CSWC Projections (W/Baby Bond CSWCL): Headed The Right Direction With 12.2% Yield

The following information is from the CSWC Deep Dive report 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”).

Capital Southwest (CSWC) is an internally managed BDC with a ~$600 million portfolio of mostly first-lien debt positions and equity investments historically providing realized gains especially in its lower middle market investments similar to Main Street Capital (MAIN). Previously, CSWC increased its regular quarterly dividend each quarter since 2015, and equity participation is partially responsible for supporting continued quarterly supplemental dividends of $0.10 per share. The current dividend yield is around 12% (MAIN is 8%).



Capital Southwest 5.95% Notes due 12/15/2022 (CSWCL)

On November 5, 2020, CSWC announced the partial redemption (another $20 million) of its 5.95% Notes due 2022 (CUSIP No. 140501206; NASDAQ: CSWCL) on December 10, 2020.

The “Bond Risk” tab of 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 1.5 or lower, its ability to meet interest expenses may be questionable.

The asset coverage ratio is a financial metric that measures how well a company can repay its debts by selling or liquidating its assets. The higher the asset coverage ratio, the more times a company can cover its debt. Therefore, a company with a high asset coverage ratio is considered to be less risky than a company with a low asset coverage ratio.


Previous CSWC Insider Purchases

From previous call: “As a further demonstration of our confidence and shareholder alignment, our directors and officers purchased approximately 107,000 shares of CSWC stock during the quarter, bringing the group’s total ownership in Capital Southwest to approximately 10% of the outstanding common stock.”


CSWC Dividend Coverage Update

“I think we do have an eye on growing the regular dividend over time, based on origination to date and sort of this transition to the five points — getting away from those unsecured bonds, we think our run rate in the next quarter or two is going to be in the $0.42 to $0.43 in terms of NII. When we feel comfortable there, we’ll probably inch up the dividend in turn. When we make the full transition out of those notes, and we start drawing on the revolver next year, we see quite a bit of an increase in NII. To quantify it long term, I think I’ve said this on the last call and once we have fully immersed in the FDIC, fully deployed, we see that’s a 20% to 25% increase relative to using bonds in the next two to three years. So we’re definitely looking ahead towards increasing that dividend slowly and steadily.”

CSWC’s Board declared a total dividend of $0.51 per share for the quarter ended December 31, 2020, including the regular quarterly dividend of $0.41 per share and a supplemental dividend of $0.10 per share.

“Total dividends for the quarter of $0.51 per share represented an annualized dividend yield on the quarter stock price per share of 14.5% and an annualized yield on net asset value per share of 13.3%. I’m also pleased to announce that our board has declared total dividends of $0.51 per share again for the quarter ended December 31, 2020, consisting of a regular dividend of $0.41 per share and a supplemental dividend of $0.10 per share.”


CSWC’s target pricing and dividend yield in the BDC Google Sheets takes into account $0.10 per share of quarterly supplemental/special distributions that will likely continue beyond 2021. Similar to MAIN, the supplemental dividends are typically covered by realized capital gains and over-earning the regular dividend. CSWC had net realized gains of $44 million during calendar Q4 2019 related to the exit of Media Recovery. As of September 30, 2020, CSWC had $1.19 per share of undistributed taxable income and gains. Management is likely going to maintain its dividends going forward as they need to distribute this over the coming quarters:

“We also continued our supplemental dividend program paying out an additional $0.10 per share, funded by our sizable undistributed taxable income balance. As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio through distributions from our UTI balance. As of September 30, 2020, our estimated UTI balance was $1.19 per share.”

From previous call: “Due to the successful sale of Media Recovery in late 2019, we were able to replenish our UTI balance to the maximum allowable level as of the end of the 2019 tax year, providing visibility on the longevity of the program well into the future. The program will continue to be funded from UTI earned from realized gains on both debt and equity, as well as undistributed net investment income earned each quarter in excess of our regular dividends. The good news is the UTI balance that you have is not affected by having realized losses. What it does create is sort of an amount that you have to overcome with realized gains before you’re able to book additional pennies into the UTI bucket. We feel like we’ve got two to three years of runway to create those gains to apply against those losses to continue this program without any interruption.”


For calendar Q3 2020, CSWC reported just above its best-case projections with higher-than-expected portfolio growth, interest and fee income covering its regular quarterly dividend by 109%. The company is now above its upper targeted leverage (1.20) with a debt-to-equity ratio of 1.29 but recently submitted its application to form a new SBIC subsidiary with access to an additional $175 million of low-cost capital with potential approval by the end of this year as discussed later.

“This quarter, we had probably about $400,000-ish of one-time fees that are above our normal expectation or run rate. Then in terms of this quarter repayments — right now I think of the one to three prepayments, one of them does not have a [indiscernible], and I think that there’s maybe one small one between the other two. So I would tell you, it’s like $50,000-ish but having said that, there’s always something that comes up so that number could be elevated by the end of the quarter.”


As predicted in the previous report, dividend coverage improved partly due to adding Delphi Intermediate Healthco back on accrual status. Over the coming quarters, dividend coverage should continue to improve due to additional investments added back to accrual status (discussed later) and reduced borrowing expenses including the previously discussed redemption of $20 million of its Baby Bond “CSWCL” and SBIC license, and new investments at a relatively higher yield. An SBIC license will provide CSWC an incremental source of long-term capital by permitting it to issue up to $175 million of SBA-guaranteed debentures. These debentures have maturities of ten years with fixed interest rates currently around 3%.

“During the quarter, we raised an additional $50 million on our 5.375% unsecured notes due 2024 and subsequently paid down $20 million on our 5.95% baby bond due 2022. We will continue to be opportunistic in paying down higher price debt to optimize net investment income while also being mindful of maintaining appropriate flexibility in our liability structure. So we will be ramping up our revolver, in fact, to both pay down some of the 5.95% bonds, as well as to accommodate originations that are not in the SBIC going forward. Finally, as we mentioned last quarter, we continue to work with the U.S. Small Business Administration towards becoming officially licensed as an SBIC. We are pleased to report that we completed our final license submittal during the quarter, and look forward to reporting developments on the status of our pending license application to our shareholders as warranted. As a reminder, final approval, and issuance to Capital southwest of an SBIC license would provide a 10-year commitment to provide Capital Southwest with up to $175 million in debt financing to be drawn to fund investment in our lower middle market strategy.”

Also, management is actively growing the portfolio including $66 million of new originations in Q3 2020: “On the new origination front, we remained active, committing $66.3 million in originations to both new and existing portfolio companies.”

On July 30, 2020, CSWC announced that the U.S. Small Business Administration (the “SBA”) has issued a “green light” letter inviting the company to file its application to obtain a license to operate a Small Business Investment Company (“SBIC”) subsidiary. During Q3 2020, the CSWC submitted its final application and is expecting to receive its first license by the end of the year with qualifying investments that could be funded as early as Q1 2021:

“We estimate that the vast majority of the deals we have reviewed over the past five years would qualify for SBIC financing, giving us a high level of competence that we will be able to invest this capital in our existing strategy and continue to support growth and employment in small businesses across the country. As a reminder, each draw from the SBIC debenture program separately represents a new debt security in our capital structure with a 10-year maturity from the date of draw, making this capital truly long term in nature. From a cost perspective, if treasury rates remain close to today’s level, the all-in cost of the SBIC debentures would be less than 3%. This program is clearly a perfect fit for our lower middle market focus and we look forward to continuing to work with the SBA in completing the application process and in successfully executing the SBA’s mission of supporting growth and employment in U.S. Small businesses. We believe we’re in the final stages of the licensing process and are hopeful of receiving our license by the end of the calendar year. We are excited to integrate the SBIC license into our capitalization strategy as the flexibility and low cost of SBIC debentures should be highly accretive to our net investment income per share, while also allowing us to continue to provide important growth and acquisition capital to U.S. Small businesses.”

“We actually expect that we’re weeks away from actually having that application. We don’t want to be presumptive, but that’s the kind of the guidance we’ve been given. So we’re going to just wait until probably December and likely start allocating those assets to the SBIC, probably in January.


On September 29, 2020, CSWC redeemed $20 million of its 5.95% Notes due December 2022 and recognized realized losses on the extinguishment of debt of $0.3 million. In August 2020, the company issued an additional $50 million of the 5.375% Notes due October 2024. As of September 30, 2020, CSWC had almost $16 million in unrestricted cash and almost $135 million in available borrowings under its credit facility for upcoming portfolio growth. In April 2018, the Board approved the application of the modified asset coverage requirements and the minimum asset coverage ratio applicable to the company was decreased from 200% to 150%. Previously, management was targeting a debt-to-equity ratio between 1.00 and 1.20 but is expecting around $30 million of prepayments in Q4 2020 and is taken into account with the updated projections along with additional prepayment fees:

“If you think about leverage up to 1.28, the answer is, yes, we’re comfortable with where we are. It is higher than our 1.1 to 1.2 target range we gave pre-COVID. If you look at — if you just take a high level, look at the depreciation in the portfolio during COVID, retracing that COVID effect on the portfolio, we’re basically back to the top end of our leverage range and so, you have to keep in mind that as the portfolio re-appreciate that leverage, all else equal will come down. So that’s one point and why I can say we’re comfortable with where we are. The next thing is we’ve got visibility on $30 million to $35 million of pre-payments coming in from portfolio companies that are performing very well and are being sold or refinanced or what have you. So if you of think about leverage, we have visibility on cash coming in. So we’ll obviously be redeploying that cash in originations.”

