Overview and Investment Strategy

General information

Secured Income Fund plc (the "Company", "Fund" or "SIF") 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").

Change of name

On 18 July 2020, the Company changed its name from SQN Secured Income Fund plc to Secured Income Fund plc.

Continuation vote

On 19 June 2020, the Company held a continuation vote (the "Continuation Vote") that, in line with the Directors' recommendation, did not pass. This vote was required under the Articles as the Company did not have a Net Asset Value of at least £250 million as at 31 December 2019. As the Continuation Vote did not pass, the Directors (as required under the Articles) convened a further general meeting of the Company on 17 September 2020 at which Shareholders approved the managed wind-down of the Company.

Investment objective and policy

On 17 September 2020, the Shareholders approved the adoption of a new investment objective and policy of the Company, as follows:

The Company will be managed with the intention of realising all remaining assets in the Portfolio in a prudent manner consistent with the principles of good investment management and with a view to returning cash to Shareholders in an orderly manner.

The Company will pursue its investment objective by effecting an orderly realisation of its assets in a manner that seeks to achieve a balance between maximising the value received from those assets and making timely returns of capital to Shareholders. This process might include sales of individual assets, mainly structured as loans, or running off the Portfolio in accordance with the existing terms of the assets, or a combination of both.

As part of the realisation process, the Company may also exchange existing debt instruments for equity securities where, in the opinion of the Board, the Company is unlikely to be able to otherwise realise such debt instruments or will only be able to realise them at a material discount to the outstanding principal balance of that debt instrument.

The Company will cease to make any new investments or to undertake capital expenditure except where, in the opinion of both the Board and the Investment Manager (or, where relevant, the Investment Manager's successors):

-       the investment is a follow-on investment made in connection with an existing asset in order to comply with the Company's pre-existing obligations; or

-       failure to make the follow-on investment may result in a breach of contract or applicable law or regulation by the Company; or

-     the investment is considered necessary to protect or enhance the value of any existing investments or to facilitate orderly disposals.

Any cash received by the Company as part of the realisation process prior to its distribution to Shareholders will be held by the Company as cash on deposit and/or as cash equivalents.

The Company will not undertake new borrowing.

Any material change to the investment policy would require Shareholder approval.

Prior to 17 September 2020, the investment objective and policy was as follows:

Investment objective

The investment objective of the Company was 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 achieved 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 included 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 have included (subject to the limit set out below) other types of investment (for example, equity or revenue- or profit-linked instruments).  The Company may have made investments through alternative lending platforms that present suitable investment opportunities identified by the Investment Manager.

Chairman's Statement

Introduction

I am pleased to provide Shareholders with my Chairman's statement, covering the interim results from 1 July 2020 to 31 December 2020.  Over the reporting period, the Company has continued to reduce platform and third-party debt.  Despite continued macro uncertainty caused by Brexit, wider geopolitical issues and the continuing Covid-19 pandemic, the target income has continued to be delivered for Shareholders and KKV Investment Management Limited (the "Investment Manager") has made a good start to returning capital as defined in the wind down plan presented to the Board. So far, the Secured Income Fund plc (the "Company") has returned 8.5p per share to Shareholders since the wind down proposals were adopted in September.

Secured Income Fund plc (LSE: SSIF) is a UK-listed specialist investment trust with a focus on secured investments that produce regular, collateralised income from investments made in a portfolio of loans to lower middle market companies in the UK and the rest of the world.

Performance

All loans underwritten since April 2017 are performing in line with expectations and there has been a marked improvement in performance over the reporting period after the initial impact of Covid-19 had been felt by our borrowers.  I am pleased to observe that amortisation and general trading conditions have improved.

For the reporting period ended 31 December 2020, the Company generated a net profit of £0.8 million comprised of earnings per Ordinary Share of 1.56p (compared to loss of £0.9 million and loss per Ordinary Share of 1.73p for the year ended 30 June 2020).  The Company's NAV at 31 December 2020 was £41.3 million (78.26p (cum income) per Ordinary Share) compared to £45.5 million (86.37p per Ordinary Share) as at 30 June 2020.  The fall in the NAV was due to the payment of dividends of 9.67p in the period, with a total return for the reporting period of 1.8%.

