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PCI: The 9% Yield Cash Machine


  • We have been capitalizing on the COVID panic, buying a lot of underpriced opportunities.
  • One sector that remains undervalued is non-agency mortgage-backed securities.
  • The housing market is on fire and new mortgages have very low yields.
  • PCI is one of the best ways to capitalize on this opportunity.
  • Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »

The unknown forms both risk and opportunity for investors. The fear of the unknown frequently causes investments to be priced lower than the actual risk calls for, which makes it a great buying opportunity.

One such opportunity is in legacy mortgages. Mortgage rates today are near all-time lows. Houses are flying off the market as fast as people can list them. House prices surged 14% in January, even as volume was up over 20%. The market is so hot, you might consider selling your house - except for the issue of where will you live? Owning mortgages is a great way to participate in this opportunity while keeping a roof over your head. Such a strong housing market should be excellent news for older mortgages, yet many continue to trade at a discount to par value.

We will be shedding light today on an elite stock that has a generous 9.4% dividend yield paid monthly. This CEF is PIMCO Dynamic Credit and Mortgage Income Fund (PCI).

PCI has a broad array of investments, is managed by a world-class manager, and many of the investments are a type that a retail investor cannot easily trade. PCI is an actively managed fund that takes advantage of market opportunities while keeping your money safe in good hands.

PCI: A Clear Winner based on Performance

PCI is managed by PIMCO, an elite management team that invests in the debt markets. PIMCO has a well-earned reputation as a world-class manager, and that is reflected in the values of their funds. PCI has been going strong, handily beating the market for the past five years before COVID-19 took the wind out of its sails. This downfall was recorded by the majority of securities listed on the market.

This is despite the recent big run of a

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This article was written by

Rida Morwa profile picture

I am a former Investment and Commercial Banker with over 35 years of experience in the field. I have been advising both individuals and institutional clients on high-yield investment strategies since 1991. I am the lead analyst at High Dividend Opportunities, the #1 service on Seeking Alpha for 6 years running.

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In addition to being a former Certified Public Accountant ("CPA") from the State of Arizona (License # 8693-E), I hold a BS Degree from Indiana University, Bloomington, and a Masters degree from Thunderbird School of Global Management (Arizona). I currently serve as a CEO of Aiko Capital Ltd, an investment research company incorporated in the UK. My Research and Articles have been featured on Forbes, Yahoo Finance, TheStreet, Investing.com, ETFdailynews, NASDAQ.Com, FXEmpire, and of course, on Seeking Alpha. Follow me on this page to get alerts whenever I publish new articles.

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Analyst’s Disclosure: I am/we are long PCI AND PTY. 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.

Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.

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Comments (154)

Jeff Swan profile picture
What are your thoughts on this? seekingalpha.com/...
PendragonY profile picture
@Jeff Swan

I think the merger is a good deal. Given the current NAVs of PCI and PDI, this will give a small bump to the dividend.
@PendragonY - can you help me understand your statement? Why would historically high premiums that PCI and PDI are trading at provide a "bump" to the distribution? Most accounts from professionals I have read weighing in on this think it will provide an avenue for PIMCO to bring the distribution down to a more reasonable level given the ongoing deterioration in UNII for both( although March was a slight improvement). Thanks in advance for your expanded thoughts.
PendragonY profile picture

I don't think there is a big issue with the distribution. Second, the PCI shares will be exchanged fro PDI shares based on the relative NAV of each fund. Right now that means that each share of PCI will become a bit over 0.8 shares of PDI. So on conversion, the PCI share will pay just over 80% of the distribution of the PDI share or about 18 cents a share. This compares to the 17.94 cents a share PCI now pays.
Risk Advisor profile picture
PCI issued a Section 19(a) letter with respect to their monthly distribution on 04/01/21. Their latest UNII Report is also weaker than it has been the last few years. Hope this does not continue to deteriorate in the future.
ALLDAY1 profile picture
@Risk Advisor
Not worried about it as mostly due to covid and as we move from covid that will also improve.

As a side note about vaccines and unless you heard it on the news you may not know
it has now been 60 years since a vaccine for polio was developed and approved for use and it is said that in the first year it was proven to be 97%
effective in eradication of the disease. We can only hope that the vaccine for covid is as effective.