In March 2019, CSWC established its equity “At-The-Market” (“ATM”) program of slowly issuing small amounts of shares at a premium to book value/NAV and accretive to shareholders. As CSWC’s stock price continues higher, management will likely use the ATM program for raising equity capital, rather than larger equity offerings. This approach is beneficial for many reasons including being more efficient, delivering higher net proceeds to the company and less disruptive to market pricing. During Q3 2020, the company sold only 35,112 shares of its common stock at a weighted-average price of $14.99 per share, raising $0.5 million.

“But that’s another point. And the third thing I would say is, if you think about — we traded well above book for almost two years pre-COVID. So I believe that we’ve proven that our business model and our strategy in a more normal market should trade above NAV. So if it trades above NAV, as you know, we’ve got an ATM program that we’re diligent about accessing at very low spreads to trade. So that’s obviously a function and our yield on NAV today is 13.5% or so. And on the stock price, it’s north of 14%. The market will figure out the risk premium on our stock over time. So we’re comfortable and just letting the market play out. But those yield levels, based on our strategy and track record, really are not where we believe those yield levels will normalize out over time, which we believe will trade above NAV and we’ll be able to raise equity. So, those are all the points that are in my head, as I look at the leverage of 1.28 and go, am I comfortable with that or not?”

As expected, its I-45 Senior Loan Fund was marked up again, remains around 10% of the total portfolio and is a joint venture with MAIN created in September 2015. The portfolio is 96% invested in first-lien assets with CSWC receiving over 75% of the profits providing 11.0% annualized yield (previously 12.5%) paying a quarterly dividend of $1.7 million compared to $1.8 million during the previous quarter.

“Turning to Slide 16, the I-45 portfolio shows meaningful improvement during the quarter as our investment in I-45 appreciated by $4.7 million or 8%. Leverage at the I-45 fund level is now 1.39x debt to equity at fair value, which is substantially improved from the March 31, quarter average of 2.51x.”


Its regular quarterly dividends are covered mostly through recurring cash sources:


CSWC Risk Profile Update

There were no additional investments added to non-accrual status during the quarter. American Addiction Centers (“AAC”), AG Kings Holdings, and California Pizza Kitchen (“CPK”) remain on non-accrual status with a total fair value of $10.9 million or 1.7% of the total portfolio. If completely written off would impact NAV per share by around 3.8% as shown in the following table.

These investments were discussed on the recent call and management is expecting some positive results including either being restructured back on accrual status (AAC and CPK) or outright sales (AG Kings is being purchased by Albertsons) and then reinvested into income-producing assets:

Q. “I wanted to touch on the non-performing loans, if I’m not mistaken, they’re all in certain stages of bankruptcy. And I think there’s been some movements since our last call. So starting with American Addiction, from what I’ve read, the information is a little sparse, it looks like you’re going to be repaid in cash on that from asset sales. Is that correct? And when will that be?”

A. “So based on what’s public, it’s going to emerge from bankruptcy relatively soonIt’ll be restructured. So the lender group, which we are a part of, will end up holding a debt security, first lien debt security in the new restructured company, and then ownership of the equity in the company. So it’ll be restructured, it will emerge from bankruptcy and Capital Southwest actually will have a board seat. And so, that’s that, it will all be resolved relatively soon. I mean, it’s not in our control, but it’s basically got to work through taxes and various things, structuring the recap, the restructuring, so that’s AC. Anyway, you want to talk about Kings and CPK, as well?”

Q. “So CPK, it looks like similarly you’re going to get equity and debt. Is that correct? And when is that going to happen?”

A. “Similar story as AC as far as what will happen from the bankruptcy perspective. So we’ll end up with a performing, firs lien note and equity in the company, we will not have a board seat in that instance. We think that’s going to happen — I think it may be announced, but it’ll be relatively soon. This manager team seems to be doing a really good job with the business. And it’s one thing, and then the other thing is that the restaurants that have opened, people come eat there, and so it tells me that the brand is relevant, and it’s desired, and there’s a demand for that brand and that concept in the market. So that’s encouraging. Clearly COVID is a bunch of noise out there. It’s affecting all the restaurants, the management team is doing some interesting creative things around that, with respect to CPK. The election and any kind of unrest that may result — unrest in an area affects all the retailers, all the places, restaurants included in those areas. So there’s clearly noise out there. But the thing I grab on to is manager team is seem to be doing a great job, we have weekly calls, and the restaurants that are open, people want to eat there. And so, based on those two things, that gives me a lot of encouragement as to the future of that concept once all the market noise, COVID pandemic noise sort of fades away, which will, this too shall pass. And so, still challenges, but good team, and there’s some definitely some signs of relevance of that concept and brand.”

Q. “And on AG Kings, obviously there was a stalking-horse bid. I haven’t seen another bid come through unless I’m mistaken. Is that correct? Or are there other folks snooping around and potentially going to offer?”

A. “Yes, so that’s actually been announced, and they signed a purchase agreement to sell the Albertsons. That’s in a process of closing/documentation process. And it’s pretty much all I should really say about it, but our evaluation is the best guess on waterfall analysis around the proceeds on a sale.”

Similar to other BDCs, I am expecting additional increases in its net asset value (“NAV”) per share over the coming quarters:

“So as far as NAV I think a big uplift in NAV for many BDCs including us will be just re-appreciation of the noise that’s been created by the current market environment. I think we certainly expect to see that. Then we have a nice equity portfolio with some companies that are growing, a couple of companies that we’ve had to decrease the appreciation to write it down based on COVID, which we certainly expect that to re-appreciate. So I think that clearly there are — from where we sit today, there are definitely tailwinds that should support NAV growth going forward.”

“Our investment strategy has remained consistent since its launch in January of 2015. We continue to focus on our core lower middle market, while also maintaining the ability to invest in the upper-middle market when attractive risk-adjusted returns exist. In a lower middle market, we directly originate opportunities consisting of debt investments and equity co-investments. Building out a well-performing and granular portfolio of equity co-investments is important to driving NAV per share growth as well as aiding in the mitigation of any credit losses over time.”

For Q3 2020, CSWC’s NAV per share increased by $0.18 or 2.7% (from $14.95 to $15.36) “primarily due to net unrealized appreciation on the investment portfolio”,

“Turning to Slide 20, the company’s NAV per share as of September 30, 2020, was $15.36 as compared to $14.95 at June 30, 2020. The main driver of the NAV per share increase was $8.4 million of appreciation in the investment portfolio, much of which was in the upper-middle market portfolio.”

There was an improvement in overall credit quality including two upgrades to ‘Investment Rating 1’ and no downgrades. Similar to other BDCs, my primary concern is the 10.0% (previously 12.5% in Q1 2020) of the portfolio considered ‘Investment Rating 3’ which implies that the “investment may be out of compliance with financial covenants and interest payments may be impaired, however, principal payments are generally not past due.”

“Turning to Slide 14, we have laid out the rating migration within our portfolio for the quarter. During the quarter we had two loans upgraded while having no loans downgraded. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale, with 1 being the highest rating and 4 being the lowest rating. The upgrades consisted of two loans to one portfolio company previously rated at 3, which were upgraded to a 2 rating based on much-improved performance. As of the end of the quarter, 80% of our investment portfolio at fair value was rated in one of the top two categories a one or two. We had seven loans representing 10% of the portfolio at fair value rated a three and only two loans representing 2% of the portfolio at fair value rated a four.”

Investment Rating 3 involves an investment performing below underwriting expectations and the trends and risk factors are generally neutral to negative. The portfolio company or investment may be out of compliance with financial covenants and interest payments may be impaired, however principal payments are generally not past due.

Investment Rating 4 indicates that the investment is performing materially below underwriting expectations, the trends and risk factors are generally negative and the risk of the investment has increased substantially. Interest and principal payments on our investment are likely to be impaired.

“Turning to Slide 12, as I previously alluded to, we had two lower than the market exits this quarter, Danforth Advisors and Trinity 3. Our debt at Danforth was refinanced by a traditional bank, repaying our loan in full, generating proceeds of $6.7 million and an IRR of 12.4%. We continue to hold equity in Danforth alongside the sponsor and we are excited to watch this management team and sponsor continue its stellar performance.”

“In the case of Trinity 3, which also appears on the New Deal funding’s for the quarter, we were able to participate in a much larger club deal which refinanced our original loan and finance a large strategic acquisition for Trinity 3. We also hold an equity interest in this company and are very excited about its continued growth prospects going forward. This continues our track record of successful exits. To date, we have generated a cumulative weighted average IRR of 14.7% on 33 portfolio exits, generating approximately $308 million in proceeds.”

New portfolio company investment transactions that occurred during the quarter ended September 30, 2020, are summarized as follows:

  • Electronic Transaction Consultants LLC, $10.0 million 1st Lien Senior Secured Debt, $3.7 million Revolving Loan, $1.0 million Common Equity: Electronic Transaction Consultants Corporation designs, implements, supports and maintains software systems used to facilitate electronic toll collections for toll road authorities and operators.
  • Ian, Evan, & Alexander Corporation (d/b/a EverWatch), $10.0 million 1st Lien Senior Secured Debt, $2.0 million Revolving Loan: EverWatch is a technology solutions company providing advanced defense, intelligence, and deployed support to mission critical missions in the national security and intelligence space.
  • RTIC Subsidiary Holdings, LLC, $6.9 million 1st Lien Senior Secured Debt, $1.1 million Revolving Loan: RTIC Holdings, LLC is the largest pure-play direct-to-consumer eCommerce provider of high-quality outdoor products that are priced for value-conscious outdoor enthusiasts.
  • Sonobi, Inc., $8.5 million 1st Lien Senior Secured Debt, $0.5 million Common Equity: Sonobi, Inc. is a digital media technology platform that directly connects advertisers in order to efficiently connect brands with their desired consumers.
  • “We had 39 lower middle market portfolio companies with a weighted average leverage ratio measured as debt to EBITDA through our security of 3.9x down from 4.1x weighted average leverage in the prior quarter. This reduction in leverage was primarily driven by EBITDA performance across the lower middle market portfolio during the quarter. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in approximately two-thirds of our portfolio companies.”
  • “Our own balance sheet upper middle market portfolio excluding I-45 consisted of 12 companies with an average leverage ratio through our security of 3.7x down meaningfully from the 4.4x weighted average leverage for the prior quarter. This decrease was also driven primarily by EBITDA improvement quarter-over-quarter across the portfolio.”