Foreign exchange hedging was removed in September 2020, with details of USD and EUR exposure published in monthly factsheets allowing Shareholders to make their own hedging arrangements as appropriate. As a result of this investors should be aware that there might be some impact on the Company if FX markets move markedly.

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

Corporate Activity

As reported in the full year accounts, on 5 June 2020, the Company novated the contract to manage the portfolio to KKV Investment Management Limited, following the management team into their new entity.  Continuity of management has been maintained with the same core team responsible for the portfolio, this allows for the smooth run-off of the portfolio as it starts the process of wind down.

Upon the recommendation of the Board, in June 2020, Shareholders voted for the Company to go into a managed wind down.  This decision was made after the Company was unable to raise new capital and meet its original goal to increase shareholder capital to £250 million by December 2019.  The Board of Directors and the Investment Manager have begun work on an orderly wind-down of the business and have made a good start on the return of capital to investors expeditiously, avoiding capital erosion where possible.  No new underwriting commitments have been made and arrangements were made for loans to begin amortisation in line with contractual terms.

Costs have been monitored carefully and management fees were renegotiated to reflect the wind down status of the Company, details of which were reported in my last report and commenced on 17 September 2020.

Dividends

The Company elected to designate all dividends for the period ended 31 December 2020 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 a consequence of the decision to proceed with a managed wind-down, the Board reviewed the dividend policy and decided to cease paying monthly dividends, paying quarterly dividends instead, as well as returning excess capital as and when the Company has excess cash reserves available for distribution.  Since September 2020, the Company has been able to make distributions equivalent to 8.5p per share, with a total of 9.67p per share being paid in the period.

Capital Distributions

Given the better than expected outlook for distribution of capital, the Company has considered the method used for future distributions.  After careful consideration and discussions with a number of Shareholders, the Board believes that one of the fairest and most cost-efficient ways of returning substantial amounts of cash to Shareholders is by adopting a B Share Scheme, whereby the Company will be able to issue redeemable B Shares to Shareholders. These are then redeemed on a Redemption Date without further action being required by Shareholders. The Board also intends to continue to make dividend payments, where possible, in accordance with the Company's dividend policy.

The quantum and timing of a Return of Capital to Shareholders following receipt by the Company of the net proceeds of realisations of investments will be dependent on the Company's liabilities and general working capital requirements. Accordingly, any Return of Capital will be at the discretion of the Board, which will announce details of each Return of Capital, including the relevant Record Date, Redemption Price and Redemption Date, through an RNS Announcement, a copy of which will be posted to Shareholders.

The adoption of a B Share Scheme will not limit the ability of the Company to return cash to Shareholders by using other mechanisms and, if the B Share Scheme is adopted, the Board will continue to review its tax effectiveness and cost efficiency over time. The Board's proposal to adopt a B Share Scheme at this point in time should not be taken as any indication as to the likely timing or quantum of any future returns of cash to Shareholders and Shareholders should not conclude that returns of capital over the next few months are likely.

Notice of a General Meeting of Shareholders was published on 26 February 2021 and I am pleased to report that these arrangements were accepted by Shareholders.

Discount

During the reporting period, the Company traded at an average discount to NAV of 17.6%.

Board of Directors

There have been no changes to Board composition during the reporting period.

Outlook

The outlook for direct loans held in the portfolio has improved since my last report and this trend is expected to continue as businesses have adjusted to the challenges of the Covid-19 pandemic.

The Board still expects the wind-down plan 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 wind down process.  However, as stated, we have already taken steps to reduce costs and will continue to do this over the coming months.  As we have already outlined in the full year report, our goal in the managed wind-down is to achieve a balance between maximising the value received from those assets and making timely returns of capital to Shareholders.

