OXLCO & OXLCN - Oxford Lane Capital Corp Preferred Shares

[thepupil]

and if we want to talk special protections, the tranches above CLO equity have special protections too. they can shut off cash flows to the equity if the collateral deteriorates. that shuts off OXLC's cash flow, which pays your dividend.

[Guest MarkS]

"Don't you think lending to this complex levered vehicle is like learning to ride a motorcycle on a hayabusa?"

Actually I'm not lending anything to this fund.  This isn't an IPO.

Mark

[thepupil]

- By purchasing the prefereds you are dependent on OXLC for timely payment of principal and interest.

 

- I think most would agree you are effectively lending to OXLC, whether or not your cash goes to OXLC or simply buys someone else's shares.

 

Your pref's are due in 2023/2024. Have you modeled out the CLO equity tranches cash flows and determined that there will be enough to pay you back at par? CLO equity is a residual tranche with no par value. It gets what is left over and a portion of your capital is returned each year. The cash flows don't look like a normal bullet bond (with coupons an a balloon payment at the end). Once again, I'm not an expert here, so please confirm all relevant details on your own. 

 

Once again, if you simply plan to sell on the technicals of going to par based on your view of what will happen and have no regard for your collateral and asset coverage, then your trade is fine.

 

It just kills me that you are relying on regulations/asset coverage rules as your downside protection rather than quality of collateral. Covenants didn't protect coal companies' bondholders. Asset quality and leverage matters.

 

this is an informative article: http://seekingalpha.com/article/3495966-risks-rewards-investing-clo-equity-funds-case-study-analyzing-4-bdcs-cefs

 

It explains well that you are lending to a depreciating asset whose cash flows can be turned off by structurally senior tranches. there are no bad assets, only bad prices. in my opinion, lending to OXLC common holders near par for low absolute appreciation potential and a single digit coupon is a bad price.

 

The same guy also has an article discussing how they will be forced to repurchase the pref's (consistent with your thesis). Where I think you could get into trouble is if asset value declines faster than their ability to repurchase the shares and keep paying preferred dividends. After repurchases, each remaining preferred shareholder is generally worse off. The author believes they will issue equity (which you mentioned and would obviously help you). That is dependent on the market's tolerance for a CLO equity fund issuing equity below NAV.

 

http://seekingalpha.com/article/3893116-analysis-oxford-lane-capitals-q4-financial-results-management-may-need-issue-new-common

 

His comment on February 12th is consistent with my initial objections to the preferred

Sean Dougherty, Contributor

Comments (42) |+ Follow |Send Message

Author’s reply » I think I laid out my thoughts on the Preferred Shares pretty well. If OXLC starts aggressively buying the preferred shares, the price should go back to par relatively quickly. I assume that they are lightly traded.

However, my problem with the PS are that they are basically subordinated to B CLO debt that is trading at L + 1500bps. It just does not seem like a good risk reward trade. However, on the short term I guess the trade should work. Good luck.

12 Feb 2016, 04:50 PM  Report Abuse

 

believe his word. not mine. he is the expert.

[Guest MarkS]

Thanks for your response, Pupil. If it's any consolation to you Sean Dougherty (assuming that's not you) published an article on Seeking Alpha, in which he agrees with your position that the shares aDon't are, in his words,  "wildly mispriced" when compare to the B CLO tranche. If the Investment Company Act of 1940 had been repealed, I would completely agree with that arguement.  But it hasn't been repealed, and it doesn't appear to me that any value is being given to those protections using that analysis. As it stands today, it appears that Oxford is slightly in breach of the leverage requirements. The preferreds being the only "debt" have a senior claim to the assets.  It looks like the value of the CLOs would have to drop about another 45% to 50% before the preferreds would begin to have any permanent impairment of capital.  Oxford has about positions in 44 different CLOs. Do they have a fat tail risk associated with them? Certainly!  But if a black swan event occurrs sufficient to cause the majority of the many companies that form the backbone of the CLOs default, the portfolios of most of the posters on this site would suffer immensely. I won't be alone.  As I've stated before, I've no intention of  marrying the position. At the rate it's going, I may be out of the position in another week or so.  Your comment that I'm only relying on the technicals without any regard to the collateral and asset coverage is unfair, uncalled for and untrue.  Nevertheless, as I've repeatedly stated, I always learn something new every time I participate on the board -  even from you pupil.

[thepupil]

- I assure you I am not Sean Dougherty, just a guy who doesn't like to see people lending to an outfit and making 700-800 bps less than securities senior to them in the cap structure. I maintain that calling the thesis "reliant on technicals" is not a crazy mischaracterization because fundamental analysis concludes there are securities that are arguably less risky and yield more (in CLO land and outside of it). it was not meant as an insult; many a good bond trade can work on technicals/catalysts/forced buyers etc.