Volatility is your friend!

BDC pricing can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher-quality portfolio that will deliver higher-than-average returns over the long term. One of my goals is to help subscribers take advantage of “oversold” conditions.



Full BDC Reports

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

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

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.

To be a successful BDC investor:

  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Diversify your BDC portfolio with at least five companies. There are around 45 publicly traded BDCs; please be selective.

TCPC: 10.7% Yield & Improving Net Interest Margin

The following information is from the TCPC Deep Dive report 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”).



Previous TCPC Insider Purchases

  • Last month, Howard Levkowitz, TCPC Chairman and CEO, purchased 20,000 shares at $10.95 per share for a total of $219,000.


TCPC Dividend Coverage Update

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 almost $45 million or $0.78 per share. However, this is typically used for temporary dividend coverage issues. 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.

Howard Levkowitz, TCPC Chairman and CEO: “The board’s decision to adjust the dividend rate was a prudent response to substantial declines in LIBOR over the last year and a half. We are confident in the sustainability of our dividend at this level. We also strengthened our diversified and low-cost leverage program by extending and expanding our SVCP credit facility and replacing our TCPC Funding credit facility with a new facility with improved terms. We appreciate the ongoing support of our lenders.”

The rapid decline in interest rates (LIBOR) has mostly been responsible for the decline in portfolio yield with “limited exposure to any further declines”. During Q3 2020 there was an increase in the overall portfolio yield due to “amendments made on several loans coupled with the higher yield on originations versus exits”:

“Investments in new portfolio of companies during the quarter had a weighted average effective yield of 9.5%. Investments we exited had a weighted average effective yield of 8.8%. The overall effective yield on our debt portfolio increased to 10%, primarily reflecting amendments made on several loans coupled with the higher yield on originations versus exits. Since the end of 2018, LIBOR declined 257 basis points or by 92%, which put pressure on our portfolio yield over this period. However, our portfolio is largely protected from any further declines in interest rates as over 80% of our floating rate loans are currently operating with LIBOR floors as demonstrated on slide nine.”

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

“Today, we declared a fourth quarter dividend of $0.30 per share payable on December 31, 2020 to shareholders of record as of December 17 and in line with the third quarter dividend of $0.30 per share paid on September 30th. We are committed to paying sustainable dividends and continuing our track record of having covered our dividend every quarter as a public company. In the third quarter, our dividend coverage ratio was 117%.”


For Q3 2020, TCPC beat its best-case projections mostly due to much higher-than-expected dividend and other income as well as improved portfolio yield and $0.03 per share of income related to prepayment premiums and accelerated original issue discount amortization. Its net interest margin improved due to the higher yield combined with lower borrowing rates.

“Investment income for the third quarter was $0.74 per share. This included recurring cash interest of $0.54, recurring discount and fee amortization of $0.06 and PIK income of $0.06. We had modest prepayments in the quarter that contributed $0.03 per share including both prepayment fees and unamortized OID. Investment income also included $0.03 of other income and $0.02 of dividend income. Our income recognition follows our conservative policy of generally amortizing upfront economics over the life of an investment rather than recognizing all of it at the time the investment is made. Combined, our outstanding liabilities had a weighted average interest rate of 3.3%, down from 3.8% or 51 basis points since the end of 2019.”

On October 29, 2020, the Board re-approved its stock repurchase plan to acquire up to $50 million of common stock “at prices at certain thresholds below our net asset value per share”. There were no additional shares repurchased during Q3 2020. From October 1, 2020 through October 30, 2020, TCPC has invested approximately $18 million primarily in three senior secured loan with a combined effective yield of approximately 10.9%.

Howard Levkowitz, TCPC Chairman and CEO: “We are pleased with the continuing strength of our highly diversified portfolio even in this challenging environment, which led to a 4.1% increase in NAV. We also further strengthened our leverage structure by increasing our unsecured debt, adding an accordion commitment to our operating facility, and replacing our funding facility on even better terms. While we remain highly selective in this lending environment, our pipeline of investment opportunities is growing, and we are prudently deploying capital to achieve strong risk-adjusted returns for our shareholders.”


Payment-in-kind (“PIK”) income declined from 7.6% in Q2 2020 to 7.4% in Q3 2020 and needs to be watched. As shown below, TCPC’s portfolio is highly diversified by borrower and sector with only 5 portfolio companies that contribute 3% or more to dividend coverage:


TCPC Risk Profile Update

During Q3 2020, TCPC’s net asset value (“NAV”) per share increased by another $0.50 or 4.1% (from $12.21 to $12.51) “primarily driven by continued spread tightening”:

“Our net asset value increased 4.1% from the prior quarter, reflecting a 1.8% net market value gain on our investments, driven by spread narrowing on middle market private credit transactions as well as improved financial results for several portfolio companies. Importantly, the overall credit quality of our portfolio remains strong.”

Some of the largest markups during the quarter were Edmentum and One Sky Flight:

“Unrealized gains included $6.9 million of appreciation in the value of our investment in Edmentum and $4.4 million of appreciation on our investment in OneSky. The strong performance at One Sky as charter flight activity has outpaced expectations and Edmentum continues to benefit from a shift toward online learning that has accelerated in the current environment.”

However, there were net realized losses of $18 million or $0.31 per share mostly due to the restructuring of its non-accrual investment in AGY Holding Corp that was discussed on the call:

“Net realized losses during the quarter were comprised primarily of the restructuring of our investment in AGY. AGY is fundamentally good business, but it has struggled with the cost of one of its major inputs rhodium. And we reached the conclusion that it was more appropriate to let a third party come into the business and pay down our position and sell down significant part of our economics and retain small preferred upside.”

CIBT Solutions, Inc. was added to non-accrual status during Q3 2020 and is a provider of expedited travel document processing services serving multinational corporations, global travel management companies, tour and cruise operators, government agencies and Do-It-Yourself travelers. GlassPoint Solar, Inc. and Avanti Communications remain on non-accrual. As of June 30, 2020, loans on non-accrual status represented 0.6% of the portfolio at fair value and 1.2% at cost. If these investments were completely written off the impact to NAV per share would be around $0.17 or 1.3%.

“As of September 30, total non-accruals were only 0.6% of the portfolio at fair value. This is a testament to our disciplined approach to underwriting, our more than 20 years of experience lending to middle market companies and the strength and breadth of the BlackRock platform.”

“We have loans to just three portfolio companies on non-accrual, GlassPoint, CIBT, and Avanti, which together represented only 0.6% of the portfolio at fair value and 1.2% of costs. CIBT, which is new this quarter is a leading global provider of immigration and visa services for corporations and individuals and the company has been challenged, given the current slowdown in international travel.”


TCPC will likely finally exit its investment in Kawa Solar Holdings “in the near future”:

“Kawa Solar Holdings is part of a larger series of securities and some of the loans in certain regions were paid off via loans [ph]. The Kawa loans, I believe, were also paid off and then what’s remaining is, some of the equity that was converted in the APAC region, which is the outstanding position. So the loans that were paid off are no longer on the balance sheet and there were a number that were successfully completed. What remains is simply the equity position as part of a conversion in Asia. That’s in a run-off mode that we’ve talked about a few times in the past. The primary asset is also an operating facility that we expect to exit at some point in the near future as we’re going through a process there.”

“91% of our investments are senior secured debt and are spread across a wide variety of industries. We have a diverse portfolio of companies with an emphasis on less cyclical businesses with limited direct exposure to sectors that have been more severely affected by the pandemic. Furthermore, our loans to companies in more impacted industries including retail and airlines are generally supported by strong collateral protections and most of our investments in these industries continue to perform well. As an example, the value of our investment in OneSky, the second largest provider of private jet aviation services in the country appreciated during the quarter based on strong performance, resulting from increased charter flight activity. At the end of the third quarter, our diverse portfolio included 101 companies. Our largest position, which represented only 4.5% of the portfolio is an equipment leasing company that itself has a highly diversified underlying portfolio of lease assets. As the chart on the left side of slide seven illustrates, our recurring income is not reliant on income from any one portfolio company. In fact, over half of our individual portfolio companies contribute less than 1% to our recurring income.”

“Our investment activity in the fourth quarter to-date has been selective and focused on companies that are minimally impacted by the pandemic or beneficiaries of the COVID impacted operating environment. Dispositions in the third quarter included payoffs of our $29 million loan to InMobi, our $16 million loan to American Broadband and the refinancing of our $11 million loan to Pulse Secure.”


Volatility is your friend!

BDC pricing can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher-quality portfolio that will deliver higher-than-average returns over the long term. One of my goals is to help subscribers take advantage of “oversold” conditions.



Full BDC Reports

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

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

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.

To be a successful BDC investor:

  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Diversify your BDC portfolio with at least five companies. There are around 45 publicly traded BDCs; please be selective.

TSLX: Continued Special Dividends Driving 11.2% Yield

The following information is from the TSLX Deep Dive report 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”).


 

This update discusses Sixth Street Specialty Lending (TSLX) which has been an excellent investment. Over the last 5 years, TSLX has provided me with annualized returns of 14% to 15% and likely headed higher as the stock rebounds and the company continues to pay supplemental dividends.


