ARCC Quick Update: Supplemental Dividend In 2021?

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • ARCC target prices/buying points
  • ARCC risk profile, potential credit issues, and overall rankings
  • ARCC dividend coverage projections and worst-case scenarios


ARCC Dividend Update

As of March 31, 2021, ARCC had around $454 million or $1.04 per share of “undistributed taxable income” which is the amount of earnings in excess of what has been paid to shareholders. Similar to other BDCs such as TSLX, GAIN, and CSWC, there is a good chance that ARCC will need to pay a portion of this amount as a supplemental dividend in 2021 to satisfy the Regulated Investment Company (“RIC”) requirements set forth by the Internal Revenue Code (“IRC”) even when utilizing the spillback provision. For now, management is retaining this amount as a cushion to support “our goal of maintaining a steady dividend throughout market cycles”:

“I want to discuss our undistributed taxable income and our dividends. We currently estimate that our spillover income from 2020 into 2021 will be approximately $454 million or $1.04 per share. We believe having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend throughout market cycles and sets us apart from many other BDCs that do not have any spillover.”

ARCC continues to reduce its overall borrowing rates as well as laddering its maturities. On June 3, 2021, ARCC priced $850 million of 2.875% notes due June 15, 2028, which is an extremely low fixed rate for an unsecured note due 2028 and is taken into account with the updated projections. Also taken into account are additional returns from its investment in Ivy Hill Asset Management as discussed by management on the recent call:

“We have continued to invest in Ivy Hill and with that obviously, we generate typically more funds under management, assets under management there that obviously increases the management fees of that company. As you know, we also invest securities in a lot of the funds and vehicles that they put together, which also just allows us to ramp up the investment income from Ivy Hill. So it is simply just an increased dividend this quarter that you should expect to see. As we invest more, obviously, we should be taking in more income from Ivy Hill. And obviously, a dividend increase just represents our continued belief that it is a very attractive investment vehicle and relationship with Ivy Hill, so just continuing upwards.”

For Q1 2021, ARCC reported another strong quarter slightly beating its best-case projections mostly due to much higher-than-expected dividend income and capital structuring service fees. Leverage (debt-to-equity) declined due to the recent accretive equity offering as well as no portfolio growth (slight decline). Its portfolio yield (at cost) decreased slightly from 8.0% to 7.9% due to new investments at lower yields.

ARCC is now near its lower targeted leverage with a debt-to-equity ratio of 1.01 (adjusted for $337 million in cash). Through April 22, 2021, the company has already funded $630 million of new investments partially offset by $432 million of exits.

“After considering our investment in capital activities during the quarter, we ended the first quarter with nearly $5.2 billion of total available liquidity and a debt-to-equity ratio net of available cash of $285 million of 1.02 times, down from 1.17 times at the end of the fourth quarter. While our leverage ratios will vary overtime, depending on activity levels, we will continue to work to operate within our stated target leverage range of 0.9 to 1.25 times.”


 

During Q1 2021, ARCC issued $1.0 billion of 2.150% unsecured notes due 2026 at a slight discount to par partially used to redeem $230 million of 6.875% unsecured notes which resulted in a realized loss on the extinguishment of debt of $43 million. In February 2021, ARCC completed a public equity offering of 14 million shares at $17.85 per share resulting in total proceeds, net of estimated offering expenses, of approximately $249.4 million. As of March 31, 2021, ARCC had $337 million in cash and cash equivalents and approximately $4.9 billion available for additional borrowings under its existing credit facilities.

“During the quarter, we extended our corporate revolving credit facility to a full five-years and upsized it by nearly $350 million, bringing the total facility size to $4 billion, which is the largest single credit facility for any BDC. In addition, we took advantage of the historically low rate environment and issued $1 billion of 2.15% unsecured notes maturing in July 2026, which was a record low coupon for us or any BDC, while also optimizing our liability structure by exercising our option to early redeem our 2047 notes at par. These $230 million of notes, which we assumed in our acquisition of Allied Capital over 10-years ago, represented the highest interest rate of any of our outstanding debt securities at 6 7/8%. We also returned to the equity markets for a secondary issuance for the first time since 2014, issuing 14 million shares of our common stock at a premium to our net asset value, bringing us net proceeds of approximately $250 million.”

Penni Roll, CFO: “With $5.2 billion of available liquidity and a predominately unsecured funding profile, we believe that our balance sheet remains one of our most significant competitive advantages and provides us with significant flexibility.”

 

Previously, ARCC’s Board reaffirmed its second quarter dividend of $0.40 per share payable on June 30, 2021:

 

As discussed in the Dividend Coverage Levels report, only BDCs that can cover dividends by at least 90% using the lower-yield Leverage Analysis with a debt-to-equity ratio of 0.80 will be considered for ‘Level 1’ dividend coverage.

 


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

OCSL Quick Update: More Dividend Increases?

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • OCSL target prices/buying points
  • OCSL risk profile, potential credit issues, and overall rankings
  • OCSL dividend coverage projections and worst-case scenarios


OCSL Distribution Update

Oaktree Specialty Lending (OCSL) remains a ‘Level 1’ dividend coverage BDC and as predicted in multiple previous projections, I was expecting dividend increases to $0.12 for calendar Q1 2021 and $0.13 for Q2 2021. On May 6, 2021, OCSL announced a $0.13 per share, up 8% from the prior quarter paid on June 30, 2021, to stockholders of record on June 15, 2021.

Armen Panossian, CEO and CIO: “The closing of the Merger on March 19 was, of course, another highlight of the quarter. We believe the combined company will provide significant value to our shareholders. As a result of our continued strong performance and potential to improve earnings following the merger, our Board of Directors announced a fourth consecutive quarterly dividend increase to $0.13 per share, up 37% from the level one year ago. OCSL generated solid earnings results in the second quarter. Net asset value per share grew by 4%, supported by continued price appreciation on our high-quality investment portfolio. Additionally, we capitalized on the current market environment by harvesting realized gains on some of our liquid debt securities and rotating out of lower yielding investments into higher yielding, proprietary ones.”

On March 19, 2021, OCSL announced the closing of the previously discussed merger with Oaktree Strategic Income (OCSI). In connection with the merger agreement, Oaktree has agreed to waive $750,000 of base management fees payable in each of the eight quarters following the closing and is taken into account with the previous projections. As shown in the ‘best case’ projections, there is the possibility of additional increases in its quarterly dividend partially due to the merger. In connection with the merger, former OCSI stockholders will receive 1.3371 shares of OCSL for each share of OCSI based on the final exchange ratio.

“I’d like to spend a few moments discussing the closing of the merger with OCSI, which occurred on March 19. As we have emphasized previously, we believe that this transaction has resulted in several benefits to OCSL, including a larger, more scaled BDC with $2.3 billion of assets, up from $1.7 billion in the prior quarter. And improvement in portfolio diversity, including the increase in first lien loans to 68% of the portfolio at fair value from 60%, increased trading liquidity. And we also expect the merger to be accretive to NII over both the near and long-term through cost savings and the two-year fee waiver. In addition, part of our rationale for the merger was improved access to more diverse, lower-cost funding sources.”

I am expecting continued improvement in earnings over the coming quarters through the use of higher leverage, continued rotation into higher yield investments, accretive impacts from the merger including fee waivers as well as higher returns from its Kemper and Glick joint ventures.

