NexPoint Credit Strategies Fund: Options Worked

|
About: NexPoint Strategic Opportunities Fund (NHF), Includes: BKS, BMA, C, COLL, CRC, CRESY, CSRA, DYN, ENLK, ET, FINL, FTNT, GTN, I, IRS, JCAP, LORL, LRN, MLPX, ORIG, PAGP, PAM, PCRX, PETM, SBGI, SGMS, SRC, TGS, TWTR, UDFI, WMB, WPZ, YPF, Z, ZG
by: Maks F. S.
Summary

NHF is a closed-end fund sponsored by Highland Capital & NexPoint Advisors, primarily invested in below-investment-grade debt and equity with the ability to hedge risk.

The Nexpoint Credit Strategies Fund currently yields an income-only distribution of 10.52% and trades at a discount of 7.50% to its net asset value.

We take a look at various metrics and changes in the fund as learned from the recently published Semi-Annual Report.

A look at leverage of the fund.

Income Idea subscribers received a more detailed analysis along with an in-depth thoughts beyond the numbers and implementation ideas, more than 2 days ago.

Please Note: This article was first published for Income Idea subscribers complete with more detailed analysis, including distribution quality and actionable investment ideas.

This article, in particular, was originally released on 9/19/2017 for our subscribers. All of the data is as of 9/19/2017.

A bit more than a month ago, I completed an in-depth look at the NexPoint Credit Strategies Fund (NHF). If you have not done so already, please take a look at it in "NHF: Keeps On Ticking."

Since then, the fund has issued its semi-annual report so I wanted to take a look at the changes.

As we have done an in-depth view of the fund not too long ago, this will be predominately looking at the changes in the portfolio and a look at leverage, a topic we have recently started discussing.

Fund Updates

At the time of our previous article, NHF yielded an income-only distribution of 10.74% and traded at a discount of 7.76% to its net asset value (8/7/2017).

Today, the fund yields 10.52% and is trading at a discount of 7.50% to its NAV.

On September 6th, the fund released their Semi-Annual shareholder report for the period ending June 30th, 2017, where we can see the latest holdings and portfolio changes.

The first thing I did was to compare the holdings from June 30th, 2017, as reported in the Semi-Annual Report and as of April 30th in the previous Form-NQ.

Please keep in mind, NHF has also raised about $100 million in a rights offering earlier this year and many of the new holdings were funded by cash.

I have summarized the major changes below.

First are the major changes in the portfolio's holdings.

Holding Equity Ticker Type Change Note
Vertellus Holdings Senior Loan Increased Fund nearly doubled its position from 820k to 1.3 million.
Weight Watchers Senior Loan Decreased Decreased holding from $14.5 million to $9.3 million
Venoco Bond Sold $5 million face worth $100k is no longer held.
Avaya Bond Increased Added $20 million par.
Scientific Games Corp (SGMS) Bond Decreased Cut position in nearly half, selling $2 million par.
Argentina Government Bonds Sovereign Bonds Increased Dramatically increased position from about $2 million face to $5.5 million.
K12 Inc. (LRN) Common Stock Decreased Cut position by 2/3 from 186k shares to 68k shares as prices rose.
Gray Television (GTN) Common Stock Decreased Cut position from 18k shares to 10k shares.
Loral Space and Communications (LORL) Common Stock Decreased Cut position from 24k shares to 13k shares.

Source: NHF Reports, compiled by MaksFS

The fund has trimmed a number of fixed income and equity positions as outlined above.

Most notable to me were the increases to a small private chemical company Vertellus and the doubling in its holdings of Argentinian Government Bonds. NHF has previously profited from Argentina bonds and it looks like they believe there is more value on the table.

Next, I looked at the reports to identify the new holdings.

