FUNDING Circle’s dedicated investment trust has seen its largest-ever decline in monthly net asset value (NAV) returns, partly due to an underperforming cohort of UK loans.
The Funding Circle SME Income Fund (FCIF) saw its NAV drop by 1.4 per cent in November, which was attributed to the adoption of new IFRS9 accounting standards – meaning expected bad debts are included in performance data – and lower projected returns for loans provided in 2016 and 2017.
FCIF said that the NAV reduction was largely attributable to the IFRS 9 changes causing an impairment on the revaluation of its deal with the European Investment Bank, which invests in UK loans via Funding Circle’s platform.
The fund also cited high hedging costs on US dollar assets and increased running costs as headwinds.
This follows a reduction in Funding Circle’s projected returns for some of its UK loans originated in 2016 and 2017.
It said that while market conditions are “generally favourable” across all the markets it operates in, higher consumer insolvencies in the UK had had a knock-on effect on some of its loans issued in those years.
Funding Circle has reacted to this by adjusting its pricing and credit strategy, as recently flagged by the firm’s chief risk officer Jerome Le Luel in a blog post on the company’s website.
Analysts at Numis said the FCIF board is “taking a more conservative view on defaults rate than is implied by the Funding Circle statistics pages.”
Numis highlighted in an update that Funding Circle had said in the first quarter of 2018 that its mid-point projected debt rate would be 2.2 per cent and has since revised this to three per cent.
Funding Circle currently has a projected bad debt range of 2.5 per cent to 3.5 per cent on its UK loans.
The FCIF update added that its guidance takes a “cautious view on loan returns and prudently assumes no material reduction in operating or financing costs.”
In response to Numis analysts’ comments, Funding Circle chief executive Samir Desai said the platform was happy with its returns.
“We are pleased with loan performance across all four of our markets, with loans taken out since 2016 projected to deliver returns of between four and seven per cent per year,” he said.
“We recently announced two lending transactions in the UK and the US worth £1bn and $1bn respectively, which is a vote of confidence in the quality and risk-adjusted returns of loans on the Funding Circle platform.
“We are projecting loans taken out today to deliver returns of between five and eight per cent globally.”
FCIF lowered its expected NAV returns to four per cent next year and said it would maintain its annual dividend at 5.25p per share.
It comes after the fund issued revised guidance in June 2018 which cut the dividend from 6.5p to a range of 5-6p for the period to June 2019.
The fund has now returned 13.4 per cent since inception in November 2015.
The update also showed the FCIF board plans to further reduce its US exposure due to foreign exchange hedging costs and will seek approval to boost its investments on the German and Dutch Funding Circle platforms from 15 per cent to 50 per cent of gross assets.
The portfolio currently has 62 per cent of assets in the UK, 20 per cent in the US, 10 per cent in continental Europe and eight per cent in cash.
It said it will also start share buybacks in the secondary market to help boost its NAV.
The fund is currently trading at a discount to NAV of 15.1 per cent.
“These are disappointing developments for FCIF, with a write down to the November NAV and a lowering of guidance for NAV total returns to four per cent per year for the period to December 2019,” a note from Numis said.
“This has been fuelled by leveraged exposure to Funding Circle’s underperforming 2016/17 loans and the board taking a more conservative view on delinquencies, as well as the higher than expected costs.
“Significantly, the board has been more conservative than the Funding Circle statistics in an attempt to create a buffer on returns, given the uncertain outlook.
“We do not expect the discount to narrow until the fund can deliver a period of consistent returns, although it is positive to see the board seeking to support the discount via buybacks.”