Analysts spend a lot of time pontificating on what the Fed might or might not do. Until it acts, there's always uncertainty and nobody knows for sure what it will do, asserts Rida Morwa, income investing specialist and editor of High Dividend Opportunities.
The ideal investment is one that will benefit if interest rates rise, but also will make a ton of money if they don't. In other words, an investment that will thrive regardless of what the Fed does.
Say hello to Eagle Point Credit Company (ECC). A closed-end fund (CEF) that invests in CLOs (collateralized loan obligations), ECC is producing a massive amount of cash flow in the current environment. The CLO positions that ECC invests in are floating-rate, while ECC's leverage is fixed rate. As a result, if interest rates rise, ECC's earnings will rise as well.
If interest rates don't rise, ECC is already covering its 10% yield, book value is growing and ECC recently issued new bonds at 5.375%, using the proceeds to redeem Notes from 6.6875% - 7.75%. This is interest savings that go straight to earnings available to common shareholders.
We're seeing the benefit as ECC just raised its dividend 17% to $0.14/month! Additionally, ECC paid an excise tax on undistributed taxable income last year. That's income that will need to be distributed in 2022, which management expects there will be excess for a special dividend again this year. The cash flow from ECC is immense.
ECC's earnings are going up even if the Fed doesn't raise. If the Fed does raise, then higher yields from floating-rate debt will increase ECC's earnings even more.
The one possible risk to the "good times" for ECC is default rates. Since ECC invests in the "equity" and junior debt tranches, default rates can have a direct impact on returns. Historically, default rates are from 2%-3%, anything below that's great.
Default rates are at record lows, and the "Shadow Default Rate" which measures borrowers who have violated a covenant or are rated below CCC by a rating agency, indicates that defaults will likely remain low. Fitch is forecasting a default rate for 2022 around 1.5%. Which is fantastic news for ECC.
Default rates were held low despite COVID because of the massive amount of liquidity in the financial system. That liquidity isn't going to disappear with a few rate hikes.
It will take the Federal Reserve years to remove the excess liquidity in the system, the Fed will likely be willing to reverse course on any sign of economic weakness. ECC is one of the best ways to benefit from the Bubble of Liquidity, and get a sky-high yield to boot.