“The Kemper joint venture had $352 million of assets invested in senior secured loans to 57 companies, this compared to $341 million of total assets invested in 56 companies last quarter. Assets increased quarter-over-quarter, mainly due to the increase in the market value of its investments and net portfolio growth as purchases exceeded sales and repayments. As a result of the underlying portfolio depreciation, OCS sales investment and the JV were written up by $5 million or 4% from the prior quarter. Leverage at the JV was 1.3 times at quarter end, up slightly from 1.2 times in the December quarter. Given the strong balance sheet and earnings power at the Kemper JV, we anticipate that we will begin to receive quarterly dividends starting next quarter. Regarding the Glick joint venture, it had $137 million of assets at March 31. These consisted of senior secured loans to 36 companies. Leverage at the JV was 1.2 times at March 31. OCSL subordinated note in the Glick joint venture, totaling $55 million is current, and we expect to receive ongoing payments, consisting of coupon interest and principal repayments of $1.3 million per quarter on a run rate basis going forward.”

On May 11, 2021, OCSL announced that it had priced $350 million of 2.700% of unsecured notes due January 15, 2027, which has been taken into account with the updated projections. OCSL had growth capital available given its historically low leverage with a debt-to-equity ratio of 0.84 as of March 31, 2021. On May 4, 2021, the company amended its Syndicated Credit Facility increasing the size to $950 million used to repay borrowings under its higher cost Deutsche Bank Facility from OCSI:

“We amended our syndicated credit facility, increasing the size to $950 million from $800 million and extending maturity by 2 years to 2026. We also retired a higher cost credit facility that was acquired from OCSI. While there are still some more to be done, we believe these actions position us well to optimally fund investments and will help reduce our overall cost of debt capital. Overall, we are very pleased with the quarter.”


The following table excludes “interest income accretion related to merger accounting” to calculate net investment income similar to the company:

 

 


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

TCPC Update: Reduced Borrowing Rates & Dividend Coverage Update

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • TCPC target prices/buying points
  • TCPC risk profile, potential credit issues, and overall rankings
  • TCPC dividend coverage projections and worst-case scenarios


TCPC Dividend Coverage Update

 

For Q1 2021, TCPC slightly beat its base-case projections due to much higher-than-expected dividend income partially offset by lower portfolio yield and only $0.01 per share of prepayment-related driving lower interest income. Payment-in-kind (“PIK”) income continues to decline from 7.6% in Q2 2020 to 3.2% in Q1 2021 the lowest level of PIK income in three years.

“Investment income for the three months ended March 31, 2021 included $0.01 per share from prepayment premiums and related accelerated original issue discount and exit fee amortization, $0.03 per share from recurring original issue discount and exit fee amortization, $0.02 per share from interest income paid in kind, $0.06 per share of dividend income and $0.02 per share in other income. Notably, this was our lowest level of PIK income in more than 3 years. Origination, structuring, closing, commitment, and similar upfront fees received in connection with the outlay of capital are generally amortized into interest income over the life of the debt investment.”


Similar to most BDCs, TCPC continues to improve or at least maintain its net interest margin through reducing its borrowing rates including its SVCP Credit Facility reduced to L+1.75% announced on June 24, 2021, and $175 million of 2.850% notes due 2026 issued on February 9, 2021. Both Fitch and Moody’s reaffirmed the Company’s investment-grade rating with stable outlook during Q1 2021.

“We also took advantage of the favorable bond market during the quarter to lower our borrowing costs. We issued an additional $175 million of unsecured notes at an attractive rate of 2.85%, which was record pricing for sub index eligible BDC bond issuance. In February, both Moody’s and Fitch, also reaffirmed our investment-grade rating with stable outlook. We ended the quarter with total liquidity of $420 million. This included available leverage of $396 million, cash of $14 million and net pending settlements of $10 million. Unfunded loan commitments of 2 portfolio companies at quarter end equaled just 4% of total investments or $75 million, of which $29 million were revolver commitments. Combined, the weighted average interest rate on our outstanding liabilities decreased to 3.48%, down from 3.54% at the beginning of the quarter.”


 

I am expecting higher amounts of dividend income partially related to Edmentum, Inc. but not as much as there was in Q1 2021. Management discussed the recurring amount of dividend income on the recent call:

“Dividend income in the first quarter included $1.3 million or $0.02 per share of recurring dividend income on our equity investment in Edmentum. I would say I would note that, that is — we view it as recurring dividend income. We had about $0.5 million from Iracore this quarter. We also had about, I think, $800,000 from 36th Street and then some other income from Amtech dividend income this quarter, about $800 million from Amtech as well. I would say most of that should be recurring. 36th Street, as you know, has a preferred rate contractual, and then we have a participation in dividend income a majority split, which has actually been — we’re well into that each quarter, and it’s growing. So that is actually partly recurring and then the variable component actually takes us up quite a bit over the recurring amount, which we like. So the majority — I would say the majority of it is recurring, but then where it’s not, we’re actually seeing good, consistent variable income that has actually been growing as it ties to 36th Street.”

Previous reports correctly predicted the reduction of TCPC’s quarterly dividend from $0.36 to $0.30 which was at the top of my estimated range of $0.28 to $0.30. At the time, the company had spillover or undistributed taxable income (“UTI”) of around $0.78 per share. However, this is typically used for temporary dividend coverage issues. Please do not rely on UTI as an indicator of a ‘safe’ dividend.

The previously projected lower dividend coverage was mostly due to lower LIBOR and portfolio yield combined with management keeping lower leverage to retain its investment-grade rating.

The previous declines in interest rates (LIBOR) were mostly responsible for the decline in portfolio yield with “limited exposure to any further declines”.

“Since December 31, 2018, LIBOR has declined 261 basis points or by 94%, which has put pressure on our portfolio yield. However, our portfolio is largely protected from any further declines in interest rates as 84% of our floating rate loans are currently operating with LIBOR floors.”


As shown below, TCPC’s portfolio is highly diversified by borrower and sector with only 4 portfolio companies that contribute 3% or more to dividend coverage:

“As the chart on the left side of Slide 6 of the presentation illustrates, our recurring income is spread broadly across our portfolio and is not reliant on income from any 1 portfolio company. In fact, over half of our portfolio companies each contribute less than 1% to our recurring income. 94% of our debt investments are floating rate. Additionally, 86% of our debt investments are first lien.”


Historically, the company has consistently over-earned its dividend with undistributed taxable income. Management will likely retain the spillover income and use for reinvestment and growing NAV per share and quarterly NII rather than special dividends.

On the previous earnings call, management was asked about resetting the dividend higher (closer to the previous level) and mentioned the lumpy nature of fee, dividend, and prepayment-related income, “investors take comfort from dividend stability” and “great pride and comfort from knowing that we’ve got good dividend coverage”. I agree.

Q. “Knowing that you folks never like to do anything in a herky jerky way and having just trimmed your dividend from 36 to 30 last year for reasons that are understandable kind of in the middle of the lockdowns. And so I’m just kind of wondering, again, not for the next quarter, two or three. But just philosophically, what would you be looking forward to or is it a goal to get back to the prior distribution?”

