Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman & Co’s Financial Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Volta Finance, your report, it sits behind a disclaimer, why is that?
A1: It’s a very standard disclaimer that many investment companies have. In essence, for regulatory reasons or some countries like the US where the report should not be read, in the UK because CLO’s – collateralized loan obligations – are not simple asset class, the report should only be looked up by professional and qualified investors. There’s nothing unusual about the disclaimer there, nothing to worry about.
Q2: Now, you called your recent piece, ‘Value added by active portfolio management’, what can you tell us about that report?
A2: In this note, what we did was we explored the company’s portfolio position and, in particular, looking at why it had increased its CLO equity rating and reduced its CLO debt rating.
We showed how this has helped deliver relative resilience through the COVID-19 crisis with AXA investment manager selecting the investments, firstly, who was price had already reflected a downturn and secondly, were recent vintages with less risk and thirdly, we’re in defensive sectors.
Now, the company marks to market its investments and has suffered from sentiment-driven effects but the annualised cash that’s actually being received is 16% of the August net asset value and market conditions are actually improving.
So, what we also did is we explored the upside optionality that the company’s portfolio now provides to any further recovery.
Q3: You talk about resilience through COVID-19 crisis to date, what did you mean by that?
A3: The actual cash flows and performance of the portfolio through the crisis have been much, much better than its accounting NAV so in July, the first month of the quarter, most CLO positions received their coupons. Yet, according to Wells Fargo research, 24% of US CLO’s actually suffered the breach of the interest diversion at that stage which meant they didn’t get all the cash they expected.
For VTA, only one of its position did not receive any cash flow and except for those position, that were only three that were even to breaching covenants. Now we understand all of those three have seen improvements through May and June and since and so have built larger cushions protecting that cashflow.
Now, what does that ultimately mean? The cash through the COVID-19 crisis has been very robust and it reflects the asset selection by AXA and this more resilient portfolio will see through to feeding a more resilient accounting net asset value in due course.
Q4: So, what’s going on with the reported NAV which, as you say, saw big falls?
A4: As I said, the company sticks to a mark to market approach and that means it catches sentiment volatility as well as changes on the underlying expected cash flows so, there’s the sentiment issue and a reality issue.
Another CLO fund, Blackstone, adopts a mark and model approach and it’s fall in March was just one third of VTA’s. Since then, Blackstone has seen a much lower level of recovery than VTA which, as I say, adopts a mark to market approach.
So, we estimate that if the company used the mark to model approach, its net asset value would be 10% to 15% higher than it’s currently reported numbers. Now, this exposes a fundamental weakness in a ‘one size fits all’ mark to market approach, what that does is it values a company as if it’s going to be forced to sell on the day of the valuation, which may well be a very distressed price and well below what it actually expects in terms of cash flows.
Now, a business like Volta Finance, with an incredibly strong balance sheet, it’s got no debt, its Repo facility was repaid early in the year and it got cash of nearly €9 million euros at the end of July, will never be in that position. It can wait for a time when the market values the assets better reflects the expected cash flow, it does not need to crystallise the distressed prices which implied by its smart market valuation.