Eagle Level Credit score Inventory: Securing An 8% YTM With Its Child Bonds (NYSE:ECC)

Introduction

I’ve lately been rising my publicity to the extra senior securities within the capital stack of CLO CEFs. In a current article I mentioned a collection 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 needed 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 deal with the time period preferreds and child bonds issued by Eagle Level Credit score, primarily as a result of I wish to cut back the chance and I’m more than pleased to just accept a decrease return to compensate for the decrease threat.

The popular dividends and time period notes take pleasure in good protection ratios

Within the first quarter of this yr, Eagle Level Credit score reported a complete funding revenue of $40.8M and whole bills of $17.4M for a internet funding revenue 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, aside from the Sequence D most well-liked shares as these don’t have a agency maturity date.

The picture above is necessary because it clearly reveals the online funding revenue earlier than taking the popular dividends and the curiosity bills into 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 infant 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 overall funding portfolio is lower than $1B, I dare to say the homeowners of the popular securities and debt securities must 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 must be adequate to soak up the affect of above-average default charges.

And this brings us to the steadiness sheet. As you possibly can see beneath, the overall dimension of the steadiness sheet is sort of $1.1B with simply $280M in liabilities and an further $34M in perpetual most well-liked shares. The whole quantity of internet belongings attributable to the frequent 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.

Contemplating the overall internet funding revenue (excluding realized and unrealized beneficial properties and losses on the portfolio) represents a a number of of the overall most well-liked dividends and curiosity cost necessities, and contemplating there may be nearly $800M in frequent 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, have in mind there’s a regulatory requirement to supply 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 share, Eagle Level Credit score must take motion to treatment the state of affairs. So whereas the infant bonds are ‘unsecured’, the 300% asset protection ratio requirement offers a further layer of security.

Zooming on a particular child bond and time period most well-liked share

Eagle Level Credit score at present has three collection of time period most well-liked shares and three collection of child bonds excellent. I’m personally extra within the child bonds for 2 particular causes: initially, they clearly rank increased within the capital stack and can at all times be extra senior than most well-liked fairness. And secondly, as a international investor, curiosity funds are handled totally different than dividend funds. Whereas the lowered dividend tax charge of 15% levied by the USA can be legitimate on time period most well-liked shares, there isn’t a withholding tax on the dividends paid on the infant bonds. In fact, each investor’s state of affairs could be totally different, so that you shouldn’t hesitate to seek the advice of a tax specialist to determine what works greatest for you.

I additionally needed 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 fascinating 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 value of simply US$22.55 per child bond, the yield to maturity is a really respectable 8% (rounded).

So whereas these child bonds mature two years sooner than ECCW, I just like the considerably increased YTM and the overall 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 traders concerned with receiving most well-liked dividends somewhat than curiosity revenue, the 2031 time period most well-liked inventory buying and selling with NYSE:ECCC might be an fascinating resolution. Buying and selling at $22.31 per most well-liked share and maturing in June 2031, the yield to maturity is roughly 8.55%.

Whereas I would favor an 8% yield to maturity on debt over an 8.55% yield to maturity on most well-liked fairness, there are many reputable causes to desire ECCC. The maturity date is barely in 2031 which ends up in the next whole return and an extended interval of 8%+ returns, whereas for some traders it’s extra tax advantageous to gather dividends somewhat than curiosity funds.

Funding thesis

I at present don’t have any place in Eagle Level Credit score nor in any of its most well-liked shares or child bonds. Nonetheless, I might be seeking to provoke an extended 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.