Aberdeen Income Credit Strategies  – Hardly A ‘Senior Loan’ Fund (NYSE:ACP)


Aberdeen Income Credit Strategies Fund (NYSE:ACP) has a high distribution yield of 14.36%, sells at a discount to its net asset value (NAV) of 3.37%, and has managed to come back from a 50% drop in price back in March to a current total return loss on the year of only about 3%. That’s a pretty attractive story.

It stacks up especially well to other funds in the senior secured loan category, where ACP has been listed for many years. Typical senior loan closed-end funds, of which we own several in our “Widow & Orphan” and “Hunker Down” Income Factory model portfolios, tend to pay lower distributions in the 7% to 10% yield range, reflecting where they operate on the credit spectrum.

While virtually all secured, syndicated corporate senior loans are non-investment grade, there is a big difference in default rates between the upper end of the non-investment-grade spectrum (double-B credits) and the lower end (single-Bs and triple-Cs). Since all the loans are secured and tend to recover substantial amounts (75-80%) of their principal when they default, it is the rate of default that differentiates the single-B and CCC cohort from the double-Bs; with double-Bs defaulting only about one-third as often as single-B and CCCs. In fact, now that rating agencies evaluate and rate the risk of default and the likelihood of recovery in the event of default as separate and distinct elements of the rating process, it is not surprising to see some well-secured loans “notched up” to investment-grade rating levels.

Here is the senior loan category as reported by CEF Connect. I have eliminated several funds that are included because they hold structured vehicles, like CLOs, that are ultimately carry loan exposure, but are completely different structures and credit risk profiles.

ACP stands out because of its high distribution (which it has maintained so far; cross your fingers!) and its relatively modest loss so far this year (in other words, it bounced back faster than most other loans funds). The higher-yielding Nuveen Credit Strategies Income Fund (NYSE:JQC) is a special case because the fund is deliberately paying out an unusually high distribution yield as part of a three-year “capital return” plan intended to make the fund more competitive in the future.

ACP’s distribution yield is very attractive, both in absolute terms and in comparison to other funds in the loan sector. Investors, however, should understand what they are buying and what risks they are taking in order to earn that 14% distribution. First of all, ACP definitely swims in the deeper end of the pool in terms of credit risk. According to its latest investor fact sheet, 85% of ACP’s portfolio is in single-B, triple-C and unrated credits.

In addition, the latest semi-annual report shows that bank loans only make up about 2% of the entire portfolio. The rest of it comprises bonds, which are virtually all unsecured and therefore carry credit losses about twice as much as a comparable amount of similarly rated senior loans.

In other words, there is a reason ACP carries a distribution yield significantly higher than “real” senior loan funds. Investors who opt for the extra yield probably end up earning it in terms of the additional portfolio risk they are carrying.

Comparing ACP to other high yield funds

This is not to say ACP is not an attractive investment for those willing to buy it with eyes wide open to the risks involved. To understand its relative attractiveness, we should compare it with other funds in the high yield space, rather than in the loan space, since that is where ACP’s real peers seem to be.

When we do that, we see that ACP doesn’t appear quite so unusual, although it still shows up as one of the higher distribution yields.

One other feature to notice about ACP is that its discount is rather low compared to other funds with high yields in both the senior-loan and high-yield categories, with an exception like Guggenheim Credit Allocation (NYSE:GGM). Having a smaller-than-typical discount means a fund has less of a cushion to absorb shocks like credit losses, and it also means it has to take more risk per dollar of return than a fund with a larger discount. That’s because when you are priced at a discount to your net asset value, your investors have more assets working for them than they actually had to pay for.

ACP, for example, is getting a 14.36% return, but it is only taking a 13.87% risk in the sense that the actual assets it owns (that it bought at a discount) only have to earn 13.87% per annum in order to pay ACP’s shareholders at a 14.36% rate. Compare it to Brookfield Real Assets (NYSE:RA), whose shareholders got such a large discount that the underlying assets that they paid for with their whopping 13.22% discount only have to earn at a rate of 12.24% in order to pay their shareholders 14.11%. The lower the rate your fund actually has to earn, the less credit risk it has to take. So the bigger the discount, the lower the relative risk an investor has to take to earn a given cash distribution yield.

