Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report sits behind a disclaimer. What can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. In the UK, because CLOs are not a simple asset class, the report should be looked at only by professional/qualified investors.
Q2: You called your recent piece ‘R&A shining light on 20%+ IRR base-case scenario’. What can you tell us about it?
A2: In our previous note, ‘Cash is king and the king is rocking and rolling’, published on 16 September 2022, we examined Volta Finance’s success in generating cashflows at near-record levels, and looked forward, considering why defaults would rise – but not to the level then built into loan prices. We also highlighted their diversification and geographical exposure.
These positive underlying features continue, and we updated investors on them in our recent note. What we also did was examine how investors could use the recent Report and Account (R&A) disclosure to better understand the true business drivers and how the company’s mark-to-market accounting creates volatility around these positive fundamentals.
Q3: So, taking your first point first, what can you tell us about the higher cashflows?
A3: For six months now, the company has been delivering annualised cashflows in excess of 20% of its NAV, which is nearly twice what we consider a normal level.
To briefly summarise how this has been achieved, the rise in their income reflects both management actions and market conditions, including i) increased allocation to CLO equity at a time when CLO equity cashflows were helped by re-fi and re-sets, and also benefited from the low default rates among underlying borrowers, ii) most underlying loans are floating-rate, and so have benefited from rising $ rates, iii) to date, inflation has been a friend, not a foe, for Volta, with borrowers able to pass on cost increases to customers and seeing the capital value of debt erode, and iv) rising re-investment yields.
Looking forward, our note also examines the resilience of these cashflows. While defaults are expected to rise from very low levels, it will be to at a manageable rate and to very manageable levels, especially bearing in mind the rising income.
Q4: You said the R&A can help investors, how so?
A4: Firstly, Volta Finance has provided a range of stress tests, with defaults rising, including one with defaults rising to 5.8% over each of the next three years (its current expectation is just 2%-3%). Even in that scenario, the IRR is 17% and, to quote from the R&A, “We must consider very punitive assumptions to fall below 20% projected IRR”.
Management spent nearly three pages also detailing the business rationale behind why it expected defaults to remain. The accounts also detail how the portfolio has been re-positioned to optimise returns, while still taking account of the risk environment. We cover all these issues in our note, as well as how marking to market introduces volatility, and why it may not reflect the real value of the business as a going concern.
Q5: What about the risk?
A5: Of course, there are risks. The last few weeks and months show how volatile markets can be. There is a macro risk to the downside, and sentiment is always hard to call. The key question is how much is in the price.