TSLX Distribution & Q3 2020 Update

On November 4, 2020, TSLX reaffirmed its regular quarterly dividend of $0.41and announced a supplemental dividend of $0.10 per share to shareholders of record as of November 30, 2020, payable on December 31, 2020.

“Based on a net asset value rebound and the overearning of our base dividend this quarter, our board declared a supplemental dividend and dividend in accordance with our formulaic dividend approach, a supplemental dividend of $0.10 per share, which is half of the quarter’s overearning was declared yesterday to shareholders of record as of November 30 payable on December 31.”

During Q3 2020, the company had realized gains of $11 million or $0.16 per share (to support continued supplemental dividends) due to the sale of its equity position in AFS Technologies, Inc. Also, TSLX still holds its Series A preferred shares of Validity, Inc. valued at $9.2 million over cost and will likely result in upcoming realized gains of $0.13 per share to support additional supplemental dividends:

TSLX is clearly one of the highest quality BDCs that actually performs well in distressed environments such as this. The management team is very skilled at finding value in the worst-case scenarios including previous retail and energy investments. TSLX often lends to companies with an exit strategy of being paid back through bankruptcy/restructuring so they are proficient at stress testing every investment with proper coverage and covenants. Please see the “Previous TSLX Portfolio Credit Track Record” section at the end of this report for some historical examples. Management has prepared for the worst as a general philosophy and historically used it to make superior returns.


Previously, the company paid $0.06 per share of supplemental in Q1 2020 and $0.50 per share of supplemental dividends paid in Q2 2020. When calculating supplemental dividends, management takes into account a “NAV constraint test” to preserve NAV per share. This is one of the reasons that management prefers not to pay large supplemental dividend payments even though the amount of undistributed/spillover income continues to grow. However, management also likes to avoid paying excessive amounts of excise tax through “cleaning out” the spillover as it “creates a drag on earnings”. This was discussed on the recent call:

“We’ve tried to avoid doing large specials, when we put in the recurring supplemental dividend framework, two, 2.5 years ago. And then given that the level set earlier at $0.50, we ended up having friction costs and kind of growing the spillover income and growing unfortunately on a per share basis, the excise tax. And so we wanted to clean it out. I think we’re basically back pre-cleanout. At the beginning of this year, when we went to the board with the proposal, we were at $1.61 per share of undistributed income and at the end of Q3 we were at $1.55. So we’re pretty much back there. The plan is to look at where we sit on tax basis and looking at the 90% rule and look at how much of excise tax is a drag on earnings. And we’ll go through the same work we did at the end of the year – at the end of this year.”


For Q3 2020, TSLX beat its best-case projections (again) covering its regular quarterly dividend by 156% due to higher than expected dividend and fee income as well as higher portfolio yield.

“Other fees, which consists of prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs continued to be relatively strong at $9.3 million led by our fees related to Dye & Durham and now Neiman ABL FILO. Other income increased from $6.5 million to $8.1 million quarter-over-quarter, primarily due to the receipt of a one-time termination fee for a commitment we made in Q1 of 2019, but it was never eligible to be funded given the required milestones in the underlying loan agreement we’re not satisfied.”

Leverage (debt-to-equity) remained mostly flat and similar to many other BDCs this quarter, TSLX improved its net interest margin with higher portfolio yield and lower borrowing rates likely driving improved dividend coverage over the coming quarters:

“Looking ahead into Q4 based on our current asset level yields and assuming average leverage in line with Q3, we would expect further net interest margin expansion of approximately 10 basis points based on this quarter’s movement in LIBOR.”


Annualized return on equity (ROE) on net investment income and net income of 15.1% and 30.1%, respectively, and an annualized year-to-date ROE on net investment income and net income of 13.5% and 14.7%, respectively.

“On a year-to-date basis, we’ve generated an annualized return on equity on net investment income of 13.5% and net income of 14.7% based on the beginning year pro forma net asset value per share of $16.77, which is adjusted for the impact of our Q4 2019 supplemental dividend of $0.06 per share. Of note, these annualized year-to-date return on ROEs both exceed our average annualized performance since our IPO through the end of 2019, which we think is notable given the difficult operating conditions experienced during the first three quarters of 2020.”

As shown in the following chart there was another increase in its portfolio yield (from 10.0% to 10.2%) and there was another decline in its borrowing rates for improved net interest margins:

“The weighted average total yield on our debt and income producing securities at amortized cost increased by approximately 20 basis points to 10.2% this quarter, primarily driven by the favorable impact of this quarter’s funding activity. The yield at amortized cost of new investments in Q3 was 11.5% compared to 10.8% for exited investments. Note that LIBOR move into Q3 had minimal impact on this quarter’s portfolio yield given that LIBOR had already fallen below the effective average LIBO floor across our portfolio in the prior quarter. Net expenses this decreased by $1.6 million to $28.2 million, primarily driven by lower interest expense from a lower effective LIBOR on our entirely floating rate liability structure; this quota, our weighted average cost of debt decreased by a notable 90 basis points. This was primarily a function of movement in LIBOR during Q2, which flowed through our cost of debt in Q3 due to the one-quarter timing lag on the libel reset dates on our interest rates swaps. We benefit from net interest margin expansion, given a decrease in the cost of that floating rate liabilities, while the earnings power of our contractual floating rate assets is protected by the LIBOR floors that we’ve structured into our loan agreements. The combination of these two forces has been the primary driver of the 100 basis points of net interest margin expansion we’ve experienced year-to-date; equating to incremental earnings of approximately $2.4 million or $0.04 per share.”

As of September 30, 2020, TSLX had $16 million in cash and cash equivalents and over $1 billion of undrawn capacity on its revolving credit facility:

“Our financial leverage of 0.81 times remained well below the regulatory limit of two times. And we had ample liquidity at quarter end with $1.02 billion of undrawn revolver commitments. At quarter end, our funding mix was comprised of 69% unsecured and 31% secured debt. And our nearest maturity was approximately two years away and only $143 million principal amount. We continue to be matched funded with a weighted average remaining life of our investments funded with debt of two years, compared to a weighted average remaining maturity of four years on our liabilities from revolver commitments.”

During Q3 2020, MD America was added to non-accrual status but TSLX received its regularly scheduled cash interest payment during the quarter and applied those proceeds to the amortized cost of the position due to the “imminent reorganization of the company’s capital structure”. In October 2020, MD America made a voluntary paydown of $1.4 million and subsequently filed for protection under Chapter 11. In Q4 2020, TSLX expects to put $9 million of its loan, or ~70% of its remaining prepetition loan at 9/30/20 fair value, back on accrual status upon MD America’s emergence from Chapter 11 and the remaining investment will be restructured into an equity position. This was discussed on the recent call:

“On MD America, we received a roughly scheduled cash – our regularly scheduled cash interest payment during the quarter, but applied those proceeds to the amortized cost of our position given our view of an imminent reorg of the company’s capital structure that result in a reduction of the value of our loan. Post quarter end, the company made a voluntary pay down of $1.4 million on our position and are subsequently filed for protection under Chapter 11 that implements prepackaged plan of reorganization. For Q4, we expect to put $9 million of our loan or approximately 70% of our remaining pre-petition loan at 9/30 fair value, back on accrual status upon the company’s emergence from Chapter 11. Our remaining investment will be restructured into an equity position. Note that the quarter-end, our total energy exposure was 2.4% of the portfolio at fair value.”

J.C. Penney was added to non-accrual status during Q2 2020 but there was a partial roll-up of its first-lien term loan into the DIP term loan and the rest remains on non-accrual. Mississippi Resources was added to non-accrual status in Q1 2020 and was previously written off with no further impact to NAV per share. The total current fair value of non-accrual investments is $19.7 million or 0.9% of the portfolio but will likely decline in Q4 2020 as MD America is restricted.

“There was a slight increase in our non-accruals this quarter from 40 basis points to 90 basis points on a fair value basis. This was primarily driven to the addition of first lien loan in MD America, an upstream E&P company, which is partially offset by removal of our pre-petition Neiman Marcus term loan and a partial roll up of our JCP’s pre-petition first lien term loan into the debt term loan.”

In September 2020, Neiman Marcus Group was removed from non-accrual status as it completed its Chapter 11 bankruptcy protection process eliminating more than $4 billion of debt and $200 million of annual interest expense. The new owners, which include PIMCO, Davidson Kempner Capital Management and Sixth Street Partners LLC funded a $750 million exit financing package that fully refinances its debtor-in-possession (“DIP”) loan.

“In September, upon the full repayment of the Neiman ABL FILO and debt loans, we subsequently funded a new $17 million par value first lien loan related to our exit financing backstop commitment. And our schedule of investments roughly $4 million difference between the par value and the cost basis of the new Neiman loan reflects our fees on the backstop, which were payable and common stock of the reorg company. Our loan today is trading at a price of approximately 104.75. This again was another way that we created value during the volatile market environment earlier this year. We believe our attractive cost base along with the company’s high quality assets and improved perspective cash flow profile post restructuring provide considerable downside protection on our investments.”

“Retail and consumer products was our third highest industrial exposure increasing from 11.3% to 13.9% quarter-over-quarter; this was primarily driven by new fundings for designer brands and centric brands, which was partially offset by the repayment of the Neiman ABL FILO Term Loan. Post quarter end, we fully exited our investment in Centric Brands in connection with a new financing obtained by the company as it emerged from bankruptcy. Pro forma the pay down of Centric Brands, our retail and consumer exposure would have been 10.5% at quarter-end and retail names – with retail names comprising 9.5% of the portfolio and 77% of this exposure consisting of ABL investments. 99 Cents is doing well and there’s going to be a significant refi risk.”


