OXLCO & OXLCN - Oxford Lane Capital Corp Preferred Shares

[Guest MarkS]

Is anyone looking at the preffered shares of Oxford Lane Capital.  They have two series of cumulative term preffereds: an 8.5% Cum Term (2024) redeemable as early as 06/30/2017, and an 7.5% Cum Term (2023) redeemable as early as 06/30/2016.  The 8.5% preferred is trading at about $22.84 and the 7.5% at about $22.20. Under the Investment Company Act of 1940, closed-end funds are subject to asset coverage requirements. For preferred shares the funds are typically required to maintain a two to one asset coverage at the time of dividend issue.  So you have some added protections compared to non regulated companies' preferreds. Oxford has established a plan sufficiant to repurchase all of both issues and has begun purchasing them in the open market. Thomas Herzfeld has just filed a 13G indicating that they are puchasing both issues.  Oxford seems to have enough financial wherewithal to repurchase the preferreds and it would make business sense to redeem them at these prices.

Thanks

Mark

[eclecticvalue]

I was looking at the common shares for the dividend yield which is at 24% div yield. Is the plan to redeem all of the preferred shares eventually?

 

I think the reason they are doing this if the HR 3868 bill passes. BDCs debt to equity ratio can be at 2:1. So they can effectively raise debt instead relying on raising capital through equity.

[thepupil]

not enough compensation for the risk in my view. ~10% YTM to be just above CLO equity is not great.

 

these pref's are significantly tighter than single B CLO 2.0 spreads (which are just above CLO equity). It is not a market I follow closely but I think those are 1000-1400 over. So I don't see the relative value.

 

If they are repurchasing these then they'll become less liquid as more and more get retired. A retail preferred of a CLO equity vehicle at $90 seems like a tough way to make money in this environment. If loans trade off further, these can be underwater pretty quickly given the embedded leverage in the CLO equity, so i really don't see these having much downside protection.

 

I'd buy the equity if I wanted to make a bet here. At least you get upside for taking the risk of impairment of capital...that being said, I hate the equity too, just less so than the prefs.

 

Why buy OXLC at NAV when you can own TFG (30% CLO equity, most of which is 1.0) at 0.5 NAV?* TFG actually grew NAV last Q.

 

You can also buy things like ACSF which has $135MM of 9/30 NAV, $45MM of which is CLO equity; it trades for $87MM. Market already writing off that CLO equity nicely.

 

*one reason is TFG is a PFIC w/ no catalyst

 

 

[thepupil]

I also think that buying out the pref's at a 10% yield shows distress/desperation/forced de-leveraging more than anything. why pay those off? what's the benefit of buying something back at $90 / 10% yield when your sector is in the toilet and yielding far more? Maybe I misunderstand the situation. It seems bizarre.

[Guest MarkS]

As I understand the rules, if a fund breaches the asset ratio requirement, they cannot issue new debt nor pay out any distributions until the breach is remedied. Additionally, the fund itself has this to say:

 

"If the Fund fails to maintain an asset coverage ratio of at least 200%, the Fund will redeem a portion of the Term Preferred Shares in an amount at least equal to the lesser of (1) the minimum number of shares of Term Shares necessary to cause OXLC to meet its required asset coverage ratio, and (2) the maximum number of Term Shares that OXLC can redeem out of cash legally available for such redemption."

 

Oxford called their 8.5% Cum Preferred (2017) in July of 2015. It seems to me that their recent decline in net asset value must be making Oxford management very uncomfortable. Herzfeld has aquired over 19% of the preferreds outstanding.

 

I did state something wrong earlier.  Oxford has a plan in place to purchase $25 million of each series. My apologies!

 

 

[thepupil]

the pref's seem like a short to me if anything....will do more work

[Guest MarkS]

I've learned a lot by reading the posts on this site, including yours, pupil. I'll look forward to your short thesis.