Market conditions have continued to be challenging but the immediate risks to the portfolio, as presented at the start of the pandemic in Q1 2020, have largely dissipated which is a testament to the careful management of borrower relationships by the Investment Manager.  However, the Investment Manager remains vigilant and is mindful of the challenges posed by any reduction in furlough and bounce back policies that have greatly assisted some of our counterparties.  As always, we shall keep investors informed of any developments as they occur, in the months to come.

We thank investors for their continued support and hope that the consistent high level of income and the healthy start to the wind down of the Company is welcomed by Shareholders.

David Stevenson

Chairman

23 March 2021

Investment Manager's Report

Overview

KKV Investment Management Limited ("KKV") assumed investment adviser responsibility for the Company on 5 June 2020.

Following the decision by Shareholders not to support continuation, we are working hard on plans to return capital to Shareholders in as expeditious way as possible without damaging capital value.  Since the wind down of the Company commenced in September 2020, we have returned 8.5 pence to Shareholders via dividend distribution and we continue to accumulate cash enabling us to continue with this policy.

We are again able to report that the Company has continued to reduce the overall legacy exposure to 14.3% with peer to peer lending making up only 0.5% of the portfolio.  IFRS 9 impairment provisions have been increased on legacy investments and now stands at 7.7% of the total NAV value. We have revised our IFRS 9 policy to reflect an industry standard approach and have provided full details of this further in the report.  Note that the difference in provisioning was less than 1% when implemented in November 2020.

The Company remains unlevered for investment and working capital purposes.

Despite the challenges of Brexit and the Covid pandemic, we have not had cause to impair our direct loan exposures to date and have observed a marked improvement in trading conditions for all our borrowers, particularly from our wholesale investments. Therefore, the Company has not credit impaired any direct loan exposures to date.

Business Update

KKV is owned by Kvika banki, an Iceland bank specialising in asset management with a total of £3bn assets under management with KKV representing 9% of this total.

Despite the continued disruption to business due to the Covid pandemic, we are pleased to report that the Company has been able to deliver operational management with few glitches with all employees equipped to work remotely throughout the period. All processes are functioning and business continuity has been maintained to a good level.

Fund management responsibility has been consistent since April 2017.  During the reporting period, we have recruited further fund management personnel to replace and enhance our capability within the team.

Max Zorza joined the business on 1 November 2020 assuming the role of Chief Operating Officer.  He previously held the role of Global Chief Risk Officer for Architas Multi-Manager (part of the AXA Group) and brings extensive operational experience to the firm. He has joined the board of KKVIM and, alongside colleagues from Kvika Securities Limited and Kvika banki hf, completes our management team reporting to Ken Hillen, executive chairman.

Portfolio

There are eleven direct loans in the portfolio with an average of £3.0m balance outstanding per loan and at an average interest rate of 10.8%.  Each loan has a bespoke legal documentation and is designed to fit to the Company's and the borrower's requirements.  There have been no defaults in this portion of the portfolio underwritten by KKV although we should caveat this statement with a warning that as the pandemic continues we may see cause for prudent impairment.  At present and where required we have provided covenant and amortisation relief or maturity extensions to our borrowers.  In accordance with IFRS 9 guidance provided by the PRA, we have not applied write downs to these loans.

There is £5.9m now held in the legacy part of the portfolio, where we have differentiated between peer to peer loans and those that are held in loan note structures with professional counterparties.  These latter loans are larger in quantum and we have a closer relationship with the underlying companies (further details relating to these investments is provided later in the report). The total number of loans via third parties have been reduced from 213 to 8 (April 2017 to December 2020) with a small number of loans amortising down each month. As mentioned above, peer to peer lending now represents only 0.5% of the portfolio with the majority of the exposure impaired 100% as at the end of the reporting period.

There were no breaches of investment guidelines during the reporting period.

As the portfolio in now in wind down, we have been focussed on urging our third-party borrowers to repay debt.  As stated in the last full year accounts, we have begun to return capital to Shareholders via dividend payments.

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 sensitivity reasons.

