2 Deep Fixed-Income Bargains From Oxford Lane And Eagle Point

seekingalpha10-19

Eagle Point Credit’s Preferred “D” is grossly undervalued due to the company’s open market selling of the shares, which has greatly suppressed its price and offers an 8.65% yield.ECC.PR.D has lagged ...

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When the selling ends, there is big upside here.Oxford Lane offers a very undervalued baby bond - symbol OXLCI. Its yield to maturity blows away the other baby bonds in the sector (and even many term preferred stocks).tobiasjo Relative Investing My philosophy of investing, and what I do within our Seeking Alpha service, involves scouring all fixed-income securities 1) within a sector, 2) within the same credit rating and 3) within the same company to find the most undervalued securities. You can't evaluate a security in a vacuum, but it can only be done in relation to other similar securities. And fortunately, I have the software to quickly accomplish this. By buying the most undervalued securities, you have less downside price risk and significantly more capital gains potential. Although I focus on high dividend paying securities, my capital gains often are greater than my interest and dividend income using this strategy, and the results greatly outperform preferred stock mutual funds and ETFs . So I don't consider myself a dividend investor but a total return investor. In this article, I will demonstrate the thinking that went into my selection of ECC (NYSE:ECC.PR.D) and OXLCI (NASDAQ:OXLCI) as 2 of the best fixed-income securities in the market. This is the thinking of a relative investor. Closed End Funds That Invest In CLO Equity Tranches There are 4 closed end funds (CEFs) that invest in CLO equity tranches. Eagle Point Credit (NYSE:ECC), Oxford Lane Capital (NASDAQ:OXLC), OFS Credit (OCCI) and Priority Income Fund (OTC:PRIF). PRIF is a private company but has issued a number of preferred stocks that trade publicly. While CLOs tend to scare off some people, what makes these preferred stocks and baby bonds safe from these CEFs is that they are legally not allowed to take leverage above 50%, and they all operate with leverage far below that. Thus, if the value of their CLOs starts to drop, they generally issue more common stock to raise cash to keep leverage low. If their leverage should break the 50% requirement, they must raise cash to bring the leverage back below 50% (or buy back their debt or sell some of their CLOs). These strict leverage requirements are why no CEF has ever had a preferred stock or bond go bad. The market doesn't get that which is why this is one of the best sectors for preferred stocks and baby bonds in terms of the yield you get relative to the safety of these securities. Eagle Point Preferred \"D\" Most of the securities issued by CLO CEFs are either baby bonds or \"term preferred\" stocks (preferred stocks that have a maturity date). There are only 2 perpetual preferred stocks issued within this sector, one from ECC (ECC-D) and one from PRIF (PRIF-K). Because PRIF is a private company and is managed by the same folks that manage the hated PSEC, historically PRIF preferred stocks pay higher yields than its CEF peers in order to get investors interested as otherwise they would prefer to buy securities from one of the other CLO CEFs. But due to ECC's decision to repeatedly sell a large number of ECC-D in the open market, its price has lagged to a ridiculous point, making it extraordinarily undervalued with lots of potential for price upside (capital gains). I believe that ECC-D has the best total return potential in the non-distressed fixed-income space. Here is a chart which demonstrates how ECC-D has totally missed the fixed-income bull market and has greatly lagged its peers for no fundamental reason. Yahoo Finance Over approximately the last 10 months, you can see that ECC-D is actually down 5.3%, and this during a strong bull market in fixed-income. I can't really think of any fixed-income security that is down over this period unless the company that issued the preferred stock has fallen on hard times. And this is certainly not the case with ECC. ECC-D has underperformed its most identical peer, PRIF-K, by over 18% and the preferred stock ETF, PFF, by around by over 11%. And if we take a term preferred from ECC, symbol ECCC, it has outperformed ECC-C by 12.0% so the huge price discount on ECC-D certainly has nothing to do with ECC having problems. So ECC-D has grossly lagged the market in general, the sector, and the other securities that ECC has issued. Relative Fair Value of ECC-D Is $22.00 Author As you can see from the above chart, ECC-D has a very large yield advantage over its closest perpetual preferred stock peer, PRIF-K. This is unusual as normally ECC-D would have a lower yield than PRIF-K due to PRIF-K being from a private CEF. If ECC-D simply had the same 7.59% yield, which would be more normal, it would trade at $22.25 per share. And if ECC-D had not lagged due to open market sales and instead followed its peers higher, it would be up around 12.5% which would put its price near $22.00. And of course, ECC-D has a lot more price upside potential at $19.50 than does PRIF-K which is much closer to par at $23.14. ECC-D Versus PSEC-A One last comparison I found interesting was ECC-D versus PSEC-A. I consider these 2 perpetual preferred stocks fairly close in safety. PSEC-A operates at higher leverage and also holds a chunk of CLOs. And as a BDC, it is allowed to leverage 2 to 1 while ECC can only leverage 1 to 1, but PSEC does have other assets besides CLOs (although they are loans to smaller companies that banks don't want to touch). Anyway, below