VCIF: A Whole-Loan Focused Fund

The Vertical Capital Income Fund (VCIF) is an interesting animal and has come up for discussion on the service. The fund allocates to non-agency whole loans (no MBS i.e. no securities). The big difference between VCIF and other funds is that the other funds allocate to securities whereas VCIF allocates to loans. So when you look at the VCIF NAV, it hardly moves (ignoring the steady downtrend due to overdistribution) while the NAVs of PCM, DMO and JLS can be hugely volatile. We saw a similar dynamic in the mREIT space over the COVID crash where those mREITs that held mortgage securities got killed because those securities are more liquid (than whole loans) and are marked-to-market. Because they are more liquid, they were the first to be sold down (ahead of loans) and so kicked off the negative price feedback loop, hurting those mREITs that were overweight securities over loans. The upshot here is that investors who don’t like to see massive jumps in the NAV may find VCIF attractive.

Within a broader income portfolio, the fund is attractive as it generates income that is linked to household balance sheets that are quite healthy – whereas most funds rely on taking corporate risk, a sector that has very high leverage.

The downside is that the fund features relatively muted performance and underlying portfolio yield. The fund’s NII yield looks to be around 3.1% (for the year ending in Sep-20) and 3.5% on price due to the 12% discount. The fund adopted an MDP of 8% x 3-month trailing NAV average. The current yield is 9.29%. Leverage is light at 11%. Expenses are quite high and capped at 2.5% of net assets. The key metric is the 5y NAV performance of 4.8% which is below other non-agency CEFs (DMO at 6.4%, JLS at 6.2%, PCM at 11.8%). The combination of low leverage, high fees, decent quality (658 average FICO score with 70% average LTV) means the yield that the fund can generate is going to be a small fraction of its very high 9%+ distribution rate. The longer-term NAV performance is a good rough approximation of the fund’s underlying yield capacity (which is likely even lower now due to lower mortgage rates). So I think investors shouldn’t expect anything more than 3-4% in terms of sustainable income / annual NAV return going forward.

The discount is likely to keep moving tighter here given the combination of the 9% yield and 12% discount will likely attract investors. Investors who like exposure to whole loans should consider mREIT preferreds with whole loan portfolios e.g. NYMT, CIM and MFA. NYMT leverage is still very low at just 0.3x with the other two at just above 1x. At the same time yields are still north of 8% – and preferreds holders don’t have to think about real “portfolio yields” since what they get in the preferred dividends is fully “earned”.

Thanks for reading.

Check out more timely commentary as well as Income Portfolios and interactive Investor Tools at Systematic Income.

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