SME Loan company (Borrower 1) - 24.2% of NAV

This is the largest individual facility provided by the Company and has been in place since May 2017.  This is a long-established lender to the SME market. The loan is an interest only and upon maturity, the debt amortises over nine months.  This amortisation commenced in January 2021 and the borrower has been able to increase the capital repayments, allowing us comfort that they will be able to repay their facility in full and on time.

Irish SME and Leasing Fund investment (Borrower 2) - 11.1% of NAV

This portfolio of 26 loans has continued to perform well despite the wider economic downturn.  They had positioned the portfolio for a Brexit impact with large exposures to Tech and Education.  In December 2020, they were able to report a 15.6% gross IRR (12.0% net IRR), this having risen from 8% in March 2020.  An independent review of their book subsequently caused an aggressive mark to market of their loans.  All of this mark down has now been recovered.  The majority of loans are delivering income and the manager has been able to make healthy distributions to the company during the reporting period.  The fund is now in its harvest phase and we expect capital distribution to accelerate as loans mature or are refinanced.

US healthcare services company (Borrower 3) - 10.7% of NAV

This credit was underwritten in December 2019.  The company specialises in ancillary medical services to a number of hospitals in the American Midwest including optometry, audiology, dentistry and podiatry.  Security is provided by debenture over all assets other than accounts receivable (although considered to be of low value), a pledge over equity which may not be diluted and a parental guarantee over all scheduled interest and principal repayments. This last element is the most important given the weaker balance sheet of the underlying business.  They have met all interest payments and have commenced amortisation on time.

This direct loan was considered of greatest risk of default when the pandemic started given the nature of business and so we have monitored receivables very tightly.

Media financing (Borrowers 4 through to 8 and Borrower 10) - 29.2% of NAV

Over the course of the last three years, SIF has funded 8 films, two of which have been fully repaid and loan obligations met in full. The remaining six are at various stages of filming and distribution.

At the beginning of the pandemic, as lender we recognised the risk that tax credits and distribution sales may be delayed and noted the cancellation of a number of film festivals when sales activity is at its most productive. We expected the shortfall in airline broadcast and cinema sales to be somewhat compensated by online content providers such as Sky and Netflix.  In reality, we had one tax credit due during May and this was paid in time by the Mexico tax authorities.

We duly offered three months extension to the timetables originally set for these projects and monitored the progress of each films.  As at July, we have further extended and fully documented the maturity dates for these loans by 12 months to allow for a longer period of repayment.

All six loans are individual facilities and are ring-fenced as individual risks. However, to mitigate the volatility of performance on individual projects, we had allowed for a waterfall structure to allow for profit share from higher performing assets to contribute to the overall repayment of the whole portfolio. It is the managers view that this mechanism will allow for all loans to be repaid in full over the extended period granted.

As at December 2020, we have noted an uptick in distributions from sales and tax credits for our portfolio of films. Three of our films have received critical acknowledgment and benefitted from significant media coverage, especially as it was one of the first feature films after the first lock down. We closed out an FX hedging facility for one of the dollar denominated films when FX rate movements allowed, reducing the administration and capital requirement associated with this position.

UK leasing company (Borrower 9) - 3.6% of NAV

This loan has been underwritten since July 2017 on a rolling twelve month basis. It is a working capital facility to be used to warehouse deals financed by block facilities already in place. The loan is supported by a debenture and the company provides quarterly management accounts and full year audited financials.  The underlying portfolio comprises a basket of loans split between two types of lending; 85% asset finance/leases with a typical deal size of £15,000 and 15% professional loans to white collar industry professionals supported by personal guarantee.

Performance from the loan book has been strong and to date they have not experienced further stress during the second lock down.  The borrower has commenced amortisation and they are meeting all interest calls on time.

LED manufacturer in Ireland (Borrower 11) - 0.9% of NAV

This is a secured term loan that has been in place since May 2017 and is secured by a guarantee from the parent company, a debenture over the borrower and a charge over equipment purchased via Capex portion of the facility.