First-lien debt accounts for around 95% of the portfolio and management has previously given guidance that the portfolio mix will change over the coming quarters with “junior capital” exposure growing to 5% to 7%.

“While none of our portfolio companies have been immune to the economic impact of COVID, only 11% of our portfolio by fair value at quarter end has experienced meaningful performance issues directly related to it. We believe the relative resilience of our portfolio is mostly a result of a deliberate shift we made in late 2014 towards a more defensive portfolio construction. Today, 95% of our portfolio by fair value is first lien and nearly 75% of our portfolio by fair value is comprised of mission critical software businesses with sticky predictable revenue characteristics. These businesses also tend to have variable cost structures that it can be fluxed down to support debt service and protect liquidity in cases of challenging operating environments.”

“A portfolio weighted average performance rating was 1.21 compared to 1.23 in Q2, on a scale of one to five with one being the strongest. There were no material changes in the overall credit metrics of our portfolio companies. Interest covers this quarter remain flat at 3.3X, net attachment point was unchanged at 0.4X, and that leverage increased slightly from 4.3X to 4.4X, which is on par with our trailing two-year historical quarterly average.”

 


Volatility is your friend!

BDC pricing can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher-quality portfolio that will deliver higher-than-average returns over the long term. One of my goals is to help subscribers take advantage of “oversold” conditions.



Full BDC Reports

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

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

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.

To be a successful BDC investor:

  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Diversify your BDC portfolio with at least five companies. There are around 45 publicly traded BDCs; please be selective.

TPVG: 12% Yield With Tech Exposure Positioned For Post-COVID

The following information is from the TPVG Deep Dive report 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”).


Summary

  • The BDC sector continues to deliver strong returns during the pandemic, including recently improved earnings, dividend coverage, and increased book values.
  • The average BDC is currently yielding 10.8% with an average dividend coverage ratio of 110% for Q3 2020 and improving net interest margins.
  • This article discusses TPVG that I recently purchased currently yielding 12% annually taking into account the special dividend announced last week.

Introduction

The following information discussing TriplePoint Venture Growth (TPVG) was previously provided in the public article “Oasis Of Dividends From This 10.8% Yielding Sector“.  Please read when you get a chance as it provides additional details discussing the overall BDC sector.


BDCs reported calendar Q3 2020 results last month, most with very strong earnings and average dividend coverage of around 110%. Also, they almost all reported meaningful increases in net interest margins due to higher portfolio yields and/or reduced borrowing expenses including TriplePoint Venture Growth (TPVG), which is discussed in this article.

There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, potential portfolio growth using leverage or equity offerings, fee structures including “total return hurdles” taking into account capital losses, changes to portfolio yields and borrowing rates, the amount of non-recurring and non-cash income including payment-in-kind (“PIK”). A portion of the reported earnings each quarter for TPVG is related to the accrual of the end of term (“EOT”) payment that ranges from 2% to 12% providing higher effective yields. EOT payments provide upside potential when loans are repaid earlier. However, this contractual payment is accrued and added to income but not paid in cash until the loan is repaid.

Source: TPVG Earnings Call Presentation


For the three months ended September 30, 2020, TPVG reported between my base and best-case projections covering its dividend by 110% with a higher-than-expected portfolio yield due to prepayment-related income. As shown below, the company reduced its debt-to-equity ratio from the upper end of its target range (1.00) to 0.63 giving the company plenty of growth capital.

Since September 30, 2020, and through November 4, 2020:

  • Nestle USA announced that it acquired TPVG portfolio company, Freshly Inc.; TPVG portfolio company Hims, Inc. announced plans to go public through a merger with Oaktree Acquisition Corp.; and TPVG portfolio company Qubole was acquired by Idera;
  • Received $32.0 million of principal prepayments generating approximately $2.4 million of prepayment fees and interest income;
  • Entered into $30.0 million of additional non-binding signed term sheets with venture growth stage companies;
  • Closed $15.0 million of additional debt commitments; and
  • Funded $6.0 million in new investments.

This information has been taken into account with my updated projections.

We are pleased to see the levels of exit, liquidity and prepayment events within our portfolio. These events generate exceptional returns on our investments and give us the flexibility to efficiently redeploy our capital.”

Source: TPVG Earnings Call


Source: TPVG Earnings Call Presentation

On October 29, 2020, the company’s board of directors declared a quarterly distribution of $0.36 per share for the fourth quarter of 2020, payable on December 14, 2020, to stockholders of record as of November 27, 2020. TPVG had around $10 million or $0.33 per share of “spillover” or undistributed income that can be used for temporary coverage shortfalls. On the recent call management mentioned that this amount could be used for “additional distributions to shareholders in the future” which could imply regular and/or supplemental dividends:

“During the third quarter, we just we distributed $0.36 per share from ordinary income as part of our regular quarterly distribution. Net investment income provided 110% coverage of the quarterly distribution, despite leverage being at the lower end of our target range. And further, we have undistributed earnings spillover from net investment income of approximately $10 million or another $0.33 per share to support additional distributions to shareholders in the future.”

Source: TPVG Earnings Call

The following discussion was from a previous call:

Q. What degree of confidence do you have in your portfolio providing earnings at this run rate – at the dividend run rate beyond the second quarter?”

A. I think that the Board always has the discussion, and it’s a prudent thing to do. So I think that we were just kind of elaborating and sharing those conversations that are natural for each quarter that we’re talking about at a distribution level. I think just given the robust discussion that always happens, we thought it would be fair to say that we are comfortable where we are with the portfolio, with the additional leverage that we have and the earnings power of the portfolio.”

As predicted in “TPVG Projections/Pricing Update (Includes Baby Bond): Upgraded Again!” TPVG announced a special dividend of $0.10 per share payable on January 13, 2021, to shareholders of record at the close of business on December 31, 2020. More importantly, was the mention of significant capital gains in 2020 which likely implies additional gains in Q4 as well as the confidence that the Board has in paying additional amounts to shareholders.

The special dividend represents a portion of the Company’s estimated net capital gain income earned during the fiscal year. The anticipated remaining undistributed net capital gain income along with the Company’s estimated undistributed taxable earnings from net investment income, which was $10.0 million or $0.33 per share, as of September 30, 2020, will spill-over into 2021.

“We benefited from our warrant and equity portfolio in 2020, generating significant capital gains for shareholders. The declaration of our third special distribution since our IPO highlights the powerful warrant and equity investment components of our returns and underscores TPVG’s differentiated business model. We are uniquely positioned to generate additional long-term shareholder returns from our warrant and equity investments.”

Source: TPVG Press Release


TPVG Risk Profile Update

TPVG provides financing primarily to venture capital (“VC”) backed technology companies at the venture growth stage (see the end of this report), similar to Hercules (NYSE:HTGC) and Horizon (NASDAQ:HRZN). As discussed in previous reports, TPVG has historically had portfolio concentration risk and management is actively working to diversify the portfolio using the ability to co-invest across the broader platform and likely one of the reasons for the previous equity offering. The top five positions currently account for around 28% of the portfolio compared to 44% in December 2018 and 57% in early 2018.

During Q3 2020, TPVG recognized net realized gains of $4.1 million including $6.0 million of realized gains from the sale of publicly traded shares held in CrowdStrike, Inc. (OTC:CRWD) and Medallia, Inc. (MDLA), offset by $1.9 million of realized losses from the finalization of asset sales of Munchery, Inc., which was rated Red (5) on the credit watch list.

There were no additional investments added to non-accrual status during Q3 2020. As mentioned earlier, TVPG finally exited its non-accrual investments in Munchery, Inc. However, TPVG invested an additional $2.5 million in Roli Ltd. as well as was marked up a portion of the investment increasing non-accruals from 2.4% to 3.1% of the portfolio fair value and from 4.6% to 4.7% at cost. This was discussed on the recent call:

We have only one company rated 4 on our watch list. ROLI, a music technology company. During the quarter we saw an increase in the value of our position in ROLI as a result of progress the company made during the quarter, which culminated in the launch of their LUMI keyboard on October 1st, favorable product reviews and strong initial demand and sales. We hope to see momentum – we hope to see this momentum translate into continued favorable trends for the company and our investment. We are in the process of working on a global restructuring of our outstanding indebtedness with them, based on that – we were waiting for the product launch and positive developments that happened during the third quarter.”

Source: TPVG Earnings Call

If these TPVG’s non-accrual investments were completely written off it would impact NAV per share by around $0.66 or 5.0%:


TPVG maintains a credit watch list with portfolio companies placed into one of five categories, with Clear, or 1, being the highest rating and Red, or 5, being the lowest. Generally, all new loans receive an initial grade of White, or 2. Munchery was its only Red (5) and was sold during Q3 2020. As of September 30, 2020, the weighted average investment ranking of its debt investment portfolio was 2.08, as compared to 2.03 as of the end of the prior quarter.

Source: SEC Filing

Source: TPVG Earnings Call Presentation


There will likely be additional liquidity and realized gains from exiting its equity investments including its remaining 16,747 shares of CRWD valued at $2.3 million over cost and 18,616 shares of MDLA valued at $0.5 million over cost as of September 30, 2020.

We sold a portion of our holdings in CrowdStrike, resulting in additional $4.9 million of realized gains in Q3, bringing our total to $24.3 million have realized gains on that name alone and also recorded $1.1 million of realized gains on our Medallia holdings. We continue to hold shares in both companies, representing $2.7 million of unrealized gain as of September 30th, and expect to exit our remaining positions over the next one quarter to two quarters.”