 

- one thing you may want to consider is that in advance of the "forced to de-lever and buy back preferreds" scenario, the company may suspend the preferred and common dividend in the event it does not want to sell illiquid CLO equity in a fire sale to buy back preferreds at par. Let's say CLO equity is yielding a prospective return of  15-25% right now. it would be painful to sell those to buy back prefs @ 7.5%-8.5% yields. It would be better for common shareholders to rip the band-aid off cut all dividends and buy back preferreds well below par.

 

- I don't read anything in the prospectus that prevents that, and preferreds have been abused in the past in many distressed and even non-distressed situations (because they generally don't have the protections of bonds and generally are not held by institutions). It's what I would do if I was in control and had no loyalty to the prefs/no reputation to protect (which as OXLC goes down there is less and less of a reputation to protect). Dividends accumulating at 7.5% and 8.5% are really cheap capital (for levering CLO equity) so why not just turn those off and reinvest elsewhere (like into busted preferreds at 40 cents on the dollar).

 

-I know nothing about management, but just considering the optics/structure (externally managed, hugely levered vehicle that wasn't satisfied with the leverage already in CLO equity so felt the need to issue preferreds to lever it up some more), I'd say unexpected and unscrupulous actions in a distressed situation should be expected.

 

-Do you have an opinion on mgt. incentives?

 

-I honestly think all this ink spilled will be for nothing and you'll get paid back, but there are much better things to lend to than an arguably distressed, externally managed, CLO equity fund of funds to make the the type of returns offered here.

 

-I am putting all this effort into this, not for solely sake of argument, but because I want to be positioned as a knowledgeable buyer of the pref's/common in the event the divvies are cut and they fall. Or as a short seller if borrow ever frees up in the preferreds. As a side benefit, I may help you, or you may dismiss this as overly paranoid. It's not a likely scenario, but it could potentially be quite lucrative.

 

http://www.sec.gov/Archives/edgar/data/1495222/000114420413034962/v347777_497.htm

 

this is where I think it is saying "we can buy back preferreds if we cut the divvies" (not a lawyer so interpret it as you will)

 

Except as required by law, we will not redeem any shares of Term Preferred Stock unless all accumulated and unpaid dividends and distributions on all outstanding shares of Term Preferred Stock and other series of Preferred Stock, if any, ranking on parity with the Term Preferred Stock with respect to dividends and distributions for all applicable past dividend periods (whether or not earned or declared by us) (x) will have been or are contemporaneously paid or (y) will have been or are contemporaneously declared and Deposit Securities or sufficient funds (in accordance with the terms of such Preferred Stock) for the payment of such dividends and distributions will have been or are contemporaneously deposited with the Redemption and Paying Agent or other applicable paying agent, provided, however, that the foregoing will not prevent the purchase or acquisition of outstanding shares of Term Preferred Stock pursuant to an otherwise lawful purchase or exchange offer made on the same terms to holders of all outstanding shares of Term Preferred Stock and any other series of Preferred Stock, if any, for which all accumulated and unpaid dividends and distributions have not been paid.

 

I'll also point out that they don't have to redeem all the preferreds if they violate the asset coverage, just enough to get them back to the right asset coverage level, so the pull to par may not be as powerful as you/others in the trade expect. If you buy a bond at $90 and 10% of the issue is going to be redeemed early at par then that's only worth $1. If 20%: $2, if 100%: $10

 

We will redeem out of funds legally available the number of shares of Preferred Stock (which may include at our sole option any number or proportion of Term Preferred Stock) equal to the lesser of (i) the minimum number of shares of Preferred Stock, the redemption of which, if deemed to have occurred immediately prior to the opening of business on the Asset Coverage Cure Date, would result in us having asset coverage of at least 200% and (ii) the maximum number of shares of Preferred Stock that can be redeemed out of funds expected to be legally available in accordance with our Articles of Incorporation and applicable law......

Later:

If fewer than all of the outstanding shares of Term Preferred Stock are to be redeemed pursuant to either the asset coverage mandatory redemption provisions or the optional redemption provisions, the shares of Term Preferred Stock to be redeemed will be selected either (1) pro rata among Term Preferred Stock, (2) by lot or (3) in such other manner as our Board of Directors may determine to be fair and equitable.

 

the bottom line is I think your thesis has holes in it. And that the asset coverage test isn't as solid of a protection as you think it is. Or as much of a catalyst as you think. in my opinion the company is more and more incentivized to turn off the divvies/rebuild as the stock goes down.

 

I tried to word this in a cordial manner.

[Guest MarkS]

Hey Pupil,

Your post was very cordial and I sincerely appreciate the effort. You make a lot of good points.  I've seen lawyers do lots of slimy things. So it would not surprise me if you were ultimately right.  I'm not sure the passage that you quoted though surports your thought.  I interpret that passage a little differently. I interpreted "redeem" as mandatory meaning the shareholders have no choice in  the matter. "Offer" seems to me more voluntary. In other words,  although management can't force preferred holders to sell shares, management can enter the market and purchase shares or tender for shares notwithstanding the fact that dividends have not been paid. But i've never practiced securities law. So i could be wrong.  The Act also allows preferred shareholders to elect board members including up to a majority under certain circumstances - mostly involving default.  Management would also have to work around that as well. At days end, I've been wrong about lots of stock picks, and this pick could ultimately be added to a long, long list. Only time will tell.

