THL Credit (TCRD) Dividend Coverage & Risk Profile Update

The following is from the TCRD Quick Update that was previously provided to subscribers of Premium BDC Reports along with revised target prices, dividend coverage and risk profile rankings, potential credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all business development companies (“BDCs”).

For Q2 2019, THL Credit (TCRD) easily beat its best-case projections due to higher-than-expected ‘other income’ related to the repayment of LAI International, Inc. (“LAI”) combined with no incentive fees paid. As expected, there was another decline in its portfolio yield and interest income as well as a decline in overall investments but leverage remained higher. Net asset value (“NAV”) per share declined by another $0.47 or 5.2% (from $8.96 to $8.49) due to net realized/unrealized depreciation of $18.7 million or $0.58 per share. However, non-accruals have decreased from 5.9% to 1.8% of portfolio fair value due to exiting LAI but Charming Charlie and Loadmaster Derrick & Equipment remain on non-accrual status.

It should be noted that if the company had lower ‘other income’ without the benefit of the additional payment from LAI and paid an incentive fee at 17.5% the dividend would not have been fully covered. But management is waiving incentive fees through 2019 as it rotates the portfolio to full cover without waivers.

During Q1 2019, the largest markdown was its investment in LAI which was placed on non-accrual status with an investment score of “5” during the quarter. TCRD made a $10.0 million follow-on first lien senior secured term loan to LAI during Q1 2019. During Q2 2019, TCRD exited its non-accrual investment in LAI resulting in realized losses of almost $23 million or $0.72 per share but also impacted NAV per share due to exiting at a lower value.

“Repayment of certain first lien senior secured term loans in LAI International, Inc., which resulted in proceeds received of $16.8 million and an additional $4.4 million in expected proceeds which are reflected as a receivable. The realized loss of $22.7 million was largely offset by a corresponding change in unrealized appreciation and a $1.5 million exit fee was recorded as income relating to the repayment of priority loans.”

TRCD previously implemented a $15 million 10b5-1 stock repurchase plan and has been repurchasing shares “at levels that are accretive to shareholders with proceeds from exits of additional control equity positions this year”. During Q2 2019, the company repurchased 701,000 shares at an average price of $6.70 (25% discount to previous NAV). The company continues to repurchase shares:

“From July 1, 2019 through August 7, 2019, TCRD repurchased 353,986 shares of common stock for a total cost of $2.4 million as part of a 10b5-1 Stock Repurchase Plan. This brings the total number of shares repurchased since adoption of the 2019 stock repurchase program on March 11, 2019 to 1,252,987 shares at a cost of $8.4 million.”

On June 14, 2019, shareholders approved increased leverage “up to an amount that reduces our asset coverage ratio of 200% to an asset coverage ratio of 150%.”

“Once we have achieved our diversification objectives, we believe it will be accretive to our shareholders to operate with additional leverage and the 1.05 to 1.15 range. Our Board has approved putting the reduced assets coverage requirements to a shareholder vote at our annual meeting in June. If approved by our shareholders, and subject to further progress in diversifying our portfolio, and successfully – our credit facility, we intend enter these modest additional leverage commencing sometime in 2020.”

4 – The portfolio investment is performing materially below our underwriting expectations and returns on our investment are likely to be impaired. Principal or interest payments may be past due, however, full recovery of principal and interest payments are expected.

5 – The portfolio investment is performing substantially below expectations and the risk of the investment has increased substantially. The company is in payment default and the principal and interest payments are not expected to be repaid in full.

As mentioned in the previous report, the Advisor decided to waive additional incentive fees through the end of 2019, as well as to lower the base management fee to “more closely align with what it believes is appropriate for a first lien floating rate portfolio”. I believe that the new fee structure is very shareholder-friendly for the following reasons:

  • Annual hurdle remains 8% (this is important as discussed in other reports)
  • Total return hurdle remains (also important and best-of-breed)
  • Base management fee reduced from 1.5% to 1.0% (this is among the lowest)
  • Incentive fee reduced from 20.0% to 17.5%
  • Deferral of PIK and non-cash items until realized

The company has been working to re-positioning its portfolio, including reducing the amount of non-income producing equity investments to 2% of the portfolio and 82% invested into Core Assets (first-lien debt and Logan JV) with a stated goal of 90%.

Christopher Flynn, CEO: “Over the past year, we have made significant progress on our strategic objectives across four dimensions— shifting the composition of our portfolio into primarily first lien floating rate assets, reducing our concentrated positions, increasing our investment in the Logan JV, and exiting our non-income producing securities. We remain confident that the steps we are taking to reduce risk in our portfolio will result in a more diversified senior secured floating rate portfolio that is positioned to deliver more stable and predictable returns for our shareholders over the long term.”

However, this has resulted in lower overall portfolio yield as shown below:

The company continues to ramp its THL Credit Logan JV from $257 million as of December 31, 2017, to $336 million as of June 30, 2019. However, the yield recently declined from 14.1% to 11.1% as shown in the following chart:

Undistributed taxable income increased from $0.21 per share to $0.29 per share due to the previously discussed earnings results and no incentive fees paid.

This information was previously made available to subscribers of Premium BDC Reports, along with:

  • TCRD target prices and buying points
  • TCRD risk profile, potential credit issues, and overall rankings
  • TCRD dividend coverage projections and worst-case scenarios
  • Real-time changes to my personal portfolio

To be a successful BDC investor:

  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • Diversify your BDC portfolio with at least five companies. There are around 50 publicly traded BDCs; please be selective.