KKV Secured Loan says the most challenging period may still be ahead for its borrowers

The direct lending sector fund, KKV Secured Loan (KKVL), formerly SQN Asset Finance Income), reported its annual results for the year-ending period to 30 June 2020. In NAV total return terms, the ordinary shares delivered -56.1% and the C shares -25.0%. The period-ending discounts for the ordinary and C shares were 11.9% and 16.4%.

We note that KKVL announced plans last September for a full wind-down of the fund. You can access our story on this by clicking here, and a subsequent valuation update story we published last November by clicking here.

Market backdrop – ‘We expect coupon obligations to be put under pressure and forbearance to be the watchword
for the next 9-12 months’

KKVL’s manager noted the following in their review: “Highly volatile pricing of all assets across the risk spectrum and intermittent volatility spurts have been facets of all fixed income sectors during the reporting period. All fixed income products fell violently from March onwards and this was particularly severe for higher-yielding assets although even US Treasury bonds were affected briefly by a liquidity squeeze. Since the introduction of emergency market support packages from central banks, these markets have settled but the economic picture remains very uncertain. As developed markets in the US, UK and Europe began to ease lockdown measures, market commentators expected a so-called “V-shaped” recovery as businesses began to emerge from their forced hibernation. Our appraisal was more circumspect and despite spread tightening during the summer months for investment-grade credits, as companies shored up their balance sheets with additional borrowing, we were particularly focussed on data relating to SME performance and securitised products such as Collateralised Loan Obligations (CLOs) and lower sub-investment grade markets where the greatest pain had been observed. We expect coupon obligations to be put under pressure and forbearance to be the watchword
for the next 9-12 months.

SME business confidence has fallen sharply and lower turnover due to COVID-19 has caused severe cash flow difficulties for many businesses, increasing demand for working capital finance. This has been coupled with a sharp increase in demand for loans and the uptake of government-backed schemes encouraging commercial banks to lend into the sector. Easing of credit criteria for loans by these banks has a second derivative effect of weakening capital adequacy and it is our expectation that once market conditions begin to normalise, lending patterns will revert to more conventional levels, allowing alternative lenders to pick up the baton once again.

The speed of recovery is, however, unclear at the present time. By way of stark illustration, unemployment in the US increased by 14 million in six weeks at the height of the COVID-19 emergency, whereas the total number of those losing jobs in the recession between June 2008 and June 2009 was 3.5 million and it then took four years for employment to return to pre-recession levels. Reversal of lost jobs takes time for an economy to absorb and we, therefore, expect this to impact consumption and consumer confidence. For lenders and borrowers alike, the safest route to normalisation is to keep sustainable businesses alive with support and forbearance, including maturity extensions and interest or amortisation “holidays”, to enable them to resume trading and servicing their loans as rapidly as possible. Where we have identified a specific COVID-19 impact, this has been the approach we have adopted across our portfolios and is relevant to KKVL/X since our appointment in June 2020.”

‘In the process of an orderly wind-down but the most challenging period may still be ahead’

KKVL’s chair, Peter Niven, said the following: “The board and the manager have now begun work on an orderly wind-down of the portfolios and hope to return capital to investors expeditiously, avoiding capital erosion where possible. In anticipation of this, the board had instructed the manager to cease all new underwriting commitments from June 2020. We have also reviewed costs in recent months and have taken steps to reduce ongoing expenses going forward. Market conditions have been, and continue to be, very challenging.

When I wrote to you last, in early April 2020, the UK was locked down due to the COVID-19 pandemic and the path forward for the world economies was very unclear. We now know that the consequences have been very severe and protracted. It is heartening that there is the glimmer of hope that a medical solution will be available in 2021 but this has had an effect on a number of borrowers. It has also made it more difficult to engage with borrowers face-to-face and has worsened the environment in which we are all working. However, the manager considers that the most challenging period may still be ahead of us, with Q1 and Q2 2021 presenting continued risks to our borrowers.”

KKVL: KKV Secured Loan says the most challenging period may still be ahead for its borrowers

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