Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman and 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 on Volta Finance Re-Set, Re-Fi, Re-Light my Fire. What can you tell us about it?
A2: In this note, we explore how favourable market conditions mean that CLO vehicles can re-finance debt cheaply, thus enhancing the value of the company’s equity positions, which have been increased substantially in recent years. We show the impact on their CLO debt portfolio and the wider loan market, and what this means for new investment returns. The key message is that the favourable conditions are expected to lift returns by 1%-1.5% p.a. for several years. VTA is also benefiting from the unexpectedly low levels of defaults. Despite this favourable outlook, they still trades at a 15% discount to NAV, albeit down from March 2020 highs.
Q3: So, tell us a bit more about the opportunity to Reset and Refi?
A3: Leveraged-debt markets took more time to recover from the initial COVID-19 shock, but most senior-tranche CLO debt (i.e. the safest element) is now back to historically low spread levels. Funding costs for CLO structure are very low, and this creates an opportunity to re-finance existing debt at a lower cost. The company has already seen five positions re-finance, at savings of 15bps-23bps. A further one is expected to complete this month (benefit ca.30bps), and it has several more in June/July. 20 positions in all could benefit. Importantly on the asset side, spreads were already relatively low and they have not moved much so we expect relatively limited end borrowers to re-finance. The cheaper funding thus drops straight down to CLO equity holders (of which VTA is one) and equity returns are expected to rise by 2% to 3% as a consequence. They have been increasing the CLO equity proportion of its book for several years and so will see that much more benefit.
Q4: So, the important thing is the liabilities are re-pricing down, while the assets are stable?
A4: Exactly, it is the gap between the two that is important and that gap is now very favourable.
Q5: And re-investment returns?
A5: In the March Factsheet, the company highlighted that the trailing six-month cashflow represented 16.3% (annualised) of NAV, and that this could be enhanced further by i) the re-financings noted above, which could lock in multi-year gains, and ii) new CLO equity positions, which have been added recently but are yet to make their first dividend payment. The new returns from here will be lower but there is still plenty for the company to go for.
Q6: And you said defaults were lower than expected?
A6: We, like Volta Finance, expect defaults to continue to materialise in 2021/2022, but the pace will be materially less than expected a year ago, and should thus be totally manageable within CLO structures. As an example, rating agencies were, at one point, forecasting 12%-14% annual default rates in 2021 for US loans. 2020 ended with just 4.6% defaults. By the end of March 2021, the trailing 12-month default rates declined again in loan markets (for the fifth consecutive month) to 3.2% and 2.0%, respectively, for US and European loans.
