

Total current assets

 

13,818

19,538

 

 

------------

------------

Total assets

 

50,664

51,736

 

 

------------

------------

Current liabilities

 

 

 

Other payables and accruals

19

(184)

(165)

Derivative financial instruments

16,17

(351)

(32)

 

 

------------

------------

Total liabilities

 

(535)

(197)

 

 

------------

------------

 

 

 

 

 

 

------------

------------

Net assets

 

50,129

51,539

 

 

------------

------------

Capital and reserves attributable to owners of the Company

 

 

 

Called up share capital

21

577

577

Other reserves

22

49,552

50,962

 

 

------------

------------

Equity attributable to the owners of the Company

 

50,129

51,539

 

 

------------

------------

 

 

 

 

Net asset value per Ordinary Share

23

95.10p

97.78p

 

 

------------

------------

 

These financial statements of SQN Secured Income Fund plc (registered number 09682883) were approved by the Board of Directors on 15 October 2019 and were signed on its behalf by:

 

Ken Hillen

Chairman

15 October 2019

 

Gaynor Coley

Director

15 October 2019

 

The accompanying notes form an integral part of the financial statements.

 

 

 Statement of Cash Flows

for the year ended 30 June 2019

 

 

Year ended 30 June 2019

Year ended 30 June 2018

 

£'000

£'000

Cash flows from operating activities

 

 

Net profit before taxation

2,236

2,809

Adjustments for:

 

 

Movement in unrealised gains and losses on loans due to movement in foreign exchange on non-Sterling loans

(110)

46

Movement in unrealised gains and losses on loans due to movement in impairments

415

269

Movement in unrealised gain on investments at fair value through profit or loss

(1)

(22)

Movement in unrealised loss on derivative financial instruments

319

182

Realised (gain)/loss on disposal of loans

(16)

40

Realised gain on disposal of investments at fair value through profit or loss

(3)

-

Realised loss on disposal of investments held for sale

51

-

Realised loss/(gain) on derivative financial instruments

206

(21)

Amortisation of transaction fees

81

59

Interest received and reinvested by platforms

(287)

(595)

Capitalised interest

(915)

(312)

Increase in investments

(2,141)

(3,443)

Taxation paid

-

(5)

 

------------

------------

Net cash outflow from operating activities before working capital changes

(165)

(993)

Increase in other receivables and prepayments

(369)

(39)

Increase/(decrease) in other payables and accruals

19

(2,901)

 

------------

------------

Net cash outflow from operating activities

(515)

(3,933)

 

 

 

Cash flows from financing activities

 

 

Dividends paid

(3,623)

(3,318)

 

------------

------------

Net cash outflow from financing activities

(3,623)

(3,318)

 

 

 

 

------------

------------

Decrease in cash and cash equivalents in the year

(4,138)

(7,251)

Cash and cash equivalents at the beginning of the year

6,125

13,376

 

------------

------------

Cash and cash equivalents at 30 June 2019

1,987

6,125

 

------------

------------

 

 

 

Supplemental cash flow information

 

 

Non-cash transaction - interest receivable

1,202

907

 

The accompanying notes form an integral part of the financial statements.

 

Notes to the Financial Statements

for the year ended 30 June 2019

 

1. General information

The Company was incorporated in England and Wales under the Companies Act 2006 on 13 July 2015 with registered number 09682883 and its shares were admitted to trading on the London Stock Exchange Specialist Fund Segment on 23 September 2015 ("Admission").

 

The Company is an investment company as defined in s833 of the Companies Act 2006.

 

Investment objective

The investment objective of the Company is to provide Shareholders with attractive risk adjusted returns, principally in the form of regular, sustainable dividends, through investment predominantly in a range of secured loans and other secured loan-based instruments originated through a variety of channels and diversified by way of asset class, geography and duration.

 

Investment policy

The Company achieves its investment objective by investing in a range of secured loan assets mainly through wholesale secured lending opportunities, secured trade and receivable finance and other collateralised lending opportunities.  Loan assets include both direct loans as well as other instruments with loan-based investment characteristics (for example, but not limited to, bonds, loan participations, syndicated loans, structured notes, collateralised obligations or hybrid securities) and may include (subject to the limit set out below) other types of investment (for example, equity or revenue- or profit-linked instruments).  The Company may make investments through alternative lending platforms that present suitable investment opportunities identified by the Manager.

 

The Company will seek to ensure that diversification of its portfolio is maintained, with the aim of spreading investment risk.

 

2. Statement of compliance

a)  Basis of preparation

These financial statements present the results of the Company for the year ended 30 June 2019.  These financial statements have been prepared in accordance with International Financial Reporting Standards ("IFRS"), as adopted by the European Union.

 

These financial statements have not been prepared in full accordance with the Statement of Recommended Practice ("SORP") for investment trusts issued by the AIC in November 2014 and updated in January 2017 and February 2018 with consequential amendments, as the main driver of the SORP is to disclose the allocation of expenses between revenue and capital, thereby enabling a user of the financial statements to determine distributable reserves.  However, with the exception of investment gains and losses, all of the Company's profit and loss items are of a revenue nature as it does not allocate any expenses to capital.  Therefore, the Directors believe that full compliance with the SORP would not be of benefit to users of the financial statements.  Further details on the distributable reserves are provided in note 22.

 

b)  Basis of measurement

The financial statements have been prepared on a historical cost basis, except for investments at fair value through profit or loss and derivative instruments, which are measured at fair value through profit or loss.  The financial statements have been prepared on a going concern basis.

 

c)   Segmental reporting

 

d)  Use of estimates and judgements

The preparation of financial statements in conformity with IFRS requires management to make judgements, estimates and assumptions that affect the application of policies and the reported amounts of assets and liabilities, income and expenses.  The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates.

 

The estimates and underlying assumptions are reviewed on an ongoing basis.  Revisions to accounting estimates are recognised in the period in which the estimate is revised, if the revision affects only that period, or in the period of the revision and future periods, if the revision affects both current and future periods.

 

Judgements made by management in the application of IFRS that have a significant effect on the financial statements and estimates with a significant risk of material adjustment in the next year are discussed in note 4.

 

3. Significant accounting policies

a)  Foreign currency

Foreign currency transactions are translated into Sterling using the exchange rates prevailing at the dates of the transactions.  Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at period-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the Statement of Comprehensive Income.  Translation differences on non-monetary financial assets and liabilities are recognised in the Statement of Comprehensive Income.

 

b)  Financial assets and liabilities

The financial assets and liabilities of the Company are defined as loans, bonds with loan type characteristics, investments at fair value through profit or loss, cash and cash equivalents, other receivables, derivative instruments and other payables.

 

Recognition

The Company recognises a financial asset or a financial liability when, and only when, it becomes a party to the contractual provisions of the instrument.  Purchases and sales of financial assets that require delivery of assets within the time frame generally established by regulation or convention in the marketplace are recognised on the trade date, i.e. the date that the Company commits to purchase or sell the asset.

 

Initial measurement

Financial assets and financial liabilities at fair value through profit or loss are recorded in the Statement of Financial Position at fair value.  All transaction costs for such instruments are recognised directly in profit or loss.

 

Financial assets and financial liabilities not designated as at fair value through profit or loss, such as loans, are initially recognised at fair value, being the amount issued less transaction costs.

 

Subsequent measurement

After initial measurement, the Company measures financial assets and financial liabilities not designated as at fair value through profit or loss, at amortised cost using the effective interest rate method, less impairment allowance.  Gains and losses are recognised in the Statement of Comprehensive Income when the asset or liability is derecognised or impaired.  Interest earned on these instruments is recorded separately as investment income.

 

After initial measurement, the Company measures financial instruments which are classified at fair value through profit or loss at fair value.  Subsequent changes in the fair value of those financial instruments are recorded in net gain or loss on financial assets and liabilities at fair value through profit or loss.

