Investment Ideas | Innovative Income Investor

Kind of a Slow ‘Digestion’ Day

While the DJIA is up a fair amount the rest of the market appears to be digesting the giant gains from last week. Of course with the bond market closed equity markets tend to be a little quieter. Quiet is good as far as I am concerned–then I just collect dividends and interest.

Today I am going to look over the new 8% term preferred from Sound Point Meridian (SPMA). The company was formed in 2022 and just went public 6 months ago—the only thing I really now about them is that they are a CLO (collateralized loan obligation) owner and they buy primarily the equity tranche. The company was not using leverage up to this point so this term preferred is very well covered with the $456 million in assets (proforma–after the term preferred offering)–with a coverage ratio of around 9.

Not really certain we need another CLO company with all the others available–i.e. Eagle Point Credit, Eagle Point Income, Oxford Lane Capital etc., but with the super asset coverage on this one it would have the best ratio in the sector–worth a look I think.

BDC Capital Southwest Continues Good Performance

Today business development company Capital Southwest (CSWC) released their earnings and as I have come to expect their performance remained pretty darned good.

I have a meaningful position in the company’s 7.75% baby bonds (CSWCZ) which I bought when the bonds were sold in 6/23. The company has performed well for as long as I have watched them–maybe 2-3 years. The baby bonds mature 8/1/2028 so a bit less than 4 years.

I am mentioning this particular issue because it is the type of holding I like to have when interest rates are moving higher. 1st off it is relatively high yield. 2ndly it has an early call available to the company in 2025 (unless rates fall there are low odds of a early call) with maturity in 2028. The high yield helps to maintain pricing levels as interest rates move higher (as long as it doesn’t get crazy) while the maturity date will keep the price close to $25 even with higher interest rates. The issue just went ex-dividend 10 days ago and had been trading at $26–now at $25.65–I paid under $25 a few cents for it so I have capital gains. There is almost zero chance of me selling this issue unless the ‘wheels come off’ the company–a perfect fit for me.

So for my BDC holdings I like to look over the financials when earnings are released. I don’t dig into the details of which companies they are invested in–these are mainly smaller company’s that one has never heard of and it is not meaningful to me to look at each individual investment. I look at an overview of the types of loans they make–I want mostly most 1st lien senior secured debt–in this case CSWC has 98% in this category. Then I want to know the non-accruals – are they reasonable? CSWC has 3.5% of the total portfolio of loans on non-accrual which is a number that is acceptable for a BDC. investment income was down $3 million quarter over quarter–but reduced expenses of $1.5 million helped to offset the reduced investment income.

The net asset value per share is $16.59 as compared to $16.60 last quarter. It is not unusual to see net asset value fall quarter to quarter–a 1 cent fall is pretty good. If I were to see NAV falling 20, 30 or 40 cents in a quarter I would be pretty concerned as it would likely mean they aren’t covering their dividend.

With BDCs, just like the CLO closed end funds, I like to see the company sell equity with an ‘at the money’ share sale program. CSWC has $412 million available on an ‘at the money’ program and during last quarter they raised $20 million selling equity at an average price of $24.49. The more equity they raise the better they ‘cover’ senior securities like the baby bonds we own.

All in all a fine company—here is their investor presentation.

If the shares price were to fall another 25-30 cents I would add to this position.

Closed End Funds – 2 Interval Funds That Issue Preferred Stock

Reviewing the comments on the website leads me to believe that there is some hesitation by some to own senior securities (preferred stocks and baby bonds) of non traded Closed End Funds. I can understand the hesitation, most of which stems from a lack of understanding of some of those company’s that issue preferred stock as leverage for the fund. We have all been conditioned to watch prices of common shares of closed end funds as an indicator of the general health of company and thus the health of our preferred shares and related dividends and obviously we can’t do that with a non traded fund.

In particular, for us, this pertains to the preferreds issued by the Priority Income Fund and the new issue from Eagle Point Institutional Income Fund–both which are non traded funds. In this case both company’s are ‘interval funds‘. Interval funds are non publicly traded funds that sell shares continuously through investment advisors that make ‘tender offers’ monthly or quarterly to purchase a percentage of their shares from holders. These periodic ‘tenders’ are meant to provide a modest level of liquidity to investors.

