 Liberum Structured CreditFair Oaks Income Good time to be allocating to CLO equityAnalyst: Shonil ChandeMkt Cap £183m | Share price $0.56 | Prem/(disc) -0.9% | Div yield 14.3%EventFair Oaks Income's NAV per share increased by 0.7% (+3.8% NAV TR YTD) in the monthly period to 31 March 2024, to $0.565. We summarise some of the main monthly market indicators below:US loan default rate: Decreased from 1.41% to 1.14% m-o-m.European loan default rate: Decreased from 1.86% to 1.65% m-o-m.Distress ratio (loans trading below 80c, a potential indicator of the direction of future defaults): Declined in the US from 5.08% to 4.95% and in Europe from 2.80% to 2.78%.Liberum viewAnother good update underlining why FAIR's CLO equity-focused strategy is an attractive place to allocate to given the lowering default rates in the broader leveraged loan markets, high distributions, relatively benign macro and the fact that CLO equity valuations have the potential to follow the normalisation path seen in CLO mezzanine debt.?This is a performing CLO equity portfolio that is attractively valued, with potential for higher valuations. We note the manager's comment (factsheet) that "the weighted average price for US CLO equity in the Master Fund's portfolio has decreased from 39.6c to 36.2c in the last 12 months while the weighted average loan bid price has risen from 93.7c to 96.6c in the same period and ii) cash-flow multiples: c. 3.5x based on March's valuations and annualised quarterly cash-flows."The chart below is a sensitivity based on the CLO portfolio, as at 31 December 2023. It shows the significant slack embedded into the valuation of the US CLO equity portfolio. We also note that the high yields in CLO equity are driven by the excess distributions to the equity holder once all liabilities are paid to debt tranches. The underlying loans that fund the CLO equity and CLO liabilities are senior secured bank loans that side above high yield debt and preferred stock and underlying loan spreads are typically in the 2.5%-4% range. We are BUYers with a target price of $0.66. |
Dividend declared, payable 2nd April. |
Liberum view
This was another positive update and we draw attention to a few points: 1) CLO equity is an attractive place to be when the macro backdrop is relatively benign, particularly against the prior expectations that mark-to-market valuations are sensitive to; 2) the stress testing detail provided by the manager across various scenarios reads positively; 3) it is the difference between expectations and actual rates default rates that matters more than the directional trend; and 4) CLO equity valuations have the potential to follow the normalisation path seen in CLO mezzanine debt and as CLO liabilities tighten, there is a greater chance of using resets to enhance the value of the control CLO equity portfolio.
The last point is significant. The chart below is a sensitivity based on the CLO portfolio, as at 31 December 2023. It shows the significant slack embedded into the valuation of the US CLO equity portfolio. Better loan market read-across should bode well. Resets would be highly significant. Should this option return, this can have a very significant impact on individual CLO equity deals. We are BUYers with a target price of $0.66. |
No liquidity today here |
Liberum on Fair Oaks Income
Investment case remains compelling despite discount closing
Analyst: Shonil Chande
Mkt Cap £177m | Share price $0.56 | Prem/(disc) -1.6% | Div yield 14.4%
Event
Fair Oaks Income’s NAV per share of $0.564, as at 31 December 2023, represented a 0.14% monthly increase and a 12.9% NAV total return in the calendar year.
Default levels firmly lower than forecast a year ago
The European loan default rate increased from 1.42% to 1.62%, and the US loan default rate increased from 1.48% to 1.53% in December. These levels are significantly below market forecasts at the end of 2022. The forward-looking distress ratio decreased from 4.79% to 4.32% in Europe and from 7.30% to 6.36% in the US.
Liberum view
FAIR has performed very well over the past year, with the underlying performance of the CLO equity and debt portfolios very well supported by corporate measures, particularly the share repurchase programme. In the context of the near outright closure of FAIR’s discount, it may be tempting to view FAIR as relatively less attractive. We make a few key points to counter this. Firstly, At NAV (ie no discount), FAIR’s dividend yield is c.4 percentage points higher than the second highest-yielding alternative fund (market caps above £150m).
Secondly, with respect to increases in default rates and the impact this can have on CLO equity valuation, as opposed to distributions given that a far more punitive environment (overacollaterlisation tests continue to build in firm support) is required to divert distributions away from the equity tranches, it is the difference between expectations and actual rates that matters more than the directional trend. Therefore, default rates below prior expectations and the declining forward-looking distress ratio are positive indicators with respect to CLO equity valuations going forward. More than 80% of the European and US loan indices are now trading above 95.
The two charts below show 1) the downward trend in the core USD CLO equity valuations in particular, mitigating risk, and 2) the potential positive impact on NAV from upward moves in valuation. If the market has modelled overly pessimistic assumptions for USD CLO equity, the prices of some of the US CLO equity tranches could rally significantly. We also note the manager’s comment in the factsheet: “Assuming the US default scenarios forecast by S&P Global Ratings, we estimate that the gross IRR for the Master Fund would be 33%, 26% and 15% in an optimistic, base and pessimistic scenario, respectively.”