 

Derecognition

A financial asset (or, where applicable, a part of a financial asset or part of a group of similar assets) is derecognised where:

-       The rights to receive cash flows from the asset have expired;  or

-       The Company has transferred its rights to receive cash flows from the asset or has assumed an obligation to pay the received cash flows in full without material delay to a third party under a "pass-through" arrangement;  and

-       Either (a) the Company has transferred substantially all the risks and rewards of the asset, or (b) the Company has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.

 

When the Company has transferred its rights to receive cash flows from an asset (or has entered into a pass-through arrangement) and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognised to the extent of the Company's continuing involvement in the asset.

 

The Company derecognises a financial liability when the obligation under the liability is discharged, cancelled or expires.

 

Impairment

Policy effective from 1 July 2018

A financial asset is credit-impaired when one or more events that have occurred have a significant impact on the expected future cash flows of the financial asset.  It includes observable data that has come to the attention of the holder of a financial asset about the following events:

·      Significant financial difficulty of the issuer or borrower;

·      A breach of contract, such as a default or past-due event;

·      The lenders for economic or contractual reasons relating to the borrower's financial difficulty granted the borrower a concession that would not otherwise be considered;

·      It becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

·      The disappearance of an active market for the financial asset because of financial difficulties; or

·      The purchase or origination of a financial asset at a deep discount that reflects incurred credit losses.

 

Each direct loan is assessed on a continuous basis by the Investment Manager's own underwriting team with peer review occurring on a regular basis.

 

Each platform loan is monitored via the company originally deployed to conduct underwriting and management of the borrower relationship.  When a potential impairment is identified, the Investment Manager requests data and management information from the platform.  The Investment Manager will then actively pursue collections, giving guidance to the platforms on acceptable levels of impairment.  In some cases, the Investment Manager will proactively take control of the process.

 

Impairment of financial assets is recognised on a loan-by-loan basis in stages:

Stage 1:

As soon as a financial instrument is originated or purchased, 12-month expected credit losses are recognised in profit or loss and a loss allowance is established.  This serves as a proxy for the initial expectations of credit losses. For financial assets, interest revenue is calculated on the gross carrying amount (i.e. without deduction for expected credit losses).

 

Stage 2:

If the credit risk increases significantly and is not considered low, full lifetime expected credit losses are recognised in profit or loss.  The calculation of interest revenue is the same as for Stage 1. This stage is triggered by scrutiny of management accounts and information gathered from regular updates from the borrower by way of email exchange or face-to-face meetings.  The Investment Manager extends specific queries to borrowers if they acquire market intelligence or channel-check the data received.  A covenant breach may be a temporary circumstance due to a one-off event and will not trigger an immediate escalation in risk profile to stage 2.

 

At all times, the Investment Manager considers the risk of impairment relative to the cash flows and general trading conditions of the company and the industry in which the borrower resides.

 

 

Stage 3:

If the credit risk of a financial asset increases to the point that it is considered credit-impaired, interest revenue is calculated based on the amortised cost (i.e. the gross carrying amount less the loss allowance).  Financial assets in this stage will generally be assessed individually.  Lifetime expected credit losses are recognised on these financial assets. This stage is triggered by a marked deterioration in the management information received from the borrower and a view taken on the overall credit conditions for the sector in which the company resides.  A permanent breach of covenants and a deterioration in the valuation of security would also merit a move to stage 3.

 

The Investment Manager also takes into account the level of security to support each loan and the ease with which this security can be monetised.  This has a meaningful impact of the way in which impairments are assessed, particularly as the Investment Manager has a very strong track record in managing write-downs and reclaim of assets.

 

Policy effective before 1 July 2018

A financial asset was impaired when the recoverable amount was estimated to be less than its carrying amount.


An impairment loss was recognised immediately in the Statement of Comprehensive Income, unless the relevant asset was carried at a revalued amount, in which case the reversal of the impairment was treated as a revaluation decrease.

 

c)   Cash and cash equivalents

Cash and cash equivalents are defined as cash in hand, demand deposits and short-term, highly liquid investments readily convertible to known amounts of cash and subject to insignificant risk of changes in value.

 

d)  Receivables and prepayments

Receivables are carried at the original invoice amount, less impairments, as discussed above.

 

e)  Transaction costs

Transaction costs incurred on the acquisition of loans are capitalised upon recognition of the financial asset and amortised over the term of the respective loan.

 

f)   Income and expenses

Interest income and bank interest are recognised on a time-proportionate basis using the effective interest rate method.

 

Dividend income is recognised when the right to receive payment is established.

 

All expenses are recognised on an accruals basis.  All of the Company's expenses (with the exception of share issue costs, which are charged directly to the distributable reserve) are charged through the Statement of Comprehensive Income in the period in which they are incurred.

 

g)  Taxation

The Company is exempt from UK corporation tax on its chargeable gains as it satisfies the conditions for approval as an investment trust.  The Company is, however, liable to UK corporation tax on its income.  However, the Company has elected to take advantage of modified UK tax treatment in respect of its "qualifying interest income" in order to deduct all, or part, of the amount it distributes to Shareholders as dividends as an "interest distribution".

 

h)  Changes in accounting policy and disclosures

New and amended standards and interpretations

The Company adopted the following new and amended relevant IFRS in the year:

IFRS 2

Share-based payments

IFRS 9

Financial Instruments

IFRS 15

Revenue from Contracts with Customers

IFRIC 22

Foreign Currency Transactions and Advance Consideration

 

 

With the exception of IFRS 9, the adoption of the above standards did not have a significant impact on the financial position or performance of the Company.  The impact of the adoption of IFRS 9 on the financial position or performance of the Company is described below, but in summary:

·        The Company has continued to measure loans, and other receivables, at amortised cost, and at fair value for all financial assets and liabilities currently held at fair value;

·        Expected credit losses are not materially different from incurred losses previously provided due to the use of security on a large portion of the Company's loans; and

·        The Company does not designate any hedges as effective hedging relationships.

 

Impact of adoption of IFRS 9

The Company adopted IFRS 9 with effect from 1 July 2018.  IFRS 9 replaces IAS 39 Financial Instruments: Recognition and Measurement and introduces new requirements for classification and measurement, impairment and hedge accounting.  IFRS 9 is not applicable to items that had already been derecognised at 1 July 2018, the date of initial application.

 

a) Classification and measurement

The Company has assessed the classification of financial instruments as at the date of initial application and has applied such classification retrospectively.  Based on that assessment:

·      All financial assets previously held at fair value continue to be measured at fair value;

·      Financial assets previously classified as loans and receivables are held to collect contractual cash flows and give rise to cash flows representing solely payments of principal and interest.  Thus, such instruments continue to be measured at amortised cost under IFRS 9; and

·      The classification of financial liabilities to which the Company is exposed remains the same under IFRS 9 as under IAS 39.

 

The classification and measurement requirements of IFRS 9 have been adopted retrospectively as of the date of initial application on 1 July 2018.  However, the Company has chosen to take advantage of the option not to restate comparatives.  Therefore, the 30 June 2018 figures are presented and measured under IAS 39.  The following table shows the original measurement categories in accordance with IAS 39 and the new measurement categories under IFRS 9 for the Company's financial assets and financial liabilities as at 1 July 2018:

 

 

IAS 39 classification

IAS 39 measurement

IFRS 9 classification

IFRS 9 measurement

 

 

£'000

 

£'000

Loans at amortised cost

Loans and receivables

44,363

Amortised cost

44,340

Investments at fair value through profit or loss ("FVTPL")

Financial assets at FVTPL

280

FVTPL

280

Cash held on client accounts with platforms

Loans and receivables

196

Amortised cost

196

Other receivables and prepayments

Loans and receivables

772

Amortised cost

772

Cash and cash equivalents

Loans and receivables

6,125

Amortised cost

6,125

Other payables and accruals

Other financial liabilities

(165)

Amortised cost

(165)

Derivative financial instruments

Designated at FVTPL

(32)

FVTPL

(32)

 

 

------------

 

------------

Net assets

 

51,539

 

51,516

 

 

------------

 

------------

 

b) Impairment

IFRS 9 requires the Company to record expected credit losses on all of its debt securities, loans and trade receivables, either on a 12-month or lifetime basis. 

