Overview and Investment Strategy

General information

SQN Secured Income Fund plc (the "Company" 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 listed on the London Stock Exchange Specialist Fund Segment on 23 September 2015 ("Admission").  On 28 April 2017, the Company changed its name from The SME Loan Fund plc to SQN Secured Income Fund plc.  In order to reflect the new name of the Company, the ticker for the Ordinary Shares was changed to SSIF, with effect from 2 May 2017.

Following the passing of resolutions at a general meeting held on 27 April 2017, the investment objective and investment policy was changed to the following:

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 intends to achieve 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 will 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.

Geography

The Company will invest 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 will invest 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 will hold 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 will seek to invest 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 will be indifferent to sector when allocating funds for investment and, instead, will adhere 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:

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 on 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.

Chairman's Statement

Introduction

SQN Secured Income Fund plc is an investment company listed on the LSE and domiciled in the UK.  It invests on a secured basis in and through small and medium sized companies in the UK and the rest of the world using fundamental credit skills.

I am pleased to update Shareholders with my second Chairman's statement, covering the period under review from 1 July 2016 to 30 June 2017.  Over the last year, the Company has undergone significant change, following a strategic review.  These changes include diversifying the Shareholder base through a successful secondary placing of the Ordinary Shares previously held by GLI Finance Limited, the appointment of SQN Capital Management, LLC and its UK subsidiary, SQN Asset Management Limited, (together "SQN"), as manager of the Company from 1 April 2017, a change of name and changes to the Company's investment objective and policy/strategy.  Under SQN's stewardship, the Company has been re-energised with the commencement of a direct lending programme.

Performance and Markets

During the early part of the reporting period, despite continuing to make platform investments, the Board acknowledged that dividend income would not be able to meet our previous expectations.  In April 2017, after the appointment of SQN as manager, we took steps to adjust the dividend policy for a short period whilst amendments were made to the portfolio.    By the end of the reporting period, SQN had made progress in rebalancing the portfolio and committing the surplus cash with the majority of investments being direct rather than via platforms, and with sufficient earnings from interest payments to support a regular dividend payment of 6.25p for the current financial year.

For the reporting period ended 30 June 2017, the Company generated a net profit of £2.4 million and earnings per Ordinary Share of 4.63p.  The Company's NAV at 30 June 2017 was £52.0 million and NAV per ordinary share 98.74p (cum income) compared with £53.4 million and 101.31p as at 30 June 2016.  The total return for the reporting period was 4.6%.

Foreign exchange exposure on the 21.4% of non-Sterling assets, as a percentage of total assets, was fully hedged and any liquidity calls arising from the hedging strategy are considered manageable within the Company's cash flow.

Corporate Activity

On 1 April 2017, management of the investment portfolio was transferred to SQN.  Details of SQN's strong credentials for performing this role are included in the Investment Manager's report.  In conjunction with the changes to the Company's investment management arrangements, our corporate broker also completed a successful secondary placing of the Ordinary Shares previously owned by GLI Finance Limited (representing 48% of the issued share capital) substantially with new investors.

At a general meeting held on 27 April 2017, the investment objective and the policy of the Company were adjusted to allow for greater concentration of investments in quality, secured direct loans.  In addition, the Board was authorised to allot up to 250 million Ordinary Shares and/or C Shares pursuant to a share issuance programme.  This share issuance programme will enable the Company to raise additional capital promptly, enabling it to take advantage of new investment opportunities, thereby expanding and diversifying its investment portfolio.  In turn, an increase in the market capitalisation of the Company should help to improve secondary market liquidity in the Ordinary Shares and attract a larger, more diversified Shareholder base.  The Company will be required to publish a prospectus before it can issue Shares pursuant to any Share Issuance Programme.

SQN committed to achieving a number of milestones (see Investment Manager's report) following their appointment and I am pleased to report that these have been achieved.  This leaves the Company at the end of this reporting period with a solid foundation on which to support future capital raisings.

Strategic Review

Following its appointment in April 2017 SQN completed a thorough strategic review of the Company's platform investments, resulting in a rationalisation of platform-originated or related investments.

At the time of SQN's appointment, approximately 31% of the Company's assets were in cash with the remainder already invested via platforms and through working capital loans to platforms.  Following the review, a decision was taken by your Board, in conjunction with the Manager, to cease making working capital loans to platforms and to reduce the number of platforms through which the Company conducts business.  The selection of preferred platforms has been made after an in-depth analysis of their credit processes and sector preferences, with a focus on diversification, "best in class" and transparency.  The Company is confident that relationships with these remaining platforms are strong and will continue to provide consistent attractive deal flow.  In the future, the Company expects the percentage of the Company's portfolio represented by platform-originated loans to reduce in favour of direct lending.  However, as the Company grows, it will continue to allocate to platforms meaningfully.