Their business has operated on a business as usual basis throughout the lockdowns.  The borrower changed some working practices to allow for split shifts and those who are able to work from home are doing so.  The supply chain is working and customers continue to operate.

After granting a six month amortisation deferral, the borrower has recommenced repayment of capital and we are discussing an early refinance of the facility.

Legacy portfolio

Co-Investments

We continue to separate pure peer to peer, technology platform-based lending from the three investments that are characterised by professional co-investment alongside other professional investors.  After significant corporate change for all three of these latter types of investment, we provide the following narrative:

UK Venture Debt (Borrower 12) - 8.8% of NAV

This business has stabilised and made very good progress in winding down the portfolio.  We are now at a stage where only three loans remain in the Loan Note structure and we are in negotiation to allow for these loans to be managed under a different corporate structure and capital to be returned to Shareholders.  This will leave one loan, the largest position in the portfolio, a broadband company, which had previously been restructured.  We shall arrange for the loan to be held as a direct investment and receive deferred income on a sale within the next two years.

As the portfolio runs off, we have received £3.8m cash over the last six months to December 2020, leaving a balance of £3.6m.

UK Offshore platform (Borrower 13) - 3.8% of NAV

The final credit from this platform has been in place since early 2017 and is a real estate linked loan to a developer on the island of Gibraltar.  It is senior in a stack of other loans underwritten by the platform itself.  After two years of careful monitoring and pressing for repayment, we have now been given notification that this will be repaid in full with accrued and penalty interest.  Throughout the period of delinquency, we had not impaired the loan as to do so would have encouraged the borrower to urge us to take a haircut on final settlement.  Our senior position ahead of the platform lender also gave us comfort that the loan would be repaid in full but this has required patience and perseverance.  This engagement continues and we are in weekly contact with the financiers and platform to monitor progress.  The platform remains confident that this loan will be repaid in full.

US business promissory note (Borrower 14) - 1.1% of NAV

This loan is a working capital facility via a promissory note with a maturity to July 2020. The borrower has been unable to settle the loan and we have since been in protracted negotiations regarding the reprofiling of the debt.  At the time of writing, our expectations and those of the borrower are not the same and we shall explore other options for repayment.

Small company bond platform (Borrower 15) - 0.0% of NAV

The only outstanding debt from this platform was a recruitment business that had undergone a protracted recovery process through the courts. This loan is fully impaired.

Peer to Peer

During the reporting period, the Company has been able to reduce the number of peer to peer loans in the portfolio from 14 to 5.

UK peer to peer loan platform (Borrower 16) - 0.5% of NAV

The platform is slowly amortising down with 9 loans being repaid over the reporting period and only 5 loans remaining on the platform.  Two of the largest loans are 50% and 80% impaired and represent 99.1% of the total outstanding balance.

Spanish peer to peer loan platform (Borrower 17) - 0.0% of NAV

We have assigned zero probability of any further collections on the remaining 7 loans within the portfolio.  We continued to push for some return from these loans but after receiving a number of liquidation confirmations, we concluded that there was very little probability of recouping any further capital.

US peer to peer business (Borrower 18) - 0.0% of NAV

The final outstanding balance of this position has been fully impaired and we have assigned no further ability to recoup funds from the platform.

IFRS 9 Policy

In relation to IFRS 9 provisioning, KKV have implemented a revised and robust systematic grading system to reflect the need to assess risk consistently, taking into account market conditions and probability of default per credit.  This uses a ten-stage categorisation methodology.  We have decided to increase disclosure of our credit policy for Shareholders to achieve a clear understanding of our approach.

Our credit model is designed to put each asset into a risk category based on the probability of default.  Credits are then individually assigned an expected loss given default ("LGD"). Inputs include specific data describing the characteristics and attributes of each loan.  Certain of those loan characteristics will be used to generate the Probability of Default ("PD") and the LGD.  This provides a firm basis for comparisons across borrowers and collateral types.