A “I just want to remind you of something that we had said earlier about a decrease in LIBOR, which basically cost $0.09 a share. So yes, we did this during the lockdown. But we were also reacting to the very significant change in LIBOR, and the math is set out. And so when we made that decision, it was really primarily looking at LIBOR as opposed to events in the portfolio. We’re very proud of having earned our dividend every quarter. We think investors take comfort from dividend stability, knowing that it’s well-earned and appropriately covered. And that’s really been our focus. I think the other thing is, as you look at our earnings, we benefited from prepayment fees. And as we discussed earlier on the call, those are lumpy. We’ve had significant prepayment fees the last couple of quarters. We don’t always — we did into Q1 of last year. In fact, we had very few of them. And Q1 tends to be a seasonally slower quarter. Paul pointed out, we hadn’t received any in a material way yet this quarter. We take great pride and comfort from knowing that we’ve got good dividend coverage. But we also know that there’s a certain lumpiness to the extra earnings from additional fees, dividends and prepayments and the more unusual items.”


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

TPVG Quick Update: Lumpy Earnings

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • TPVG target prices/buying points
  • TPVG risk profile, potential credit issues, and overall rankings
  • TPVG dividend coverage projections and worst-case scenarios


TPVG Dividend Coverage Update

TPVG’s dividend coverage needs to be assessed on an annual basis due to the lumpy nature of earnings from successful portfolio companies prepaying loans. This results in certain periods of higher prepayment fees driving higher earnings often followed by lower earnings due to being underleveraged and not having a fully invested portfolio.

“I would like to remind everyone that while prepayments are a natural part of our venture lending model, it does come with a great deal of uncertainty. One of the other aspects of prepayment activity is that the origination vintage of alone that prepays really does matter. Given the nature of income acceleration when a loan prepays, the characteristics of income changes, the longer the loan remains outstanding, for example, should alone repay or prepay in its first year, we would generally recognize a comparatively higher level of income.”

This is what happened in Q1 2021 driving interest income well below previous levels due to lower amounts of prepayment-related income as well as the previous prepayments resulting in “lower weighted average principal outstanding on our income-bearing debt investment portfolio”

“Our earnings were impacted by the significant prepay activity we’ve experienced over the past several quarters on our overall portfolio size, despite strong new commitments, growing investment funding and stable core portfolio yield is in the past. We believe any shortfall is temporary and will be more than made up during the rest of the year as the fundamentals of our industry.”

Also, there were some timing issues with new investments near the end of the quarter which did not contribute a full quarter of income and likely some prepayments earlier in the quarter:

Q. “Was there a mismatch in terms of the timing of repays versus the timing of originations? Did, did repays come early in the quarter and were originations stacked towards the back of the quarter?”

A. “Yeah. So I think generally that is what happens, fundings tend to occur towards the end of the quarter and usually in the last month of a quarter in particular and prepays, I think we, we had announced on our year end results that we had already had some prepay. So that was definitely the case for Q1. And I would, I would argue that that’s, that’s pretty typical. We’re fundings tend to average short towards the latter half of, of a quarter in prepays can happen in the early part as well.”

However, since March 31, 2021, and through May 4, 2021, the company has already received $46 million of prepayments generating more than $2.0 million of accelerated income. There is a good chance that many of the prepayments for Q1 ended up in Q2 and the first quarter is typically the slowest for new investments.

“We remain in a strong position to generate NII or net investment income in excess of our distribution over the longterm. As we always have in fact, over the last four years and cumulatively, since our IPO, we have over earned our distribution. We’ve also paid three special distributions, including one that we just made last week. Additionally, other trend that we will benefit from is the acceleration of exit events”

As of March 31, 2021, the company’s unfunded commitments totaled $168.8 million and through May 4, 2021, had closed $52.0 million of additional debt commitments and funded $23.7 million in new investments. Leverage remains low due to previous early repayments driving a debt-to-equity ratio of 0.57 net of cash giving the company plenty of growth liquidity.

“We need to position ourselves to take advantage of the strong demand we are seeing from venture growth stage companies. We expect this to continue throughout 2021 and the first quarter we increased signed term sheets by 142% year over year. And our pipeline continues to be more than a billion. We expect to accelerate funding throughout 2021. And our poise drawn our ample liquidity, which we further enhanced in the first quarter through upsizing our credit facilities and also completing our second investment grade notes offering under very attractive terms.”

The Board reaffirmed its quarterly distribution of $0.36 per share for Q2 2021 and there is still estimated spillover income of $0.45 per share for temporary dividend coverage shortfalls as well as another Q4 2021 special dividend.

“As of June 16th to be paid on June 30th, we have significant spillover income totaling, approximately $14 million or $0.45 per share at the end of the quarter to support additional distributions in the future.”


As shown below, early prepayments are lumpy including a previous low in Q3 2019 driving lower portfolio yield and much lower dividend coverage as shown in the previous table.


On March 1, 2021, TPVG closed a private offering of $200 million 4.50% institutional unsecured notes due 2026, and used a portion of the proceeds to redeem its 5.75% Baby Bond (TPVY) lowering its overall borrowing rates:

“During the first quarter, we executed on our playbook to diversify our funding sources, lower our cost of capital, and strengthen our funding capabilities. Upsizing our credit facility and completing our second investment grade notes offering will enable us to meet the increasing demand from venture growth stage companies.”

From previous call: “we are refinancing our most expensive term debt to baby bonds with 22% cheaper notes. Concurrently, with the private notes offering this week, DBRS maintains its investment-grade rating [BBB] on TPVG given the strength and diversity of our portfolio and the reasonable level of leverage we maintain.”


It should be noted that TPVG is one of the only BDCs currently with 100% unsecured borrowings giving the company much more flexibility over the coming quarters:


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

NMFC Management Committed To Paying Dividends Through 2022

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • NMFC target prices/buying points
  • NMFC risk profile, potential credit issues, and overall rankings
  • NMFC dividend coverage projections and worst-case scenarios


New Mountain Finance (NMFC) has a relatively higher dividend yield consistently covered, with a defensively positioned portfolio and management that exhibits higher quality indicators including responsiveness to personal requests for information, waived management fees, look-back feature for the capital gains portion of the incentive fee. However, NMFC does not have a ‘best-of-breed’ fee structure due to income incentive fees not taking into account realized or unrealized losses. Management has “committed to paying quarterly dividends of at least $0.30 over the next seven quarters” through fee waivers.

“New Mountain was built with defensive growth industries and risk control in mind long before COVID hit. The great bulk of NMFC’s loans are in areas that might best be described as repetitive, tech-enabled business services such as enterprise software. Our companies often have large installed client bases of repeat users who depend on their service day-in and day-out. These are the types of defensive growth industries that we think are the right ones at all times, and particularly attractive in difficult times.”


NMFC Dividend Coverage Update

On May 4, 2021, NMFC entered into a fee waiver agreement and the Investment Adviser agreed to reduce the base management fees not exceed 1.25% of gross assets through December 31, 2022. Also, management has “committed to paying quarterly dividends of at least $0.30 over the next seven quarters” through additional fee waivers:

“We are pleased to announce again a second quarter distribution of $0.30 per share payable on June 30, 2021 to holders of record as of June 16, 2021. With the continued support of our Investment Adviser, we are committed to paying quarterly dividends of at least $0.30 over the next seven quarters as we expect our positive performance will continue.”