Bottom Line

When we compare ACP to other high-yield bond funds, rather than to senior loan funds, its distribution yield is still at the high end, but is not so extreme as it seemed when categorized with the loan sector.

Investors should bear in mind that high-yield bonds, because they are unsecured, will suffer more damage overall if the economy tanks again for reasons that could stem from pandemic, economic, or political causes, or all three. So loans, being at the top of the capital structure, should offer more protection than bonds if markets go south over the next few months or in 2021.

ACP, however, pays investors well who are willing to take that risk, hopefully in a well-diversified portfolio. Managed on a global basis with teams in London, Philadelphia and Boston, ACP also does a good job of spreading the risk internationally, with 70% of it in developed countries outside the United States.

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Steve Bavaria

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ACP over the next 72 hours. 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.





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Hanmi Financial: Eye On Loan Modifications (NASDAQ:HAFC)


Earnings of Hanmi Financial Corporation (NASDAQ: HAFC) increased to $0.30 per share in the second quarter, from $0.08 per share in the first quarter of 2020. A large gain on the sale of securities was responsible for the jump in net income. Earnings will likely remain subdued in the year ahead because of elevated provision expense and normalization of gains on sales of securities. On the other hand, the accelerated booking of fees under the Paycheck Protection Program, PPP, will likely boost earnings. Overall, I’m expecting HAFC to report earnings of $0.63 per share in 2020, down 40% from last year. HAFC is currently facing very high credit risks because around 29% of its total loans required modification amid the COVID-19 pandemic. The stock price is unlikely to increase until HAFC reports a reduction in loans requiring payment concessions. Hence, I’m adopting a neutral rating on HAFC.

Modified Loans at a Disconcerting Level

As mentioned in the second quarter’s 10-Q filing, HAFC approved applications to modify $1.4 billion of loans and leases due to hardships amid the COVID-19 pandemic. These modified loans and leases made up 29% of the total portfolio at the end of the last quarter. HAFC’s substantial exposure to the hospitality segment was partly responsible for the modifications. Around $944.9 million of loans, representing 19.6% of total loans, were to the hospitality industry, as mentioned in the 10-Q filing. Altogether, the vulnerable loan segments of hospitality, food service, and retail made up 35% of the portfolio at the end of the last quarter, as mentioned in the 10-Q filing. Unlike loans in the retail sector that may resume payments soon, I’m expecting hospitality loans to continue to require assistance for the next couple of quarters because people will likely remain cautious and avoid travel until COVID-19 gets under control. Due to these factors, HAFC is currently facing high credit risks.

HAFC reported a provision expense of $25 million in the second quarter, up from $16 million in the first quarter of 2020. I’m expecting the provision expense in the remaining two quarters of the year to decline from the second quarter’s high but remain above normal. For the full year, I’m expecting HAFC to report a provision expense of $80 million, up from $30 million last year.

Normalization of Gains on Securities to Reduce Non-Interest Income

HAFC’s non-interest income increased by 236% quarter over quarter to $21 million in the second quarter of 2020. The jump in non-interest income was mostly attributable to gains of $15.7 million on the sale of securities. The normalization of these gains in the second half of the year will reduce non-interest income. On the other hand, the resumption of sales of Small Business Administration loans, or SBA, will increase non-interest income. The management mentioned in the second quarter’s conference call that they had suspended the sale of SBA loans in the second quarter due to the disruption in the secondary market. As a result, there were $17.9 million of SBA loans held for sale at the end of June, with a weighted-average trade premium of 8.97%, as mentioned in the second quarter’s earnings release. The management intended to resume the SBA loan sales in the third quarter. Considering these factors, I’m expecting HAFC to report a non-interest income of $8 million in each of the remaining two quarters of the year, as opposed to $21 million in the second quarter and $6 million in the first quarter of 2020.

Accelerated Booking of Fees Under the Paycheck Protection Program to Support Earnings

As mentioned in the 10-Q filing, HAFC had $301.8 million of loans outstanding under the Paycheck Protection Program, or PPP, at the end of the last quarter. Assuming fees of 3.2% and funding cost of 0.35%, PPP will likely add $9 million to net interest income over the life of the loans. I’m expecting most of the PPP loans to get forgiven before the year-end; hence, I’m expecting HAFC to accelerate the booking of the fees in the fourth quarter.