@Risk Advisor I looked at the Section 19(a) of PCI and PTY during the past few months. They look very similar, ~90% distribution being income. As such, the possibility of a distribution cut seems very low.
At the end of the year, what is the expense ratio taken from ?
PendragonY profile picture

The fund takes it on a regular basis, not in one lump at the end of the year. And it comes out of the fund's assets and income.
fyi, it has negative 40 cents uni. So it has over two months of income to make up from a deficit.
PendragonY profile picture

You have to understand what UNII is. CEFs have a requirement to distribute NII to shareholders, and UNII is the balance of that amount. BUT that isn't the only source of cash to pay distributions.

I know exactly what UNII is. If its not making NII then its either selling assets for capital gain to distribute or selling core. It's definitely not earning enough to cover is monthly distribution on just income alone.
PendragonY profile picture

Again, that doesn't mean it isn't earning its distributions. NII is only ONE source of cash.
Ethan Roberts profile picture
As a long time Realtor and real estate investor, I watch very carefully for signs that the real estate market will either continue to boom or to bust. Doing so allowed me to sell several properties in 2006, and then ride out the crash until 2009 when I felt it was safe to re-enter that market. A few things make me nervous again in 2021: 1) The rise in interest rates, yesterday's tepid auction notwithstanding. Any continuation of higher rates mean prices will either plateau or have to decline, despite lower inventory levels. 2) Zillow stock (ZG) dropping from $210 to $123 in a two week span (has since rebounded to $149) may be related to interest rates, but it may also be an early warning sign for real estate. 3) people buying properties sight unseen and getting into crazy bidding wars is reminiscent of 2006, and you know what happened after that. 4) A mortgage buddy tells me, "this time is different" because interest rates are lower than 2006 and the borrowers are stronger now. Well, we know it's never different, and they didn't have Covid and its fallout to deal with 15 years ago.
PendragonY profile picture
@Ethan Roberts

In 2006, builders were adding new properties at a high rate, that hasn't happened yet. Inventory remains low because people who want new homes are having a hard time finding them, so they are delaying putting their own house on the market. My wife is a Realtor and while she sees some of the bidding as being a bit crazed, she doesn't see values spiking too much because banks aren't willing to lend out money with crazy valuations (again unlike 2006).
Rida Morwa profile picture
@Ethan Roberts The mortgages that PCI owns are ones that were taken out pre-2009. So they have well over a decade of payments under their belt and are based not on last year's prices but housing prices in 2006-2008. Which even before the aggressive runup we have seen, have enjoyed a decade of more steady and reasonable inflation and were roughly 60% LTV at 2019 housing prices.

I agree that buying 3% yielding mortgages that are being issued today to buy houses that are 20%+ more expensive than a similar house last year is walking on the edge and a very unattractive investment. Ironically, those mortgages are selling at a much higher price than the seasoned decade+ mortgages. I think there is certainly more room for a soft landing today. 2009 was the result of a buildup over several years. If this type of hot market is maintained for several years, then I think there is reason to fear another 2009. If it slows down going into 2022 to a more sober rate, then I think you avoid any kind of foreclosure crisis and only those who are buying non-agency mortgages today see real losses.
Ethan Roberts profile picture
@PendragonY Perhaps it depends on where you live. We are having some value spiking where I am because we continually get multiple bids on every decent property, and often the highest bid is all cash, so no appraisals are made. The higher prices being paid then increase values in those areas.
Geo update? Cut dividend?
PendragonY profile picture

No, that was an erroneous report. GEO had no news on the dividend and doesn't intend to report on the next payment for some time yet.
One thing I noted about PCI is a very high expense ratio - it's 4.18%. Most of its peers have a ratio less than 2%.
PendragonY profile picture

PDI has a very similar fee. And about half of the fee is for the cost of the leverage used.
@PendragonY how does the company charge you for that at the end of the year?
PendragonY profile picture

They don't. Typically they take it out of the fund during the year as a regular expense.
Rida what’s up with GEO
Rida Morwa profile picture
@SouthTexasHunter They recently issued some convertible notes to refinance their 2022 bonds. Their guidance is at $2.03/share so they are trading at a very low multiple of 4x FFO and that guidance assumed that 100% of their BOP contracts would be terminated on the renewal date. We should find out in the next few weeks if the BOP is actually going to cancel their contracts, so there is some upside potential to that guidance.
PendragonY profile picture

