Recently I read an article describing how opportunistic hedge funds have been swooping in and picking up bargains in high yield corporate bonds and senior loans after the sharp selloff this summer. These funds prefer this sector to richly priced US Treasury debt.
The Invesco Van Kampen Senior Income Trust (VVR) is a relatively “pure play” higher quality senior loan CEF. At the end of August, 93% of the VVR portfolio was in senior loans with about 86% 1st lien loan and 7% 2nd lien loans. The remaining 7% of the portfolio is in corporate bonds, equities, short term devt and cash.
Last month, I wrote a report on VTA which is another Invesco CEF that also invests in senior loans. By contrast, VTA has only 77% of the portfolio in senior loans with only 67% in 1st lien loans.
About 40% of the VVR portfolio is invested in loans with “LIBOR floors”. A LIBOR floor is a feature sometimes built into a debt instrument whose interest payments are linked to LIBOR. Floating rate loans with a LIBOR floor pay an interest rate of LIBOR plus the applicable margin as long as LIBOR remains above the specified floor level. If, however, LIBOR falls below the floor, the interest rate is the LIBOR floor level plus the applicable margin. Essentially, this makes it a fixed rate loan until the LIBOR rate exceeds the specified floor level. LIBOR floors have been used more recently in the low LIBOR environment we have seen since 2008.
Compared to most other fixed income investments, using leverage on senior loan investments involves less risk from rising short-term interest rates, since the income from senior loans adjust to rising rates once the LIBOR floor level is exceeded.
One thing I like about 1st lien senior loans is that they are most senior in the capital structure and interest on the loans is often continued even when there is a default. The loan recovery for many of these defaulted loans can be very high.
The annual default rate for VVR has consistently been well under 1%. For the last trailing 12 months ending in August, the default rate for the VVR portfolio was actually zero!
VVR is currently selling at a discount to NAV of -8.39% compared to the 6 month average discount of -2.34%. The 1-Year Z-Statistic is -2.36. This means the current discount to net asset value is more than two standard deviations below the mean.
VVR has been paying a steady monthly distribution of $0.024 per month. The average monthly earnings per share was reported as $0.0248 in August, so the fund has been earning its payout. But the average UNII per share (undistributed investment income)is -$.002, so there is not a large margin of safety against a future dividend cut.
Portfolio Management Team
Earned an A.B. from Harvard College and an MBA from the Darden School of Business at the University of Virginia.
Phillip Yarrow, CFA
Chartered Financial Analyst, portfolio manager, has managed the Fund since 2007. He earned a B.S. in mathematics and economics from the University of Nottingham and an M.B.A. in finance from Northwestern University.
Capital Structure Breakdown (as of 08/2011)
1st Lien Senior Loan
2nd Lien Senior Loan
Moody’s Credit Quality (as of 08/2011)
Invesco Van Kampen Senior Income Trust (VVR)
- Total Assets= 1178 MM Total Common Assets= 828 MM
- Annual Distribution Rate= 6.76%
- Dividend Frequency= Monthly
- Current Monthly Distribution= $0.024 per share ($0.288 per year)
- Loan Default Rate (trailing 12 months)= 0.0%
- Baseline Expense ratio= 1.01% (before interest expense)
- Discount to NAV= -8.39% 6 Month Avg. Discount= -2.34%
- Portfolio Turnover rate= 50%
- Leverage= 30%
- Average 3 Mos. Daily Trading Volume= 618,000 shares (about $2.95 MM)
The Federal Reserve has announced a policy of keeping short-term interest rates at zero until 2013. I believe this partially explains why the discount to NAV has widened recently on VVR and other floating rate bond closed-end funds. It is true that the zero interest rate policy should keep the floating rate cash flows low for the next few years, but over 40% of the portfolio earns higher interest than the floating rate margin because of the LIBOR floors.
The fund benefits from fairly low borrowing costs. The average cost of fund leverage was reported as 2.67% in August, which is below the NAV yield of 6.26%.
VVR is attractive now as a very low duration, higher income play. It is a good holding for a tax deferred retirement account. I believe it is quite possible that the discount to NAV may narrow over the next few months which would add to the total return. VVR is fairly liquid and usually trades over 700,000 shares a day with good size available on the bid-ask spread.