 

IFRS 9 provisioning originally led to a one-off increase in the Company's NAV of 0.94% from 1 July 2018 when the impairments decreased by £483,000 from £699,000 to £217,000 (0.42% of the 30 June 2018 NAV).  Since then, the Company's approach to IFRS 9 provisioning has changed (please see the Investment Manager's Report for more details).  In these financial statements, an approach (consistent with that adopted at 30 June 2019) has been followed from 1 July 2018.  This has resulted in a decrease in the Company's NAV at 1 July 2018 from the adoption of IFRS 9 of £23,000, instead of the 0.94% increase as originally announced.  All material loss provisions are related to platform impairments on investments made before the Investment Manager took control of the portfolio.  Since assuming management of the Company on 1 April 2017, SQN Asset Management Limited has reduced platform exposure from 100% to under 50%, delivering on the strategy of providing income from direct lending originated and underwritten solely by the Investment Manager.  The Company has managed the risk posed by peer to peer platform exposure effectively and will continue to reduce the overall exposure to these platforms to the target weight of 20% of the whole portfolio.

 

Given that the adjustment to NAV is driven purely by a revised accounting methodology, underlying performance is unaffected as this change is purely an accounting adjustment and has no bearing on the loans held within the Company.

 

The carrying amounts of amortised cost instruments continued to approximate those instruments' fair values on the date of transition after transitioning to IFRS 9.

 

Impact of adoption of IFRS 15

The Company adopted IFRS 15 with effect from 1 July 2018.  IFRS 15 replaces IAS 18: Revenue and establishes a five-step model to account for revenue arising from contracts with customers.  In addition, guidance on interest and dividend income have been moved from IAS 18 to IFRS 15 without significant changes to the requirements.  Therefore, there was no impact of adopting IFRS 15 for the Company.

 

i)   Accounting standards issued but not yet effective

The International Accounting Standards Board ("IASB") has issued/revised a number of relevant standards with an effective date after the date of these financial statements.  Any standards that are not deemed relevant to the operations of the Company have been excluded.  The Directors have chosen not to early adopt these standards and interpretations and they do not anticipate that they would have a material impact on the Company's financial statements in the period of initial application. 

 

 

Effective date

IFRS 9

Financial Instruments - amendments regarding prepayment features with negative compensation and modifications of financial liabilities

1 January 2019

IAS 1

Presentation of Financial Statements - amendments regarding the definition of materiality

 

1 January 2020

IAS 8

Accounting Policies, Changes in Accounting Estimates and Errors - amendments regarding the definition of materiality

 

1 January 2020

IAS 12

Income Taxes  - amendments resulting from annual improvements

1 January 2019

IFRIC 23

Uncertainty over income tax treatment

1 January 2019

 

4. Use of judgements and estimates

The preparation of the Company's financial statements requires the Directors to make judgements, estimates and assumptions that affect the reported amounts recognised in the financial statements and disclosure of contingent liabilities.  However, uncertainty about these assumptions and estimates could result in outcomes that could require a material adjustment to the carrying amount of the asset or liability in future periods.

 

Estimates and assumptions

The Company based its assumptions and estimates on parameters available when the financial statements were approved.  However, existing circumstances and assumptions about future developments may change due to market changes or circumstances arising beyond the control of the Company.  Such changes are reflected in the assumptions when they occur.

 

i) Recoverability of loans and other receivables

In accordance with IFRS 9, from 1 July 2018, the impairment of loans and other receivables has been assessed as described in note 3b.  When assessing the credit loss on a loan, and the stage of impairment of that loan, the Company considers whether there is an indicator of credit risk for a loan when the borrower has failed to make a payment, either capital or interest, when contractually due and upon assessment.  The Company assesses at each reporting date (and at least on a monthly basis) whether there is objective evidence that a loan classified as a loan at amortised cost is credit-impaired and whether a loan's credit risk or the expected loss rate has changed significantly.  As part of this process:

·      Platforms are contacted to determine default and delinquency levels of individual loans; and

·      Recovery rates are estimated. 

 

 

The analysis of credit risk is based on a number of factors and a degree of uncertainty is inherent in the estimation process.  The determination of whether a specific factor is relevant and its weight compared with other factors depends on the type of product, the characteristics of the financial instrument and the borrower, and the geographical region.  It is not possible to provide a single set of criteria that will determine what is considered to be a significant increase in credit risk. Events that the Company will assess when deciding if a financial asset is credit impaired include:

·      significant financial difficulty of the borrower;

·      a breach of contract, such as a default or past-due event; and

·      it becoming probable that the borrower will enter bankruptcy or other financial reorganisation.

 

Although it may not always be the case (e.g. if discussions with a borrower are ongoing), generally a loan is deemed to be in default if the borrower has missed a payment of principal or interest by more than 90 days, unless the Company has good reason not to apply this rule. If the Company has evidence to the contrary, it may make an exception to the 90 day rule to deem that a borrower is, or is not, in default. Therefore the definitions of credit impaired and default are aligned as far as possible so that stage 3 represents all loans that are considered defaulted or otherwise credit impaired. 

 

At present no direct loans to SMEs fall within Stage 2 or Stage 3. However, if a situation were to arise where a direct loan to an SME were reclassified as Stage 2 or Stage 3, the probability of default and lifetime expected credit loss would be assessed on a case by case basis and would be pertinent to the probability of recovery.

 

 

IFRS 9 confirms that a Probability of Default ("PD") must never be zero as everything is deemed to have a risk of default; this has been incorporated by the Company. All PDs will be assessed against historic data as well as the prevailing economic conditions at the reporting date, adjusted to account for estimates of future economic conditions that are likely to impact the risk of default. 12-month PD will be applied across the collective as a cumulative in Stage 1, currently set at 2% in line with the Investment Manager's historic performance data, market knowledge, and credit enhancements (this is equivalent to there being 1 default for an average portfolio of 50 unique borrowers. Once an investment moves to Stage 2 then PD will be calculated on an individual basis (and adjusted for Stage 3 if appropriate). All assessment is based on reasonable and supportive information available at the time.

 

Lifetime ECL will be applied across the collective as a cumulative in Stage 1, split according to the investment's classification. For direct loan investments this is calculated as 2% of the individual investment's Contracted Cash Flows ("CCF"), and 2% of the investment's CCF for platform investments. These Stage 1 Lifetime ECL amounts are taken to be the investments' floor amounts- the Lifetime ECL for any investment can never be less than its floor amount. Once an investment moves to Stage 2 then Lifetime ECL will be calculated on an individual basis. Lifetime ECL will be reviewed at each reporting date based on reasonable and supportive information available at the time.

 

Further details of the judgements applied in assessing the recoverability of loans can be found in the IFRS 9 section of the Investment Manager's Report.

 

 

 

LiftForward impairment

The Company's largest peer to peer investment is a junior position and represents a risk of write-down.  In March 2019, the Investment Manager met with the owner/founder and agreed an incentive plan to expedite collections of the underlying portfolio and agreed a three month period to show improvement.  They informed the Company that they had written down a large proportion of this portfolio in their accounts due to a sales process underway at the time.  They were advised that if no improvement was forthcoming, the Investment Manager would take over collections and it was explained that the Investment Manager has a good track record, together with its partners, in achieving better recoveries.

