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SQN Asset Finance reveals more problems in its portfolio

SQN Asset Finance reveals more problems in its portfolioSQN Asset Finance Income Fund has published accounts for the year ended 30 June 2017. The chairman points out that the fund is now three years old and has ben paying dividends consistently on a monthly basis (these totalled 7.25p for the year under review, up 1.8% on the prior year). The NAV of the ordinary shares edged up from 99.45p to 99.63p over the year. earnings per ordinary share were 8.58p.

Delays in  investing C share proceeds

As at the end of September 2017, the group has allocated approximately GBP53 million, of the 2016 C Share capital, between drawn and committed investments and an additional GBP12 million of transactions have been approved, together with a pipeline of GBP96 million. The chairman says that, for much of 2017, the market experienced a slowdown in activity linked, in part, to the uncertainty surrounding the United Kingdom’s exit from the European Union which caused businesses to delay making decisions on capital equipment acquisition, expansion, and renovation. Rather than assuaging those concerns, the surprise General Election, and its subsequent result, threw the market into a prolonged state of hesitation which has still not fully subsided. Consequently, the pace of deployment of the net proceeds of the 2016 C Share issue has been slower than anticipated. They say that they continue to invest judiciously and will not deploy capital in haste, but maintain their robust underwriting approach. They say that they are, fortunately, now seeing some pick-up in deal flow after the holiday season.

Good news overshadowed by Suniva

The managers’ report stresses that £113m of capital was deployed in the year at rates above 9%. Four transactions repaid early, representing approximately GBP10 million invested, all at yields at or above the originally anticipated rates including a 27.01% IRR on a GBP4 million investment in heavy hose manufacturing and turning equipment which originally  had a projected yield of 9.50%. the reports says: “The positive performance of the Group has been overshadowed by the events surrounding an investment made in solar manufacturing equipment for US-based Suniva“. We have covered this elsewhere.

This report says: “Under normal circumstances, which have already been demonstrated with other assets in the portfolio, if the debtor was unable to make payments, the equipment could be taken back and either re-positioned with another company or sold into the secondary market. With the amount of subordinated equity in the Suniva transaction, there should have been sufficient value in the equipment to cover the Group’s exposure and, if there were any shortfall, the corporate guarantee would be there to cover it with all accrued interest and penalties. 

The events that led to Suniva’s default involved a coordinated effort to circumvent or directly violate existing trade laws both in the United States and in accordance with the World Trade Organization. When an investment is underwritten, it can only be underwritten in the context that all market participants will operate within the established legal framework. This unlawful activity distorted the market which resulted in devastating harm to Suniva, the US solar manufacturing industry as a whole and the value of the equipment that secures the Group’s investment. All this in a very short time period.”

More problems in its portfolio

The report goes into some detail on SQN’s portfolio. There is good news and bad news in the statement. Most investments seem to be running to plan except for Suniva and:

The Group has provided GBP13.3 million of financing for four Jumbo Class Multipurpose Vessels built between 2007 and 2009 with a Dutch operator. Charter rates on vessels in this segment remained under significant pressure for the duration of the year and resulted in a pattern of consistent payment delinquencies. After having evaluated the situation, the Investment Managers and the Board came to the conclusion that the vessels should be sold at market prices to pay off the outstanding balances and close the investment. It is anticipated that the sale will take up to six months and that proceeds will cover all outstanding principal and interest. During the sale process, the debtor is continuing to make interest payments. Principal balance outstanding as at 30 June 2017: GBP12,915,750.”

The Group invested GBP13.1 million in a 2.5 MW gas to grid Anaerobic Digestion Plant in Peterhead, Scotland in co-operation with Scotia Gas Networks (“SGN”). The plant converts merchant waste, grass silage, and crops into bio-methane which is sold to Total Gas and injected into the national gas grid through SGN’s grid connection. The construction and commissioning had encountered some delays and missed milestones. The plant is operating though not yet at the warrantied level. The project will require approximately GBP2 million more in order to reach commissioning. The Group has agreed to provide this financing in exchange for increased equity warrants in the project to 44%. The Group expects to recover this additional investment under the warranties and EPC contract. The plant is estimated to be fully operational in the first quarter of 2018 at which time the approximately 14 year lease term will commence. Principal balance outstanding as at 30 June 2017: GBP15,275,160.”

The Group provided financing in the amount of GBP10.2 million secured by mobile, modular buildings used in the hospitality industry to serve as hotel rooms at different events throughout Europe. The investment was made in coordination with the operator’s plan to transition its business toward semi-permanent arrangements like remote worker accommodations and away from short-term rentals. The transition was intended to be completed over a period of two years. Management was changed in April 2016 and the Group was asked to allow interest-only payments from September 2016 to July 2017. The Group applied the security deposit to cover those payments and reduced the outstanding exposure to GBP8.2 million. Given the long-lived nature of the assets, a restructured solution is being worked out that better matches the current cash flow while amortising the debt. Principal balance outstanding as at 30 June 2017: GBP7,616,723.”

The Group invested GBP8.5 million secured by medical equipment for a new hospital in Green Valley, Arizona in the United States. The initial investment was divided between two equipment-secured notes; one with a term of 4 years and the other with a term of 5 years. The investment was further collateralised by a lien on unencumbered property owned by the hospital. The hospital encountered delays in securing crucial insurance reimbursements and, as a consequence, was unable to attract specialist doctors whose services were a meaningful component of the projected income of the hospital. As a result, the hospital filed for U.S. bankruptcy protection in order to reorganise while the insurance issues were resolved and specialist doctors are on-boarded. Given the crucial nature of the equipment financed by the Group and its long economic life, the Group and the hospital were able to reach an agreement within the bankruptcy court that keeps the equipment in place and protects the principal of the investment. The investment has been restructured into two notes with terms of 10 and 15 years which are secured by all of the assets originally financed under the notes and the equipment that was purchased directly by the hospital. The interest rate on the notes was reduced to 2.5% but the principal balance was increased by $1.0 million and a third note will be issued for additional accruing interest at 7.5% which is subordinate to other debts of the hospital. Principal balance outstanding as at 30 June 2017: GBP8,320,872.”

The Group invested GBP3.6 million in the senior portion of a portfolio of helicopters on lease to three separate lessees who in turn sub-lease the fully serviced helicopters to end-users that include military, government, medical, and corporate clients. During the year, one of the lessees filed for bankruptcy in the United States and the Group restructured the leases, extending the term and lowering the payments on four helicopters. Two helicopters, with a different lessee, came to the end of their respective leases and are now subject to purchase agreements over a term of 48 months at the expected values. Two additional helicopters have come off lease with one sold to a bank participating in the financing while the medical helicopter is being offered for sale in the market. The helicopter sold to the bank was sold below the projected value which was absorbed by the equity in the portfolio. Principal balance outstanding as at 30 June 2017: GBP3,925,920.”

The Group invested GBP3.5 million for the construction and lease of a portfolio of telecommunication towers located in Brazil for a company based in Florida in the United States. The investment was secured by an investment grade insurance policy with a reputable reinsurance syndicate that includes Hanover Re, PartnerRe, QatarRe, and Lloyd’s of London. The initial investment term was 14 months but the CEO of the company unexpectedly passed away which left the company in the control of a highly competent engineer who was also a partner. The company asked for an extension of the term while they reacted to the loss. The Group granted this extension and is now working with the remaining partner to sell the portfolio of towers as had originally been planned.”

SQN : SQN Asset Finance reveals more problems in its portfolio

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