Due to the PPP forgiveness, the total loan balance will likely decline in the year ahead. Moreover, HAFC concentrates on commercial real estate loans, the demand for which is likely to remain low due to the uncertainties related to COVID-19. Consequently, I’m expecting the year-end loan balance to be 5.9% below the June-end balance and 2% below the 2019 ending balance. The following table shows my estimates for loans and other balance sheet items.

Expecting Full-Year Earnings of $0.63 per Share

Above-normal provision expense and normalization of gains on securities will likely pressurize the earnings in the year ahead. On the other hand, the accelerated booking of PPP fees will likely support earnings in the last quarter. Overall, I’m expecting HAFC to report earnings of $0.63 per share in 2020, down 40% from last year. The following table shows my income statement estimates.

Hanmi Financial Income Forecast

The probability of an earnings miss is unusually high this year because of the heightened credit risks that can result in a negative surprise in provision expense.

Dividends Likely to Stabilize

HAFC cut its quarterly dividend twice this year, from $0.24 per share in the first quarter to $0.12 per share in the second quarter and then $0.08 per share in the third quarter. I’m not expecting a further cut because the earnings and dividend estimates suggest a payout ratio of 55% for the fourth quarter of 2020 and 29% for 2021, which is manageable. Moreover, HAFC is currently well-capitalized. The company reported a tier I capital to risk-weighted assets ratio of 10.86%, as opposed to minimum regulatory requirement of 6.0%. Assuming the company maintains its quarterly dividend at $0.08 per share, the leading dividend yield arrives at 3.4%.

However, there is a high credit risk that can lead to an earnings surprise in the year ahead. Due to the chance of an earnings surprise, there are chances of a dividend cut.

Risks Likely to Restrain the Stock Price, Regardless of the Attractive Valuation

I’m using the historical price-to-tangible-book ratio, P/TB, to value HAFC. The stock traded at a P/TB multiple of 0.73 in the first half of 2020. Multiplying this ratio with the June 2021 forecast tangible book value per share of $18.1 gives a target price of $13.3 for the mid of next year. This price target implies a 39% upside from HAFC’s August 31 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.

Hanmi Financial Valuation Sensitivity

As discussed above, HAFC is facing a high level of credit risk that threatens earnings and valuation. The stock price is unlikely to increase until and unless loans requiring modification decline to a satisfactory level. The risks will likely overshadow the attractive valuation in the next four to six months. Hence, I’m adopting a neutral rating on HAFC for the near term.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and risk tolerance before investing in the stock(s) mentioned.





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No student loan payments for the rest of the year — what this means for all types of college borrowers


You don’t have to make another federal student loan payment in 2020. Now is the time, though, to decide what to do before your bill arrives in January 2021.

Federal student loan borrowers were already in an automatic interest-free pause on payments as part of the original coronavirus relief bill, known as the CARES Act. This pause was expected to expire Sept. 30, but an extension of the forbearance through Dec. 31 was directed in a memorandum signed by President Donald Trump on Aug. 8.

However, it’s uncertain that all the student loan relief measures included in the original CARES Act, such as a pause on collection activities, will also continue.

“The language of the executive order is not clear,” says Betsy Mayotte, president and founder of The Institute of Student Loan Advisors. It’s also possible, she says, that Congress will make additional changes before the current automatic forbearance period ends.

See: Trump’s order to extend payment freeze on some student loans leaves ‘many unanswered questions’

For now, the forbearance extension is to begin Oct. 1 and run through the end of the year, barring any legal challenge. The Department of Education is expected to issue additional guidance in the coming days on the details of the memorandum.

Here’s what the student loan payment relief extension is likely to mean for you, depending on your situation:

You have federal loans and face financial hardship

Although January 2021 is just a few months away, it’s enough time to make a change to your federal loan payments and avoid defaulting on the loans.

“There is no harm or downside in talking to your servicer now,” says Scott Buchanan, executive director of Student Loan Servicing Alliance, the trade association of student loan servicers. “You want to be well-prepared for whenever this does expire.”