Earnings and Dividends

Dividends per Ordinary Share declared in respect of the reporting period were 6.375p (see Note 5).

The Company elected to designate all dividends for the year ended 30 June 2017 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.

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 to smooth future dividend flows.

The Company expects to achieve its annual dividend target of 6.25p, rising to at least 7.00p from July 2018, and a total return target of at least 8.0%.

Discount

From the commencement of the reporting period and until the announcement of SQN's appointment and the secondary placing of the Ordinary Share held by GLI Finance Limited on 8 March 2017, the Company traded at an average discount to NAV of 6.9%.  Since then, this discount has closed materially.  Given the substantial improvement in outlook for the performance of the Company and the radical changes undertaken, it is hoped that this discount will continue to narrow.

Change of Name

With effect from 28 April 2017, further to the appointment of SQN as the Company's manager and the change of focus to direct loans, it was considered appropriate to change the name of the Company from The SME Loan Fund plc to SQN Secured Income Fund plc.  The ticker for the Ordinary Shares changed from SMEF LN to SSIF LN on 2 May 2017.

Board of Directors

I am pleased to report that, after the changes made to the Board in the last reporting period, its composition has remained stable and no changes were made during the current reporting period.

The Board has made good progress in engaging with the new management team and have established regular communications in line with governance guidelines.

As the Board expects the size of the Company to increase substantially over the coming years it has decided to appoint an additional director. An independent search firm has been employed to find a suitable individual.

Outlook

The Board has made significant progress towards both improving corporate governance and the Company's internal control processes. Rationalisation of platform investments and increased secured direct lending have also been addressed.  Meanwhile the outlook for direct lending opportunities remains very promising and the Company has an abundant pipeline of investment opportunities to consider over the coming months.

After a period of turbulence, I anticipate that following the appointment of SQN as our Investment Manager, the Company will now fulfil its mandate of delivering stable income and a healthy risk-adjusted total return.

Richard Hills

Chairman

8 September 2017

Investment Manager's Report

Introduction

Welcome to the first Investment Manager's report under the stewardship of SQN Asset Management Limited ("SQN AM").  We assumed responsibility for this mandate on 1 April 2017 and I am delighted to report that we have already made meaningful progress.  We are confident that after a thorough strategic review and making our first few investments, the outlook for the Company is good.

SQN Secured Income Fund plc is an investment company listed on the LSE and domiciled in the UK.  It invests on a secured basis in and through small and medium sized companies in the UK and the rest of the world using fundamental credit skills.

SQN is a credit fund manager with a successful track record in managing assets within an investment company structure having launched the SQN Asset Finance Fund in July 2014.  The SQN Group has a total of circa £750 million of assets under management and has a core competency in credit management and we are suitably resourced to deliver income and total return in line with expectations.  Most significantly, we retain our own origination team within the SQN Group which enables us to build a good pipeline of new investment opportunities.  We have offices in the UK and the US.

The addition of SQN Secured Income Fund plc under the SQN umbrella is a perfect complement to the existing strategies managed by SQN, all focused on secured, credit-driven investments with security provided by underlying assets.  Deal flow for SQN Secured Income Fund plc is a natural progression of the existing SQN business lines which has historically been captured by entities with limited UK-focused capacity.  SQN Secured Income Fund plc now provides the opportunity to target these investments that we believe will produce above market, risk-adjusted returns and regular income.

In the short window since our appointment:

·      Dawn Kendall was appointed as managing director of SQN AM.

·      Amberton Asset Management Limited ("Amberton") was appointed as sub-manager to ensure continuity of relationships and smooth transition.

·      A review of the platforms has been completed with solid platforms retained.

·      Performance of remaining platforms has improved.

·      The remaining cash of 31% of the portfolio has been invested under the Company's revised mandate, focussed on direct investments.

·      A new business pricing structure has been created at rates between 9.5% and 11.5%, sufficient to increase overall portfolio yield to meet the return targets.

·      The majority of cash has been committed with a healthy pipeline of new opportunities supporting a future capital raise.

With the introduction of direct lending to the Company's portfolio, an enhanced risk management regime has been introduced.  SQN AM's investment approach recognises the significance of strong processes and a robust governance regime and, accordingly, each drawdown requires a "triple lock" sign off from its legal, credit and portfolio management teams. This is in addition to the extensive portfolio management and platform relationship capabilities SQN AM inherited within Amberton.