 

 

 

In June, having observed slow progress, the Investment Manager began a series of meetings to agree interaction mooted in the previous quarter.  Two executives from the investment Manager visited LiftForward in New York in July and August, to agree a process for the way forward and to have an update on the sale of the business.  At the time, they were in the middle of a two stage Due Diligence, which caused delays to the provision of information. With effect from 30 June 2019, the Company has impaired this platform exposure by 25% with a 100% expectation of write-down for this part of the portfolio. This is a pre-emptive move and takes into account a best estimate of loans that are now being managed out by attorneys. The decision to use a 25% impairment rate is based upon the Investment Manager's past experience of platform performance.

 

Whilst a 25% impairment is based on past experience, the amount finally received may be higher or lower than this. A 10% increase or decrease in the impairment on this loan would result in a -/+£226,000 change in the net asset value of the Company.

 

 

Non-adjusting event

In September 2019, a loan on one platform was reclassified from stage 1 to stage 2, due to a non-adjusting event that occurred after the year end. As this event occurred post year end and the situation was not in existence at 30 June 2019, the Directors determined that this was a non-adjusting event (see note 26 for further details).

 

 

 

Further details of the judgements applied in assessing the recoverability of loans can be found in the IFRS 9 section of the Investment Manager's Report.

 

 

 

Collateral

While the presence of collateral is not a key element in the assessment of whether there has been a significant increase in credit risk, it is of great importance in the measurement of ECL. IFRS 9 states that estimates of cash shortfalls reflect the cash flows expected from collateral and other credit enhancements that are integral to the contractual terms. Due to the business nature of the Investment Manager, this is a key component of its ECL measurement and interpretation of IFRS 9, as any investment would include elements of (if not all): a fully collateralised position, fixed and floating charges, a corporate guarantee, a personal guarantee, coverage ratios between 130% to 150%, and an average LTV of 85%.

 

 

 

Loans written off

Financial assets (and the related impairment allowances) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In circumstances where the net realisable value of any collateral has been determined and there is no reasonable expectation of further recovery, write-off may be earlier.  Platform loans of £126,000 were written off in the year (2018: £40,000).

 

 

Renegotiated loans

A loan is classed as renegotiated when the contractual payment terms of the loan are modified because the Company has significant concerns about a borrower's ability to meet payments when due. On renegotiation, the loan will also be classified as credit impaired, if it is not already. Renegotiated loans will continue to be considered to be credit impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future payments.

 

 

 

All data calculated for IFRS 9 purposes is consistent with the overall methodology employed by SQN across all of its UK public funds.  In addition to the methodology used, the Company has taken impairment data from Platforms for the assessment of loans with third party exposure.  Again, this is consistent with the approach SQN would expect to take in these circumstances.

 

 

 

There were no new assets originated during the year that were credit-impaired at the point of initial recognition. There were no financial assets that have been modified since initial recognition at a time when the loss allowance was measured at an amount equal to lifetime expected credit losses and for which the loss allowance changed during the year to an amount equal to 12-month expected credit losses.

 

There were no financial assets for which cash flows were modified in the year while they had a loss allowance measured at an amount equal to the lifetime expected credit loss.

 

 

 

Please see note 3b, note 14 and note 24 for further information on the loans at amortised cost and credit risk.

 

     

 

 

Announcement date

Pay date

Total dividend declared in respect of earnings in the year

Amount per

Ordinary Share

 

 

£'000

 

30 August 2018

28 September 2018

307

0.583p

25 September 2018

26 October 2018

307

0.583p

25 October 2018

23 November 2018

307

0.583p

29 November 2018

28 December 2018

307

0.583p

21 December 2018

25 January 2019

307

0.583p

30 January 2019

22 February 2019

307

0.583p

28 February 2019

29 March 2019

307

0.583p

27 March 2019

26 April 2019

307

0.583p

24 April 2019

24 May 2019

307

0.583p

29 May 2019

28 June 2019

307

0.583p

25 June 2019

26 July 2019

307

0.583p

25 July 2019

23 August 2019

307

0.583p

 

 

------------

------------

Dividends declared (to date) for the year

3,684

7.00p

Less, dividends paid after the year end

(614)

(1.17)p

Add, dividends paid in the year in respect of the prior year

553

1.05p

 

 

------------

------------

Dividends paid in the year

 

3,623

6.88p

 

 

------------

------------

 

In accordance with IFRS, dividends are only provided for when they become a contractual liability of the Company.  Therefore, during the year a total of £3,623,000 (2018: £3,318,000) was incurred in respect of dividends, none of which was outstanding at the reporting date (2018: none).  The dividends of £307,010 each, which were declared on 25 June 2019 and 25 July 2019, had not been provided for at 30 June 2019 as, in accordance with IFRS, they were not deemed to be liabilities of the Company at that date.

 

All dividends in the year were paid out of revenue (and not capital) profits.

 

6. Related parties

As a matter of best practice and good corporate governance, the Company has adopted a related party policy which applies to any transaction which it may enter into with any Director, the Investment Manager, or any of their affiliates which would constitute a "related party transaction" as defined in, and to which would apply, Chapter 11 of the Listing Rules.  In accordance with its related party policy, the Company obtained: (i) the approval of a majority of the Directors; and (ii) a third-party valuation in respect of these transactions from an appropriately qualified independent adviser.

 

Loan to Medical Equipment Solutions Limited ("MESL")

In June 2017, the Company loaned £1,380,000 to MESL, whose Chairman is Neil Roberts, who is also chairman of SQN Capital Management, LLC.  Loan interest of £104,000 was earned in the year (2018: £127,000), £2,000 of which was outstanding at 30 June 2019 (2018: £3,000).  The loan bears interest at 10.0% per annum and is for a period of five years from the date of drawdown.  The loan is to be repaid via 60 monthly payments.

 

At 30 June 2019, the balance of the loan was £909,000 (2018: £1,156,000).

 

The Directors and the Investment Manager are also considered to be related parties. See notes 7 and 8 for further details.

 

7. Key contracts

a)  Investment Manager

The Investment Manager, SQN Asset Management Limited ("SQN UK") and SQN Capital Management, LLC ("SQN US"), has responsibility for managing the Company's portfolio.  For their services, the Investment Manager is entitled to a management fee at a rate equivalent to the following schedule (expressed as a percentage of NAV per annum, before deduction of accruals for unpaid management fees for the current month): 

·      1.0% per annum for NAV lower than or equal to £250 million; 

·      0.9% per annum for NAV greater than £250 million and lower than or equal to £500 million; and 

·      0.8% per annum for NAV greater than £500 million.

 

The management fee is payable monthly in arrears on the last calendar day of each month.  No performance fee is payable by the Company to the Investment Manager.

 

The Company may also incur transaction costs for the purposes of structuring investments for the Company.  These costs form part of the overall transaction costs that are capitalised at the point of recognition and are taken into account by the Investment Manager when pricing a transaction. When structuring services are provided by the Investment Manager or an affiliate of them, they shall be entitled to charge an additional fee to the Company equal to up to 1.0% of the cost of acquiring the investment (ignoring gearing and transaction expenses).  This cost will not be charged in respect of assets acquired from the Investment Manager, the funds they manage or where they or their affiliates do not provide such structuring advice. 

 

The Investment Manager has agreed to bear all the broken and abortive transaction costs and expenses incurred on behalf of the Company.  Accordingly, the Company has agreed that the Investment Manager may retain any commitment commissions received by the Investment Manager in respect of investments made by the Company save that if such commission on any transaction were to exceed 1.0% of the transaction value, the excess would be paid to the Company.

 

With effect from 1 April 2017, the former Investment Manager, Amberton, was appointed as Sub-Investment Adviser to the Investment Manager. From that date, Amberton was no longer directly appointed by the Company and was not entitled to a fee from the Company.  The fees of the Sub-Investment Adviser were borne by the Investment Manager. Amberton ceased to act as Sub-Investment Adviser to the Investment Manager with effect from 1 June 2018.