One thing likely impacting GEO's price is that there was some incorrect information being reported by some brokers that GEO had cut their dividend.
Hi; I have also been investing in PCI base on your and Pendragon Y articles and recommendations. However copying from TD Ameritrade PCI company profile ( Its portfolio of investments include banks, integrated oil, pipelines, electric utility and chemicals.) it seems that real estate (home) mortgages are not their primary investment or am I confused....
PendragonY profile picture
@Hall Buzz

About 40% of PCI's assets are RMBS. And it is by far the largest class of assets they hold.
Zucks profile picture
Have had PCI for years, but wonder what will happen if the bond market enters a prolonged bear market of rising interest rates. Last spring, I assumed rates would triple in a year. Going forward I expect any I further increase of no more than 150 basis points. None of this hurts PIMCO. However, if rates rise further and faster, CEFs could tank. I agree with everything you wrote and will continue to hold, but am watching the 10 year each weekday morning on “Opening Bell”.
PendragonY profile picture

PCI bought a lot of RMBS well below par and the loans that make up most of the purchases have higher rates than available today. Unless there is a huge spike in rates, PCI should be able to add more assets at good prices and generate plenty of income to cover the distribution. If market sentiment pushes the share price down, I'll buy more.
Declining NAV since inception, no distribution tax breaks and a 10%premium. There are much better deal to be had.
8investor profile picture
@me_too example of where that is?
Dick Cod profile picture
@me_too We all pick our own indicators, but IMO NAV since IPO isn't a very good one. It ignores appx $4 in year end extras since issuance and a 5yr total return of 16.75% ---- vs 16.72% for SPY if that comparison matters. As it happens, I think I may be able to buy it a little cheaper soon, but it will continue to be a near-permanent part of my portfolio.
Regards, Dick
Rida Morwa profile picture
@me_too NAV was $23.88 at IPO and PCI spent most of 2018-2019 above $23 NAV. Their NAV in February 2020 was $23.32. So I would not characterize that as "declining NAV since inception". NAV took an obvious leg down in March of 2020 and has been climbing back up since.
Unless interest rates are going lower , most likely higher you can make the case for these stocks were at an all time high.
Lady Mere profile picture
Rida. Thanks for an informative article on PCI. I own it now and considering buying more. You recently wrote and recommended PFFA and was wondering if you have a preference between PFFA and PCI?
Rida Morwa profile picture
@Lady Mere They are very different investments with absolutely zero overlap. I believe in having a diversified portfolio, so I don't see it as an "either or" question. I hold both. Which one you should consider buying now would depend upon your current portfolio and whether it is appropriate to increase your exposure to preferred shares or to mortgages.
PendragonY profile picture
@Lady Mere

I own both and while I am currently more inclined to add to PFFA than to PCI that is entirely due to the relative amounts of those I already have. PCI is currently about 3% of my portfolio while PFFA is about 0.50%.
"MBS prices crashed like there already was a foreclosure crisis" Bank stocks also crashed like there was going to be a foreclosure crisis. Which wasn't going to happen with the rising price of homes. Why I loaded up on bank stocks a couple months ago. Long NWBI, ASB, USB and WFC pfd.
jjs22 profile picture
PCI and PDI are core holdings for me. Have been for a long time and have never disappointed. Even with the current premium of Market vs NAV the DRIP discount brings things pretty much back to even. I wish all my DIVI stocks did that same thing but most don't. Another nice sweetener to an already rock solid investment. Thanks again Rida and Pendragon!
truthBtold profile picture
@jjs22 Can you explain the DRIP discount? I don't think I'm getting it
pitri1 profile picture
@truthBtold if i am not mistaken, his dividends are buying him cheap shares while the NAV is low. so he is getting a bargain without putting any more of "his own" money into the stock
PendragonY profile picture
Some of the PIMCO funds allow you to reinvest dividends at NAV. Check with your broker to see if they are in the program.
For the short term i have pulled out of all my PCI and sitting cash. Raising interest rates will kill NAV, which PCI has been selling to cover the NII. Sitting at -.40c YTD means more selling of NAV to keep up the current dividend. Even if PCI were to cut back to where it was 2 years ago, it still would not cover the current income shot fall.
With PCI trading at a steep premium as of this writing (almost a $2/share over nav ~10%); i dont know how anyone isnt taking profits and preparing for a pull back.
There are brighter days ahead, but probably not for another 8 months; Those that are not current on their mortgage will need months to get caught back up, not weeks. .
PendragonY profile picture
@User 38929656

NAV is increasing for PCI.
Think. Focus. Health. Wealth profile picture
And premium to nav also increasing... +9.3% premium today per Pimco website vs 7.6% when article was written
PendragonY profile picture
@learning to be patient with mr mkt

Since you like price increases so much, that is a strange complaint for you to make. And not really relevant to the claim that PCI is destroying NAV to make the distribution.
mmcdonough1 profile picture
What's not to like - or at least be cognizant of - is paying more than NAV for a highly levered (40%), non-agency MBS lender when suppressed interest rates have (artificially) inflated all asset prices - including collateral (home) values.