With the revision of the investment objective and policy of the Company, we have pursued investments in four core areas: secured trade finance, receivable finance, wholesale lending and secured commercial opportunities, including development loans and commercial property in growth sectors.    As is consistent with other SQN AM programmes, we aim to avoid consumer credit exposure.  We consider this to be a prudent approach that reduces risk of correlated performance with any macro-economic headwinds.

At the time of SQN AM's appointment, approximately a third of the Company's assets were in cash with the remainder invested via platforms and through working capital loans to platforms.  Following a review, a decision was taken to cease making working capital loans to platforms and to reduce the number of platforms through which the Company conducts business. The selection of preferred platforms was made after an in-depth analysis of their credit processes, sector preferences and pricing structures, with an emphasis on diversification, "best in class" and transparency.  The Company is confident that relationships with these remaining platforms are strong and will continue to provide good loan deal flow.  In the future, the percentage of the Company's portfolio represented by platform-originated loans is expected to reduce in favour of direct investments.  However, it is intended that platform-originated loans will continue to be an important part of the portfolio and, as the Company grows, should be of a meaningful size in the market.

Available cash has been primarily deployed into direct lending opportunities originated by SQN AM.  The nature of these direct investments is diverse and provides high levels of security with regard to covenant provision.  Each loan has been established making use of SQN AM's extensive network of industry contacts and all loans have been extended at rates of interest commensurate with exceeding the Company's target returns (a target annual dividend of 6.25p per share for the current financial year, increasing to at least 7.00p per share with effect from July 2018, and a target annual return of at least 8%).  Most pleasing is that loans are with businesses where the Company expects to nurture long term relationships as they grow.

In addition to targeting higher average yields, the investments made since the change of manager have also been of a longer duration keeping capital at work and reducing reinvestment risk and drag.  As at July 2017, a little more than 35% of the portfolio positions had investment terms of three years or longer with just under 20% between one and two years.  The current average term is less than two years but is targeted to increase now that the restrictive provisions in the operating documents have been revised and now allow for concentrations of more than 2.5% for any single exposure.  We believe, given the high-touch nature of direct investments and the extensive due diligence performed, appropriate diversification can be achieved with an average transaction size of circa 5% of the value of the Company.

Investment Outlook

Annual borrowing by UK SMEs is £75 billion and is used to fund various things including business expansion, purchase of premises, fixed assets or capital expense to develop new products and markets.  As reported by the Bank of England and the British Bankers' Association this demand is unlikely to diminish given the contraction of total bank lending to this segment of circa 15% over the last five years (2011 - £189 billion v 2016 - £164 billion).  High Street lenders (six banks) own more than 70% of this current lending pool.  Challenger banks have filled some of the void, increasing their loan exposure by 31.5% over the same period.  However, their target market is different to ours - their typical customers tend to be either much smaller or much larger. This represents a significant gap in the market for the Company, as our preferred pool is providing flexible and sensible financing to businesses with £5-20 million turnover per year.  We consider that we are well placed, when compared with our peers, to make material positive progress in this market.

Dawn Kendall

Managing Director

SQN Asset Management Limited

8 September 2017

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.  Prior to the change in Investment Objective, which was approved at the general meeting held on 27 April 2017, the Company invested in a range of loans originated principally through investee platforms with which the Sub-Investment Adviser is familiar.  Since the appointment of the new Investment Manager and the change in the Investing Policy, the Company has also increased its exposure 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 flow 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 and Sub-Investment Adviser monitor the recoverability of the loans (on an individual loan basis) each month and impairs loans where appropriate. 

Platform risk

The Company is dependent on platforms, for that reducing part of the loan portfolio originated through platforms, 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 and Sub-Investment Adviser undertake 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, Sub-Investment Adviser and other advisers.

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.

Details of the premium/discount of the share price to NAV are disclosed below.

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.

The Board believes that 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 three male Directors.  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.  Following discussions with the Investment Manager regarding the anticipated returns from the Company's portfolio (both in the shorter and longer terms), the Company rebased its annual dividend target to 6.25p per Share, increasing to at least 7.00p per Share with effect from July 2018.  The monthly dividend at the new rate of 0.525p per Share was first paid in June 2017.  Over the longer term, the Company will be targeting an annual net asset value total return of at least 8%.

The Company has (to date) announced dividends of £3,356,000 (6.375p per Ordinary Share) for the year ended 30 June 2017, being 86.0% of distributable income 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 2017, 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 which 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 2017 the shares were trading at 97.75p, a 1.00% discount to NAV.  However, the three month average share price was a 1.12% discount to NAV. 

Richard Hills

Chairman

8 September 2017