“We’re implementing a dividend support program for at least the next two-years by pledging to charge no more than a 1.25% management fee on all assets. For the next two years, we also pledged to reduce our incentive fee, if needed to support the $0.30 dividend. We do not anticipate needing to use this pledge, but want shareholders to have greater confidence in the current dividend. While we believe our ability to earn our $0.30 quarterly dividend remains intact as we come out of the COVID crisis, given the twin headwinds of a very low base interest rates and what we believe is a temporarily increased non-interest earning equity portfolio, we want to assure our shareholders that the dividend and the earnings base that supports it are secure. To that end, we are implementing a program whereby for at least the next two calendar years, we will effectively guarantee to reduce our incentive fee if needed to make sure earnings support the $0.30 dividend. Further in order to simplify our fee structure instead of waiving fees on a portion of certain managed assets as we historically have done for at least the next two years, we will simply charge a 1.25% management fee on all assets. We believe these two important changes even further align management’s interest with those of our shareholders, an approach that has always informed our actions.”

Over the next seven quarters management is working to improve earnings through lowering its borrowing expenses and increasing returns including from its Senior Loan Programs and rotating the portfolio out of equity positions and non-income-producing assets:

“Equity portfolio with things like Edmentum, Benevis and UniTek and we actually believe there is tremendous potential in those names to create real economic value, but of course for every dollar that’s in a non-yielding piece of equity at non-cash and non-income yielding piece of equity that obviously is a dollar that’s not earning NII in the quarter. So, nothing has changed, and in fact, our outlook continues to brighten for those names, and from a timing perspective, it’s not the case that we think we’re going to own them any longer than we would have thought last quarter. It’s just the timing of those uncertain right like will you because it’s a lumpy will you exit one of those and convert that into cash, that’s redeployed in NII generative traditional debt securities we just don’t know. So, we want to just make sure that the new explicit NII per action program has enough runway to make sure we can recycle those proceeds.”

It should be noted that there will likely be less dividend income paid in Q2 2021 due to Edmentum Inc. and is taken into account with the updated projections:

Q. “Edmentum looks like they paid a dividend here in the first quarter and was curious if you expect that dividend to be stable on a going-forward basis or how should we think about just the level of that dividend coming in from Edmentum?”

A. “Yes, that’s really more a truing up of some elements from the fourth quarter transaction. So we do not expect Edmentum to be a regular payer of dividends. So it was more of a one-time post transaction settling than it was a policy of paying dividends, I think Edmentum is going to be more of a growth entity than a dividend payer.”

There is a good chance that management would extend the fee waivers if the company was not covering its dividend but management seems confident that would not be needed:

“So we’re not saying it’s two years for sure and then we said at least two years and that’s important. We feel pretty good about just naturally earning the $0.30, but we recognize there are some post COVID headwinds and we want to make sort of explicit what’s been frankly implicit, and we just don’t want anyone to be worrying about the $0.30 dividend and the sustainability and the coverage it through NII and I think in a listen two years as we’ve all seen in the world is a very long time and we’ll be readdressing if and as needed, but I think our hope and expectation is that two years from now the things that have hurt the dividend, the base rate going down and the larger equity portfolio. We’ll have made progress and there’ll be just much more fulsome coverage to give people that more traditional confidence in the dividend. And of course, if there is not, we are going to be, I think you’ve seen as we’ve always been very supportive. I would be shocked if we weren’t, we needed to extend it, we will likely extend it.”

As discussed in the previous report, management is working to improve its net interest margins by reducing borrowing expenses. In March and April 2021, the company extended and reduced the borrowing rates on its Deutsche Bank and Wells Fargo credit facilities. On February 5, 2021, NMFC announced the redemption of its 5.75% notes due 2023 (CUSIP 647551209; “NMFCL”) on March 8, 2021, using the proceeds from its recent private placement of $200 million of 3.875% notes due 2026. These notes were also used to redeem its 5.31% unsecured notes due May 2021. Moody’s and Kroll recently assigned/affirmed their investment-grade credit ratings:

“We have made material progress decreasing the cost and increasing the duration and flexibility of our liabilities. Specifically, we have extended our two main asset-backed secured credit facilities to $730 million Wells Fargo facility and the $280 million Deutsche Bank facility out to 2026. At the same time, we were able to lower applicable spreads on these two facilities by 40 basis points and 25 basis points respectively. On the unsecured side, we received an investment grade rating from Moody, which will allow us to access the institutional bond market, even more effectively than in the past, which should further reduce our cost of capital. We also received an upgraded outlook from Kroll Bond Rating Service.”


On May 5, 2021, NMFC and SkyKnight Alpha entered into an agreement to establish a joint venture, NMFC Senior Loan Program IV (“SLP IV”) transferring/contributing 100% of their membership interest in SLP I and SLP II to SLP IV. The purpose of the joint venture is to invest primarily in senior secured loans issued by portfolio companies within its “core industry verticals”. Also, the SLP IV entered into a $370 million revolving credit facility with Wells Fargo at a rate of LIBOR plus 1.60% per annum.

“Finally, we combined the SLP I and SLP II funds into a newly created SLP IV, the scale of which will allow for more simplified and efficient financing and execution going forward.”


On January 4, 2021, NMFC announced that its Board authorized an extension of its $50 million share repurchase program “to be implemented at the discretion of NMFC’s management team”. Unless further extended by NMFC’s board of directors, the Company expects the repurchase program to be in place until the earlier of December 31, 2021, or until $50 million worth of NMFC’s outstanding shares of common stock have been repurchased. To date, only $2.9 million worth of repurchases have been made.

For Q1 2021, NMFC reported between its base and best-case projections covering its dividend with slightly higher-than-expected dividend and other income during the quarter. Also, its portfolio yield remained stable and leverage (debt-to-equity) declined slightly.

 


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

GBDC Quick Update: Reduced Borrowing Rates

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • GBDC target prices/buying points
  • GBDC risk profile, potential credit issues, and overall rankings
  • GBDC dividend coverage projections and worst-case scenarios


This update discusses Golub Capital (GBDC) which is a BDC with ‘higher quality’ management, access to SBIC leverage, and its higher credit quality portfolio. GBDC has one of the most investor-friendly fee structures, with a base management fee that is calculated at an annual rate of 1.375% (compared to 1.50% to 2.00%, for many) of average adjusted gross assets, excluding cash and cash equivalents. GBDC’s fee structure includes a ‘total return hurdle’ which means that its incentive fee structure protects total returns to shareholders by taking into account capital losses when calculating the income portion of the fee. Incentive fees are paid after the hurdle rate is reached, requiring a minimum return on net assets of 8% annually. Once this hurdle is reached, the advisor is entitled to 100% of the income up to 10%. This ‘catch-up’ provision catches up the incentives to 20% of pre-incentive fee net investment income and then the advisor is paid 20% after the ‘catch-up’. However, GBDC is currently between the 8% and 10% hurdles so its incentive fees are much lower and basically ensures dividend coverage.


GBDC Recent Insider Purchases

  • The Chairman and CEO have purchased over $35 million of common shares over the last 10 months.


GBDC Dividend Coverage Update

I am expecting improved dividend coverage over the coming quarters for many reasons including portfolio growth through increased leverage, improved net interest margins, and recent/continued increases in its NAV per share.  For the three months ended March 31, 2021, GBDC hit its best-case projections with slightly increased portfolio yield (from 7.4% to 7.5%) and higher fee income partially offset lower portfolio growth (decline). Leverage (debt-to-equity) declined due to increased NAV per share and repayments/sales/exits exceeding new investments for the quarter. NAV per share increased by another 1.8% “primarily attributable to portfolio companies that generally continued to perform well. Strong performance across the portfolio was reflected in our internal performance ratings that have largely returned to pre-COVID levels.”

