Eagle Point Income Stock: A Unique Value in Our Current Environment (NYSE: EIC)
(This article was first shared with our Inside the Income Factory members and trial subscribers several weeks ago.)
I want to share this idea with our readers quickly because, while many funds are in price down right now and their distributions are higher than normal, I think Eagle Point Income (NYSE:EIC) may represent an unusual value.
As readers of my last EIC article will know, the fund is Eagle Point Credit’s (ECC) safer and higher balance sheet sibling. ECC buys equity from Secured Loan Obligations (or “CLOs”), the “virtual banks” that buy senior secured floating rate loans issued by large corporations and syndicated by banks like JPMorgan Chase, Bank of America, Citibank, Credit Suisse, etc. (For an introduction to CLOs, see my article “CLOs for Dummies”.)
Just like real banks, CLOs leverage their equity by about 9 or 10 to 1. In the case of banks, the top tranche is made up of customer deposits (checking and savings accounts, CDs, etc.). ). Below, many banks and/or their corporate holding companies issue more “junior” debt, which is lower than deposits in payment rank, but higher than equity. CLOs also have junior debt, which is usually rated triple-B and double-B.
EIC, the subject of this article, primarily participates in double-B rated debt, which is the sweet spot in the CLO liability structure. Below is “D” which applies to debt that has not paid interest and/or principal.
For double-B rated CLO debt to suffer even a partial loss, the equity of the CLO below it must be completely wiped out; i.e. go to zero value. This has happened very rarely in the three or four decades of CLO issuance, especially in the category of CLOs issued since the crash of 2008/2009. As a result, there have only been a relative handful of double-B rated CLO paper defects in the history of CLO issuance.
With EIC’s price falling recently (along with most other funds) and its distribution just increased, it is paying a 9.3% yield at market close on Friday (March 25). I urge readers to refresh their memory on EIC by reading my article from late last year. At the time (October 2021) I was somewhat excited that EIC had just increased its distribution and was returning just over 8% which seemed like a lot given the then prevailing market conditions and what the other high yield funds were paying. Now, EIC looks even more attractive at 9.3%, and everything I wrote about it back then still applies:
- Powerful institutional ownership (67% by insurance companies and other heavyweights).
- Credit history of CLO “BB” debt which is actually safer (i.e. has lower default rates) than conventional BB corporate debt, but pays higher coupons than corporate debt of equivalent rating.
- Yes, that’s true, strange as it may seem when we expect our corporate debt markets to be relatively efficient.
- Personally, I think this is a supply/demand aberration, where many traditional institutional investors (pension plans, university endowments, mutual funds) and their external boards, investment committees or shareholders either (1) don’t really understand “securitized” vehicles like CLOs, and/or (2) still confuse them with the asset class of debt-backed bonds (“CDOs”), which contained loans wrongly or fraudulently underwritten mortgages and home loans and helped precipitate the great crash of 2008/2009.
- CLOs, by the way, are a totally different asset class, despite their somewhat similar initials. Unlike CDOs, which caused so much trouble in 2008, CLOs are highly transparent, contain large syndicated loans to large corporations that are fully rated for default and loss expectations, and as an asset class has came through the crash of 2008/2009 in good shape.
Here is a chart comparing a number of well-known and highly regarded high yield bond funds to EIC in terms of credit profile and current distribution yield. As a proxy for the credit profile, I took the percentage of each fund’s portfolio that included debt (i.e. bonds, loans, etc.) rated double B or better. Double-B, if you look at default statistics over several decades, has a demonstrably lower level of default per year than single-B or triple-C rated debt issuers. In fact, single B-rated issuers tend to default at rates several times higher than double Bs, and triple C-rated issuers at a rate several times higher than single Bs, so there are serious “cliffs”. as financial data specialists would call them. , when you move from one ranking category to another. It really makes a difference in credit quality and default/loss expectations when you compare one fund to another in terms of the composition of their portfolios. As you can see in this chart, Eagle Point Income has a better credit profile than all of these other high-yield bond funds, with 67% of its portfolio in double-B rated credits. many that we hold in our Inside the Income Factory model portfolios and/or in my personal portfolio, all have riskier portfolios than EIC’s, given that they all have a lower percentage of assets rated double-B or more.
Yet even though EIC has the lowest risk portfolio, with its current distribution yield of 9.3%, it pays a higher yield than all but Allspring Income Opportunities (XEADX) and PGIM Global High Yield (GHY) which pay slightly higher at 9.4% and 9.6% respectively (which may reflect the fact that the market is making them both pay a little because their coverage ratios have been somewhat fragile recently and we expect numbers to day to see if they have improved).
But more interesting and relevant to our discussion here is the comparison of EIC with highly rated funds like BlackRock Corporate High Yield (HYT), KKR Income Opportunities (KIO) or Ares Dynamic Credit Allocation (ARDC), which, although they may have excellent records and reputations, clearly seem to have demonstrably riskier portfolios than EIC, when measured by their credit rating profiles. Yet the market has priced the EIC at a level where it pays even more than they do. (I own and am totally happy with HYT, KIO and ARDC, in my personal portfolio and some of our Inside the Income Factory models, and nothing here is meant to denigrate them. It’s just that EIC probably represents value still best in the current market environment.)
As explained above, I don’t think the market has rational (i.e. risk-based) reasons to charge EIC more, and the excess return simply reflects supply/demand aberrations. In short, there is a potential boon here for Income Factory and other investors looking to achieve what is essentially “equity return without equity risk.” This is how we often describe our high yield strategy of collecting our total return through a “river of cash” that we can reinvest and accumulate to create our own income and portfolio growth, without depending on “wish, wait and hope” for unstable flight. market to do it for us.
Watch and see what you think.