Source: TPVG Earnings Call

Source: Yahoo


TPVG has around $46 million invested in Prodigy Finance Limited which lends to international graduate students and is currently marked at full value likely due to:

Q. Looking at Prodigy Finance, that’s a decent sized maturity at the end of 2020, now 18.7 million. My understanding is that student loans for international students which I’d imagine with my limited information is pretty challenged. Is there any context or color you can provide on the status of that lender obligation?”

A. So, just to clarify that’s a lender to international graduate students. So, I’d say Prodigy lends to those graduate students attending top tier business school, engineering school and law school. So, the folks that have a higher likelihood of getting jobs regardless of crisis. So, I would say the very focused approach or thoughtful approach, they’re not lending to under grads, they’re not lending to just any graduate programs but very focused on those degrees particularly again business schools, engineering schools and then a small percentage of law schools. And then top schools only. So, I’d say the good news is very focused on higher quality company or sorry obligor based than traditional students.”

Source: TPVG Earnings Call

During Q3 2020, TPVG’s net asset value (“NAV”) per share increased by less than expected $0.11 or 0.8% (from $13.17 to $13.28 mostly due to over-earning the dividend by $0.04 per share and net realized/unrealized gains of $0.07 per share.

Source: TPVG Earnings Call Presentation

TPVG’s portfolio is typically around 90% debt investments structured as “growth capital loans” or “equipment financing” and mostly backed by a senior position on all assets (see below), typically with warrants that provide upside potential. However, around 31% of growth capital loans are with borrowers that have other facilities in a senior position to TPVG and I have classified as “second lien.”

Source: TPVG Earnings Call Presentation

I consider TPVG to have a safer-than-average risk profile due to mostly 1st lien positions with VC equity support. The following discussion is from the recent earnings call:

During the quarter, four portfolio companies raised over $430 million of capital. This brings our total to 22 portfolio companies raising over $2.8 billion of capital since the beginning of the year, approximately 70% of our portfolio companies have 12 months or more of cash runway.”

Growth activity well underway here in the fourth quarter. We believe this positive trend will continue in our business and serve as a basis for meaningful growth in 2021. This is due to several reasons. The first is our focus on technology. We are living in a different world in one of uneven consequences. The technology sector is one of the more sustainable parts of the economy today and is an area for investment for the foreseeable future. TriplePoint will continue to benefit from this trend as we provide loans and invest primarily in technology-driven companies and sectors, many of them experiencing tailwinds and stand to benefit in this environment.”

Many of our portfolio companies operate in the virtual and digital technology world today, and TPVG is well positioned to take advantage of this ecosystem as new venture capital investments remain focused in it. We’re seeing this not only within our own portfolio companies, but within the broader venture ecosystem as well, further validating the needs of these companies for venture lending. This activity continues to be robust this year and includes everything from the emergence of these facts to multi-billion dollar acquisition exits. Increase opportunities for venture lending in today’s environment also includes providing financing for many of the companies out there that are actively considering opportunistic acquisitions in the COVID era.”

Source: TPVG Earnings Call

Source: TPVG Earnings Call Presentation


Volatility is your friend!

BDC pricing can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher-quality portfolio that will deliver higher-than-average returns over the long term. One of my goals is to help subscribers take advantage of “oversold” conditions.

On September 24, 2020, the Fear & Greed Index (“F&G” in the chart above) hit 40 and I purchased shares in six BDCs including TPVG all of which have easily outperformed the S&P 500 during the same period. I will be discussing the other five BDCs in upcoming articles.



Full BDC Reports

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

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

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.

To be a successful BDC investor:

  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Diversify your BDC portfolio with at least five companies. There are around 45 publicly traded BDCs; please be selective.

2 Dividend Stocks To Buy With Improving Book Values

The following information is from the PNNT and PFLT Updates that were 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”).


 

Summary
  • The BDC sector continues to deliver strong returns during the pandemic, including recently improved earnings, dividend coverage, and increased book values.
  • This article discusses two stocks that I own one of which I consider a ‘Buy and Hold’ that has provided excellent returns so far in 2020.
  • The other position is more of a trading position with upside potential (discussed below) and currently trading at a 42% discount to its book value.
  • Also included are my predictions for the general markets and BDC pricing over the next 2 to 3 months.
  • BDC investors typically get at least 2 to 3 buying points each year.


Introduction

This article is part of a series discussing how to build a retirement portfolio using general market volatility and business development companies (“BDCs”). Similar to REITs, BDCs are regulated investment companies (RICs), required to distribute more than 90% of their profits and gains to shareholders avoiding corporate income taxes before distributing to shareholders.

This structure prioritizes income to shareholders (over capital appreciation) driving higher yields that currently range from around 7% to 13%. The following yields take into account special/supplemental dividends for 2020.

This article discusses PennantPark Investment (PNNT) and PennantPark Floating Rate Capital (PFLT) both of which were founded by Art Penn who also co-founded Apollo Investment (AINV) in 2004.


Quick BDC Market Update

  • Please see the end of this article for my expectations of BDC pricing over the next 2 to 3 months.

As predicted last week in “11% Dividend Yielding BDC Sector Continues To Soar“, BDCs continue to rebound and outperform the general markets for many reasons discussed in the article as well as a rotation into cyclicals and higher yield. Most BDCs (including PNNT and PFLT) have been reporting stronger-than-expected quarterly results with increased NAV/book values and improved net interest margins due to higher portfolio yields and/or reduced borrowing expenses. Also, non-accruals remain very low (so far) and BDCs still have conservative valuations (below par) on many of their investments that I am expecting to slowly reflate as they have been due to tighter spreads and an improved economic outlook. The following was from Ryan Lynch at KBW earlier this month:

business development companies are performing much better here than they did compared to the global financial crisis – and better than investors would have expected earlier this year. The trajectory of loss rates and changes in book value have been improving over the past two quarters, rather than deteriorating.

Why hasn’t this downturn been as severe as the GFC? Lynch says that’s in part due to the combination of massive government stimulus and liquidity from the government and Federal Reserve, as well as some conservative positioning among the BDCs headed into this downturn.

When it comes to portfolio loss/gain rate, the top performers among the BDCs are Sixth Street Specialty Lending (NYSE:TSLX), TriplePoint Venture Growth (NYSE:TPVG), and Hercules Capital (NYSE:HTGC). Conversely, the worst performers on loss rate so far are First Eagle Alternative Capital (NASDAQ:FCRD), Investcorp Credit Management (NASDAQ:ICMB), and FS KKR Capital (NYSE:FSK).

The following chart compares the last 12 months’ performance for PNNT and PFLT to UBS ETRACS WF BDC Index ETN (BDCS). Both PNNT and PFLT have recently bounced higher for the reasons discussed below.

Source: Yahoo

As mentioned in many previous articles, BDCS (the ETN) consistently underperforms the average BDC for many reasons including higher weightings in many of the BDCs that underperform and fund fees. Currently, there are around 45 publicly traded BDCs but the top 7 weightings account for 55%, 3 of them with lower quality management and 6 of them have underperformed the average BDC so far in 2020.

Source: UBS Etracs


Upcoming NAV Increases & Realized Gains

As mentioned earlier, I am expecting most BDCs to report continued increases in book values or net asset values (“NAVs”) over the coming quarters including PFLT and PNNT.

After the markets closed on November 18, 2020, PFLT reported results that included in the following disclosure:

Subsequent to September 30, 2020, our portfolio company, Cano Health, LLC (ITC Rumba, LLC), entered into a business combination agreement with Jaws Acquisition Corp (JWS), a special purpose acquisition vehicle, and other parties, subject to certain closing conditions, with an expected closing late first quarter or early second quarter 2021. Based on the closing stock price of JWS on November 13, 2020, our $2.3 million common stock fair valuation as of September 30, 2020 would increase to an estimated $9.0 million, which includes a combination of cash and stock, assuming the transaction closes based on the agreed terms. This would represent a net asset value increase of $0.17 per share, as of November 13, 2020. Our shares are owned by a limited partnership controlled by the financial sponsor and are subject to customary lock up restrictions. As a result, the fair value on December 31, 2020, may likely include an illiquidity discount not in the public trading values indicated above. There can be no assurance that the implied value of our equity interest will be representative of the value ultimately realized on our equity investment.

Impact on PFLT:

As mentioned above, based on the closing stock price of JWS on November 13, 2020, PFLT’s $2.3 million common stock fair valuation as of September 30, 2020, would increase to an estimated $9.0 million, which includes a combination of cash and stock. This would represent a NAV increase of $0.17 per share. The shares are owned by a limited partnership controlled by the financial sponsor and are subject to lock-up restrictions. As a result, the fair value on December 31, 2020, may likely include an illiquidity discount, not in the public trading values.


Impact on PNNT:

PNNT reported after the markets closed the following day (November 19, 2020) but before that, I sent the following update to investors:

PNNT also has investments in Cano Health including 375,675 shares compared to PFLT as 46,763 shares which were valued at $9.0 million or approximately $192.46 per share. This would imply that PNNT’s shares could be worth $72.3 million compared to the $11.0 million as of June 30, 2020. Simply using PFLT’s recently released financials would indicate that PNNT will have around $7.9 million of unrealized gains during the three months ended September 30, 2020, which is around $0.12 per share. However, there will likely be significant gains in the following quarter of an additional $0.80 per share or a 10% increase in NAV. Also, the amount of realized gains could be $68 million or around $1.00 per share which I need to confirm and this is assuming the valuations provided by PFLT. These are just preliminary estimates and I will be starting a small trading position today before PNNT reports results at the close.

Before PNNT reported I was able to purchase shares at an average price of $4.06 per share:

Once PNNT reported results, we found out that the company sold its first-lien loan in Cano Health to the PennantPark Senior Loan Fund (“PSLF”) but still held its 375,675 shares valued at $72.3 million as of November 13, 2020, compared to the fair value of $18.8 million as of September 30, 2020, implying an unrealized gain of $53.5 million or $0.80 per share as mentioned above. This would imply an increase in NAV of around 10.2% and the potential for realized gains of $68.0 million or around $1.01 per share.