KKVIM Probability of Default Grades:

Loans secured by realisable assets have an expected loss quantum based on the underwriting criteria for the respective collateral type.  Loans that are more than 90 days in arrears will typically become Stage 2 assets unless this is for exceptional circumstances. Loans are categorised as in default, and hence Stage 3, when they are over 180 days in arrears and have no credible plan to catch up.

For LGD purposes if the assets supporting the loan are not easily realisable e.g., fixed plant, we assume on default that the business has failed and therefore the recovery will be equivalent to an unsecured loan.

KKVIM LGD (Loss Given Default) Approach:

The percentage provision under IFRS 9 for a facility is this LGD multiplied by the credit rating Probability of Default as allocated above.

At the time of writing, the economic effects of the pandemic seem likely to continue for some time and we will therefore keep these provisions under regular review. Having observed some improvement in debt service on our Stage 1 loans from June 2020 onwards, we have not identified any marked increase in overall volatility as the second wave of the pandemic began in Q4, 2020.  However, we continue to monitor the portfolio carefully and it would be unwise for us to ignore the elevated risk that this uncertainty represents to our borrowers and to not flag the possibility of further loan loss provisions we may have to apply in the future as the global economy braces itself for further economic contraction.

Outlook

The reporting period has been a relatively quiet one in relation to credit events and we are confident that we will be able to return capital to Shareholders under the plan presented to the Board at the time of the EGM.  In some circumstances, this timetable will be shortened by our careful management of relationships and encouragement to refinance.

All things considered, the loan book has held up very well and we have made good progress in returning capital to our Shareholders in an efficient and expeditious manner.

We would like to thank Shareholders for their support and look forward to sharing further updates on the progress made on wind down in future months.

Dawn Kendall

KKV Investment Management Ltd

23 March 2021

Principal Risks and Uncertainties

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, are set out below:

·       macroeconomic risk;

·       credit risk;

·       platform risk;

·       regulatory risk; and

·       reputational risk.

Further details of each of these risks and how they are mitigated are discussed in the Principal Risks and Uncertainties section of the Strategic Report within the Company's Annual Report for the year ended 30 June 2020.  The Board believes that these risks are applicable to the six month period ended 31 December 2020 and the remaining six months of the current financial year.

Covid-19

The Covid-19 pandemic is a risk to the global economy. Details of the macroeconomic impact, as it may affect the Company, are provided in the Chairman's Statement and Investment Manager's Report.  The Investment Manager and Administrator invoked their business continuity plans to help ensure the safety and well-being of their staff thereby retaining the ability to maintain business operations. These actions helped to ensure business resilience.

The situation is changing so rapidly that the full impact cannot yet be understood, but future cashflows and valuations are more uncertain at the current time, and may be more volatile than in recent years.  Indeed, the level of estimation uncertainty and judgement for the calculation of expected credit losses has increased as a result of the economic effects of the Covid-19 pandemic. However, the impact of defaults that might occur in future under different economic scenarios has been reflected in various models to enable the Board to evaluate the Company's viability, and the Directors believe that the Company is well placed to survive the impact of the Covid-19 pandemic, thereby enabling the Company to realise its assets in an orderly manner.

On behalf of the Board.

Governance

Statement of Directors' Responsibilities

The Directors are responsible for preparing the half-yearly report and condensed financial statements, which have not been audited or reviewed by an independent auditor, and are required to:

·      prepare the condensed half-yearly financial statements in accordance with International Accounting Standard 34: Interim Financial Reporting, as adopted by the European Union, which give a true and fair view of the assets, liabilities, financial position and profit for the period of the Company, as required by Disclosure and Transparency Rules ("DTR") 4.2.4 R;

·      include a fair review of the information required by DTR 4.2.7 R, being important events that have occurred during the period and their impact on the half-yearly report and condensed financial statements and a description of the principal risks and uncertainties for the remaining six months of the financial year; and

·      include a fair review of information required by DTR 4.2.8 R, being related party transactions that have taken place during the period which have had a material effect on the financial position or performance of the Company.

The Directors confirm that the half-yearly report and condensed financial statements comply with the above requirements.

On behalf of the Board.