If you know you’ll have difficulty repaying the debt, contact your servicer now about enrolling in an income-driven repayment, or IDR plan — it caps payments at a portion of your income and extends the repayment term. If you don’t have a job, your payment could be zero. If you’re already enrolled in IDR, make sure to recertify your income if it has changed.

You can still make payments on your federal loans

If your finances haven’t been affected by the economic downturn, you can use this time to prioritize financial goals.

Consider making payments toward the principal on your federal loans to lower your overall debt. Since your loans are on automatic forbearance, you’ll need to contact the servicer to do so.

You can also make a dent in other financial goals, such as paying down credit card debt or padding your emergency fund.

Your federal student loans are in default or rehabilitation

All collection activities on federal student loans are suspended through Sept. 30, such as wage garnishment and collection calls. However, experts say, the new memorandum doesn’t specifically indicate that collections would be suspended through the end of the year.

Similarly, if you’re currently rehabilitating defaulted student loans, the original six months of nonpayment counted toward the nine needed to complete the process. But the memorandum doesn’t specify this would continue under the forbearance extension. Contact your servicer for more information.

You’re pursuing Public Service Loan Forgiveness

Federal student loan borrowers pursuing Public Service Loan Forgiveness don’t need to make payments until Sept. 30. Those months of nonpayment still count toward the 120 payments needed to qualify for PSLF as long as you’re still working full time for an eligible employer.

Also read: The problem with Pell Grants: They’re not keeping up with the cost of college

However, there is no indication yet that the new memorandum applies to borrowers pursuing PSLF, experts say. Contact your servicer to find out if the additional months of forbearance would count toward PSLF. If not, consider making payments during this time to keep on track.

You recently graduated from college

If you were expecting to start making payments on your loan within the period of extended forbearance, your first payment won’t be due until January. Usually, interest accrues during a grace period, but if your six-month grace period overlaps with the administrative forbearance period, interest won’t grow.

Use this time to find out who your servicer is and what your first bill will look like.

If you think you can’t make your minimum payment come January, you can apply for an income-driven repayment plan to cap payments at a portion of your income (it could be zero if you don’t have a job). Apply for income-driven repayment at least two months before repayment starts.

You’re taking time off from school

Federal loans typically have a grace period of six months after you leave school. If you have student loans and last attended school in the spring, your payments would start to come due this fall. The extended forbearance period would delay your first payment until January.

Be sure to read: A gap year could haunt students financially for years—but it could be worth it

When you resume classes, you can defer payments until you finish school as long as you are enrolled at least half time. But student loans get only one grace period; you won’t have another after you graduate or leave school again.

You have private student loans

Your lender may offer private student loan relief in the form of a payment pause or reduced payments. While a number of lenders structured relief plans to end Sept. 30, many are open to an extension or additional relief.

Also see: Kamala Harris on student-loan forgiveness, Medicare, universal basic income, credit scores — and a tax on trading stocks

Contact your lender to ask about additional deferments or payment reductions. You can also apply for existing loan modification programs for financial hardship. These will vary from lender to lender — but interest will continue to accrue, unlike with federal loans.

You’ll likely have to apply for private loan relief individually since most lenders aren’t making payment pauses or loan modifications automatic, Mayotte says.

You have nongovernment owned FFEL or Perkins loans

Student loan borrowers with the Federal Family Education Loan (FFEL) Program or Federal Perkins loans not owned by the Education Department don’t have access to the automatic forbearance.

To take advantage of the forbearance, you’ll need to combine your loans into a federal direct consolidation loan. Consolidating loans will cause any unpaid interest to capitalize, or be added to the principal balance. Contact your loan servicer to determine how consolidation will affect the total repayment amount, interest rate and loan balance.

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Kodak shares plunge after U.S. blocks $765 million loan deal By Reuters


© Reuters. FILE PHOTO: A worker cleans a Kodak booth at the Las Vegas Convention Center in preparation for 2019 CES in Las Vegas

(Reuters) – Shares of Eastman Kodak Co (N:) fell about 40% on Monday and were on track for their worst single-day decline after the U.S. government blocked a $765 million loan to the company, which was going to make drug ingredients for use in possible COVID-19 vaccines, because of “alleged wrongdoing” by executives.