 

On February 24, 2021, GBDC closed an offering of $400 million of unsecured notes at 2.500% due in 2026. This is an excellent fixed rate for flexible unsecured borrowings and improves the overall strength of the balance sheet as well as lowering the overall borrowing rate.


As shown in the following chart, the net interest margin (green line) previously increased to 5.1% but declined slightly due to the higher weighted average cost of borrowings. Similar to all BDCs, management is working to reduce borrowing rates including the recently issued notes at 2.50% and lower-cost credit facilities. On February 11, 2021, GBDC entered into its $475 million JPM Credit Facility (one-month LIBOR plus 1.750% to 1.875%) and repaid its WF Credit Facility (one-month LIBOR plus 2.000%).

“GBDC took advantage of attractive market conditions to continue to optimize its balance sheet. We executed a second unsecured bond issuance, building on the success of our inaugural offering last year. We also closed a new corporate revolver. These financings are consistent with the strategy you have heard us discuss before, low-cost, flexible financing with limited near-term maturities.”

“On February 11th, we closed on a $475 million revolving credit facility with JPMorgan which matures on February 11, 2026, and has an interest rate that ranges from one-month LIBOR +1.75% to one-month LIBOR + 1.875%. Second, On February 24th, we issued $400 million of unsecured notes, which bear a fixed interest rate of 2.5% and mature on August 24, 2026. With the completion of our second unsecured debt issuance, our percentage of unsecured debt as a percentage of total debt increased to 38.0% as of March 31st. And finally, on February 23rd, we decreased the borrowing capacity under our revolving credit facility with Morgan Stanley to $75 million. After the end of the quarter, we further amended this revolving credit facility to, among other things, extend the reinvestment period through April 12, 2024, extend the maturity date to April 12, 2026, and reduced the interest rate on borrowings to one-month LIBOR + 2.05% from one-month LIBOR + 2.45%.”


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

FDUS Update: Baby Bonds “FDUSZ” and “FDUSG”

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • FDUS target prices/buying points
  • FDUS risk profile, potential credit issues, and overall rankings
  • FDUSdividend coverage projections and worst-case scenarios


 

This update discusses Fidus Investments (FDUS) which has provided investors with higher returns supported by equity investments. FDUS has maintained NAV per share performance and realized gains relative to most BDCs with equity investments in over 87% of its portfolio companies which is primarily responsible for NAV growth and dividend income to support supplemental/special dividends paid over the last 8 years.

 


FDUS Dividend Coverage Update

On May 6, 2021, the company reaffirmed its regular quarterly dividend of $0.31 and another supplemental dividend of $0.08 for Q2 2021. As of March 31, 2021, the company had $0.98 per share of spillover income (or taxable income in excess of distributions) that can be used for additional supplemental dividends.

As predicted in previous reports, FDUS slightly increased its regular dividend in February 2021 and recently announced a dividend strategy that includes an easily sustainable regular dividend as well as a variable portion to pay out the excess earnings as needed (similar to TSLX, HTGC and CGBD) and was discussed on the call:

“The Board has devised a formula to calculate the supplemental dividend each quarter, under which 50% of the surplus and adjusted NII over the base dividend from the prior quarter is distributed to shareholders. For the second quarter, the surplus is $0.15 per share. Therefore, on May 03, 2021, the Board declared a base quarterly dividend of $0.31 per share, and a supplemental quarterly cash dividend of $0.08 per share.”

From previous call: “As a result of the steady improvement in the overall health of the portfolio since then, the Board has increased the base quarterly dividend by $0.01 to $0.31 per share and implemented a supplemental quarterly dividend for 2021 equal to 50% of the surplus in adjusted NII over the base dividend for the prior quarter. Being aggressive with dividend policy just doesn’t seem like the right thing to do. We feel this approach is a good solution for at least 2021 and provide significant upside to the base dividend as we had in the last two quarters, while also providing what I would say is a durable and flexible distribution model in these uncertain timesWill this be a permanent move? It could be. I think the base dividend is something we will always look at, but the approach is a good one. And I wouldn’t say we are the first to do this. But I do think it’s a good one, especially in this environment and we will consider kind of on a permanent basis as well as we move forward, but this is a 2021 move at this point.”


Also, previous reports correctly predicted the reduction in FDUS’s quarterly dividend from $0.39 to $0.30 per share announced in May 2020. FDUS has paid supplemental dividends over the last 8 years but usually in Q4 (last 5 years) and many of them are around $0.04 as shown below.


There is the potential for significant realized gains related to the exit of certain equity investments including Pfanstiehl, Inc.Pinnergy, Ltd., and Global Plasma Solutions which were among the largest markups in 2020. If these investments were sold at the fair value as of March 31, 2021, would imply potential realized gains of over $61 million or $2.51 per share which would likely drive a significant increase in supplemental dividends over the coming quarters. Also, these investments currently account for 9.1% of the portfolio fair value and could be reinvested into income-producing assets driving higher earnings and a potential increase in the regular dividend.


However, FDUS does not have a controlling interest in these companies, and management mentioned “there is no rush” to exit Pfanstiehl as the company has additional upside potential:

“We did rotate half of our investment and rotate out of it in Q1 of last year. Pfanstiehl is a manufacturer of high-purity sugars and active ingredients for injectable drugs and biologic drugs, mostly in the oncology arena, are focused on the oncology arena. They also do participate in the vaccine arena to a certain degree. I’d say the company is performing very well, and the outlook is also strong. So the positives are outweighing any potential negatives of COVID-19 at this point in time. So valuation reflects the performance of the company. And I would say, look, we’re – we like the outlook of the business. We are not in control of the company and that would require discussions with the company or sale of the business which neither of what are happening at this point, but I don’t think there is any rush.”

During Q1 2021, FDUS had net realized gains of $3.2 million or $0.13 per share due to exiting many of its equity investments including Software Technology, Rohrer, and FDS Avionics:

“We have equity investments and approximately 87.3% of our portfolio companies with weighted average fully diluted equity ownership of 5.3%. For the three months ended March 31, we recognized approximately $3.2 million of net realized gains from the sale of several equity investments including Software Technology a $1.4 million gain, FDS $0.9 million gain, and Rohrer $0.9 million gain.”


The updated projections take into account lower amounts of expected fee income (relative to the previous quarter) and continued repayments offset by new investments:

“When I look at Q2 from a fee perspective, my current expectation would be for fees to be lower. In Q1, we had about $3.1 million of fees approximately half of that was from prepayments. And so in Q2, I would expect our fees to really be driven more from origination activity and maybe to a minor extent, maybe a few amendment fees, but not the level of prepayment fees we saw in Q1. We expect Q2 to be relatively busy from origination perspective this quarter was I guess in April, we had $43 million in origination. We’re working hard on several opportunities right now. We do expect repayments to continue through the year, but at a slower pace than the recent past. Overall, we believe the portfolio is headed in the right direction and remains well structured in support of our capital preservation and income goals. Our strategy is working and we remain committed to our goal of growing net asset value over time through careful investment selection, and focus on preservation and on generating attractive risk adjusted returns.”

