Tougher regulatory requirements that were introduced following the financial crisis have reduced the willingness of the banks to lend to UK small and medium sized enterprises (SMEs). This has created a lucrative gap in the market that a number of closed-ended funds aimed at income investors have sought to take advantage of.
A good example is Hadrian’s Wall Secured Investments (LON:HWSL), which floated on the London Stock Exchange last June. The fund raised £80m at launch and it has now allocated 96% of the net IPO proceeds. As soon as it is fully invested the objective is to pay a 6% annual dividend on the issue price of a pound a share and to generate a NAV total return of 7% to 8% per annum.
Like most other income orientated closed-ended funds the shares have moved on to a premium to net asset value (NAV). This currently stands at 11%, although even at this level they still offer an attractive prospective yield of 5.6%. The high premium adds an extra risk, although the Board has said that they would consider share buy‐backs if the price were to slip to a discount of more than 5%.
HWSL is run by International Fund Management Ltd, which is a part of the Channel Islands-based Praxis IFM Group, but responsibility for the investments has been delegated to Hadrian’s Wall Capital, which is staffed by an experienced team of credit investors.
Hadrian’s Wall Capital was created in 2010 to provide specialist investment advisory services in the credit markets. Their core experience is secured and structured credit in areas such as equipment finance, SME finance, infrastructure, property and residential real-estate.
The investment trust analysts at Winterflood point out that unlike peer‐to‐peer or market place lenders, the firm is actively involved in assessing the credit risk associated with individual loans, structuring the transactions and negotiating the associated documentation. This ensures that it is comfortable with the credit risk and retains control of the investment.
The fund will typically lend to businesses with revenues of between £1m and £25m, with these sorts of firms making up about 28% of the UK economy. Each loan will normally be up to a maximum of £6m, but they are all negotiated individually based on the particular circumstances. The biggest single investment is capped at 10% of the NAV.
Loans are secured against physical and financial assets and will only be made where the borrower has sufficient cash flows to afford the repayments. Most of the debts will have maturities of 3 to 5 years and will be sourced via the investment adviser’s network of contacts, which includes lending platforms, alternative finance providers and brokers.
At the end of March £74.8m of the £78m net IPO proceeds had been allocated. Of these, £52.6m had already been loaned out, with the other £22.2m being loans for which commitment letters had been executed with the deals expected to be closed before the end of April.
The £52.6m was comprised of eight direct loans to businesses, as well as 387 indirect loans. These represented investments in portfolios of smaller assets, such as loans and leases and were generally structured in a form consistent with other asset securitisation transactions.
In total the portfolio had a weighted average life at origination of 3.9 years with all the amounts secured at a weighted average loan‐to‐value (LTV) ratio of 77.5%. The yield was 8.9% and the biggest loan was £6.5m.
The five largest investments accounted for £18.7m or 24% of the assets. These had an initial weighted average life of between two and five years with the LTV ratios ranging from 52% to 93%. The biggest loan was to a property trading company that buys homes from people who are looking for a quick sale with the price being arranged at a discount to fair value.
There was also a 5-year £5m loan granted to a specialist car leasing business. The firm is using the money to help finance the purchase of the cars that are then leased on short-term contracts. This money is secured on a 93% LTV ratio that does not rely on the second hand value of the vehicles.
Attractive proposition for income investors
With all closed-ended funds it can be quite instructive to check the shareholder register to see who the biggest investors are. According to data from Winterflood Securities, at 12 April the five largest shareholders held 83% of its share capital. These included high quality long‐term investors such as Old Mutual, Invesco, Investec Wealth & Investment, and Premier Asset Management. It would seem logical to assume that these would be likely to maintain their positions in order to collect the ongoing stream of income.
One of the main downsides of the fund is that the costs are on the high side. The investment advisory fee is 1% per annum, but Winterflood estimate that the total ongoing charges would be around 1.5% based on the current fund size. The Board doesn’t currently anticipate borrowing money for investment purposes, although it can use debt to provide short-term liquidity and to buy back its shares.
The investment advisor is confident about the level of new investment opportunities and has recently announced that it intends to raise additional capital to take advantage of them. Further details are expected in the near future and if successful this would be expected to reduce the ongoing charges as the fixed element of the cost would be spread across a bigger asset base.
HWSL publishes its unaudited estimated NAV on a monthly basis and there is also a quarterly fact sheet and portfolio update to keep investors informed of the progress to date. The loans are included in the books at their amortised cost based on the fixed interest rate implicit in the loan agreement, so the NAV should be pretty stable.
The shares are only up about 7.5% on the launch price, mainly because it has taken most of the period to invest the proceeds, and the NAV has remained virtually static at around 98p. Two dividends totalling 0.6 pence have been paid to date, but Winterflood expect that the distributions will hit the target rate of 1.5p per quarter by the end of the second quarter of this year.
Hadrian’s Wall Secured Investments offers an attractive prospective dividend yield of 5.6% with quarterly distributions. If it successfully gets up to its target dividend of 1.5p per quarter in the next few weeks there is every chance that the shares could move on to a higher premium.