Thanks

Mark

[thepupil]

DISCLAIMER: I have never worked in structured credit, traded structured credit, read a CLO prospectus, am a novice with a rudimentary understanding. I did trade a low risk securitized product for 2 years out of college, so have some very general understanding of securitization. Those more knowledgable, feel free to correct, refine, etc.

 

I don't really have a "thesis", just think that the preferreds are a very poor risk/reward from a long perspective and a very efficient hedge from a short stand point. I think the base case is that they'll be okay, but there are other safer and less levered things available in the market that offer similar return.

 

That's the rub really. The preferreds represent a very "thin tranche" with binary risk.

 

As of 12/31 we have

 

$296MM of investments ($287MM of which is CLO equity)

$149MM of preferred stock net of other assets

$147MM NAV

 

It's easy to look at that and say the pref's aren't all that levered. I mean the investments must fall by another 50% for the pref's to take a hit. The problem with that idea is that 97% of the investments are effectively 10X levered. Now CLO equity is levered with long duration capital (the other more senior tranches) and most do not get margin called with loans going down/spreads going up, but defaults and losses on the sale of collateral do hurt CLO equity.

 

Without a full understanding of CLO securitization and the structure of each individual CLO, I can't really comment very specifically. I would just point out that the loan index fell about 3 points and NAV fell about 30%, so the 10:1 leverage heuristic basically holds with that. Also note that loans are off another 1.5 points since quarter end.

 

The S&P/LSTA leverage loan index closed at 91.26% on December 31, 2015 compared to 94.21% as of September 30, 2015. As of February 1, 2016, the S&P/LSTA leverage loan index stood at approximately 90.2%.

 

Simplifying the CLO strucure and ignoring all the intricacies (which there are many I'm sure), let's just say the equity will lose 10X whatever default expenses are. Default rates are currently at 1.5%. I think CLO equity is priced to a standard 2% default rate or something like that, so since they've fallen in price, a higher default rate is being priced in.

 

According to S&P, the trailing 12-month leverage loan default rate by number of loans at the end of January 2016 rose to approximately 1.5% from 1.2% at the end of December, the highest level in over 2 years.

 

Since OXLC is basically a pile of CLO equity levered with preferreds, if defaults pick up dramatically (not impossible), then there is basically just as much downside in the preferreds as the common, without all the upside. I'm not predicting a crazy rise in default rates, but CLO equity has yields in the mid-high teen's for a reason! The pref's should yield more since they aren't really much further up in the capital structure. If the equity goes from $90-$100 and the pref's are the bottom 1/3 of that, then the difference between par payoff to the pref's and $0 is a few points. That's what I mean by "thin tranche".

 

From more of a trading perspective, I imagine those who hold the common and preferred may be ignorant yield pigs** and if NAV and stock continue to fall, they may dump the stock. If there is further bad trading in loans, OXLC may cut the common and preferred divvy. These aren't going to trade at $90 if that happens.

 

Lastly, there are plenty of money good HY bonds in the $80's and $90's that don't have the same embedded leverage. These are callable as you point out, so you've got 10 pts of upside plus carry, and like 90 pts of downside if we have an '08 scenario in loans*.

 

I would note the one question on the call was from a broker in Boca Raton asking about the safety of the preferred dividend. Boca, my hometown, isn't exactly a hotbed of financial sophistication; it is a hotbed of wealthy retirees seeking yield though.

 

Bottom line: i'm not sure if that was coherent or additive and am frankly to lazy to figure out when they might have to cut dividend. I'm not going to short it; I would just steer very clear of the pref's as a long. If I wanted a pure play hyper levered vehicle to get long loans, I'd consider the equity. As I understand, reinvestment at low prices and good yields can make CLO equity work out even better when spreads are wider, but OXLC probably isn't the best way to play that given it looks like it may be having issues with leverage rules and may be a forced seller.

 

the vehicle just looks and feels fragile. and i own a ton of tetragon and a little ACSF so it's not like I'm incredibly scared of this stuff, but this is a whole nother level of leverage!

 

Operator

[Operator Instructions] Our first question will come from [Casey Miller] [ph] of Aegis Capital.

