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Eagle Point Income Stock: A Unique Value In Our Current Environment (NYSE:EIC)

Eagle Point Income Stock: A Unique Value In Our Current Environment (NYSE:EIC)

Young Business Boy Making Pound Sterling

Young Business Boy Making Pound Sterling

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(This article was first shared several weeks ago with Inside the Income Factory members, trial subscribers, and others.

I wanted to share this idea quickly with our readers. While many funds are at a discount right now and their distributions may be higher than usual, I believe Eagle Point income (NYSE:EIC) may represent an unusual value.

As readers of my last article on EIC know, the fund is the safer, further-up-the-balance sheet sibling of Eagle Point Credit (ECC). ECC purchases equity of collateralized loans obligations (or “CLOs”) from the “virtual bank” that buys senior-secured floating rate loans syndicated by banks such as JPMorgan Chase and Bank of America, Citibank and Credit Suisse. For a primer on CLOs see my article “CLOs for Dummies”.

CLOs leverage their equity in the same way as real banks by 9 to 10 to 1. The top tranche in the case of banks is customer deposits (checking, savings accounts, CDs etc.). Many banks and/or holding companies issue lower-ranking “junior” loans, which are below the deposits in rank for payment but above the equity. CLOs can also have junior debt. This is typically rated triple B and double B.

EIC, the subject, participates in double B rated debt. This is the sweet spot within the CLO liability structure. Double-B ratings are the highest rung of the non-investment-grade rating ladder that runs from CCC- to BB+. Below that is “D”, which refers to debt that has not paid interest or principal.

CLO debt with a double-B rating must lose at least a portion of its equity. go to zero value. This has been very rare in the three- or four decades of CLO issuance. It is especially common in the CLOs issued in the decade following the crash in 2008/2009. In the history of CLO issuance, there have been very few double-B rated CLO paper failures.

EIC’s recent price drop (alongside most other funds) and its distribution just being increased means that it is now paying a yield rate of 9.3% at Friday’s market close (March 25, 25). I urge readers read my article from late last year to refresh their memories about EIC. EIC had just increased its distribution (October 2021), and was yielding slightly more than 8%. This seemed quite a bit considering the current market conditions and what other high-yielding funds were paying. EIC is now attractive at 9.3%. All of the things that I wrote back then about it still apply.

  • Powerful institutional ownership (67% for insurance companies and other heavy-hitters).
  • Credit history of CLO “BB” debt that is actually safer (i.e. has lower default rates than conventional corporate BB) but pays higher coupons than comparable corporate debt.
  • Yes, that’s right. Strange as it may seem when we expect our corporate credit markets to be relatively efficient.
  • Personally, I believe it’s a supply/demand aberration. Traditional institutional investors (pension plans and university endowments) don’t understand “securitized” vehicles such as CLOs and/or confuse them with the collateralized loan obligation (“CDO”) asset type, which contained poorly or fraudulently underwritten home equity loans and home mortgages. This confusion led to the 2008/2009 financial crisis.
  • CLOs are a completely different asset class than CDOs, despite having similar initials. CLOs are transparent and contain large syndicated loans to large corporations. They are fully rated for default and loss expectations.

Here’s a table that compares a number well-respected high-yield bond fund to EIC in terms their credit profile and current distribution yield. As a proxy for credit profiles, I calculated the percentage of each fund’s portfolio that was debt (i.e. bonds, loans, etc.) Double-B or higher rating. If you look at default statistics over many years, double-B has a demonstrably lower rate of defaults per year than debt issuers rated one-B or three-C. Single-B rated issuers default at rates that are many times higher than double-Bs. Triple-C’s default at rates that are many times higher as single-Bs. There are serious “cliffs”, as financial data people would call them, when you move from one rating to the next. Comparing funds based on their portfolio compositions can make a big difference in credit quality and default/loss expectation. This chart shows that Eagle Point Income has a better credit score than any of these high-yield bond fund funds. It has 67% of its portfolio in double B rated credits. The other funds, which are all fine funds, many which we have in our Inside the Income Factory model portfolios or in my personal portfolio, all have more risky portfolios than EIC’s because they all have a lower percentage of assets rated at least double-B.

High-yield bond fund comparisons

CEFConnect

EIC is the least risky of all the portfolios, but with a current distribution yield of 9.3%, it pays a higher yield that any other except Allspring Income Opportunities XEADX and PGIM International High Yield (GHY), which pay slightly less. This may be due to the market making them both pay more, as their coverage ratios have been a bit shaky in recent years. We’re waiting for up-to-date figures, to see if they’ve improved.

EIC is compared to highly regarded funds like BlackRock Corporate High Yield(HYT), KKR Income Opportunities(KIO) or Ares Dynamic Credit Allocations (ARDC), which, while all have excellent records, reputations, and clearly have riskier portfolios than EIC. This is based on their credit ratings profiles. EIC is priced at a level that makes it pay even more than it does. (I am a total fan of HYT, KIO, and ARDC in my personal portfolio, as well as some Inside the Income Factory models. This is not to disparage them. EIC may be a better investment in the current market.

As I stated above, I don’t think the market has any rational motives (i.e. EIC should pay less, but the market has no rational reasons (i.e. Income Factory and other investors seeking to make an “equity yield without equity risk” have a chance to reap the benefits of this potential windfall. We often refer to our high yield strategy, which allows us to collect our total return via a river of cash that we can reinvest and compound to generate our own income and portfolio growth without relying on a fickle market.

Take a look and let us know what you think.

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