I note that my research shows there are 92 non traded interval funds in existence.

Why non traded and why interval? These funds are meant to provide access to sometimes illiquid securities–i.e. real estate related investments etc. While the Priority Income Fund and the Eagle Point Institutional Income Fund are focused on the ownership of CLOs they are able to invest elsewhere in investments which are not liquid. Additionally non traded closed end funds often have ‘suitabilty’ restrictions, thus they are not suited for public trading.

The sale of common shares of non traded funds on a continuous basis is made at the net asset value of the shares—and the tender offers to buy shares periodically is made at net asset value. Of course when one buys shares through their investment advisor they may well pay a higher price – i.e it includes a commission (or load) of sorts.

The good part of these funds is that they file all their reports and information with the SEC so we have access to information continually (not daily, but at least monthly). These are not non reporting funds, just non traded. This is NOT a situation similar to AmTrust Financial where they do not file their financials with the SEC ever.

I own 2 issues of Priority Income Fund term preferreds and feel totally comfortable with monthly updates. Like any other CEF I want them to maintain a high asset coverage ratio – Priority is now at 320% (6/30/2024) which provides safety for senior security holders.

So I never recommend securities to anyone so this is not a recommendation to buy anything–but I don’t let the non traded status of a closed end fund deter me from a purchase of a senior security if it meets my investing needs.

Targeting 12% in the next 12 Months with This Investment Grade Preferred

I’ve started digging for issues where I believe I can garner at least a 5-6% capital gain and a 6-7% dividend while waiting for a year. The issues that I currently hold have probably maxed out a large share of their capital gains and are limited to the coupon return as we move down the road.

For instance I hold a position in the Affiliated Managers 5.875% subordinated note (MGR) which is trading right at $25/share and I have a 12% capital gain in the position. Obviously my yield on my cost is somewhat higher as I bought some shares at $20.59, but regardless any gains from this point forward are limited to 5.875%. Certainly shares can move higher, but I believe this issue will remain somewhat pinned to $25 as it is a target for being called if interest rates continue to move lower.

I have just bought the Brighthouse Financial 5.375% perpetual preferred (BHFAN) just now at a cost of $20.80/share for a current yield of about 6.5%. I am looking for this issue to move to the $22/share area over the course of the next year–a realistic goal I believe for an issue that is a split investment grade issue (BBB- from S&P).

Note that the Affiliated Managers baby bonds are in my sock drawer–but regardless they could be sold if it moves a bit higher.

The bottom line is that in order to move my returns up I need to add a bit more risk—so I will be looking for issues that I believe give me that 12% (more or less) potential for the next year.

Still the Reigning ‘Safety’ Closed End Fund Preferred–By a Long Ways

I try to watch the coverage ratio that each of the closed end funds (CEFs) have on their ‘senior securities’. As most of you know CEFs have to have a coverage ratio of at least 200% on their preferreds. If the value of their portfolio takes a steep stumble they might crack this rule and when they do they need to redeem shares until they are back in compliance (or alternatively sell a bunch of common shares).

The champion of all coverage ratios today – and for as long as I can remember is closed end fund Tri-Continental Corp (TY). TY has a 5% perpetual preferred outstanding (a $50/share issue with a ticker of TY- or TY-P or TY/P or TY.PR depending on the broker etc) which has been outstanding since 1963. The coverage ratio is OVER 4000%–does that spell safety? It is redeemable at any time at $55/share. Currently it is trading at $47.45 for a current yield of 5.27%. Obviously the low yield means one will forgo a couple percent of yield–BUT you never have to worry about the safety. SAFETY doesn’t mean the share price will always give you a positive total return. The preferred has traded as low are $18/share (or there abouts) back in 1972-1973—wish I would have been around then to ‘back up the truck’.

Why doesn’t TY redeem the shares? The redemption would only cost them $37 or $38 million. That has always been a question–maybe the board of directors own most of the shares? Who knows.

These shares trade rather thinly—around 990 shares per day according to Yahoo Finance. You have to use limit orders as it can move plus and minus $1/share

So if you want pure safety this one is for you. Disclosure–I have owned this one for years (and years)—I don’t sell it I just collect my dividends.

From time to time I update coverage ratios of all CEF preferred and baby bonds which one can see here.