The following is an update to the previous public PNNT article “PennantPark Investment: 55% Discount To Book Driving 14% Yield“:

PNNT’s incentive fee “hurdle rate” of 7.0% is applied to “net assets” to determine “pre-incentive fee net investment income” per share before management earns its income incentive fees. As shown in the following table, the company will likely earn around $0.137 per share each quarter before paying management incentive fees covering around 114% which is ‘math’ driven by an annual hurdle rate of 7% on equity. However, depending on changes in credit quality, there is a chance that PNNT could be downgraded to ‘Level 2’ dividend coverage. Also shown in the table is a ‘Pro-Forma’ scenario using an increased NAV per share to a conservative $8.50 and the company would need to earn $0.149 per share before paying incentive fees to management. It is important to note that PNNT could earn less but management would not be paid an incentive fee.

PNNT’s Board extended the incentive fee waiver for an additional quarter through December 31, 2020. My primary concerns for PNNT are mostly related to commodity-related exposure and lack of a “total return hurdle” incentive fee structure to protect shareholders from capital losses.

It should be noted that the previous dividend reduction was accurately predicted in many previous reports. PNNT typically announces its December dividend during the first week of December which is next week.

Source: Fidelity


Summary & BDC Market Expectations

As my subscribers are well aware, 2020 has been an excellent year for me and I have made 52 purchases over the last 11 months (many of which were pre-COVID). As shown below, four of these purchases were PFLT with an average yield on cost of almost 20% and average total return of 88%:

Source: BDC Buzz

I consider PFLT to a ‘buy and hold’ position so I do not plan on selling unless there is a potential problem and will continue to purchase during general market pullbacks (as predicted at the end of this article).

However, PNNT is a trading position for me due to being higher risk (discussed below) and simply using the average BDC price-to-NAV multiple of 0.93 (shown in the first table) would imply a stock price for PNNT of around $7.00 to $8.00.

However, this is NOT how BDCs are priced and PNNT has not traded over $7.00 for a while now including pre-COVID. Also, PNNT has energy/oil-related exposure (discussed next) combined with a lack of a “total return hurdle” incentive fee structure. However, PNNT has higher quality management that has historically done the right things including voluntary fee waivers related to previous capital losses.

Source: BDC Buzz

Source: Fidelity

The fair value of energy, oil & gas portfolio exposure recently decreased from $113 million to $98.0 million due to additional markdowns of RAM Energy and ETX Energy. However, these investments still account for around 9.1% of the portfolio which is an increase due to selling some of its portfolio investments to the PSLF. Previously, PNNT recapitalized RAM Energy and converted all of its remaining debt obligations to equity. As mentioned in previous reports, both RAM Energy and ETX Energy have suspended all drilling activities and reduced all nonessential capital expenditures, expenses and personnel.

Source: SEC Filings & BDC Buzz

As shown in a previous table if PNNT completely marked down its oil/energy-related investments the impact to NAV per share would be around $1.46 or 18.6%. This more than priced into the stock that is currently trading at a 42% discount to NAV/book value. However, these investments do not produce income, and dividend coverage would not be impacted other than the leverage ratio. Management will likely exit these investments over the coming quarters (depending upon pricing) and was discussed on the previous call.

PRA Events, Inc. was added to non-accrual during the quarter status due to COVID-19 related issues similar to MailSouth, Inc. that added the previous quarter and need to be watched. As of September 30, 2020, non-accrual accounted for 4.9% and 3.4% of the overall portfolio on a cost and fair value basis, respectively.

As mentioned earlier, I started a trading position in PNNT at an average price of $4.06 last week and the stock is already over 13% higher. I will likely sell at some point and hoping for over $5.00 which could be soon especially after the company confirms its quarterly dividend next week.


General Market Expectations:

As for the general BDC market, I am expecting the following;

  • Pullback (mid to late December): lockdowns, vaccine delays/issues, stalled stimulus, tax-loss harvesting, investors taking gains
  • Rally (late December to late January): partial reversal of pullback drivers, general new year optimism, BDCs reporting another quarter of better-than-expected results
  • BDCs Report Results (February): improved net interest margins, NAV per share gains, reaffirmed dividends, and some Q4 special dividends

I believe that there is a good chance that the markets will pull back during the second/third weeks of December 2020 followed by a rally in late December or January. A temporary pullback could be driven by a few potential issues including a larger spike of Covid-19 cases driving fears of additional lockdowns, vaccine delays/issues, Congress stalling on stimulus talks, tax-loss harvesting, or retail sellers taking gains (for Holiday shopping).

The rally in general markets (or at least BDCs) could be driven by a partial reversal of whatever caused the markets to pull back, new year optimism of light at the end of the tunnel, and-or ultimately BDCs reporting another quarter of better-than-expected results similar to previous quarters. I believe that Q4 2020 results will be much better than Q3 2020 for the reasons discussed in previous updates including improved net interest margins (due to higher portfolio yields and/or reduced borrowing expenses) that did not fully impact the earnings for Q3 2020. Also, NAV per share gains will likely be much higher for Q4 2020 and I will discuss in upcoming reports. BDCs will begin reporting Q4 2020 results at the end of January so investors need to be ready to make purchases before.

BDC pricing often reacts quicker and more extreme than the general markets so you need to be prepared to make changes to your portfolio when needed. My upcoming articles will discuss putting together a ‘shopping list’ so that investors are ready for the next round as there are typically 2 to 3 buying points each year. I will discuss this in detail in the next article



Full BDC Reports:

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

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

To be a successful BDC investor:

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

Additional disclosure: I am long 17 BDCs but only 2 of them were discussed in this article.

BDC Market Update & MRCC Issuing Shares Below NAV

The following information is from the MRCC Projections Update that 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”).


Quick Update:

As mentioned in “8% To 10% Balanced Portfolio Yield Investing In America: Part 2” on Seeking Alpha, I will be using this blog for additional public updates on individual BDCs.

 


Quick BDC Market Update

As mentioned in previous articles, I was expecting Business Development Company (“BDC”) pricing to pull back from the recent highs for various reasons including profit-taking and a partial return to “risk-off” mode. Please note that most BDC charts look similar to the one below with a peak on June 8 and then mostly down.

Annotation 2020-07-12 231552

I am expecting volatility through July until BDCs start to report Q2 2020 results (see dates at the end). However, I am expecting many BDCs to report stronger-than-expected results including net asset value “NAV” increases, adequate dividend coverage, and reaffirming current dividends. Many of the NAV increases will be due to:

  • Tightening of yield spreads (will impact each BDC differently depending on loan mix)
  • Likely improved valuations related to COVID-19 as many BDCs made large general write-downs due to the uncertainty of the impact as of March 31
  • PPP aid which reduced liquidity and leverage issues for many portfolio companies

It is important to understand that the values BDC management applied to their assets on March 31, 2020, were conservative as we did understand which companies/sectors would be the most impacted. Of course, there will be some increased non-accruals but for most BDCs, this will more than offset by improved valuations on other investments. As these results are reported (mostly in early August), it will drive some positive headlines and another rally in BDC pricing as investors are looking to improve portfolio yield/returns in this low yield environment.

Clearly, the potential for additional or renewed lockdowns related to COVID-19 is a concern driving markets lower, including BDCs that are now yielding around 14% (see list below).

Annotation 2020-07-12 231308

 



 

This article discusses Monroe Capital (MRCC) that is trading at a 37% discount to book value/NAV for the reasons discussed in “Why Investors Are Selling 12% Yielding Monroe Capital” that also predicted the recent dividend cut almost 6 months ago:

From January 26, 2020: “the quarterly dividend will likely be reduced to between $0.25 and $0.30. This also is shown in the worst-case projections that take into account continued credit issues likely from the investments discussed later in this report”


Issuing Shares Below NAV:

I am often asked about concerns that most BDCs have the ability to issue shares below NAV and hopefully, the following will help.

Most BDCs have the ability to issue shares below NAV typically related to lending facility covenants and/or extreme worst and best-case scenarios. During market volatility, BDCs could temporarily break a bank covenant and be forced to stop paying dividends until the company is back in compliance. The ability to issue even small amounts of equity can easily bring the BDC back into compliance. Also, having this option likely improves lending rates or other terms. I only invest in BDCs with higher quality management that would not issue shares below NAV unless it was an extreme case that could be either bad or good (opportunistic) such as using to make an acquisition at extremely low prices as ARCC did with Allied Capital and was a huge win for investors and NAV down the road:

The Company has also received stockholder approval to issue shares of its common stock under NAV for each of the last eight years (the “Annual Under NAV Approval”), and despite the Company trading below NAV for periods during such time frame, including for most of 2016, it has only used the flexibility provided by the Annual Under NAV Approval one time. In 2009, during a period of significant credit market volatility when credit spreads increased materially, the Company, acting pursuant to the Annual Under NAV Approval, prudently issued shares of its common stock at a price below NAV and invested the proceeds from such issuance at attractive returns to stockholders. These proceeds were also used to create liquidity and financial flexibility in an uncertain time of extreme volatility. While such issuance was at a price below NAV, it resulted in less than a 2.5% dilution in the aggregate net asset value of the Company. Additionally, the Company believes that this financial flexibility was a key component of the Company’s ability to opportunistically acquire Allied Capital Corporation, which transaction was agreed to on October 26, 2009 and closed on April 1, 2010 (the “Allied Acquisition”). The Company’s NAV increased during the one-year period following the date of the Company’s most recently determined NAV prior to such issuance, increasing from $11.21 (as of June 30, 2009) to $14.11 (as of June 30, 2010). The increase in the Company’s NAV from June 30, 2009 to June 30, 2010 includes a $1.11 per share increase related to the gain on the Allied Acquisition. Furthermore, for the one-year period following the date of such issuance, the Company’s total stockholder return outperformed that of every other BDC with a market capitalization of greater than $500 million. Therefore, periods of market volatility and dislocation have created, and may create again, favorable opportunities for the Company to make investments at attractive risk-adjusted returns, including opportunities that may increase NAV over the longer term, even if financed with the issuance of common stock below NAV.

