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Funding Circle SME Income Fund downgraded to 'sell' by Liberum

Liberum downgraded its rating on the fund to 'sell’ from ‘hold’ and cut its target price to 89p from 109p

Funding Circle
FCIF has been weighed down by higher hedging and operating costs

Funding Circle SME Income Fund Ltd (LON:FCIF) shares have weakened over the past week and have "further to go", according to analysts at Liberum.

Liberum downgraded its rating on the peer-to-peer lending fund -- separate from Funding Circle Holdings PLC (LON:FCH), which had a rough start to London trading in October -- to 'sell’ from ‘hold’ and cut its target price to 89p from 109p.

FCIF’s shares were changing hands at 96p each at the time of writing, down from 102p at the start of the week.

Liberum said the fund has a gross portfolio yield of about 10%, no management fee, low-cost debt, reasonable credit performance, and yet, the levered return is expected to be only 5-6%.

In comparison, the projected ungeared return for the Funding Circle ISA is 6-7%, the broker noted.

Hedging costs

Earlier this year FCIF warned that rising hedging costs would force it to cut its dividend to 5-6p, down from its current annual payout of 6.5p.

“The cost of hedging US Dollar denominated assets has increased materially since mid-2016 as interest rates have diverged,” Liberum said.

“The cost of hedging US assets is now circa 2% per annum.”

The broker said high operating costs and US loss rates were also a concern. It estimates operating costs, excluding loan servicing fees, were equivalent to 1.1% of net asset value in 2018.

Liberum noted that the fund has incurred high operating costs despite the advantage of not having to pay a management or performance fee due to its passive investment process.

It added: “In addition to the hedging costs for US loans, the high operating costs partly explains why the projected return from investing in the Funding Circle ISA on an unlevered basis is greater than what FCIF is currently producing.”

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