Also taken into account with the updated projections are the following subsequent events:

  • On April 1, 2021, we invested $11.0 million in first lien debt of Winona Foods, a leading provider of natural and processed cheese products, sauces, and plant-based alternatives.
  • On April 1, 2021, we invested $5.5 million in first lien debt and $1.0 million in common equity of Level Education Group, LLC (dba CE4Less), a leading provider of online continuing education for mental health and nursing professionals.
  • On April 5, 2021, we invested $25.5 million in first lien debt, common equity, and made a commitment up to $2.0 million of additional first lien debt of ISI PSG Holdings, LLC (dba Incentive Solutions, Inc.), a tech-enabled incentive rewards and digital marketing firm that facilitates and optimizes its clients’ indirect sales channel strategies.
  • On April 5, 2021, we exited our debt investment in The Kyjen Company (dba Outward Hound). We received payment in full of $15.0 million on our second lien debt, which includes a prepayment fee.
  • On April 14, 2021, we exited our debt investment in Medsurant Holdings. We received payment in full of $8.0 million on our second lien debt.
  • On April 29, 2021, we exited our debt investment in Virginia Tile Company. We received payment in full of $12.0 million on our second lien debt.

 


For Q1 2021, FDUS easily beat its best-case projections covering 147% of its quarterly regular dividend due to much higher-than-expected fee income resulting from an increase in prepayment and amendment fees, partially offset by a decrease in origination fees.

“I would say Q1 fee income was a little higher than normal. There were some events there that were large events, not small, that’s been obviously positive, and it’s a benefit of our model. But it’s not something that I would say is going to reoccur every quarter for sure.”

Edward Ross, Chairman and CEO: “For the first quarter, our portfolio generated strong adjusted NII, including a lift from fee income. NAV per share grew for the fourth consecutive quarter reflecting an ongoing trend of improving health of the portfolio overall since the pandemic began last year. As a result of continued high levels of M&A activity in the lower middle market, repayments were once again above historical averages and, as expected, outpaced originations.”


Baby Bonds “FDUSZ” and “FDUSG”

On December 16, 2020, FDUS priced a public offering of $125 million of 4.75% unsecured notes due January 31, 2026, and used the proceeds to redeem all of its outstanding 5.875% notes due 2023 (FDUSL) and “a portion” of its outstanding 6.000% notes due 2024 (FDUSZ) callable on February 15, 2021). On December 23, 2020, FDUS announced the redemption of $50 million of 6.000% notes due 2024 (FDUSZ) total of $69 million) Notes on February 16, 2021.

“In Q1, using the proceeds from our December bond offering, we fully redeemed our 5.875% $50 million notes due 2023 and partially redeemed $50 million of our 6% public notes due 2024. In addition, we paid down $19.2 million of SBA debentures and our second SBIC fund. We realized a one-time loss on extinguishment of debt in Q1 of approximately $2.2 million from the acceleration of unamortized deferred financing cost on the redeem bonds and SBA debentures.”

FDUSZ and FDUSG are considered ‘lower risk’ Baby Bonds due to the company having higher quality management and better-than-average historical credit performance as well as an adequate asset coverage ratio and interest expense coverage which are shown in the updated projections.

The “Bond Risk” tab in the BDC Google Sheets includes a summary of metrics used to analyze the safety of a debt position such as the “Interest Expense Coverage” ratio which is used to see how well a firm can pay the interest on outstanding debt. Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm. A higher coverage ratio is better, although the ideal ratio may vary by industry. When a company’s interest coverage ratio is only 1.5X or lower, its ability to meet interest expenses may be questionable.

 


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

Quick Preview: “REITs Continue To Underperform BDCs”

The following information was previously provided to subscribers of Premium BDC Reports along with target prices, dividend coverage and risk profile rankings, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all Business Development Companies (“BDCs”).


As discussed last month in “This High-Yield Sector Continues To Pummel REITs“, Business Development Companies (“BDCs”) have easily outperformed Real Estate Investment Trusts (“REITs”) and are starting to get some “respect” for the reasons discussed in previous articles (see list below) including minimal investments in cyclical sectors (discussed below), stronger credit performance than many private equity/debt funds and even many banks during recessionary periods, maintaining and often improving dividend coverage while others are cutting.

BDC pricing (multiples and yields) continues to head back to levels from early 2014 before the S&P and Russell removed BDCs from their indexes due to concerns cited by the indexes, including the distortion of expense ratios driven by AFFE rules. This was predicted and discussed last year in “New SEC Rules Could Improve Pricing For The BDC Sector“.


Introduction to Business Development Companies (“BDCs”)

Similar to REITs, Business Development Companies (“BDCs”) are regulated investment companies (“RICs”) required to pay at least 90% of their annual taxable income to shareholders, avoiding corporate income taxes before distributing to shareholders. This structure prioritizes income to shareholders (over capital appreciation), driving higher annual dividend yields that mostly range from around 6% to 10%.


Comparison or BDC and REIT Returns Since 2015

  • It should be noted that the BDC sector is relatively new and many of the best BDCs have not been publicly traded for longer than 10 years.

As mentioned in the article linked above, BDCs have easily outperformed REITs over the last 18 months but the following tables show the comparable total returns since 2015 which takes into account 2 major pullbacks in BDC pricing (2018 and 2020).

The following tables assume that you purchased each position at the close of Dec. 31, 2015, and sold at the close of July 6, 2021, collecting (not reinvesting) the dividends (includes paid, accrued, specials, and supplementals). Please see the end of this article for my takeaways from these tables.

I have included many of the BDCs that I cover as well as some others along with many of the larger/popular equity and mortgage REITs. The top performers were predicted/discussed in previous articles including:


Comparison or BDC and REIT Returns Since 2019

The following tables show the updated returns over the last 18 months including VanEck Vectors BDC Income ETF (BIZD) and WF BDC Index ETN (BDCZ) which continually underperform the average for the reasons discussed in “ETFs Are The Worst Way To Invest In This High-Yield Sector“.

I do cover some of the lower return BDCs including AINV due to being one of the ‘older’ BDCs and FSK only due to being one of the largest in the sector especially after taking into account the merger with FSKR. It should be noted that BDCZ has quite a bit of exposure to many of the lower-performing BDCs including FSK and FSKR that accounted for more than 15.5%.

The “Other BDCs” include many of the lower performing companies that I do not actively cover including SLRCSCMOXSQBBDCHCAPPFXBKCCFCRD, and SAR. It should be noted that all of these BDCs with the exception of SAR and BBDC have not reached their pre-COVID stock price levels similar to AINV and FSK partially responsible for the lower returns. Also, most of these BDCs have cut their dividends and will be discussed in the next article.


The following tables show the comparable REIT returns including the Vanguard Real Estate Index Fund (VNQ) and a Mortgage REIT Index (REM) which have outperformed many/most of the larger REIT components. As mentioned in previous articles, I only invest in VNQ (during market pullbacks) for my REIT allocation which has easily outperformed many of its components including AVBESSEQRSPGADCWPCFCPTONNNSTOR, and PSB.


Why do REITs Underperform BDCs?

Upcoming articles will discuss many of the reasons that the average REIT underperforms the BDC sector including return on equity (“ROE”) measures and dividends/distributions paid to shareholders and some simple fundamentals including changes in net asset/book values.

It should be noted that most BDCs continue to position their portfolios away from cyclical sectors and into growth, technology, defensive sectors that will continue to do well over the coming quarters. Also, almost every BDC used the recent pandemic to strengthen their balance sheets with longer-term unsecured borrowings at extremely low fixed rates. These changes have resulted in much stronger balance sheets ready for anything from an economic recession to an overheated economy driving higher interest rates.