 

During the year, a total of £513,000 (2018: £518,000) was incurred in respect of management fees, of which £42,000 was payable at the reporting date (2018: £42,000).

 

b) Administration fees

Elysium Fund Management Limited ("Elysium") is entitled to an administration fee of £100,000 per annum in respect of the services provided in relation to the administration of the Company, together with time based fees in relation to work on investment transactions.  During the year, a total of £117,000 (2018: £116,000) was incurred in respect of administration fees, of which £30,000 (2018: £28,000) was payable at the reporting date.

 

8. Directors' remuneration

During the year, a total of £108,044 (2018: £114,135) was incurred in respect of Directors' remuneration, none of which was payable at the reporting date (2018: none).  No bonus or pension contributions were paid or payable on behalf of the Directors.  Further details can be found in the Directors' Remuneration Report.

 

9. Key management and employees

The Company had no employees during the year (2018: none). Therefore, there were no key management (except for the Directors) or employees during the year.

 

The following dividends were paid to the Directors during the year by virtue of their holdings of Ordinary Shares (these dividends were not additional remuneration):

 

Ken Hillen

£344 (2018: £315)

David Stevenson

£1,394 (2018: £1,276)

Gaynor Coley

£12 (2018: none)

Richard Hills (resigned 18 December 2018)

£428 (2018: £964)

 

10. Auditor's remuneration

For the year ended 30 June 2019, total fees, plus VAT, charged by RSM UK Audit LLP, together with amounts accrued at 30 June 2019, amounted to £42,000 (2018: £38,000), all of which related to audit services (2018: £38,000).  As at 30 June 2019, £40,000 (2018: £35,000) was due to RSM UK Audit LLP.

 

11. Other expenses

 

Year ended 30 June 2019

Year ended 30 June 2018

 

£'000

£'000

Audit fees (note 10)

42

38

Registrar fees

37

30

Other expenses

34

48

Directors' national insurance

28

4

Listing fees

17

13

Accountancy and taxation fees

11

8

Custodian fee

-

13

 

------------

------------

 

169

154

 

------------

------------

 

12. Taxation

The Company has received confirmation from HMRC that it satisfied the conditions for approval as an investment trust, subject to the Company continuing to meet the eligibility conditions in s.1158 of the Corporation Tax Act 2010 and the ongoing requirements for approved investment trust companies in Chapter 3 of Part 2 of the Investment Trust (approved Company) Tax Regulations 2011 (Statutory Instrument 2011.2999).  The Company intends to retain this approval and self-assesses compliance with the relevant conditions and requirements.

 

As an investment trust the Company is exempt from UK corporation tax on its chargeable gains.  The Company is, however, liable to UK corporation tax on its income.  However, the Company has elected to take advantage of modified UK tax treatment in respect of its "qualifying interest income" in order to deduct all, or part, of the amount it distributes to Shareholders as dividends as an "interest distribution".

 

 

Year ended

30 June 2019

Year ended

30 June 2018

 

£'000

£'000

Reconciliation of tax charge:

 

 

Profit before taxation

2,236

2,809

 

------------

------------

Tax at the standard UK corporation tax rate of 19% (2018: 19%)

425

534

Effects of:

 

 

-       Non-taxable investment gains and losses

164

94

-       Interest distributions

(589)

(628)

 

------------

------------

Total tax expense

-

-

 

------------

------------

 

Domestic corporation tax rates in the jurisdictions in which the Company operated were as follows:

 

Year ended

30 June 2019

Year ended

30 June 2018

United Kingdom

19%

19%

Guernsey

nil

nil

 

Due to the Company's status as an investment trust and the intention to continue to meet the required conditions, the Company has not provided for deferred tax on any capital gains and losses.

 

13. Earnings per Ordinary Share

The earnings per Ordinary Share of 4.25p (2018: 5.33p) is based on a profit attributable to the owners of the Company of £2,236,000 (2018: £2,809,000) and on a weighted average number of 52,660,350 (2018: 52,660,350) Ordinary Shares in issue since Admission.  There is no difference between the basic and diluted earnings per share.

 

14. Loans at amortised cost

 

 

Year ended            30 June 2019

  Year ended            30 June 2018

 

£'000

£'000

Loans

47,726

44,653

Unrealised loss*

(422)

(94)

 

------------

------------

Balance at year end

47,304

44,559

 

------------

------------

Loans:

Non-current

36,614

31,918

 

Current

10,642

12,445

Cash held on client accounts with platforms

48

196

 

------------

------------

Loans at amortised cost and cash held on client accounts with platforms

47,304

44,559

 

------------

------------

*Unrealised loss

 

 

Foreign exchange on non-Sterling loans

715

605

Impairments

(1,137)

(699)

 

------------

------------

Unrealised loss

(422)

(94)

 

------------

------------

 

 

 

The movement in unrealised gains/losses on loans comprises:

 

Year ended            30 June 2019

  Year ended            30 June 2018

 

£'000

£'000

Movement in foreign exchange on non-Sterling loans

110

(46)

Movement in impairments

(415)

(269)

 

------------

------------

Movement in unrealised gains and losses on loans

(305)

(315)

Impact of transition to IFRS 9

(23)

-

 

------------

------------

Total movement in unrealised gains and losses on loans

(328)

(315)

 

------------

------------

 

The weighted average interest rate of the loans as at 30 June 2019 was 10.31% (2018: 9.24%).

 

The table below details expected credit loss provision ("ECL") of financial assets in each stage at 30 June 2019:

 

 

Stage 1

Stage 2

Stage 3

Total

 

£'000

£'000

£'000

£'000

30 June 2019

 

 

 

 

Direct loans [1]

33,032

-

-

33,032

ECL on direct loans

(16)

-

-

(16)

 

------------

------------

------------

------------

Direct loans net of the ECL

33,016

-

-

33,016

 

------------

------------

------------

------------

 

 

 

 

 

Platform loans [1]

11,585

3,117

426

15,127

ECL on platform loans

(12)

(735)

(374)

(1,121)

 

------------

------------

------------

------------

Platform loans net of the ECL

11,573

2,382

52

14,007

 

------------

------------

------------

------------

 

 

 

 

 

Accrued interest

799

288

3

1,090

 

------------

------------

------------

------------

 

 

 

 

 

Total loans [1]

44,617

3,117

426

48,160

Total ECL

(28)

(735)

(374)

(1,137)

 

------------

------------

------------

------------

Total net of the ECL

44,589

2,382

52

47,023

 

------------

------------

------------

------------

 

[1]

These are the principal amounts outstanding at 30 June 2019 and do not include the capitalised transaction fees, which are not subject to credit risk.  At 30 June 2019, the amortised cost of the capitalised transaction fees totalled £233,000.

 

The table below details the movements in the year of the principal amounts outstanding and the ECL on those loans:

             

 

Non-credit impaired

Credit impaired

 

 

Stage 1

Stage 2

Stage 3

Total

 

Principal outstanding[1]

Allowance

for ECL

Principal outstanding[1]

Allowance

for ECL

Principal outstanding[1]

Allowance

for ECL

Principal outstanding[1]

Allowance

for ECL

 

£'000

£'000

£'000

£'000

£'000

£'000

£'000

£'000

At 1 July 2018

28,735

(19)

15,679

(310)

535

(393)

44,949

(722)

Transfers from:

-    stage 1 to stage 2

(2,176)

2

2,176

(2)

-

-

-

-

-    stage 2 to stage 1

14,801

(52)

(14,801)

52

-

-

-

-

Net re-measurement of ECL arising from transfer of stage

-

41

-

(564)

-

-

-

(523)

Net new and further lending/repayments, and foreign exchange movements

3,257

-

68

89

12

(9)

3,337

80

Loans written-off in the year

-

-

(5)

-

(121)

28

(126)

28

 

------------

------------

------------

------------

------------

------------

------------

------------

At 30 June 2019

44,617

(28)

3,117

(735)

426

(374)

48,160

(1,137)

 

------------

------------

------------

------------

------------

------------

------------

------------

 

 

[1]

These are the principal amounts outstanding at 30 June 2019 and do not include the capitalised transaction fees, which are not subject to credit risk.  At 30 June 2019, the amortised cost of the capitalised transaction fees totalled £233,000.