is a one-month price chart that shows that while ECC-D is down slightly, PSEC-A is up 22.3%. Yahoo Finance This is a crazy disconnect. Here are the current yields of PSEC-A and ECC-D, and they show that ECC-D is grossly undervalued relative to PSEC-A. Author To me, ECC-D is world's better than PSEC-A. While ECC-D is a strong buy and maybe the most undervalued preferred stock in the market, PSEC-A is a strong sell for anyone who owns it. Prices used in the above portion of this article are from early in trading on 10/16/2024 OXLCI - Very Undervalued Baby Bond Prices used in the below portion of this article are from the close on 10/14/2024 Again, we are doing a \"relative\" comparison within a sector. We are still dealing with CLO CEFs, but now with baby bonds rather than preferred stocks. While PRIF and OCCI have not issued baby bonds, OXLC and ECC have each issued 3 baby bonds to go along with their 3 preferred stocks. I consider bonds from CEFs to be extraordinarily safe because 1) not even a preferred stock from a CEF has ever gone bad let alone a bond, 2) their legal leverage limits are 33% so lower than the 50% leverage on preferred stocks, 3) in the case of OXLC, in its March annual report they had only leveraged their bonds 11%, although it may be somewhat higher now, and 4) the bonds are at the top of the capital stack so all common stock and preferred stock would have to be wiped out before the bonds would take a hit. Although the baby bonds from OXLC and EC are not rated, I would consider them at least BBB-. If we look at the bonds of BBB- rated BDCs, they tend to be in the 5.5% range in terms of yield to maturity (YTM) while OXLCI has an 8.15% YTM. So OXLC and ECC baby bonds as a group are very undervalued and offer (in my opinion) the best place to buy undervalued bonds. And within this very undervalued sector, OXLCI is quite undervalued, making it an excellent bond. Here is a chart of the YTMs on the 6 bonds from ECC and OXLC plus the term preferred stocks from OXLC, ECC and OCCI. Author The first 6 items in the above spreadsheet are baby bonds. In the rightmost column, you can see that the yield to maturity of OXLCI is 8.15%, clearly the highest. It seems kind of insane that OXLCL, which matures 9 months later than OXCLI, offers only a 7.03% YTM. So, OXLCI is extremely undervalued relative to its closest peer. The only other baby bond that can be considered, on a relative basis, is OXLCZ if one prefers a shorter term bond and does not want to lock in the 8.15% yield for a long time. Another thing that is interesting to me is that the current yield on OXLCI is 8.56% while all of the other bonds have current yields below 7% and even below 6%. Normally, mispricings come from when investors mistakenly look at current yield rather than YTM in their bond decisions, and those with high current yields tend to be overvalued. But here it is just the opposite. OXLCI is actually quite undervalued despite having far and away the highest current yield. And maybe even more amazing is when you look at the preferred stocks in the above table. You can see that OXLCI actually has a higher YTM than all of the \"term preferred\" stocks available except 1 which is virtually the same. How can a bond, which is higher in the capital stack and more safe, have a higher YTM than inferior preferred stocks which will be wiped out before any bond impairment would happen. So I see no reason to own term preferred stocks in this sector. OXLCI is far better than all of the term preferred stocks and if you want a shorter term security, OXLCZ would be a far better place to put your money than in the \"term preferred space\". I own both OXLCI and OXLCZ. Summary In this article, I demonstrated the thinking process that goes into finding the most undervalued securities whose potential capital gains and oversized yields are highly likely to produce market beating results. Not only do we focus on yield mispricings, but also focus on securities that have greatly lagged the market for no fundamental reason. ECC-D fits the bill. It not only has a very large yield advantage over its peers, like PRIF-K and PSEC-A, but it has grossly lagged the market and its sector in terms of price performance by around 12.5%. And this is not due to any fundamental problem, but simply due to the fact that ECC has decided to sell a large number of shares of ECC-D in the open market to raise cash. They have followed up their original announcement of open market sales with 2 more announcements of increased sales of ECC-D. Once this selling is finished, ECC-D could be like a coiled spring that has been set free. I believe that ECC-D has the best total return potential among relatively safe fixed-income securities with fair value at around $22.00. OXLCI also fits the bill. Its yield to maturity (YTM) is much better than its closest sector peers. The best comparison is OXLCI versus OXLCL. OXLCI has a YTM of 8.15% while OXLCI has a YTM of only 7.03% but they should be selling at around the same YTM. OXLCI actually matures 9 months prior to OXLCL. So this is a big mispricing. In fact, OXLCI has a higher YTM than even the term preferred stocks in its sector except for 1 which has a YTM similar to OXLCI. None of this makes sense, and when you run across illogical mispricings like this, you generally have an excellent investment opportunity.  Although OXLCI is not rated, I assess OXLCI baby bond to be a BBB- credit based on super low leverage, being at the top of the capital stack, and legal requirements that force OXLC to keep leverage very low. If we look at BBB- rated bonds from BDCs, they currently offer around 5.5%. 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