A high proportion of floating rate investments has driven a 10% increase in the annual dividend for shareholders in Sequoia Economic Infrastructure Income (SEQI), the £1.6bn Guernsey-based infrastructure debt investor.

The portfolio has 58% in floating rate investments, which paved the way for a 10% increase in the annual dividend, from 6.25p to 6.875p.

‘The level of dividend cash cover has been increasing and has reached 1.21x for the financial year 2022/23, which is a significant improvement from 1.06x for the prior year,’ said Stifel analyst Iain Scouller.

‘The increase is due to a combination of rising short-term rates, as reflected in the uplift in the yield-to-maturity from 8.4% to 11.9%, and interest being received in cash that was previously capitalised, known as “PIK interest”.’

However, while the fund entitled its annual results ‘resilient performance despite volatile market’, Scouller commented that ‘it probably doesn’t feel like it’ for shareholders who saw the value of their shares drop 16.1% in the year to end March.

The shares moved from a 2% premium to a 14% discount to net asset value (NAV) against a backdrop of an increase in credit spreads and tighter lending conditions globally, driven by interest rates which rose ‘at almost unprecedented speed’, said SEQI chair Robert Jennings.

That was despite the board buying back 33.4m shares during the period, 1.9% of opening shares in issue. The discount has continued to widen to stand at 19.1% yesterday.

The fund’s NAV declined by 7.2% over the year, mostly reflecting the effect of higher interest rates and credit margins on loan values. When the dividend is accounted for, the NAV declined by 0.9%.

‘Well positioned’

Jennings said the fund is ‘well positioned’ in the current high interest rate environment.

‘We have demonstrated our resilience throughout the challenges of the last eight years and, our well-diversified portfolio, growing interest income and disciplined approach to capital deployment gives us confidence for our future,’ he said.

The fund’s investment manager pointed to weak high-yield bond and leveraged loan markets coinciding with the current risk aversion dominating bank lending, which makes borrowers ‘more willing to accept the additional pricing power enjoyed by alternative debt providers’.

Their ability to negotiate improved terms feeds through to favourable conditions for investors such as higher interest rates, fees, covenants and collateral provision.

A selective approach to new investments and limited funds means the manager is turning down more than 90% of the lending opportunities it comes across.

Loan impairments

However, scrutiny fell on the fund’s non-performing loans. Of the three non-performing investments previously identified, one has been exited at a loss. That leaves Bulb Energy, which collapsed into administration in the autumn of 2021, and a loan backed by the property at 4000 Connecticut Avenue, Washington (formerly called Whittle Schools). These represent around 3.3% of NAV.

However, the annual report revealed that 10% of the portfolio in total is subject to ‘enhanced scrutiny’ by the manager.

‘There also appears to be a number of other loans with uncertain cash flows which have suffered an impairment,’ said Scouller.

‘It would help if Sequoia gave more detail on these. For example, RM Infrastructure [RMII] has flagged an issue at a new hotel in the Glasgow area, in which it has a joint exposure with Sequoia, but Sequoia has not given any detail of any impairment on this.’

He also cast doubt on the expected pull-to-par – the accretion in loan valuations as they approach their repayment dates.

In monetary terms, the fund expects the pull-to-par to be ‘material’, pencilling in a total of almost 7p per share over the next few years. ‘[That] may be optimistic, in a more difficult operating environment,’ commented Scouller.

Nevertheless, he sees scope for the shares to re-rate ‘once the market sees through “peak” interest rates and the heightened impairment risk during this downturn’. Stifel has a ‘buy’ rating on the shares.