                   

At 30 June 2019, the Board considered £1,137,000 (2018: £699,000) of loans to be impaired:

 

 

30 June 2019

30 June 2018 [1]

 

£'000

£'000

LiftForward

566

-

Sancus Funding

466

515

MyTripleA

62

80

UK Bond Network

17

104

Direct SME loans

15

-

Other

11

-

 

------------

------------

Total impairment

1,137

699

 

------------

------------

[1]

The 30 June 2018 figures were prepared in accordance with IAS 39, not IFRS 9 (see note 3h).

 

During the year, £126,000 (2018: £40,000) of loans were written off and included within realised gain on disposal of loans in the Statement of Comprehensive Income.

       

The following table details the impairments of financial assets at 30 June 2018 (prior to the adoption of IFRS 9):

 

 

 

Unimpaired loans

Loans in default

Total

30 June 2018

 

£'000

£'000

£'000

Direct loans [1]

 

16,817

-

16,817

Impairment (prior to adoption of IFRS 9)

 

-

-

-

 

 

------------

------------

------------

Total (net of the impairment)

 

16,817

-

16,817

 

 

------------

------------

------------

 

 

 

 

 

Platform loans [1]

 

26,064

2,068

28,132

Impairment (prior to adoption of IFRS 9)

 

-

(699)

(699)

 

 

------------

------------

------------

Total (net of the impairment)

 

26,064

1,369

27,433

 

 

------------

------------

------------

Total impairment

 

-

(699)

(699)

 

 

------------

------------

------------

 

 

 

 

 

[1]

These are the principal amounts outstanding at 30 June 2018 and do not include the capitalised transaction fees, which are not subject to credit risk.  At 30 June 2018, the amortised cost of the capitalised transaction fees totalled £113,000.

 

See note 3b and note 4i regarding the process of assessment of loan impairment.

           

15. Investments at fair value through profit or loss

 

Year ended 30 June 2019

Year ended 30 June 2018

 

£'000

£'000

Balance brought forward

280

258

Disposals in the year

(52)

-

Realised gain on disposal of investments at fair value through profit or loss

 

3

 

-

Movement in unrealised gain on investments at fair value through profit or loss

 

1

 

22

 

------------

------------

Balance at year end

232

280

 

------------

------------

 

 

 

For further information on the investments at fair value through profit or loss, see note 16.

 

16. Fair value of financial instruments at fair value through profit or loss

The following table shows financial instruments recognised at fair value, analysed between those whose fair value is based on:

-       Quoted prices in active markets for identical assets or liabilities (Level 1);

-       Those involving inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices) (Level 2);  and

-       Those with inputs for the asset or liability that are not based on observable market data (unobservable inputs) (Level 3).

 

 

At 30 June 2019, the financial instruments designated at fair value through profit or loss were as follows:

 

30 June 2019

 

Level 1

Level 2

Level 3

Total

Financial assets/(liabilities)

£'000

£'000

£'000

£'000

Unlisted equity shares

-

-

232

232

Derivative financial instruments (note 17)

-

(351)

-

(351)

 

------------

------------

------------

------------

Total financial assets/(liabilities) designated as at fair value through profit or loss

-

(351)

232

(119)

 

------------

------------

------------

------------

           

 

At 30 June 2018, the financial instruments designated at fair value through profit or loss were as follows:

 

30 June 2018

 

Level 1

Level 2

Level 3

Total

Financial assets/(liabilities)

£'000

£'000

£'000

£'000

Unlisted equity shares

-

-

280

280

Derivative financial instruments (note 17)

-

(32)

-

(32)

 

------------

------------

------------

------------

Total financial assets/(liabilities) designated as at fair value through profit or loss

-

(32)

280

248

 

------------

------------

------------

------------

 

Level 2 financial instruments include foreign currency forward contracts.  They are valued using observable inputs (in this case foreign currency spot rates).

 

Level 3 financial instruments include unlisted equity shares. Net asset value is considered to be an appropriate approximation of fair value as, if the Company were to dispose of these holdings, it would expect to do so at, or around, net asset value.

 

Transfers between levels

There were no transfers between levels in the year (2018: none).

 

17. Derivative financial instruments

During the year, the Company entered into foreign currency forward contracts to hedge against foreign exchange fluctuations.  The Company realised a loss of £206,000 (2018: profit of £21,000) on forward foreign exchange contracts that settled during the year.


As at 30 June 2019, the open forward foreign exchange contracts were valued at £(351,000) (2018: £(32,000)).

 

18. Other receivables and prepayments

 

30 June 2019

30 June 2018

 

£'000

£'000

Accrued interest

1,090

759

Prepayments

27

13

Other receivables

24

-

 

------------

------------

 

1,141

772

 

------------

------------

 

19. Other payables and accruals

 

30 June 2019

30 June 2018

 

£'000

£'000

Management fee

42

42

Audit fee

40

35

Administration fee

30

28

Legal fees

25

-

Other payables and accruals

24

18

Directors' national insurance

23

3

Transaction fees

-

20

Deferred investment income

-

19

 

------------

------------

 

184

165

 

------------

------------

 

20. Reconciliation of liabilities arising from financing activities

IAS 7 requires the Company to detail the changes in liabilities arising from financing activities, including both cash and non-cash changes.  Liabilities arising from financing activities are those for which cash flows were, or future cash flows will be, classified in the Company's statement of cash flows as cash flows from financing activities.

 

As at 30 June 2019, the Company had no liabilities classified as cash flows from financing activities (2018: none).

 

21. Share capital

 

30 June 2019

30 June 2018

 

£'000

£'000

Authorised share capital:

 

 

Unlimited number of Ordinary Shares of 1 pence each

-

-

Unlimited C Shares of 10 pence each

-

-

Unlimited Deferred Shares of 1 pence each

-

-

50,000 Management Shares of £1 each

50

50

 

------------

------------

 

 

30 June 2019

30 June 2018

 

£'000

£'000

Called up share capital:

 

 

52,660,350 Ordinary Shares of 1 pence each

527

527

50,000 Management Shares of £1 each

50

50

 

------------

------------

 

577

577

 

------------

------------

 

The Management Shares are entitled (in priority to any payment of dividend of any other class of share) to a fixed cumulative preferential dividend of 0.01% per annum on the nominal amount of the Management Shares.

 

The Management Shares do not carry any right to receive notice of, nor to attend or vote at, any general meeting of the Company unless no other shares are in issue at that time.  The Management Shares do not confer the right to participate in any surplus of assets of the Company on winding-up, other than the repayment of the nominal amount of capital.

 

22. Other reserves

 

 

Profit and loss account

 

 

Special distributable reserve

 

 

Distributable

 

Non-distributable

 

 

Total

 

£'000

£'000

£'000

£'000

At 30 June 2017

50,942

109

420

51,471

Realised revenue profit

-

3,303

-

3,303

Realised investment gains and losses

-

(19)

-

(19)

Unrealised investment gains and losses

-

-

(475)

(475)

Dividends paid

-

(3,318)

-

(3,318)

 

------------

------------

------------

------------

At 30 June 2018

50,942

75

(55)

50,962

Impact of transition to IFRS 9 (see note 3h)

-

-

(23)

(23)

 

------------

------------

------------

------------

At 30 June 2018 - revised for the application of IFRS 9

50,942

75

(78)

50,939

Realised revenue profit

-

3,097

-

3,097

Realised investment gains and losses

-

(238)

-

(238)

Unrealised investment gains and losses

-

-

(623)

(623)

Dividends paid

(689)

(2,934)

-

(3,623)

 

------------

------------

------------

------------

At 30 June 2019

50,253

-

(701)

49,552

 

------------

------------

------------

------------

 

With the exception of investment gains and losses, all of the Company's profit and loss items are of a revenue nature as it does not allocate any expenses to capital.