The U.S. International Development Finance Corp (DFC) was slated to grant the loan to Eastman Kodak, which is looking to move deeper into the pharmaceutical arena.

But alarms were raised after senior Democratic lawmakers asked federal regulators to investigate securities transactions made by the company and its executives around the time it learned it could receive the government loan.

U.S. President Donald Trump said last week the government would investigate the circumstances surrounding the announcement of the loan.

“Recent allegations of wrongdoing raise serious concerns,” U.S. International Development Finance Corp (DFC) said late on Friday in a tweet.

The company’s shares have soared more than five-fold, with retail traders on the popular Robinhood trading app piling into the stock since DFC announced it would sign a letter of interest to provide the loan to the company.

More than 900 million shares have exchanged hands since the loan announcement, nearly 12 times the company’s outstanding shares.

Shares of the company were down 39.50% at $9 in pre-market trading on Monday.

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HSBC warns loan losses could hit $13 billion as profit plunges 65% By Reuters


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© Reuters. FILE PHOTO: A Chinese national flag flies in front of HSBC headquarters in Hong Kong

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By Lawrence White and Alun John

LONDON/HONG KONG (Reuters) – HSBC Holdings (NYSE:) PLC warned its bad debt charges could blow past a previous estimate to $13 billion this year and said its profits more than halved, as the coronavirus pandemic hammered the bank’s retail and corporate customers worldwide.

The results from Europe’s biggest bank by assets on Monday reinforced the trend of lenders across the world increasing their buffers to absorb souring loans at a time when companies – from aviation to retail and hospitality sectors – are reeling from the impact of COVID-19.

HSBC reported a pre-tax profit of $4.32 billion for the first six months this year, lower than the $5.67 billion average of analysts’ forecasts.

The bank increased its estimate of the total bad debt charges it could take this year to between $8 billion and $13 billion from $7 billion-$11 billion, reflecting worse-than-expected actual losses in the second quarter and expectations of a steeper decline in the economy.

“What we have seen this quarter is quite a sharp shift in economic outlook for the global economy, the famous ‘V’ has got a lot sharper and as a result we have materially increased our provisions,” Chief Financial Officer Ewen Stevenson told Reuters.

HSBC’s business in Britain has been hit particularly hard, Stevenson said, as it took a $1.5 billion charge against expected credit losses.

While the bank’s results were bolstered like those of its U.S. and European peers by higher revenues from fixed income trading, analysts said investors were likely to be disappointed by the higher forecast bad debt charges.

Its Hong Kong listed shares dropped as much as 4.7% on Monday afternoon, outpacing a fall in the local benchmark, to their lowest since March 2009.

TROUBLE AHEAD

The bank’s credit impairment provisions in the first-half soared to $6.9 billion, compared to $1 billion in the same period a year earlier. It had set aside $3 billion to cover loan losses in the first quarter.

Impairment charges included a $1.2 billion writedown on the value of software it owns, mainly in Europe, it said.

While HSBC’s core capital ratio, a key measure of financial strength, rose to 15% at the end of June thanks to favourable regulatory changes, the bank warned the metric would likely decline this year as falling credit ratings hit its risk-weighted asset ratio.

Its revenues fell 9% in the six-month period, as global interest rate cuts and declining market values on assets in investment banking and insurance outweighed higher trading income.

HSBC is continuing to review its long-term dividend policy, CEO Noel Quinn said in a statement.

The bank earlier this year halted payouts in response to a regulatory request in Britain, infuriating many of its retail investors who rely on it for income, particularly in Hong Kong.

Quinn told Reuters the bank’s staff headcount has fallen by some 4,000 this year after it restarted a redundancy programme that was put on ice after the coronavirus outbreak.

The bank is aiming to cut costs by 3% this year from that restructuring as well as lower employee spending on travel and other items during the pandemic, he said.

Only a fifth of the around 9,000 staff in its headquarters in London’s Canary Wharf district would be able to return to work in the near term for safety reasons, Quinn told Reuters.





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