Source: ARCC Debt Investor Presentation

I will likely not spend much time on mortgage REITs as I do not see these as long-term holding positions. The following table shows the change in mortgage REIT distributions for the companies listed in the previous tables (excluding GPMT which became publicly traded in 2017) showing an average decline of almost 50%:

Also, I will discuss portfolio allocations for BDCs and REITs, total return comparisons between additional (smaller and less known) BDCs and REITs, other considerations including risk and pricing volatility. Again, the BDC sector is relatively new and many of the best BDCs have not been publicly traded for longer than 10 years but I will provide comparisons of some of the older BDCs in upcoming articles.


Summary & Takeaways

The following table includes the return comparisons from the previous tables with some quick takeaways below that will also be discussed in upcoming articles.

What is the best way for yield-oriented investors to maximize their returns over the long term while earning solid dividends?

  • Adjust portfolio allocations including higher amounts of BDCs compared to REITs as they have been outperforming over the long and short term.
  • For your REIT allocation please use VNQ which outperforms the average but with a lower yield. VNQ has much better diversification than BIZD/BDCZ.
  • If you are investing for higher total returns especially in a rising rate and/or inflationary environment it’s likely better to invest in higher quality BDCs.
  • If you are investing mostly for higher yield it’s better to use a typical/average BDC vs. mREITs.
  • For the same amount of income with less risk, it’s better to invest 50% less capital in BDCs at 8.3% compared to equity REITs at 3.1% to 3.6%.
  • Do not use BIZD or BDCZ to invest in the BDC sector as they continually underperformed the average BDC. You could pick five random BDCs and easily have higher returns and likely higher yield due to fees.
  • Mortgage REITs are likely not good long-term holdings but can provide higher yields and returns if traded correctly. REM is lower yield but could also reduce the risk for that sector.
  • Investors can easily make higher returns by taking advantage of pricing volatility.

Full BDC Reports

  • Weekly BDC Sector Update – Before the markets open Monday morning we provide quick updates for the sector including significant events for each of the companies that we follow along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, what to look for in the coming week, and any other meaningful economic events that need to be considered for the sector.
  • Deep Dive Projection Reports – Detailed reports on 2 to 3 BDCs per week prioritized by first focusing on potential issues such as dividend coverage and/or portfolio credit quality changes. We look for portfolio updates that might be mentioned in the SEC filings as compared to company announcements. Then, reports are prioritized based on pricing opportunities including equity offerings.

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

 

PNNT Quick Update: Starting To Pull Back

The following information was previously provided to subscribers of Premium BDC Reports along with:

  • PNNT target prices/buying points
  • PNNT risk profile, potential credit issues, and overall rankings
  • PNNT dividend coverage projections and worst-case scenarios


Summary

  • PNNT is currently considered a ‘Hold’ but has started to pull back and we thought that this might be a good time to provide a quick update.
  • I am expecting $26 million or $0.39 per share of realized gains during calendar Q2 2021 related to the exit of its equity position in Wheel Pros.
  • On June 3, 2021, its portfolio company Cano Health (CANO) closed its combination with JWS with PNNT’s shares publicly tradable in December 2021.
  • However, CANO has declined by around 9% through June 30, 2021, and down another 14% through July 19, 2021, which will drive unrealized losses likely offset by other investments.
  • PNNT previously reported results last month between its base and best case projections with ‘core NII’ of $0.133 per share and 111% coverage of the quarterly dividend.
  • As expected its NAV per share grew by another 5.2% mostly due to equity investments driving PNNT’s leverage (debt-to-equity) well below historical levels (0.75 net of SBA debentures).
  • The company has started exiting some of its non-income-producing assets which will likely be reinvested into “yield generating debt instruments”.
  • There was a slight decline in income from its recently formed joint-venture PSLF but is expected to grow over the coming quarters.


PNNT Dividend, NAV Per Share & Management Fees Update

PNNT continues to improve dividend coverage partially due to its previous and upcoming increases in its net asset value (“NAV”) per share combined with its 7% hurdle, the eventual selling and reinvesting of many of its equity positions, and its new joint-venture PennantPark Senior Loan Fund (“PSLF”) with Pantheon Ventures that will likely improve its portfolio yield and risk-adjusted returns.

“With regard to income generation, we have the opportunity to rotate out of our out of our equity investments over time and into yield instruments. In addition, we have the ability to grow the P&L balance sheet, and that of our PSLF JV with Pantheon, which should also generate additional income for the company. Our goal is to fully extend the existing JV and we have a little bit of room to go there. And then you know, subject to pantheons approval of course, in partnership, we be totally open to expanding that JV optimizing it if you look at what’s going on over PFLT our sister company with Kemper. We’ve grown that JV, we’re growing more, we’ve optimized the financing by doing a CLO transaction to get a higher ROI.”

“We have several portfolio companies in which our equity investments have materially appreciated in value as they’re benefiting from the recovery. This is solidifying and bolstering our NAV. As part of our business model, alongside the debt investments we make we selectively choose to co invest in the equity side by side with a financial sponsor. Our returns on these equity investments have been excellent over time. From inception through March, 31, our $226 million of equity investments have generated an IRR of 28% and a multiple on invested capital of 2.9 times. We are pleased that we have significant equity investments in five of these companies, which can substantially move the needle of our NAV. I would like to highlight those five companies, they are Cano, Wheel Pros, Walker Edison, PT Network, and JF Petroleum. As of March 31, PNNT owned equity securities, with a cost and fair market value of $40 million and $43 million, respectively. These companies are gaining financial moment in this environment, and our NAV should be solidified to bolster from these substantial equity investments as their momentum continues. Additionally, we are pleased with a liquidity event that Wheel Pros and Walker Edison, which are a solid start to our equity rotation program.”

I am expecting almost $26 million or $0.39 per share of realized gains during calendar Q2 2021 related to the exit of its equity position in Wheel Pros as discussed on the recent call:

“Wheel Pros is the largest national distributor of aftermarket custom wheels. Our equity position has a cost of $500,000 and a fair market value of $26.4 million as of March 31. At the end of March, the company announced a strategic transaction with the new sponsor investment vehicle, which will result in the full exit of our investment in Wheel Pros. The transaction is expected to close in the next couple of weeks. This will resolve in our equity investment in Wheel Pros, generating an IRR of 104% and a multiple on invested capital of seven times.”

On June 3, 2021, its portfolio company Cano Health, Inc. (CANOclosed its business combination with Jaws Acquisition Corp (“JWS”). As shown in the following table, this investment is marked well above cost and could result in $70.4 million or $1.05 per share of realized gains if sold at the previous fair value.


However, the stock price for CANO has declined by around 9% from March 31, 2021, through June 30, 2021, and down another 14% through July 19, 2021, which will drive unrealized losses likely offset by appreciation from other portfolio equity positions.

Also, there is a six-month lock-up on its shares with 20% of the exit proceeds paid to the financial sponsor and a 6% illiquidity discount applied to the valuation for the March 31, 2021, results. Management discussed Cano Health on the recent call:

“Cano health is a national leader in primary health care who is leading the way in transforming healthcare to provide high quality care at a reasonable cost to a large population. Our equity position as a cost and fair market value on March 31, of $2.5 million and $73 million respectively. We believe that there’s a massive market opportunity for Canada to grow in the years ahead with a Medicare Advantage program and merger with Jaws acquisition is scheduled to close in June. At that time, we will receive another $6.7 million in cash and 6,629,953 shares of Cano health and limited partnership controlled by a financial sponsor where the sponsor will earn 20% of the exit proceeds, the shares will be locked up for six months. From a valuation perspective due to the lockup, the independent valuation firm valued the position with a 6% illiquidity discount to traded value on March 31.”