Holding Type Value
California Resources Corp (CRC) Bond $6 million par @8% due 2022 worth $3.8 million.
Albertson's Bond $3.2 million par @5.57% due 2025 worth $2.98 million.
Intelsat Jackson Holdings (I) Bond $4.5 million par @9.75% due 2025 worth $4.5 million.
PetSmart (PETM) Bond $2 million par @8.88% due 2025 worth $1.85 million.
Provincia de Buenos Aires Sovereign $40 million par @24.08% due 2022 worth $2.4 million.
Provincia de Mendoza Sovereign $24 million par @24.63% due 2021 worth $1.48 million.
Energy Transfer Partners (ETP) Common Stock 108k shares worth $2.2 million.
Plains GP Holdings (PAGP) Common Stock 85k shares worth $2.2 million.
Transportadora de Gas del Sur SA (TGS) Common Stock 63k shares worth $1 million.
Williams Cos., Inc (WMB) Common Stock 35k shares worth $1 million.
YPF SA (YPF) Common Stock 23.8k shares worth $521k.
Banco Macro (BMA) Common Stock 15k shares worth $1.3 million.
Harmony Merger corp Common Stock 1.2 million shares worth $12 million.
Specialty Financial Products Common Stock 18 million shares worth $20 million.
CSRA Inc (CSRA) Common Stock 32k shares worth $1 million.
Fortinet (FTNT) Common Stock 158k shares worth $5.9 million.
Sinclair Broadcast Group (SBGI) Common Stock 29.5k shares worth $970k.
Collegium Pharma (COLL) Common Stock 58.8k shares worth $736k.
Pacira Pharma (PCRX) Common Stock 45.7k shares worth $2.1 million.
Cresud S.A.C.I.F. (CRESY) Common Stock 27.8k shares worth $540k.
IRSA Inversiones (IRS) Common Stock 8.7k shares worth $209k.
United Development Funds IV (OTCPK:UDFI) Common Stock 25k shares worth $75k.
Jernigan Capital REIT (JCAP) Common Stock 77k shares worth $1.69 million.
Spirit Realty Capital REIT (SRC) Common Stock 697k shares worth $5.16 million.
Barnes & Noble (BKS) Common Stock 149k shares worth $1.1 million.
The Finish Line, Inc. (FINL) Common Stock 232k shares worth $3.2 million.
Dynergy (DYN) Common Stock 237k shares worth $1.9 million.
Pampa Energia (PAM) Common Stock 16.7k shares worth $982k
Global X MLP & Energy Infrastructure ETF (MLPX) Common Stock 155k shares worth $2.1 million
EnLink Midstream Partners (ENLK) MLP 131k shares worth $2.228 million.
Williams Partners LP (WPZ) MLP 27.5k shares worth $1.1 million.
Citigroup (C) Call Options 9,700 9/15/17 $65 Strike.

Source: NHF Reports, compiled by MaksFS

Overall, the fund has added meaningful positions in energy and infrastructure, be it individual holdings, partnerships or even ETFs.

Beyond that, many of the names which were added are emerging market names, many of which are located in South America.

The positions that immediately jump out are the $64 million par value of Argentinian bonds for the provinces of Buenos Aires and Mendoza.

The positions are currently worth slightly less than $4 million but are yielding very high rates. Perhaps management believes they will be able to recover on those like they did previously with the Argentina sovereigns. Hopefully!

In true "recovery" fashion, the fund has picked up some shares of United Development Funding IV (OTCPK:UDFI), a mortgage REIT. A failed mortgage REIT that is.

If you are not up on the news, UDFI was involved in a scandal that was made public by a hedge fund. In essence, UDFI was making loans to clients that were using those proceeds to repay loans in earlier REITs. Many believe there is still value there. From April through June, UDFI has traded from as low as $1.70 to as high as $3.70 or so. Depending on when the fund picked it up, they might have already made some money. Today, it is sitting at around $3.15.

The other noteworthy position is the Citigroup (C) via call options which we will discuss shortly.

Next, I looked at the positions that had a quarter over quarter decline in value.

Holding Ticker Type Value
LLV Holdco Senior Loan $900k Value drop.
Texas Competitive Senior Loan Value dropped from $346k to $230k.
iHeart Communications Bonds Value dropped from $707k to $457k.
Ocean Rig (ORIG) Common Value fell from $639k to $353k.
NexPoint Real Estate Opportunities REIT Common Value declined from $67 million to $62 million.

Source: NHF Reports, compiled by MaksFS

There were 5 positions that had noteworthy declines in value.

The first was a senior loan for LLV Holdco, a holding company for a Lake Las Vegas project. It is a $9.2 million bankruptcy exit revolver that was valued at $7.393 million as of June 30th. As of April 30th, it was worth $8.275 million. It would be interesting to know.

The senior loan position in Texas Competitive Electric Holdings Cop declined from $346k to $230k as that company is exiting restructuring. It was made upon the equity I believe.

The iHeart Communications loan has also declined, with the $2 million par paying 14% due 2021 dropping in value from $707k as of the end of April to $457k as of the end of June. The iHeart Media stock has also declined during this time-frame.

Ocean Rig continues to decline. The fund owned 2.242 million shares valued $353k as of June 30th.

The biggest one where I am struggling, however, is the affiliate REIT, the NexPoint Real Estate Opportunities REIT, whose value declined from $67 million to $62 million quarter over quarter. Will have to do a bit of digging on that.

On the plus side, the fund has made some great investments that have worked out. Below are the 4 that made me notice.

Holding Ticker Type Value
Twitter (TWTR) Common Value increased from $21 million to over $25 million.
Citigroup Call Call Options $2.2 million cost worth $4 million at expiration.
Citigroup Put Put Option Wrote $65 put options, collected $754k in premiums, would expire worthless.
Zillow Short Common Shares dropped from about $49 to $39 today.

