EIC - CEF Weekly Review: When Distribution Cuts Are Good News

2023-09-23 07:00:00 ET

Summary

• We review CEF market valuation and performance through the third week of September and highlight recent market action.
• Most sectors saw NAV gains, but discounts widened, particularly in the Covered Call and Equity sectors.
• Invesco trimmed distributions on many CEFs including IHIT, potentially indicating a termination of this CMBS 2023 term fund.
• The Blackstone loan CEF trio raised distributions, while Eagle Point Income Fund hiked its distribution by 13%. Carlyle Credit Income Fund saw a rise in NAV and hiked its distribution to 14%.

Welcome to another installment of our CEF Market Weekly Review, where we discuss closed-end fund ("CEF") market activity from both the bottom-up - highlighting individual fund news and events - as well as the top-down - providing an overview of the broader market. We also try to provide some historical context as well as the relevant themes that look to be driving markets or that investors ought to be mindful of.

This update covers the period through the third week of September. Be sure to check out our other weekly updates covering the business development company ("BDC") as well as the preferreds/baby bond markets for perspectives across the broader income space.

Market Action

Although most sectors saw NAV gains, discount action remained weak and nearly all sector discounts finished wider. Higher-beta sectors like EM Equity, MLPs and REITs outperformed.

Month-to-date, loan CEFs are in the lead, taking advantage of broad-based credit spread tightening and a low duration profile.

Equity CEF sector discounts widened considerably recently and have only been wider during the COVID period and the Energy crash over the past decade.

This is mostly due to the Covered Call and Equity sectors. Although the NAVs of these sectors have held up well over the past month, prices have stagnated.

Market Themes

At the start of the month Invesco trimmed distributions on many of their CEFs with most affected being Muni funds. Interestingly, the company cut the CMBS 2023 term fund IHIT especially hard. IHIT now has a distribution rate on NAV of just 3.1%.

A distribution cut is not a development that is welcomed by investors however in the case of IHIT it is actually positive. Normally when a term CEF starts cutting distributions it is as a prelude to termination. The fund’s expected termination is at the start of December which offers a potential 5% opportunity over 3 months. Another sign the fund will likely terminate is that it has no leverage and its cash position is 15% as of July.

A dividend cut doesn’t just suggest a termination is likely - it also often pushes the discount wider as well. This provides a good opportunity to add the fund at a wider discount and monetize a higher alpha opportunity into the termination.

Of course there is no guarantee the fund will terminate. It can easily ask shareholders to approve a switch to a perpetual fund. However, up to now it has been making moves indicative of termination.

Market Commentary

The Blackstone loan CEF trio ( BSL ), ( BGX ) and ( BGB ) raised the distribution by 8-9%. The funds have not been shy about raising their distributions, doing so each quarter. This makes the sixth consecutive hike for the funds. BGX and BGB have a more mixed allocation with bonds making up around 15-17% of the portfolio whereas BSL is a more pure-play loan fund. The funds have lagged the sector somewhat over the past year which looks to be because of their higher-quality allocation.

The Eagle Point CLO Debt / Equity CEF Eagle Point Income Fund ( EIC ) hiked the distribution by 13% to $0.18. The NAV yield of the fund is now 16.1% - less in price terms. The fund last raised its distribution at the start of the year so another jump is arguably overdue.

EIC holds primarily floating-rate assets financed with fixed-rate preferreds. Despite the fund’s high-beta holdings (quarter in CLO Equity, rest in CLO Debt) its performance remains a question mark. EIC has put in an annualized total NAV return of 8% over the last 3 years. A comparable fund XFLT has managed almost twice that. And even loan CEFs have managed 6% despite floating-rate leverage and much lower yielding assets. Until this performance question mark is resolved it remains a difficult fund to own.

More good news from the new CLO Equity CEF Carlyle Credit Income Fund ( CCIF ). August NAV came in at $8.52 or a nearly 4% rise over the July figure. This boost was due to a combination of a rise in CLO valuations as well as an exit in one of the legacy positions above the marks. On the day of the announcement the fund closed at a 7% discount - very cheap for a CLO CEF.

The distribution was also hiked to 14% - a big jump from the previous 8% and well above the target 12% figure. As was highlighted in the recent article, the 8% distribution was a joke and less than half of other CLO CEFs. The new 14% distribution is more reasonable but is still pretty conservative. Recall that pure CLO Equity CEF distribution rates on NAV are closer to 20% while a mixed CLO Equity / Debt CEF EIC is at 16%. A big question mark is what proportion of the portfolio will CLO Equity be and, two, whether the fund will leverage up. In any case, there is a good chance we will see another distribution hike if not as massive as the 75% one we just witnessed.

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