Unidentified Analyst

I was just wondering if there is any risk of the preferred dividends being cut or not take? Thank you.

 

Jonathan Cohen

Certainly we haven't made any public comments about the preferred stock dividend and the preferred stock dividends have been declared for the fourth quarters as we've discussed. So no, we don’t have anything on that topic to convey.

 

*I recognize most CLO equity recovered nicely post crisis but this time may be different, particularly if corporate credit rather than mortgage credit is the problem

 

**some who hold the common may be far more sophisticated and smarter than I and have a view on the return prospects of the CLO equity tranches

[Guest MarkS]

According to the report issued yesterday by Oxford, their cash flow is very healthy at approximately 24.5 million for the quarter.  As noted in my earlier posts, Oxford has two related problems. First, under the Investment Company Act of 1940, they cannot issue dividends if their asset coverage ratio falls below a certain amount - in this case 200%.

https://www.law.cornell.edu/uscode/text/15/80a-18

Oxford also appears to have contractually obligated themselves to enter the market and purchase preferred shares whenever their asset coverage falls below 200%. See quote from post above.

As you point out in your post, Oxford is dangerously close to violating the asset coverge requirement.

Their preffereds are thinly traded. IMHO Oxford will enter the market and rapidly drive up the price of the preferreds. But you know what they say about opinions? They are like a__holes - everybodys got one.

Thanks

Mark

[thepupil]

IMHO Oxford will enter the market and rapidly drive up the price of the preferreds.

 

I hope they do as that would provide an excellent entry point for shorting.

 

the cash flow to OXLC will be very healthy until it isn't...I don't know the details of the CLO's that OXLC owns, but I would be very concerned that further deterioration in loans may cause the structure to divert cash flows away from the equity, forcing a cut of the common and preferred dividend, a further decline in NAV, a breaking of the leverage rules, and selling by ignorant yield pig holders of the pref's who don't understand the risk they are wearing.

 

https://books.google.com/books?id=Y2pHmaCWxNgC&pg=PA92&lpg=PA92&dq=clo+divert&source=bl&ots=EMs90ZadJ8&sig=YzDowPbj_R60VbCkaCppFZwnfIA&hl=en&sa=X&ved=0ahUKEwia2IjD6ODKAhWCPB4KHUCGD10Q6AEIHDAA#v=onepage&q=clo%20divert&f=false

[thepupil]

7% borrow on the preferreds....looks like I'm not the only one with the idea. the borrow makes it unattractive in my view and the risk more fairly priced. longs who lend will make 17% which seems more appropriate for the risk they are taking. I don't have enough confidence to pay that negative carry. just know there are people willing to pay 7% / year to bet against you. they may be rational and more sophisticated; they may not.

 

also note how borrow rate increased recently

[Guest MarkS]

Hi ThePupil,

I see from your post that the cost to borrow has gone up. As of January 15, 2016,  the short interest in OXLCO was miniscule.

http://www.nasdaq.com/symbol/oxlco/short-interest 

Could the increase in borrow cost be related to the increase in volitility rather than the actual number short sales?

Thanks

Mark

[thepupil]

I don't know.

 

My purpose is to show the risky-ness of the preferreds and to take a short position if it were available at a favorable price and cost of borrow. So far your thesis seems to be "others are/may be buying this issue and the price will go up".

 

I don't see any mention of relative value or fundamental risk and reward. If you have assessed those things and are comfortable, then that's fine, just go in with eyes open.

 

here's a fun snip from the link above from the structured finance textbook i googled...

 

[Guest MarkS]

I don't believe that your assessment of my thesis is completely accurate. Nevertheless,  I sincerely appreciate your comments. I learn something new every day on this board - even when I don't agree with the post. And isn't that the point of the board?

Thank you.

Mark

[thepupil]

it is indeed the point of this board. sorry, i come off as angry when i type.

 

But none of what you wrote so far has the letters "CLO" or "CLO equity" or "underlying leverage" in it. That scares me! I'm assuming you know more than you are letting on, but would rather seem alarmist and angry than let that pass without warning you in case you don't know the risks.

