Closed end fund Oxford Lane Capital (NASDAQ:OXLC) surprised and delighted its shareholders two days before Thanksgiving with the announcement of a 5-cent quarterly dividend increase from $.55 to $.60 (9%), plus a special one-time extra dividend of 10 cents per share, to be paid at the end of the next quarter in March 2014.
This brings Oxford's yield up to 14.25% as of the pre-Thanksgiving close of $16.80 per share. Despite the dividend rise of 9%, the stock only moved up by 4%, leaving some of the improvement in OXLC's overall risk/reward profile from before the dividend announcement still "on the table" for investors who may wish to buy in at the higher yield. (The stock is now showing at a premium of almost 7%, but that doesn't mean much given how micro-thin the active trading market is for most of OXLC's underlying assets, and the fact that NAV represents the best estimate of what prices the assets could be sold at if anyone were actually buying and selling them on a particular day.)
Besides the obvious benefit of the higher dividend, investors are very pleased at the message it sends about management's confidence in being able to continue paying a dividend that was very high, compared to other stocks and funds, to begin with. One of the questions all investors ask themselves (and certainly asked me quite pointedly in their comments when I first began writing about Oxford Lane on Seeking Alpha earlier this year) when they see an ultra-high dividend stock like OXLC is whether it is too good to be true. "Too good to be true," in a stock dividend, can mean any one of number of things:
· Dividends that are not sustainable and are likely to be cut (in which case the market has already brought the price down in anticipation of the cut, leaving the yield temporarily and misleadingly high)
· Companies whose earnings are volatile and which have a policy of raising and lowering the dividend over time as their earnings fluctuate (e.g. Annaly and other mortgage REITs)
· Companies that are extremely high risk (or are perceived to be)
Oxford Lane is a classic case of a company that is perceived to be very risky for a number of reasons:
· It is complicated to understand because its business model is unlike any other retail fund. It buys equity and debt tranches of collateralized loan obligations ("CLOs"), which are securitizations of corporate bank loans. Corporate bank loans are senior, secured, floating-rate loans made by commercial banks to non-investment grade corporations (most corporations are non-investment grade.) These are the same companies that issue high-yield bonds, but because loans are senior and secured by collateral, they rank ahead of high-yield bonds in the event of default and statistics compiled by S&P and Moody's over many decades show that credit losses for loans are less than half what they are for high yield bonds (which are unsecured and sometimes even subordinated to other creditors.) Because of their solid credit history and floating-rate coupons (i.e. no interest rate risk), loans are a perfect candidate for securitization into CLOs. A CLO is like a bank without walls. The equity, perhaps 10% of the liabilities (i.e. 10 to 1 leverage), receives all the excess income from the assets after the liabilities are paid. A simple example might be: $100 million in assets (i.e. corporate loans) yielding 6%; financed by perhaps $70 million of senior AAA-rated debt paying a coupon of, say, 2%, and another $20 million of junior debt paying, say, 12%. That mix of debt (lots of cheap senior debt, a little bit of more expensive junior debt, averages out to an average funding cost on the CLO of perhaps about 4%. If you are the equity $10 million, you are collecting a 2% spread (i.e. 6% minus 4%) on the entire $100 million (actually a little more because your equity is funding directly 10% of the assets), which provides a gross spread to the equity of over 20%. Every CLO is a bit different, but that's the basic idea. Anyone interested in more explanation of OXLC and CLOs should see my earlier articles: HERE (http://seekingalpha.com/article/1740352-savvy-senior-ira-portfolio-slow-and-steady-11-return-for-first-9-months) and HERE (http://seekingalpha.com/article/1321911-10-return-in-q1-for-savvy-senior-ira-now-what-do-we-do). If you are looking for stable predictable long-term cash flows and are willing to accept short-term price fluctuation, than CLOs are attractive investments. Hedge funds and institutional investors discovered this years ago and were rewarded when the senior loan market and CLOs holding them sailed through the credit crash of 2007-2009 with their cash-flows intact (their market prices took a ride down and then back up, along with other high-yield bonds and stocks, but investors who held and didn't panic made out well, just as holders of stocks and high-yield bonds did.)
· The name CLO (Collateralized LOAN Obligation) conjures up the similar but totally different asset class CDOs (Collateralized DEBT Obligations), which were the sub-prime mortgage and home-equity loan securitizations that blew up and almost took the financial markets with them. As mentioned, CLOs are totally different assets and their behavior through the crisis was totally different as well. Securitization (buying financial assets - credit cards, auto loans, student loans, mortgages, corporate loans, life insurance policies, etc.) is just a legal vehicle, a special type of financial contract and structure. Securitizations are neither good nor bad, per se. It all depends on the assets you put in them. But CLOs and other prudently structured securitizations were all tarred with the same brush in the great credit market panic that ensued in 2008. When good assets get driven down by panic selling, of course, that creates opportunities for (1) huge losses for those who panic and sell out, but also (2) big gains for those who hold on or increase their positions. OXLC was formed to take advantage of the latter opportunity. What is particularly attractive and unique about it is that it is the only retail investment vehicle available to non-institutional investors, like us.
Two other things to note, that I consider especially important:
1. OXLC, by its very nature, is a complex investment to understand and analyze. The management, which has a lot of its own money invested in the fund, seems to appreciate that and in recent months seems to be making a concerted effort to make its investor literature (reports, presentations, etc.) more comprehensible to the ordinary reader. (Check out their website for recent investor materials, like the semi-annual report, investor presentations, etc.)
2. If you do that, you will see that one particular point OXLC's management has been emphasizing is that their dividend (just raised to 60 cents per quarter) is more than 100% earned in terms of actual cash-in-hand cash-flow from their CLO investment portfolio. Sustainability of dividend is obviously a big deal to all of us investors (include OXLC's own management), so the reassurance of both a big dividend increase, and the fact that even with the increase the dividends are well within the fund's current cash-flow intake, are together pretty reassuring.
So I plan to enjoy my Thanksgiving turkey today even more, with the additional "gravy" having been provided by our friends over in Greenwich, CT who run OXLC.