Manager’s Commentary – Geoff Castle – November 2015

Written by Geoff Castle

In challenging circumstances, the Pender Corporate Bond Fund was off 2.7%* through the month of November. The month was generally weak across the board in high yield markets, a product of tax-loss selling combined with generally negative fund flows in high yield credit and very weak commodities. Two specific items, a transaction-related markdown on NRL Energy (-56 bps) and a sharply lower price for the Westmoreland Coal Term Loan (-67 bps), accounted for almost half of the Fund’s decline. Another area of weakness was the Fund’s position in consumer finance bonds, including those of CNG Holdings, Enova International and Speedy Cash.

As difficult as this period is, we are relieved to be facing this tough credit market with a vastly improved risk profile and robust liquidity. In September we inherited a Fund with heavy weightings in the highest risk band of securities (which we count as securities rated CCC or below, or having a Bloomberg 1 year default probability of greater than 2%). From takeover, the weight in the highest risk category has declined from roughly 50% to less than 20% today. And our liquidity position remains very robust with cash at 20% weight as of November 30.

Opportunity

While we need to face the reality of a difficult market, we also continue to like the return opportunity of the securities held. Downside price momentum has created many attractive risk/return situations.

These include:

  • Westmoreland Coal Term Loan: Although the loan price has declined to the low $60’s from $89 in September, our expectation is that EBITDA will continue to cover interest by over 2x in 2016 and beyond due to the very long-term nature of the company’s customer contracts. At the current loan price, the Fund’s entire investment can be recouped from the effective 13% cash interest rate prior to maturity.
  • Enova International: This consumer finance company is well-positioned to survive a slight reduction in the size of the consumer loan industry due to its online focus not requiring asset turnover at storefronts. In studying the balance sheet we see current loan assets due in less than one year carried at a greater value than the market value of all of the company’s debt. Yet at the current mark, the bonds have an 18% yield to maturity.
  • Energy Fuels Inc.: Another higher yielding security, this note has a cash yield of over 17% despite the company’s current assets being more than double the amount of debt maturing in 2017. And in the past six months EBIT has been more than six times interest costs.

We have performed careful surgery to reduce risk in the Fund. But we have also held onto key securities, such as the positions described above, where the rationale for holding is very compelling. The overall mix of the portfolio (current yield on the Fund averages 6.2%) is now positioned in a yield range above the investment grade universe but below the average high yield security.

NAV Transparency

It has been a particular point of emphasis for us to ensure that the Fund NAV is solid despite the challenging market. In this context, the sale of the very illiquid unsecured NRL Energy 8.5% notes of 2018 helped improve NAV quality. Sale of this inherited position, whose issuer we believe may be heading towards a difficult debt work-out, resulted in a noticeable 56 bps write down against a stale prevailing market price. In the absence of our trade, the stale price may have persisted for several weeks or perhaps even months. Inaction in these circumstances might have been flattering to the NAV. However, we believed that continuing to hold these bonds would have only magnified risk in the Fund at a stale mark. Both the trade of NRL Energy and last month’s write-down of the Southern Pacific Term Loan reflect proactive efforts on our part to ensure that the NAV is as “hard” as possible. Such actions favour long-term holders of the fund.

Onward and Upward

The Fund at present has a weighted average current yield of 6.2% with average duration of 1.6 years. On a forward looking basis, we are optimistic about returns. Coupons of securities held are attractive and many securities possess strong rebound potential. However we are not reckless. Rather than double down in a volatile market, we have positioned ourselves with a risk profile greater than that of the investment grade universe, but much more moderated than that of the high yield market. Our hope is that we have found a sweet spot to deliver on our goal of a robust level of income to our clientele while maintaining an appropriate focus on preservation of capital.

7 December 2015
*F Class