Source: NHF Reports, compiled by MaksFS

First, the fund has been quite successful with Twitter. From April 30th to June 30th, the value has increased from $21 million to over $25 million.

On the flip-side, the fund has been short Zillow, both (Z) and (ZG). While I am not familiar with their short case, the stock is down quite a bit long term.

From April through June, however, Zillow has increased from the mid $30's to as high as $50 per share. Since then, however, both share classes from $50 to the current $39 per share.

The solid big win however where the fund has won on both sides of the trade on Citigroup.

The fund has purchased some time ago 9,700 Citigroup September 17th, 2017, $65 call options for $2.282 million. Assuming they were held until expiration, the options would be worth more than $4 million at expiration just last week (buying a call gives the holder the "right" to "buy" at the strike price. i.e. need price to go up).

At the same time, the fund "wrote" the same September 17th, 2017, Put options with the same $65 strike price and have received $754,828 in premiums. When you write an option, you now have the obligation. With Put options, the owner has the right to sell you the shares at the specified price. The fund as the writer had the obligation to buy shares at the $65 if the options were exercised. As the price of Citigroup went over $65, the put options would expire worthless.

Leverage

As we have started discussing leverage in recent closed-end fund articles and we have not done so in our previous NHF article, let's take a look.

As per CEF Connect, the fund had about $98 million in leverage exposure, or about 14.77% leverage for the fund as of 6/30/2017.

If there is a weak point in the fund versus its peers it would be, in my opinion, the lending covenants.

The primary lender is State Street Bank & Trust with whom a line was established as of 2/2/2011.

As of June 30, 2017, the amount outstanding under the Credit Agreement is $85,650,000 with an interest rate of LIBOR+1.75%. The Credit Agreement’s maturity date is on December 15, 2017.

Source: NHF Semi-Annual Report

As the maturity on the credit agreement is December 6th, the fund has started repaying the line as required.

The Fund is required to pay down $10,000,000 on each of July 6, 2017, August 6, 2017, September 6, 2017, October 6, 2017, November 6, 2017, and December 6, 2017, and may not later draw on any amounts paid down. As of June 30, 2017, the fair value of the outstanding Credit Agreement was estimated to be $86,426,373 and would be categorized as Level 3 within the fair value hierarchy. The fair value was estimated based on discounting the cash flows owed using a discount rate of .50% over 6-month risk-free rate.

Source: NHF Semi-Annual Report

For the 6 months ending June 30th, the fund's average daily note balance was $98.8 million with an average interest rate of 2.65%.

The good news is, the fund has established another line of credit in 2013 with BNP Paribas at a meaningfully smaller interest rate.

On May 16, 2013, the Fund entered into a Committed Facility Agreement with BNP Paribas Prime Brokerage, Inc. (“BNPP PB, Inc.”) (the “Committed Facility Agreement”). The current facility size of the Committed Facility Agreement is $75,000,000 and the Fund is required to pay 0.55% on the uncommitted balance and LIBOR + 0.75% on amounts borrowed.

The downside to this credit facility, however, are the covenants.

The Fund has the right to terminate the Committed Facility Agreement on 90 days notice, and BNPP PB, Inc. has the right to terminate the Committed Facility Agreement immediately.

Source: NHF Semi-Annual Report

As of June 30th, the fund had $12.2 million under this credit facility.

I suspect the recent rights offering and the associate proceeds will be used to both delever the fund, pay down the expiring credit facility and to subsequently re-lever with the new one.

Bottom Line

The fund has done well this year so far, both from the performance aspect and as far as growing the fund through the over-subscribed rights offering.

I am glad to see many longer-term investments and shorter-term trades work out. NHF is just being NHF.

There are a few things to take note of however as we discussed before.

First, the fund has added significant energy exposure to the portfolio. You have to decide whether you are okay with that or not.

The other thing to take note of is the leverage situation which I believe is still developing.

The primary credit facility is coming to maturity and the fund is paying down the loan. On the flip-side, the secondary $75 million line of credit does offer significantly lower rates, however, it can be terminated at any time by the lender.

Going forward, I would like to see either stronger covenants for the credit facilities OR seeing the fund go unlevered.

Income Idea

Want further analysis and my take beyond the numbers? Please consider subscribing to my premium marketplace service, Income Idea.

Income Idea subscribers received a more detailed analysis of the fund along with a discussion of the fund beyond the research numbers. More importantly, a more detailed discussion of whom the fund works best for, whether it is the right time to invest in it or not, and actionable strategies for implementation if it belongs in your portfolio.

I believe in active management that works, and I am here to help you find those opportunities. Please follow me here on Seeking Alpha as we look for those opportunities and sort out the good managers from the mediocre. Simply click the "Follow" button next to my name at the top of the article or on my profile page.

Disclosure: I am/we are long NHF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.