Bargain 8.80% Eagle Point Term Preferred Stock: Antidote To Reinvestment Risk

seekingalpha04-24

Fixed-income portfolios with primarily shorter term bonds and term preferred stocks have reinvestment risk.Reinvestment risk is the risk that when your bonds mature that interest rates will be lower ...

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This lowers your income.In my opinion the best fixed-income securities for safety and yield are term preferred stocks issued by closed end funds (CEFs) that invest in CLOs.Eagle Point Credit’s term preferred stock that matures in 2031 (symbol ECCC) is definitely my favorite security for helping to minimize your reinvestment risk with its 8.80% YTM.In this article we look at and compare term preferred stocks and baby bonds from Oxford Lane and Eagle Point Credit.   tobiasjo Reinvestment Risk Reinvestment risk is the risk that when your term preferred stocks or your bonds mature that you will not be able to reinvest that money at similar or better yields because interest rates have fallen. This will result in the decline of your future income. At our service, we offer a recommended bond ladder with recommended bonds and/or term preferred stocks that mature in several different years. How a bond ladder works is that you stagger your maturities so that some of your fixed-income securities mature relatively soon, some are more medium term, and some are longer term. For example, you could have bonds maturing in every year for the next 12 years or for whatever period you choose. What this does for you is that if rates rise, you will have some shorter term maturities that will provide you with money to take advantage of the now higher yields available. But on the other hand, if interest rates fall, you will still have a number of higher yielding securities in your bond ladder that will continue to provide you higher yields than are currently available in the market. Term Preferred Stocks For those not familiar with term preferred stocks, these are preferred stocks that have a maturity date. Most preferred stocks are perpetual and have no maturity date and thus, when you buy them, you really have no idea what your return will be. This is because prices of perpetual preferred stocks can drop significantly depending on what happens to interest rates as we have seen in recent times with high quality $25 par preferred stocks now selling in the teens. These may never recover in price, leaving you with a permanent loss of capital. But when you buy term preferred stocks, you know exactly what your return will be when you buy it and that you will receive par when they hit their maturity date. They can temporarily drop in price, but ultimately, you will receive par value when they mature. Term preferred stocks can be excellent investments. Term Preferred Symbol ECCC ECCC (NYSE:ECCC) is a term preferred stock from Eagle Point Credit (NYSE:ECC). ECCC currently offers a 8.80% yield-to-maturity (YTM) and matures on 6/30/2031. It is the longest duration term preferred stock that I am aware of making it uniquely suited for a laddered portfolio and for mitigating against reinvestment risk. Over the many years that I have invested in fixed-income, my favorite term preferred stocks and baby bonds have been from BDCs (Business Development Companies) and CEFs that purchase CLOs. These have generally offered much higher yields than securities in other sectors while still being quite safe. While both BDCs and these CEFs invest in higher risk assets, they are limited in how much leverage they can take which keeps them out of trouble. No term preferred or baby bond from a CLO CEF or BDC has ever gone bad. BDCs are limited to leverage of 2 to 1 while CEFs have very strict leverage limits of 1 to 1 ($1 of book value for every $1 of debt). Or in other words they must have assets that are at least twice their liabilities keeping leverage at 50% or less. And although ECC could operate at 50% leverage, it tends to operate at only 30% leverage. Not only does this 30% leverage make its term preferred stocks safe, but ECC generally sells above NAV making it easy and profitable for it to issue more common stock which can raise the cash necessary to keep leverage low if it should start to rise. ECCC Is Undervalued First it is important to note that because we are in an inverted yield curve interest rate environment where short term treasuries yield more than long term treasuries. Thus, you are often not paid more in yield when you buy longer term bonds than shorter term bonds which is not typically the norm. Here are some bonds from BDC ARCC. Interactive Brokers As you can see from the righthand columns, the yield on the 2025 bond is about the same as the 2031 bond. Most BDC bonds are issued with 5 year maturities so almost all are between a few months to maturity and less than 5 years. But ARCC has a rare 2031 bond. But in my opinion, this 6.25% yield is quite poor relative to ECCC’s 8.8% yield despite the fact that this ARCC bond may be less risky. BDC bond yields have come down a lot over the last year while CLO CEF term preferred and baby bond yields have not. Now the spread in yield between BDC bonds and CLO CEF bonds and term preferreds very much favors the CLO CEF securities. There are some good BDC baby bonds but they generally don’t go beyond 2028 and still have much lower yields at around 7.6%. There are 3 publicly traded CLO CEFs but only 2 that have issued baby bonds and term preferred stocks with longer duration. They are tickers OXLC (NASDAQ:OXLC) and ECC. Here are their bonds and term preferred stocks that mature between 2029 and 2031. So let’s see how ECCC stacks up.   Author Since there is generally little difference in yield between longer and shorter term bonds in the market now, when comparing ECCC to the other term preferred stock from ECC, symbol ECCF, ECCC’s 8.80% YTM is far superior in yield to ECCF’s 8.16%. And if we look at the 2 other 2031 maturing securities which are bonds, they average a 7.60% YTM which is also way under ECCC’s 8.80% YTM. Certainly bonds offer a little more security than a term preferred stock, but given that leverage limits make ECCC quite safe, I believe that ECCC is a much better value. I have followed this sector for a long time and the term preferred stocks rarely offer this much of a better yield than the baby bonds from the same company. Thus, I believe ECCC is quite a bargain now. If you are looking for a good 2029 security for your bond (and term preferred) ladder, OXLCO looks like a very good choice. And if you want the additional security of a bond, ECCV also looks good and far better than the other 2 bonds, OXLCL and ECCW. In fact, the ECCV bond provides the same YTM as the ECCF term preferred. When a bond offers the same YTM as a term preferred stock from the same company with the same maturity date, there is a clear mispricing going on here. And when the 2029 ECCV bond yields 8.17% versus 7.59% for the 2031 ECCW bond, ECCV looks like quite a good value. Summary Global inflation is running hot, and interest rates are likely to stay buoyant, at least near term. But over a longer term, rates could certainly drop significantly. We are overdue for a recession, which usually results in lower rates. Thus, reinvestment risk should not be ignored unless you are willing to see your income tumble in the future. Within stocks we see that there is a big dispersion in valuations. The above example shows that you can see the same in fixed income. The article focuses on reinvestment risk; that is the risk that rates will fall in the future and so when your bonds or term preferred stocks mature, you will have to reinvest that money at lower rates. Of course this will mean a drop in income for your portfolio. It is my belief that BDC bonds and bonds and term preferred stocks from CEFs that invest in CLOs historically offer the best yield relative to their safety. Currently fixed-income securities from CLO CEFs offer the best value in the market, in my opinion. They also offer some longer maturities than BDC bonds which generally are only issued for 5 years and thus are just now starting to issue some 2029 bonds. Term preferred stock, ECCC, lets you lock in an 8.80% YTM until mid 2031. I see nothing better out there for securities that mature after 2030. The safety is strong as ECC operates at 30% leverage and is not allowed to go over 50% leverage. 8.80% is a very strong yield for a security of this quality and is quite undervalued in my opinion.  For those looking for 2029 securities for their bond ladder, I like term preferred stock OXLCO and baby bond ECCV.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429117378"}