Alignment and repurchases
FAIR has overseen a highly effective share repurchase programme since October 2022, with tangible impact across several metrics. A focus on CLO equity, which has historically delivered a double-digit cash yield, and CLO debt, meant that even after reducing its annual dividend, in 2022, from 9.5c to 8c to fund the repurchases, the dividend yield at NAV remained above 13%. Other initiatives include the fixed-life realisation share class and re-investing 25% of management fees whenever the shares trade at a discount. We are BUYers with a target price of $0.66. |
You need to phone HL and answer some questions, confirming you acknowledge this is a "complex investment'. You don't have to understand any complexities, just need to acknowledge it's not a standard investment type. Then deal by phone if still happy. Don't know about usual spread. |
I can not trade electronically directly on HL. I wanted to take a first position here.
Do you know if that is because of low liquidity?
And what is normally the spread you pay to buy into FAIR? |
Took some here today too for an initial position GLA |
And also VTA/VTAS. FAIR are priced in USD, and at the current exchange rate 56c = 44.37p. VTA is priced in Euros but you might as well buy the same animal VTAS in pence. TORO is also priced in Euros. They are pretty similar but FAIR stick mainly to USA debt, TORO mostly European and VTAS split roughly 50/50. Otherwise the principal difference is the discount to NAV. TORO is the highest, FAIR lowest virtually evens and VTAS somewhere in the middle. |
Seems one can sell more than one can buy electronically
I thought the price was around 0.443 |
LG,
FYI TORO is a similar animal. |
Joined you all this morning with a first purchase. Switched out of AA4 - too many question marks. Will look to add to build up to quota. I like income! |
PS1, Fair announce the currency conversion rate a short while prior to divi payment and pay the divi in GBP. |
Had a large position in TFIF for many years- in fact it's been one of my steadiest performers !!Thinking of having a nibble can here anyone explain how the dividend is paid through the broker if it's declared in us currency ?Thanks |
Oak Bloke Commentary on FAIR... |
SP at its highest for nearly 2 years. We are almost at the latest NAV of 56.3c. In a falling interest rate environment the huge yield could spell a rerating. If the dividend stayed the same and the risk appetite accepted 12% we would have a share price of 66c, or rise of 21%. High income and capital gain, I think I am having a wet dream. |
Thanks Blue. O&G is a bit of a rollercoaster these days. Holding on, just :-) |
#322 I'm worried about DEC short term, but we'll know soon whether they'll maintain the dividend. I can't see any reason not to, but will be reassuring to see it.
I'm not aware of any FAIR presentations, no. |
Hi Tag.
I'm mostly bunkering down and not switching much around at present. Probably not your thing because it's not currently income earning, but I'm expecting good things from Casp in coming weeks. It's an oil producer in Kazakhstan with known oil under the ground, they just need to overcome the technical obstacles to get it out of the ground. Sentiment is rock bottom along with the price but would be transformative if they can get a deep well to flow.
Sticking with FAIR, VTAS, DEC, SBLK and a few other but smaller holdings, all for income. Apologies all for off topic. |
I should have bought more at sub50c per share back in July. If it drops down to anywhere near 50c again I will certainly take another tranche.
Have you been looking at anything interesting lately Blue? I have been pushing some money into Infra with a mix of BBGI and GCA for a bit of diversity. |
There's the Q3 dividend declared, 2c again, payment 15th December.
Yield is just under 15%. |
Liberum-
Half-year report confirms quality of investment portfolio
Analyst: Joachim Klement
Mkt Cap £176m | Share price $0.53 | Prem/(disc) -9.2% | Div yield 15.2%
Event
Fair Oaks Income released its interim report for the six months ended 30 June 2023. For the reporting period, the NAV total return was 9.0% compared to -5.3% in the same period 2022. The NAV total return for the realisation shares was 9.7% (vs. -5.0% in the same period 2022). The increase in Nav has continued in the months since June. The August NAV was $0.581 for the 2021 shares for an additional 3% appreciation in NAV in the last two months.
Over the period, the Master Fund received total distributions of $33.2m (H1 22: $45.0m). Distributions in January were negatively impacted by large movements in Libor and Euribor which affected the CLO assets and liabilities differently due to timing issues. Distributions recovered in April. The focus on originating and controlling CLO subordinated notes has resulted in fundamental performance above the market average. Origination and control allowed the Master Funds to veto specific loans when the transactions were launched and to monitor and influence the CLOs over time. Lower fees in primary investments also allowed CLO managers to construct more conservative portfolios with no need to reach for yield. As a result, the Master Funds have benefitted from underexposure to sectors such as retail or energy.
Liberum view
In our in-depth note in August (Fair Oaks Income (BUY, TP $0.7) - Attractive CLO equity return outlook (43 pgs)) we emphasised the opportunity in CLO markets at the moment. As FAIR is marking its CLOs to market rather than mark-to-model, the downside is already reflected in the price and the ongoing recovery in loan markets leads to a significant pull on NAV higher. Add tot hat the sector-leading dividend yield of 15.4% and we recommend BUYing the fund with a TP of $0.66. |
Yield is generous at current level (15%) and in current climate it's good to have a reliable, consistently high income flow from this. Would be quite content if it stayed at 8c pa for years to come. |
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