[thepupil]

MarkS, these are ripping. I am tempted to short them. did you end up buying? they are now at $94 and $96, callable in 2016 so upside is only to par. downside is very high given their collateral is CLO equity and the dividends are at risk. at some point it's a worthy short, even with borrow costs, thoughts?

 

OXLCP is quoted at 26% borrow on IB...nevermind...wow!

[Guest MarkS]

Hi Pupil,

I bought shares just above $22. So you and I are on differnt sides of the trade.

Thanks

Mark

[thepupil]

so I'm assuming you know what CLO equity is, right? I apologize if that is condescending. You just have never explicitly acknowledged the risk/leverage in your trade.

 

I never shorted and won't because of the borrow. you able to lend out your shares? does it not scare you that the common is falling? or that people are willing to pay very high rates in addition to coupon to bet against you?

 

 

[Guest MarkS]

Do you ever watch the tv show "The Big Bang Theory?"  You and Sheldon Cooper, a main character, have similar people skills.

[thepupil]

Do you ever watch the tv show "The Big Bang Theory?"  You and Sheldon Cooper, a main character, have similar people skills.

 

not my money at risk...sorry for trying to help...keep clipping that carry and enjoy your investment

[thepupil]

but seriously, do you know what this thing owns?

 

Is it so much to ask you to say "yes, I do and understand the risks...I have the following view on the outlook for CLO equity tranches and am choosing to lend to this externally managed conflict ridden fund of CLO equity tranches for a niggardly single digit yield and 5% upside to par and bear the downside of 10X levered credit risk for the following reasons:_______"

 

Otherwise you appear willfully ignorant.

 

People skills or not, you asked for discussion. On a value investing board, to me the discussion should regard risk and reward. You appear to not want to discuss risk.

[Guest MarkS]

Pupil,  I should not have made that ad hominem attack.  Please accept my apologies.

 

I've never said that I'm going to marry my position. The preferreds were trading significantly below par and a catalyst existed to drive the price to par.  It seemed to me that once Oxford breached  the statutorialy imposed leverage limits they had three basic choices. First, they could take a scorched earth approach and stop paying dividends on the common stock and accumulate assets until the breach is remedied. In my opinion, this solution would do more harm than good.  Or they could either issue new shares or they could sell down assets - or a combination of the two -and repurchase the preferreds with the proceeds. Both of these solutions would hurt the common but benefit the preferreds. I hold no long term opinion as to the value of the common or the validity of CLOs in general.

 

Thanks for your continued support.

Mark

[thepupil]

I'm not here to give you support. I'm here to help you understand where you are in the capital structure.

 

You still haven't used the term "CLO Equity". Having "no long term opinion as to the value of the common or the validity of CLO's in general" is not an option, in my view when you are lending to a vehicle that owns only CLO Equity for low absolute upside.

 

Once again, if you understand what I'm saying, my warnings are not necessary. But my gut is you don't.  If your time horizon is short enough and you simply don't care about the risk, then that's fine. I'd argue your trade has been successful and has made money from the bounce from 90 - 96. Why wait for the full move to par?

 

please see the attached picture.

[Guest MarkS]

Pupil,

Okay. Last time. These are not ordinary preferred shares. They have special protections that ordinary preferred shares do not have. Period!  You keep hammering on your one point without ever addressing this basic fact.  If you want to short the preferreds, please feel free to do it. 

Mark

[thepupil]

special protections don't matter if your collateral goes to zero and/or your cash flow gets turned off. I don't think that's likely and actually own some CLO equity at steep discounts through some other stocks. But relying on "special protections" is tough when you are this levered. What if there is simply no bid for CLO equity if/when their cash flow gets diverted from OXLC? And all for 4 points to par and 7.5% coupon?

 

you mentioned in other posts you were "just starting out". Don't you think lending to this complex levered vehicle is like learning to ride a motorcycle on a hayabusa?