 

22. Other reserves

The two £307,010 dividends (see note 5), which were declared on 25 June 2019 and 25 July 2019, will be paid out of the special distributable reserve.

 

23. Net asset value per Ordinary Share

The net asset value per Ordinary Share is based on the net assets attributable to the owners of the Company of £50,129,000 (2018: £51,539,000), less £50,000 (2018: £50,000), being amounts owed in respect of Management Shares, and on 52,660,350 (2018: 52,660,350) Ordinary Shares in issue at the year end.

 

Reconciliation to NAV announced on 25 July 2019

Subsequent to the year end, the Company became aware of information in relation to loans on two platforms.  In addition, a readjustment to certain credit loss allowances was made to better reflect the underlying conditions of the inherited portfolio and revised judgements of the provisions required under IFRS 9 (please see note 4i  and the Investment Manager's Report for more details).  As a result, the loss allowance as at 30 June 2019 for those two platforms has been amended, resulting in a difference in the net asset value disclosed in these financial statements from that announced on 25 July 2019 as follows:

 

 

30 June 2019

30 June 2019

 

£'000

pence per share

Net asset value announced on 25 July 2019

51,153

97.04

Increase in platform loss allowance and associated decrease in accrued loan interest

(1,024)

(1.94)

 

------------

------------

 

50,129

95.10

 

------------

------------

 

24. Financial Instruments and Risk Management

The Investment Manager manages the Company's portfolio to provide Shareholders with attractive risk adjusted returns, principally in the form of regular, sustainable dividends, through investment predominantly in a range of secured loans and other secured loan-based instruments originated through a variety of channels and diversified by way of asset class, geography and duration.

 

The Company will seek to ensure that diversification of its portfolio is maintained, with the aim of spreading investment risk.

 

Risk is inherent in the Company's activities, but it is managed through a process of ongoing identification, measurement and monitoring.  The Company is exposed to market risk (which includes currency risk, interest rate risk and price risk), credit risk and liquidity risk from the financial instruments it holds.  Risk management procedures are in place to minimise the Company's exposure to these financial risks, in order to create and protect Shareholder value.

 

Risk management structure

The Investment Manager is responsible for identifying and controlling risks.  The Board of Directors supervises the Investment Manager and is ultimately responsible for the overall risk management approach within the Company.

 

The Company has no employees and is reliant on the performance of third party service providers.  Failure by the Investment Manager, Administrator, Broker, Registrar or any other third party service provider to perform in accordance with the terms of its appointment could have a significant detrimental impact on the operation of the Company.

 

The market in which the Company participates is competitive and rapidly changing.  The risks have not changed from those detailed on pages 20 to 30 in the Company's Prospectus, which is available on the Company's website.

 

Risk concentration

Concentration indicates the relative sensitivity of the Company's performance to developments affecting a particular industry or geographical location.  Concentrations of risk arise when a number of financial instruments or contracts are entered into with the same counterparty, or where a number of counterparties are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political or other conditions.  Concentrations of liquidity risk may arise from the repayment terms of financial liabilities, sources of borrowing facilities or reliance on a particular market in which to realise liquid assets.  Concentrations of foreign exchange risk may arise if the Company has a significant net open position in a single foreign currency, or aggregate net open positions in several currencies that tend to move together.

 

With the aim of maintaining a diversified investment portfolio, and thus mitigating concentration risks, the Company has established the following investment restrictions in respect of the general deployment of assets.

 

Investment Restriction

Investment Policy

Geography

- Exposure to UK loan assets

- Minimum exposure to non-UK loan assets

Minimum of 60%
20%

Duration to maturity

- Minimum exposure to loan assets with duration of less than 6 months

- Maximum exposure to loan assets with duration of 6 - 18 months and 18 - 36 months

- Maximum exposure to loan assets with duration of more than 36 months


None
None
50%

Maximum single investment

10%

Maximum exposure to single borrower or group

10%

Maximum exposure to loan assets sourced through single alternative lending platform or other third party originator


25%

Maximum exposure to any individual wholesale loan arrangement

25%

Maximum exposure to loan assets which are neither sterling-denominated nor hedged back to sterling


15%

Maximum exposure to unsecured loan assets

25%

Maximum exposure to assets (excluding cash and cash-equivalent investments) which are not loans or investments with loan-based investment characteristics


10%

 

The Company complied with the investment restrictions throughout the year and up to the date of signing this report.

 

Market risk

(i)     Price risk

Price risk exposure arises from the uncertainty about future prices of financial instruments held.  It represents the potential loss that the Company may suffer through holding market positions in the face of price movements.  The investments at fair value through profit or loss (see notes 15 and 16) are exposed to price risk and it is not the intention to mitigate the price risk.

 

At 30 June 2019, if the valuation of the investments at fair value through profit or loss had moved by 5% with all other variables remaining constant, the change in net assets would amount to approximately +/- £12,000 (2018: +/- £14,000).  The maximum price risk resulting from financial instruments is equal to the £232,000 carrying value of the investments at fair value through profit or loss (2018: £280,000).

 

(ii)     Foreign currency risk

Foreign currency risk is the risk that the value of a financial instrument will fluctuate because of changes in foreign currency exchange rates.  Currency risk arises when future commercial transactions and recognised assets and liabilities are denominated in a currency that is not the Company's functional currency.  The Company invests in securities and other investments that are denominated in currencies other than Sterling.  Accordingly, the value of the Company's assets may be affected favourably or unfavourably by fluctuations in currency rates and therefore the Company will necessarily be subject to foreign exchange risks. 

 

As at 30 June 2019, a proportion of the net financial assets of the Company, excluding the foreign currency forward contracts, were denominated in currencies other than Sterling as follows:

 

 

 

Investments at fair value through profit or loss

 

Loans and receivables

 

Cash and cash equivalents

 

Other payables and accruals

Exposure

Foreign currency forward contracts

Net exposure

30 June 2019

£'000

£'000

£'000

£'000

£'000

£'000

£'000

US Dollars

-

4,359

32

-

4,391

(4,625)

(234)

Euros

-

3,658

1

-

3,659

(3,583)

76

 

---------------

---------------

---------------

---------------

---------------

---------------

---------------

 

-

8,017

33

-

8,050

(8,208)

(158)

 

---------------

---------------

---------------

---------------

---------------

---------------

---------------

30 June 2018

 

 

 

 

 

 

 

US Dollars

-

5,235

1,921

-

7,156

(7,516)

(360)

Euros

63

4,839

628

-

5,530

(5,417)

113

 

---------------

---------------

---------------

---------------

---------------

---------------

---------------

 

63

10,074

2,549

-

12,686

(12,933)

(247)

 

---------------

---------------

---------------

---------------

---------------

---------------

---------------

 

In order to limit the exposure to foreign currency risk, the Company entered into hedging contracts during the year. At 30 June 2019, the Company held foreign currency forward contracts to sell US$11,480,000 and €4,110,000 (2018: US$9,950,000 and €6,140,000) and to buy US$5,610,000 and €120,000 (2018: nil) with a settlement date of 31 July 2019.

 

Other future foreign exchange hedging contracts may be employed, such as currency swap agreements, futures contracts and options.  There can be no certainty as to the efficacy of any hedging transactions.

 

At 30 June 2019, if the exchange rates for US Dollars and Euros had strengthened/weakened by 5% against Sterling with all other variables remaining constant, net assets at 30 June 2019 would have (decreased)/increased by £(8,000)/£7,000 (2018: £13,000/£(15,000)), after accounting for the effects of the hedging contracts mentioned above.

