Earlier I had read an article, which Bea Babbage also posted today on site, a Bloomberg article on CLOs.
Companies we follow on this site a bit, Eagle Point Credit (ECC), Oxford Lane Capital (OXLC) and Priority Income Fund (untraded), all are primarily focused on owning collateralized loan obligations (CLOs).
These companies issue term preferred shares to leverage their investments. Being closed end funds, these companies must have a coverage ration of 200% on senior securities (debt and/or preferred stock are senior securities), so this always brings a measure of safety to the preferred issues.
We have owned all of these term preferreds in the past and currently own a small position in the Priority Income Fund term preferreds.
This article from Bloomberg is simply ‘food for thought’–no predictions for disaster from me–nor should anyone sell any holdings they have based on this article–BUT everyone should know that there are risks in owning any higher yielding security.
For those without bloomberg access or just wanting perspective from a different source, Wolf Street blog covered the same ground today:
https://wolfstreet.com/2019/11/04/leveraged-loan-downgrades-spike-collateralized-loan-obligations-clo-get-cold-feet-trigger-selloff-b-rated-loans/
Thanks Landlord
Also, keep in mind the common shares of ECC and OXLC currently sell at a 31% and 19% premium respectively. Any problem and that premium will disappear in a flash. I would expect the preferreds to be impacted also, 200% coverage or not but not as badly as the common shares. JMO
Tim
Thanks the heads up. On a related issue, several of the national munie funds which I own have been going down marginally or sideways. Given their generally high level of security and declining interest rates, I would have assumed that these funds would rise in market price which does not seem to be happening. Any insights into why that might be? I ask as some liquidity events will take place shortly and was expecting to add to munie holdings but fail to understand the weakness. Or is it just some of my holdings? tia sc
I have noticed Muni CEFs coming down in the past month or so as well. Holding several from different providers – Pimco, Blackrock, etc…
Mostly California Munis + a couple of general Muni CEFs.
Would note that $PPS for almost all of them ran up 30% or more since end of 2018. Kind of staggering for dull, boring, Munis!
I started trimming around early summer, taking gains when I thought it was advantageous. Many CEFs proceeded even higher -:(
Considering that the 10Y note has started to climb, the drop in Muni prices makes some sense.
Also – just wondering about re-balancings? Its that time of year, usually lots of tax-selling or re-positioning happens.
I am waiting for Muni CEFs to fall 15 – 20% before adding.
steven
Many thanks your thoughts. You are probably right that end of the year tax selling could offer a better opportunity. That said, declines improve the yields which should attract buyers so not sure how this will work out. Would value your thughts on interesting national munie funds i.e. which ones might be worth considering at such a point. tia sc
O.T. : Tim what do you make of ATAX weak earnings? They barely covered the distro this qtr.
Re ATAX
Keep in mind that this quarter was a transition quarter as the gp recently sold. As such, thought that several actions might have been delayed until both managements become fully aligned. Moreover, the actual performance relative to a year ago probably not that bad. The company remains interesting. The key is how the new gp will do. best SC
TechGuy–sorry I don’t follow them closely. I checked them out years ago, but not recently.
Who knows why Bloomberg published the article when they did. They have an agenda, everyone does on Wall Street. You should assume that it is not consistent with yours.
I was surprised when I calculated what my Warren “Medicare for All” trading tax would be as currently proposed. And, I don’t trade very much.
Marc–we all know (I think) who pulls the strings at a Bloomberg company, but just the same investors would do well to be more aware of possible issues with CLOs sometime down the road.
Ha–I didn’t calulate my ‘warren’ trading tax, because I might be in all gold by then–who knows.
Maybe they’re wrong and totally clueless, but most professional investors are glued to their Bloombergs. I wouldn’t dismiss it as fake news. There are real issues with CLOs. The timing of the article is due to the recent spate of downgrades and lev loan blowups.
Maybe I’m missing something but what are you including when you calculate your “warren trading tax”? As far as I understand, the 2 proposed trading taxes would be the 1) taxing unrealized gains as they accrue, and 2) the financial transactions tax. However, as I read it, the transactions tax are for firms/institutions but not for “investors”. So,how can you calculate a tax on unrealized gains before you know how much in gains you have?
I am a trader / advisor. There are a lot of issues regarding a trading tax on securities.
As to CLO’s, anyone who owns a CLO product should best understand what vintage they own and have 100% transparency into how the varying tranches will react under market stress. If you do not have this information and cannot weather the storm then CLOs can be a very difficult asset to own.
200% coverage ratio means they won’t go bankrupt as fast. They could probably survive a minor meltdown though the price would drop to reflect increased risk. If there’s a major meltdown then nothing is safe.
It all depends on how fast the meltdown progresses. Once the 200% is violated, they will presumably sell assets and buybacks preferreds until they are back in compliance with the 200% requirement. As long as the bottom doesn’t completely fall out of the market suddenly, there shouldn’t be a problem with slowly selling assets to get back to 200% coverage.
200% provides an adequate margin of safety in my opinion such that it’s hard to imagine how things go wrong for preferred holders outside of conflicts of interest or negligent/fraudulent management. The 150% requirement for BDCs may not be sufficient which is why I swapped most of my PSEC baby bonds for PRIF preferreds. With BDC bonds, you don’t want BDCs with significant CLO exposure unless you’re getting paid for it (like I was when PSEC bonds were at par).
Try and take a look at ECC – they have 92 pct. CLO equity in their portfolio. On top of that they have 40 pct. leverage in their CEF. Never before have I seen a construction that put leverage on top of CLO equity. The equity tranche has approx. 10 x leverage in itself !!!. Of course many will argue that recoveries in senior bank loans have historically been around 70 pct. I don’t believe that will be the case next time. It will not take much market turmoil and/or defaults before investors can start to get nervous and start to wonder if their pref. are money good. Back in 08/09 most CLO equity pieces were marked down to between 0 and 10 cents on the dollar. Most recovered and CLO’s are not as risky today – but my guess would be that the underlying loans are riskier today than they were 10+ years ago.
No need to try and earn an extra 150 bp. on these CLO cef’s. Risks are high and difficult to quantify…
Tks for the article, sir. I have noted the 200% coverage ratio. That ratio mandate was not mentioned in the bloomberg article. What am I missing?