Tag: VTAS

Volta Finance Ltd (LON:VTAS) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.

Q1: Volta Finance was one of the attendees at your recent forum, and you produced a note on the company highlighting the questions and answers from attending investors. I see the first question was about being a forced seller of assets, which sounds like a read-across from the problems seen at Woodford and H20 What can you tell us about that?

A1: We see minimal read-across from those situations.

First, there is no redemption pressure, as the company has the permanent capital of a closed-ended structure.

Second, there is limited gearing – just over 10% of the fund – and this is structured so it can be repaid over a year; by way of comparison, in the last 12 months, total cash generation from income, natural maturities and sales were close to 40% of the portfolio.

Third, the Board is clearly independent from the manager; it combines extensive experience in the industry with a broad investment company knowledge, and critically has individuals who are not afraid to challenge the manager.

 Fourth, we detailed in our 26 June note on the Manager’s Hardman & Co Forum presentation the extensive and independent verification of asset values; the actual prices they have achieved on asset sales fully verify its accounting approach.

Finally, the company’s platform distribution is not an issue for the company. Lots of reasons here why there is no read-across at all.

Q2: The bias of other questions appeared to be on credit.  Could you comment how VTAS may optimise returns if the expected gentle economic deterioration happens?

A2: Looking forward, AXA IM expects more volatility on credit, and one way to benefit is to invest in CLO equity. Critically, new CLO equity benefits from higher re-investment returns. While this might, at first sight, appear counter-intuitive, the actual market-wide returns from CLO equity issued just before the 2007/08 financial crisis were around twice those issued in the years before.

It is all about balancing higher impairments against higher spreads and picking the right manager to exploit the opportunities.

We discussed downturn scenarios extensively our initiation report in September last year and, more specifically, in our note, Investment opportunities at this point of the cycle, published on 14 January 2019. In summary, we believe the manager has the necessary experience through the cycle and expertise to deliver.

It is worth noting it outperformed the market in generating those higher returns earned from CLOs issued in the financial crisis.

Q3: On credit, we hear a lot about lenders getting squeezed on their security and, especially, so- called cov-lite documentation. How do you see that evolving for them?

A3: Anecdotal evidence from a senior credit executive in a major bank and multiple other sources is that the effective enforceability is weaker than in 2007. For Volta Finance, we need to break up the impact of these changes into the two key credit loss determinants.

First, for a given economic pattern, the probability of default is lower, but, second, the loss in the event of default is higher. At this stage, it is too early to know whether the ultimate economic effect will be different, the company management’s view is that any net impact will be modest. However, we believe investors also need to focus on the sentiment impact. Fewer defaults are better for sentiment than lots of defaults.

As both the company’s NAV and its discount are sensitive to sentiment, in any downside, the extreme sensitivity-driven volatility seen in the past should not recur.

Q4: there were some questions about the relationship with AXA Investment Management. What can you tell us about that?

A4: AXA IM has advantages of scale, risk control, deal access and excellent long-term performance. Axa has a material investment in structured finance, which we believe is a long-term core business to it. For Volta Finance, there are clear conflicts of interest policies and reporting structures in place. Perhaps most critical is the fact that the Board is willing to challenge the manager.

Volta Finance Ltd (LON:VTAS) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.

Q1: You have recently written a report on Volta Finance. Can you tell me a bit about the company?

A1: Volta is a closed-ended investment company that invests in structured finance assets, primarily Collateralised Loan Obligations or CLOs. Looking though the technical jargon, what investors need to know is that the company earns a steady flow of interest from a hugely diversified loan portfolio with around 700 underlying borrowers. It invests in a range of instruments but that is the underlying risk. They aim to provide a stable stream of income to investors through quarterly dividends. There is of course a lot of skill in picking the right investments and Volta’s deep market understanding has identified assets mis-priced for risk.

Q2: I notice that when I go on your website, I have to tick a box confirming I am a “Relevant Person” and not a US person before I can get to the research. Why is that?

A2: The company is subject to a number of regulatory and legal restrictions. Unlike a normal company, but like many investment companies, these rules mean US investors should not get information about them. If your listeners want to look through the legalese about relevant person, the issue is that their investments can be complex and subject to sentiment-driven price volatility. The long term returns are all about the cashflows from the underlying loans but there may be a load of short term noise in any periods when markets get worried but to the medium to long term investor as long as defaults on underlying loans don’t rise significantly, the cash keeps rolling in. Indeed as we outline in our note short term noise is good news because it allows for reinvestment at higher rates, so boosting future cashflows. With the potential for short term volatility it is not an investment for the archetypal widow or orphan and should only be considered by sophisticated investors who understand volatility. Volta’s own Key Information Document has a recommended hold period of 6 years. The tick box gives the legal definition for those that are interested.

Q3: Your report looked at the managers March presentation. What did we learn?

A3: The key takeaways were Volta Finance’s flexible mandate means it can exploit whichever element of the CLO market offers the best opportunity. This is likely to see further allocations to CLO equity tranches in the near term. Second, the credit cycle is likely to turn but this should be gentle and create re-investment opportunities. We agree with the company on both points. Third the portfolio can be quickly re-positioned if market conditions change. Fourth, the management and board experienced the financial crisis.

Q4: In the section “Hardman comments” you particularly highlight covenant lite documentation and how it may affect the sector. Can you tell more about that?

A4: Our market feedback is that cove-lite documentation has not only weakened in terms of issuance add-ons, EBITDA leverage and the use of adjusted EBITDA, but there has also been a noticeable reduction in covenants around asset sales. A senior credit officer suggested the effectiveness of covenants is now weaker than in 2007. We concur with management’s view that, ceteris paribus, this will see lower default rates and lower recoveries (with a net unknown impact on expected ultimate loss). Part of the unknown effect is how many companies will be able to survive for longer because of the covenants and if they do so will they then be able to recover with greater benefit from looser fiscal/monetary policies. The effect on sentiment to CLO stocks is also unclear. We believe that lower defaults are highly likely to be well received and that there would be less over-reaction on the downside as a consequence. We suspect that the offsetting negative sentiment that may be expected from lower recovery rates could be delayed until there is more visibility of the actual numbers. We are more optimistic, therefore, than management that sentiment-driven volatility will be reduced following weakened covenants.