CVC Income & Growth (CVCG ), the £122m loan and bond fund managed by CVC Credit Partners, has hiked its quarterly dividend by 66% after its floating rate debt portfolio enjoyed a surge in income after last year’s leap in interest rates.

The Jersey-investment company today declared a 2.5p dividend per sterling share and 1.75 cents per euro share, up from 1.5p and 1.5 cents. This lifts the shares classes’ respective dividend yields to 7.5% and 7.3%, up from 6.4% and 7% last week.

This is the third time in two years the closed-end fund in riskier, sub-investment graded debt has increased pay-outs, which offered an annual rate of 4.5p per share in April 2021.

The jump in dividends reflects a huge increase in cash generation as coupons from investments have escalated as central banks have raised base rates in the fight against inflation.

It also reflects fund manager Pieter Staelens’ move last year to reduce the allocation to fixed income high yield bonds and lift floating rate loans. These accounted for a  record 85.5% of the portfolio in December versus just 11.3% in fixed rate assets.

13% cash yields

The 2022 selloff in credit markets, caused by the hawkish tightening in monetary policy, has generated an extraordinary rise in the cash yields Staelens can generate by depressing the prices of the loans he can buy.

Cash yields have risen from 7-8% a year ago to 13% today, leaving the scope for further dividend increases, the company’s board said in a stock exchange announcement.

‘The board of directors is currently reviewing the level of the company’s quarterly dividends in the light of the significantly elevated cash yield being produced by the investment vehicle’s underlying portfolio, and any changes will be announced once that review is complete,’ said chairman Richard Boleat.

Default risk priced in

Speaking to Citywire before today’s announcement, Staelens (above) explained that although non-investment grade loans were more likely to default on repayments as the cost of borrowing increased and the economy worsened, essentially the risk was limited and offset by the high level of income.

Over the last five years, default rates in leveraged loans had been around 1% a year, Staelens said, peaking at about 2.5% shortly after Covid. Last year, 0.6% of loans defaulted.

The manager, who joined CVC Credit Partners from Janus Henderson five years ago, said the fund holds senior secured loans, meaning that in the wind-up of a business they stood at the head of the queue of creditors, before equity shareholders.

By contrast, he said high yield bonds tended to be unsecured and therefore had lower recovery rates.

Historically, recovery rates on leveraged loans have been about 66 cents in the dollar, so if there’s a default investors receive about two thirds of par value, whereas for high yield bonds, that’s historically been around 40 cents in the dollar, Staelens said.

Estimating a 2.5% default rate for 2023 and assuming a two-thirds recovery, the loss rate would be only 1%, covered by the interest on the portfolio. With the current level of income, if default rates spiked to 5%, the losses would still be covered, he said.

To minimise risk, Staelens only invests in very large companies with average pre-tax profits of £300m and avoids small and medium-sized corporate borrowers that will struggle with higher interest rates.

Recently, he has bought loans in the travel and leisure sector which are proving popular despite the cost-of-living crisis as people put holidays ahead of non-essential consumer items like furniture.

Investec a big backer

Trading on a 7% discount below asset value, CVCG shares have escaped the notice of many income investors, although Investec Wealth owns 29% according to Refinitiv data.

At 93p, the shares trade below the 100p level at which they launched 10 years ago, having fallen from a peak of 115p in October 2018. Including dividends, over five years they have generated a total return of just 6.4%. The big increase in pay-outs suggests that, if accompanied by a re-rating of the underlying assets, CVCG could see those returns improve in future.

Shareholders who hold their stake for over a year can also use a twice-yearly exit facility allowing them to sell shares at a 1% discount to NAV.