The Fed's grand monetary experiment has resulted in unprecedented debt levels (nominally - and relative to GDP), diminished returns on the growing debt burden, and instability on multiple fronts. The experiment is far from resolved, and history may reveal the imprudence of layering significant additional debt on already over-levered balance sheet. The smartest people on the planet cannot predict future interest rates, or how or when unsustainable debt levels ultimately get resolved.

How do we know credit markets can freeze up / seize up on a dime? Because they just did so - a year ago - resulting in a horrific 44% drawdown in PCI, and a total return (w/ dividends) loss on an NAV basis for the year ended 2-28-21.

Viewed through a clearer risk-adjusted lens, the current “risk-adjusted return” here may or may not be adequate. The backdrop is more fragile - and the range of potential outcomes (unintended consequences) wider - than meets the eye.

The benchmark ten-year Treasury yield has quickly tripled as bond vigilantes digest another round of gargantuan – and poorly designed - fiscal stimulus, along with rising commodity prices, a declining USD, and rapid economic acceleration.
Rida Morwa profile picture
PCI is not a lender. They buy MBS, mostly older MBS. That is a very different role than originators or owning a direct loan. The houses securing the mortgages were bought over 12-years ago and the mortgages are somewhat paid down from the original purchase price and being paid down at an accelerated rate. Their leverage is primarily through non-recourse repurchase agreements, a form of lending where the only collateral is the security being bought. PCI's leverage with that kind of borrowing is quite low compared to other companies that use the strategy.

NAV on 2/28/2021 was $20.40. NAV on 2/28/2020 was $22.94. During that period, PCI paid out $2.088. For a total return on NAV of $22.488. That is a 2% loss for the year. Those who bought on 2/28/20 had a slight positive total return on market value by 2/28/2021. That positive return is larger when you take into account the time value of money. Getting a dividend from PCI in March, April and May provided substantial time value to the investment as that was a great time to be buying almost anything.

The "horrific" drawdown was shared by most tickers in the stockmarket. Those that panicked and joined the selling lost money. Those who followed us and used those dividends to reinvest through the downturn came out ahead.

So I do not see your characterization of the risk as being very clear.
PinHi profile picture
Hi Rida, as always, great article. Not sure why Seeking Alpha shows a dividend cut from Jan. 2020 to May 2020 down to .0244/share. (I didn't own it then) Nasdaq site shows no dividend cut. I tend to believe the Nasdaq site. Comments anyone?

Dick Cod profile picture
@PinHi PCI has never had a distribution cut. It DID increase its distribution once since IPO.
Regards, Dick
PinHi profile picture
@Dick Cod Thanks Dick. So always double check SA data I think is what we are saying. I'm a new subscriber since Dec. 2020
PendragonY profile picture

SA is having some difficulting with its data on distributions.
riggsfoutz profile picture
Thanks for the update on PCI. Dumped my Apple and Amazon few months ago for political reasons. (Bad reason to sell, but good outcome in retrospect). Went back over your previous articles. Got more PCI, DX, HFRO. Thanks to you every month. Still hopeful on NRZ.
Rida Morwa profile picture
@riggsfoutz Thank you for stopping by- DX is one that went on sale last week. I added a bit more myself.
I would take a look at the coverage reports and notice pci’s very low coverage ratio. Roc or distribution cut may be coming. Buying after the price drop could provide some capital appreciation along with the distribution.
Rida Morwa profile picture
@ohppleaseme PCI realized some losses and their UNII report showed they were not covering for a few months, however NAV continued to grow. They had numerous hedges that were negatively impacted when rates crashed. In recent months their coverage improved substantially and their NAV continues to grow. So I think it is always important to look at the UNII report in context.
PendragonY profile picture

To add to what Rida said, understand that UNII is more about what they are required to distributed and not so much about what they can distribute. If NAV is increasing that makes it far less likely that a shortfall in NII will result in a distribution cut.
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