There is a good chance that PNNT will be selling its equity positions in PT Networks, and Walker Edison Furniture over the next 12 to 18 months. These investments along with the previously discussed Wheels Pros were marked up again and now account for almost $91 million or 7.7% of the portfolio with the proceeds to be reinvested into income-producing assets. As shown in the table below, these investments are marked well above cost and will likely result in a total of $65 million or $0.97 per share of realized gains.


Management discussed these investments on the recent call mentioning additional NAV upside as well as increased earning potential through reinvestment:

“As of March 31, equity represented approximately 36% of the portfolio. Over 60% of this 36% has come from appreciation over the last 12 months driven by many of the companies previously mentioned. Our long term goal continues to target that percentage down to about 10% of the portfolio. As we monetize the equity portfolio, we’re looking forward to investing the cash into yielding debt in investments to increase Net investment income.”

Q. “The long term goal, to get equity, obviously, non equity down to 10%. What’s a realistic timeframe to achieve that goal? I mean, there’s that three years out, is it going to take longer than and it’s certainly not going to happen in 12 months?”

A. “Certainly not a year and, and hopefully not three years. You know, you’re right. I mean, I don’t know if that’s a tight enough band for you. Some of these we control some of these we don’t control we control RAM, to some extent, but we don’t control where the oil and guess M&Amarket is, when the oil and gas M&Amarket starts to heat up. We will meet in a hopefully more action RAM, we do control PT, pivot. And that that, you know, is more in our control in that market strong. So that may be you know, sooner rather than later, does that mean 12 months or 18 months, it’s kind of something in that zone. We don’t control Cano. We don’t control Walker Edison, etcetera. So, you know Cano going through the dispatch process, hopefully in the next month or six weeks. We said well control it after it does the [indiscernible] back but at least it’s more and more on its way to a liquidity event. That’ll be a big milestone. So yes, a year to three years just as a general you know, if you really want to say let’s run the table, get it down to 10%. I think that’s probably right.”

“Walker Edison is a leading e-commerce platform focused on selling furniture exclusively online through top ecommerce companies, our equity position as a cost of 1.9 million and a fair market value of $16.7 million as of March 31. Shortly after quarter and the company executed a refinancing and dividend recap, which resulted in shareholders receiving two times their costs while maintaining the same ownership in the company. This resulted in PNNT receiving a $3.8 million cash payment on his equity position.”

Q. “On Walker Edison you mentioned that $3.8 million cash payment, what should we expect, say half of that to be recognized as dividends and maybe the other half to be returned to capital and take your cost basis down to zero or with the whole thing, the dividend?”

A. “It’ll be based on what we could tell it’ll be the first obviously the first part of its return on capital. And the second part of it looks like it’s can be counted as a capital gain.”

“PT Network is the leading physical and occupational therapy provider in the Mid-Atlantic states. Our equity investment in PT came through a restructuring which came about after the company made several operational mistakes. We’ve always had a positive view of the industry and the outlook to the industry tailwinds and demographics, which results in comparable companies trading at EBITDA multiples of 12 to 15 times. Under our ownership, we brought in an excellent management team who corrected those operational mistakes and has shepherded the company well through COVID. Our equity position as a cost of $23 million, and the fair value of $48 million as of March 31.”

My primary concerns for PNNT are mostly related to the recent increase in payment-in-kind (“PIK”) interest income from 13.0% to 20.3% of total income over the last two quarters and the commodity-related exposure combined lack of a “total return hurdle” incentive fee structure to protect shareholders from capital losses. However, management consistently “does the right thing” including continued fee waivers and previously reducing its base management (from 2.00% to 1.75%) and incentive fees (from 20.0% to 17.5%).


 

PNNT March 31, 2021, Quick Update

PennantPark Investment (PNNT) reported between its base and best case projections with ‘core NII’ of $0.133 per share and 111% coverage of the quarterly dividend adjusting for $0.2 million provisions for taxes. There was a slight decline in interest and dividend income from its recently formed joint-venture PennantPark Senior Loan Fund (“PSLF”) but is expected to grow over the coming quarters. Also the company has started exiting some of its non-income-producing assets which will likely be reinvested into “yield generating debt instruments”:

Art Penn, Chairman/CEO: “We are pleased with the substantial increase in NAV this past quarter due to material appreciation in the value of several equity investments. We believe that we can generate increased income over time by rotating those equity positions into yield generating debt instruments. We are starting to see some progress on the exit of those equity investments. Additionally, we have the ability to grow the PNNT balance sheet and our PSLF JV which should also generate additional income for the Company.”

As expected its NAV per share grew by another 5.2% mostly due to equity investments driving PNNT’s leverage (debt-to-equity) well below historical levels (0.75 net of SBA debentures) giving the company plenty of growth capital for increased earnings potential.

For additional detail about PNNT including dividend coverage potential and risk profile, please read “PNNT Updated Projections/Pricing: Dividend Increases Coming“.  We will update this report next month.


 


Full BDC Reports

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.

Quick Preview: “The Worst Way to Invest the BDC Sector: BIZD & BDCZ”

The following information was previously provided to subscribers of Premium BDC Reports along with target prices, dividend coverage and risk profile rankings, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all Business Development Companies (“BDCs”).


BDC Sector ETFs/ETNs

I have recently noticed increased attention to using BIZD and BDCZ as investment vehicles for the BDC sector and I will discuss these in an article titled “The Worst Way to Invest the BDC Sector” later this week.

To start, BDCs are relatively new and a small sector compared to REITs so there are not many companies that provide sufficient trading volumes or market cap to create a quality ETF/ETN. Their allocations are terrible and currently have 11% to 15% in FSK, 5% to 6% in PSEC, and another 30% to 35% in other companies that might be adequate quality but currently overpriced and I would not recommend at these levels. But the worst part is that these investments (BIZD/BDCZ) somehow find a way to underperform not just the average BDC but also their specific allocations which must be due to poor management including fees and ‘adjustments’. I have gone through a quarterly analysis using their exact allocations and not able to tie the results as they are usually lower by around 2% annually.

I’m not a fan of using calendar dates to track BDC returns because most people who invest in this sector take advantage of volatility and no one was buying on December 31, 2019, as BDC prices were near new highs at the time. But it is a way to compare returns over a certain time period and the following tables show how much BIZD/BDCZ have underperformed the average.

It should be noted that FSK, MAIN, and AINV have lower performance for the reasons discussed in  previous updates:


Below are the updated equity and mortgage REIT returns compared to VNQ and REM in the following table which have seriously underperformed the average BDC over the last 18 months.


Full BDC Reports

  • Weekly BDC Sector Update – Before the markets open Monday morning we provide quick updates for the sector including significant events for each of the companies that we follow along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, what to look for in the coming week, and any other meaningful economic events that need to be considered for the sector.
  • Deep Dive Projection Reports – Detailed reports on 2 to 3 BDCs per week prioritized by first focusing on potential issues such as dividend coverage and/or portfolio credit quality changes. We look for portfolio updates that might be mentioned in the SEC filings as compared to company announcements. Then, reports are prioritized based on pricing opportunities including equity offerings.

This information was previously made available to subscribers of Premium BDC Reports. BDCs trade within a wide range of multiples driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). This means investors need to do their due diligence before buying.