Zuberka
Introduction
I’ve just lately been growing my publicity to the extra senior securities within the capital stack of CLO CEFs. In a current article I mentioned a sequence of most well-liked shares issued by Precedence Earnings Fund (OTC:PRIF) and as the time period most well-liked shares of that CLO-equity centered CEF yielded 8.75% to maturity, I wished to take a look at one other CLO Fairness heavy CEF. Eagle Level Credit score Firm (NYSE:ECC) is the CLO Fairness heavy sibling of Eagle Level Earnings (EIC) which predominantly focuses on CLO debt.
On this article I’ll predominantly give attention to the time period preferreds and child bonds issued by Eagle Level Credit score, primarily as a result of I need to scale back the chance and I’m very happy to just accept a decrease return to compensate for the decrease threat.
The popular dividends and time period notes get pleasure from good protection ratios
Within the first quarter of this yr, Eagle Level Credit score reported a complete funding earnings of $40.8M and whole bills of $17.4M for a internet funding earnings of $23.4M. As you possibly can see beneath, the curiosity bills and time period most well-liked dividends are included within the working bills, apart from the Collection D most well-liked shares as these don’t have a agency maturity date.
ECC Investor Relations
The picture above is essential because it clearly reveals the online funding earnings earlier than taking the popular dividends and the curiosity bills under consideration was roughly $27.6M and ECC wanted lower than 1/6 th of that quantity to cowl the funds on the time period most well-liked shares in addition to the child bonds. This additionally means the CEF can simply cowl in extra $20M per quarter in losses on its funding portfolio earlier than jeopardizing the popular dividends and curiosity funds. Contemplating the entire funding portfolio is lower than $1B, I dare to say the house owners of the popular securities and debt securities ought to be well-shielded from potential defaults within the portfolio. Whereas investing in CLO fairness is inherently riskier than investing in CLO debt, the present returns on ECC’s positions ought to be ample to soak up the influence of above-average default charges.
And this brings us to the steadiness sheet. As you possibly can see beneath, the entire measurement of the steadiness sheet is nearly $1.1B with simply $280M in liabilities and a further $34M in perpetual most well-liked shares. The entire quantity of internet property attributable to the widespread fairness holders of ECC was $781.5M and that would be the first buffer in case issues go south. Of the $993M in investments, $725M consisted of CLO Fairness tranches.
ECC Investor Relations
Contemplating the entire internet funding earnings (excluding realized and unrealized positive aspects and losses on the portfolio) represents a a number of of the entire most well-liked dividends and curiosity cost necessities, and contemplating there’s nearly $800M in widespread fairness on the steadiness sheet, which ranks junior to the popular securities, I really feel comfy proudly owning the extra senior securities within the capital stack.
And naturally, take into account there’s a regulatory requirement to offer an asset protection ratio of 200% for most well-liked fairness and 300% for debt securities. As quickly because the ratio dangers dropping beneath that proportion, Eagle Level Credit score must take motion to treatment the state of affairs. So whereas the child bonds are ‘unsecured’, the 300% asset protection ratio requirement gives a further layer of security.
Zooming on a selected child bond and time period most well-liked share
Eagle Level Credit score presently has three sequence of time period most well-liked shares and three sequence of child bonds excellent. I’m personally extra within the child bonds for 2 particular causes: to start with, they clearly rank larger within the capital stack and can at all times be extra senior than most well-liked fairness. And secondly, as a overseas investor, curiosity funds are handled completely different than dividend funds. Whereas the diminished dividend tax price of 15% levied by the USA can also be legitimate on time period most well-liked shares, there isn’t any withholding tax on the dividends paid on the child bonds. After all, each investor’s state of affairs may be completely different, so that you shouldn’t hesitate to seek the advice of a tax specialist to determine what works finest for you.
I additionally wished so as to add period to my portfolio so my preliminary focus was on the 6.75% notes maturing in 2031 that are buying and selling with ECCW as ticker image, however the yield to maturity is simply round 7.2%. And that’s why the 2029 notes had been a bit extra attention-grabbing to me. Buying and selling with NYSE:ECCV as ticker image, these notes mature on the finish of January 2029 and have a 5.375% coupon. On the present worth of simply US$22.55 per child bond, the yield to maturity is a really respectable 8% (rounded).
Looking for Alpha
So whereas these child bonds mature two years sooner than ECCW, I just like the considerably larger YTM and the entire return on the remaining 4.5 years might be roughly 34% (rounded) and I can reinvest the proceeds in 2029 in one other safety (and maybe into the 2031 child bonds).
For buyers excited about receiving most well-liked dividends fairly than curiosity earnings, the 2031 time period most well-liked inventory buying and selling with NYSE:ECCC might be an attention-grabbing answer. Buying and selling at $22.31 per most well-liked share and maturing in June 2031, the yield to maturity is roughly 8.55%.
Looking for Alpha
Whereas I would like an 8% yield to maturity on debt over an 8.55% yield to maturity on most well-liked fairness, there are many reliable causes to desire ECCC. The maturity date is simply in 2031 which leads to a better whole return and an extended interval of 8%+ returns, whereas for some buyers it’s extra tax advantageous to gather dividends fairly than curiosity funds.
Funding thesis
I presently haven’t any place in Eagle Level Credit score nor in any of its most well-liked shares or child bonds. Nevertheless, I might be trying to provoke a protracted place. Ideally within the child bonds with ECCV as my choice however given the 200% asset protection ratio requirement, I don’t thoughts having publicity to the popular shares both.