 

(iii)   Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or the fair values of financial instruments.  The Company is exposed to risks associated with the effects of fluctuations in the prevailing levels of market interest rates on its financial instruments and cash flow.  However, due to the fixed rate nature of the majority of the loans, cash and cash equivalents of £1,987,000 (2018: £6,125,000) were the only interest bearing financial instruments subject to variable interest rates at 30 June 2019.  Therefore, if interest rates had increased/decreased by 50 basis points, with all other variables held constant, the change in value of interest cash flows of these assets in the year would have been £10,000 (2018: £31,000).

 

 

 

Fixed interest

Variable interest

Non-interest bearing

Total

30 June 2019

£'000

£'000

£'000

£'000

Financial Assets

 

 

 

 

Loans

47,256

-

-

47,256

Cash held on client accounts with platforms

-

-

48

48

Investments at fair value through profit or loss

-

-

232

232

Other receivables

-

-

1,114

1,114

Cash and cash equivalents

-

1,987

-

1,987

 

------------

------------

------------

------------

Total financial assets

47,256

1,987

1,394

50,637

 

------------

------------

------------

------------

Financial Liabilities

 

 

 

 

Other payables

-

-

(184)

(184)

Derivative financial instruments

-

-

(351)

(351)

 

------------

------------

------------

------------

Total financial liabilities

-

-

(535)

(535)

 

------------

------------

------------

------------

 

 

 

 

 

Total interest sensitivity gap

47,256

1,987

859

50,102

 

------------

------------

------------

------------

 

 

 

 

 

 

Fixed interest

Variable interest

Non-interest bearing

Total

 

£'000

£'000

£'000

£'000

30 June 2018

 

 

 

 

Financial Assets

 

 

 

 

Loans

44,363

-

-

44,363

Cash held on client accounts with platforms

-

-

196

196

Investments at fair value through profit or loss

-

-

280

280

Other receivables

-

-

759

759

Cash and cash equivalents

-

6,125

-

6,125

 

------------

------------

------------

------------

Total financial assets

44,363

6,125

1,235

51,723

 

------------

------------

------------

------------

Financial Liabilities

 

 

 

 

Other payables

-

-

(146)

(146)

Derivative financial instruments

-

-

(32)

(32)

 

------------

------------

------------

------------

Total financial liabilities

-

-

(178)

(178)

 

------------

------------

------------

------------

 

 

 

 

 

Total interest sensitivity gap

44,363

6,125

1,057

51,545

 

------------

------------

------------

------------

 

The Investment Manager manages the Company's exposure to interest rate risk, paying heed to prevailing interest rates and economic conditions, market expectations and its own views as to likely moves in interest rates.

 

Although it has not done so to date, the Company may implement hedging and derivative strategies designed to protect investment performance against material movements in interest rates.  Such strategies may include (but are not limited to) interest rate swaps and will only be entered into when they are available in a timely manner and on terms acceptable to the Company.  The Company may also bear risks that could otherwise be hedged where it is considered appropriate.  There can be no certainty as to the efficacy of any hedging transactions.

 

Credit risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Company, resulting in a financial loss to the Company.

 

At 30 June 2019, credit risk arose principally from cash and cash equivalents of £1,987,000 (2018: £6,125,000) and balances due from the platforms and SMEs of £47,304,000 (2018: £44,559,000).  The Company seeks to trade only with reputable counterparties that the Investment Manager believes to be creditworthy.

 

The Company's credit risks principally arise through exposure to loans provided by the Company, either directly or through platforms.  These loans are subject to the risk of borrower default.  Where a loan has been made by the Company through a platform, the Company will only receive payments on those loans if the corresponding borrower through that platform makes payments on that loan.  The Investment Manager has sought to reduce the credit risk by obtaining security on the majority of the loans and by investing across various platforms, geographic areas and asset classes, thereby ensuring diversification and seeking to mitigate concentration risks, as stated in the "risk concentration" section earlier in this note.

 

The cash pending investment or held on deposit under the terms of an Investment Instrument may be held without limit with a financial institution with a credit rating of "single A" (or equivalent) or higher to protect against counterparty failure.

 

The Company may implement hedging and derivative strategies designed to protect against credit risk.  Such strategies may include (but are not limited to) credit default swaps and will only be entered into when they are available in a timely manner and on terms acceptable to the Company.  The Company may also bear risks that could otherwise be hedged where it is considered appropriate.  There can be no certainty as to the efficacy of any hedging transactions.

 

Please see note 3b and note 4 for further information on credit risk.

 

Liquidity risk

Liquidity risk is defined as the risk that the Company will encounter difficulties in realising assets or otherwise raising funds to meet financial commitments.  The principal liquidity risk is contained in unmatched liabilities.  The liquidity risk at 30 June 2019 was low since the ratio of cash and cash equivalents to unmatched liabilities was 4:1 (2018: 31:1).

 

The Investment Manager manages the Company's liquidity risk by investing primarily in a diverse portfolio of loans, in line with the Prospectus and as stated in the "risk concentration" section earlier in this note.  The maturity profile of the portfolio, as detailed in the Investment Manager's Report, is as follows:

 

 

30 June 2019

30 June 2018

 

Percentage

Percentage

0 to 6 months

11.6

17.0

6 months to 18 months

31.2

25.3

18 months to 3 years

24.8

16.6

Greater than 3 years

32.4

41.1

 

------------

------------

 

100.0

100.0

 

------------

------------

 

Capital management

The Board's policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the Company.  The Company's capital comprises issued share capital, retained earnings and a distributable reserve created from the cancellation of the Company's share premium account.

 

To maintain or adjust the capital structure, the Company may issue new Ordinary and/or C Shares, buy back shares for cancellation or buy back shares to be held in treasury.  During the year ended 30 June 2019, the Company did not issue any new Ordinary or C shares, nor did it buy back any shares for cancellation or to be held in treasury (2018: none).

 

The Company is subject to externally imposed capital requirements in relation to its statutory requirement relating to dividend distributions to Shareholders.  The Company meets the requirement by ensuring it distributes at least 85% of its distributable income by way of dividend.

 

25. Contingent assets and contingent liabilities

There were no contingent assets or contingent liabilities in existence at the year end (2018: none).

 

26. Events after the reporting period

Dividends

Two dividends of 0.583p per Ordinary Share, which (in accordance with IFRS) were not provided for at 30 June 2019, have been declared out of the profits for the year ended 30 June 2019 (see note 5).

 

On 29 August 2019, the Company declared a dividend of 0.583p per Ordinary Share for the period from 1 July 2019 to 31 July 2019.  This dividend was paid on 27 September 2019. On 25 September 2019, the Company declared a dividend of 0.583p per Ordinary Share for the period from 1 August 2019 to 31 August 2019.  This dividend will be paid on 25 October 2019.

 

Platform impairments

Subsequent to the year end, the Company became aware of information in relation to loans on three platforms.  As a result:

-         The loss allowance and accrued loan interest as at 30 June 2019 for two of the platforms has been amended, resulting in a difference in the net asset value disclosed in these financial statements from that announced on 25 July 2019 (see the reconciliation in note 23); and

-         In September 2019, a loan on one platform was reclassified from stage 1 to stage 2, due to a non-adjusting event that occurred after the year end.  This has resulted in an increase in the loss allowance on that platform post year end of £832,000. The principal outstanding and the loss allowance on this loan at the year end were £8,322,000 and £8,322 respectively.  In September 2019, the loss allowance was increased by £832,000 to £840,000, with the principal remaining at £8,322,000, thereby reducing the net assets and profit, with effect from September 2019, by £832,000.

 

There were no other significant events after the reporting period.

 

27. Parent and Ultimate Parent Company

The Directors do not believe that the Company has an individual Parent or Ultimate Parent.

 

---  ENDS ---


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