Thanks

Mark

PS  I type these post on a crappy tablet. So please forgive the many typos.

[thepupil]

opened a 2.5% short in OXLCO @ 98.5 and about 17% annualized negative carry with the borrow costs of 10%.

 

we'll see what happens, could get further squeezed, might lose money, but I think it's a good hedge with asymmetric risk / return

 

[Guest MarkS]

Good luck. I got out today.

Thanks

Mark

[thepupil]

Third Ave commentary shows CLO B's down 20% in january, cites many CLO 2.0 equity tranches at NAV below 0...

 

these pref's should not trade at $97.

 

 

 

 

As of January 2016, Morgan Stanley found 348 US CLO 2.0 deals’ equity tranches currently having

NAV below zero. CLO 2.0 are deals that took place after the 2008 credit crisis and that typically feature

higher levels of subordination, tighter collateral eligibility requirements, and shorter non-call and

reinvestment periods than the pre-2008, or CLO 1.0, deals.

Q1-2016-Credit1.pdf

[benhacker]

Pupil,

 

have you thought about short common.

 

what's the latest NAV, how often do they have to report?

 

seems that this equity is a train wreck in the making.  $8 was reported at 12/31... seems NAV should be down another 3rd from there easy, so certainly market is discounting this, but you have dividend cuts + potential continuation of bad news.  Seems like unlikely to surprise to the upside.

 

Borrow is 4.5%.

 

You may be right that the PFD is more interesting... but I do like the 40 act protection of the PFD... the worse it gets the harder the equity slices hit the bid to get the PFD out at least partially at par.

 

... You see a big turnaround in CLO equity here?  Possible?

[thepupil]

The upside leverage in the common scares me, whether it's irrational or not I just can't short something so levered.

 

The pref's are callable in June so they shouldn't really go much higher than par. Even with such high borrow and negative carry, the downside just feels more quantifiable on shorting the pref's.

 

Also in a way the common is senior to the preferred since it gets paid a huge portion of equity if things go well and since the assets are by nature depleting the pref doesn't get principal returned until 2022.

 

I really think the 40 act protection will become less consequential if collateral really deteriorates, but it would make me have more conviction of managemt were to sell their preferreds they own.

 

I like owning CLO equity through ACSF and TFG where there are other assets and large NAV discounts, and shorting it through OXLCO. Could be the wrong approach though.

[benhacker]

Thanks for your thoughts.

 

I agree with your criticism's upthread of MarkS's perceived approach to this PFD trade, but I actually agree with Mark that the PFD w/ 40 act protections is likely to be money good (even in this case).  This is maybe the only time I've seen a 1940 act PFD that makes me wonder if it will be impaired, but I think to get that, you need to get sloppy marks on the CLO equity, and then get them liquidating into bad tape within a few days to not get the PFD out at par.

 

It could happen, but I actually think the 40 act protections are super bearish for the common as it means liquidation (if it happens) will be highly unorderly because no banker gets to make a choice about the timing of how cash is created to redeem...

 

anyway, thanks for sharing your thoughts.... no position for me.

[thepupil]

http://www.bloomberg.com/gadfly/articles/2016-01-25/a-hotbed-of-leveraged-loan-shorts-with-nowhere-to-go?cmpid=yhoo.headline

 

Interesting article on loans / CLO's

[thepupil]

opened a 2.5% short in OXLCO @ 98.5 and about 17% annualized negative carry with the borrow costs of 10%.

 

we'll see what happens, could get further squeezed, might lose money, but I think it's a good hedge with asymmetric risk / return

 

covered @ $99.5, snap back in credit/levered real estate related equities was very strong and benefited a lot of longs, moving on having lost a point on price and paid the negative carry for a month. will look to re-short if/when credit backs up.

 

still think this is a great way to short risky/structured credit given the fixed upside.

 

[thepupil]

BUMP....this Oxford Lane pref’s at $96 sure do look shortable right now...same movie as before. OXLC’s NAV is collapsing; they are buying back the pref’s; OXLC could go to zero and the pref’s could too...threat to CLO equity is probably higher this time around.

 

Blast from the past.

[matts]

BUMP....this Oxford Lane pref’s at $96 sure do look shortable right now...same movie as before. OXLC’s NAV is collapsing; they are buying back the pref’s; OXLC could go to zero and the pref’s could too...threat to CLO equity is probably higher this time around.

 

Blast from the past.

 

have you looked at the baby bonds of ECC? ECCX and ECCY. Similar company but sitting higher in the cap structure. I bought a small position when ECCX was trading at ~22.65. I imagine they will just sell more prefs and/or common during the pain period and the bonds should be money good and eventually recover to par.