Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report sits behind a disclaimer. What can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. In the UK, because CLOs are not a simple asset class, the report should only be looked at by professional/qualified investors.
Q2: You called your recent piece Yield (10%, covered and growing) + capital growth. What can you tell us about it?
A2: In our note Re-Set, Re-Fi, Re-Light my Fire, published on 5 May 2021, we explored how favourable market conditions mean that CLO vehicles can re-finance debt cheaply. This enhances the value of Volta Finance’s CLO equity positions, which have been increased substantially in recent years, and is expected to lift total returns by 1%-1.5% p.a. for several years. The higher cashflow further backs an already covered dividend with a 2022E yield of 10.1%. With returns above the cost of the dividend, the NAV is growing (supporting further dividend growth). With income and capital growth appealing to a range of investors, the discount to NAV may narrow, going forward.
Q3: So, tell us a bit more about the opportunity to Reset and Refi?
A3: The bottom line is that the CLO cost of funds is going down while its asset yield is relatively stable. This means the margin, the gap between what its receives and what it pays away, is widening, which benefits CLO equity holders like VTA.
Q4: And what does that mean for VTA investors?
A4: We see four distinct opportunities for VTA investors, all of which are enhanced by the superior returns generated from CLO re-financing.
First, it makes the high yield even more secure because Volta’s equity positions are more profitable and upstreaming more cash to Volta. Secondly, with returns well above the dividend payout, we forecast that the NAV will grow, generating potential capital gains for investors. Thirdly, the dividend policy is to pay out an annualised 8% of NAV, so, as the NAV increases, investors should benefit from higher dividends. Fourthly, it will be good for sentiment and the secure income, capital gains and rising yield may thus encourage a closing of the high discount to NAV.
Q5: Your note also looked the NAV recovery since March 2020. What can you tell us about that?
A5: As a brief summary, Volta Finance marks to market its assets and so captures any illiquidity and sentiment volatility in them, leading to sharp falls in periods of distress followed by rapid recoveries as market sentiment normalises. We believe this NAV volatility also has an impact on sentiment to the shares, leading to wider discounts on the lower NAV at times of distress. A double whammy. Looking at the recovery in NAV since March 2020 it appears driven by the elimination of this sentiment discount on underlying assets and the re-financing gains are thus an incremental opportunity from here.
Q6: And a couple of words on the credit environment generally?
A6: At one point, last year, rating agencies were forecasting 12%-14% annual default rates in 2021. By the end of May 2021, the actual trailing 12-month default rates declined again in loan markets (for the fifth consecutive month) to 1.7%, for both US and European loans. We believe most modelling still assumes 2% and 4% for 2021, so there may be upside from credit being better than expected.