Source: ARCC SEC Filing

MRCC is overleveraged and currently issuing shares through its “at the market” equity program at prices 30% to 40% below book value/NAV and will have a negative impact on upcoming results including NAV per share.

The following information was included in a recent SEC filing:

“this prospectus supplement and the accompanying prospectus. The equity distribution agreements provide that we may offer and sell up to $50,000,000 of our common stock from time to time through the Sales Agents in negotiated transactions or transactions that are deemed to be “at the market offerings,” as defined in Rule 415 under the Securities Act of 1933, as amended. As of the date of this prospectus supplement, we have sold $8.7 million of our common stock under the equity distribution agreements. Our common stock is listed on The Nasdaq Global Select Market under the symbol “MRCC.” On June 23, 2020, the last reported sale price of our stock on The Nasdaq Global Select Market was $7.12 per share. Our net asset value as of March 31, 2020 was $10.04 per share.”

“The table below assumes that we will sell all of the remaining common stock available under the program as of June 23, 2020 of $41.3 million at a price of $7.12 per share (the last reported sale price of our common stock on The Nasdaq Global Select Market on June 23, 2020)…The following table sets forth our capitalization as of March 31, 2020, and on an as adjusted basis giving effect to the $6.2 million of common stock sold from March 31, 2020 to June 23, 2020 at an average price of $7.86 per share and to the assumed sale of $41.3 million of our common stock at a price of $7.12 per share (the last reported sale price of our common stock on The Nasdaq Global Select Market on June 23, 2020) less commissions and expenses.”

It should be noted that as of the writing of this article, the stock was trading at $6.33 (not $7.12) which is a 37% discount to NAV and would have a larger impact if the company is actively issuing shares. Please keep in mind that any shares issued after June 30, 2020, will impact Q3 2020 results (not Q2 2020).

Source: MRCC SEC Filing

 


Previous Insider Purchases & Ownership:

  • It should be noted that the most recent insider purchases were at prices below $7.00:

Source: Gurufocus

 


Monroe Capital 5.75% Notes (MRCCL) due 10/31/2023:

I have previously invested in MRCC’s Baby Bond “MRCCL” but sold due to the amount of leverage, lower-quality assets, and declining interest expense coverage all of which increase its risk ranking. As mentioned in previous articles, I rank each Baby Bond using portfolio credit quality and many metrics including the ones listed below.

Please see the following links from Investopedia for more information:

 

 


MRCC Dividend Update

One of the methods that I use to assess BDC dividend coverage is my Optimal Leverage Analysis based on portfolio growth using available cash and borrowings (leverage) as well as changes in portfolio yield and potential credit issues. This is a longer-term run rate analysis of coverage that includes “stable” and “lower” portfolio yields with minimal amounts of non-recurring income and is an apples-to-apples comparison using similar amounts of leverage. In May 2020, MRCC announced a quarterly dividend reduction from $0.35/share to $0.25/share.

Annotation 2020-07-12 230508

 


My Current BDC Investment Plan

My last two major purchases of multiple BDC common stocks were March 12 and March 19 and included 14 higher-quality BDCs. I was lucky and bought at or very near the previous lows and now collecting dividends and:

  • Waiting for BDCs to report Q2 results (see dates below),
  • Watching for preliminary result announcements (similar to NMFC discussed last week),
  • Gathering information (portfolio and capital structure updates),
  • Updating projected changes to NAV and dividend coverage for each BDC,
  • Planning for future purchases.

Annotation 2020-07-12 230233


Full BDC Reports:

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

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

To be a successful BDC investor:

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

Goldman Sachs BDC (GSBD) Merger Update: June 2020

The following information is from the GSBD Projections Update that 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”).


Quick Update:

As mentioned in “8% To 10% Balanced Portfolio Yield Investing In America: Part 2” on Seeking Alpha, I will be using this blog for additional public updates on individual BDCs.

 


GSBD Merger With MMLC Update

On June 11, 2020, GSBD and MMLC announced that they had amended and restated the Original Merger Agreement (the “Amended Merger Agreement”). The Amended Merger Agreement has been unanimously approved by the Boards of Directors of both companies. GSBD and MMLC previously announced that they had entered into an Agreement and Plan of Merger dated as of December 9, 2019 (the “Original Merger Agreement”).

Why are the terms of the Merger being amended?

In order to comply with provisions of the Investment Company Act of 1940 which require that a merger of affiliated business development companies not result in dilution to either party, the Original Merger Agreement contained a closing condition whose satisfaction was dependent on the trading price of GSBD’s common stock. Heightened volatility in the current market precipitated by the COVID-19 pandemic has created uncertainty as to whether this condition can be met. The Amended Merger Agreement eliminates this closing condition while still ensuring that the transaction would not result in dilution to either party.

What are the key changes from the original merger terms?

The consideration has been changed from a fixed exchange ratio to a “net asset value for net asset value” exchange. Based on this change, the exchange ratio will be determined at closing such that shares issued by GSBD to MMLC shareholders will result in an ownership split of the combined company based on each of GSBD’s and MMLC’s respective net asset values. Based on March 31, 2020 net asset values and pro forma for the MMLC distributions, transaction costs and the repayment of MMLC’s revolving credit facility described below, GSBD would issue approximately 1.0656 shares for each MMLC share outstanding. The total share consideration to MMLC shareholders would represent a 17% premium to the pro forma MMLC net asset value, based on the closing market price of GSBD as of June 10, 2020.

The variable cap on GSAM’s incentive fees has been extended for an additional year, through the end of 2021. The Variable Incentive Fee Cap provides that incentive fees payable to GSAM will be reduced if net investment income (”NII”) would be less than $0.48 per share without implementation of the incentive fee cap.

Upon closing the transaction, GSAM has agreed to reimburse GSBD and MMLC for all fees and expenses incurred and payable by GSBD or MMLC or on their behalf in connection with the transaction, subject to a cap of $4 million with respect to each of GSBD and MMLC.

Prior to closing the Merger, MMLC’s board of directors will declare a $75 million distribution to MMLC shareholders relating to the pre-closing period. This distribution is an amount equal to approximately 8.1% of MMLC’s March 31, 2020 net asset value.

What impact will a change in the market price of GSBD stock price have on the Merger Consideration to be received by MMLC stockholders?

Under the “NAV for NAV” exchange mechanism, the shares issued by GSBD to MMLC shareholders will result in an ownership split of the combined company based on each of GSBD’s and MMLC’s respective net asset values. Changes in the market price of the GSBD stock price will therefore have no impact on the exchange ratio. However, the total value of the consideration received by MMLC stockholders will be the product of the shares received in the exchange, and the price of GSBD stock.

What are the benefits of the Merger to GSBD stockholders?

The GSBD Board and the GSBD Special Committee weighed various benefits and risks, both with respect to the immediate effects of the Merger on GSBD and its stockholders and with respect to the potential benefits that could be experienced by the combined company after the Merger. These potential benefits include, among others:

Expected to be Accretive to Short and Long-Term NII: GSAM expects the merger to be accretive to GSBD’s net investment income per share both in the short and long-term, reflecting a variable incentive fee cap through 2021, as well as anticipated optimization of the combined company’s capitalization following the close of the transaction. On June 11, 2020, GSAM announced that it will waive a portion of its incentive fee for the four quarters of 2021 (Q1 2021 through and including Q4 2021) payable pursuant to the Investment Advisory Agreement for each such quarter in an amount sufficient to ensure that GSBD’s net investment income per weighted average share outstanding for such quarter is at least $0.48 per share. This waiver helps to ensure that the distributions paid to GSBD’s stockholders are not a return of capital for tax purposes. This waiver is an addition to the existing waiver with the same terms that applies through the end of 2020.

Benefits of Scale: The combination more than doubles the size of GSBD, and is expected to result in benefits of scale, including improved access to diversified funding sources, cost synergies and greater trading liquidity.

Improved Balance Sheet: GSBD’s debt to equity ratio is expected to decline, creating more capacity to deploy capital into today’s attractive investment environment while adding a greater margin of safety to maintain investment grade (“IG”) credit rating and comply with regulatory and contractual leverage ratios.

What approvals are required for the Merger to be completed, and what is the expected timing of such approvals?

Consummation of the Merger is subject to certain closing conditions, including receipt of approval from each of the MMLC and GSBD stockholders, regulatory approval and other closing conditions. The Merger is currently anticipated to close during Q4 2020, subject to the satisfaction of certain closing conditions.


GSBD Dividend Update

The Board has approved special distributions of $0.15 per share, and “payable post-closing in three $0.05 per share quarterly installments currently expected to begin Q1 2021”:

GSBD has covered its dividend by an average of 112% over the last 8 quarters growing spillover/undistributed income to $46.6 million or around $1.15 per share. GSBD’s dividend coverage is not reliant on fee and dividend income, some of which is amortized over the life of the investment, reducing the potential for “lumpy” earnings results.

“Loan origination fees, original issue discount and market discount or premiums are capitalized, and the Company then amortizes such amounts using the effective interest method as interest income over the life of the investment. Consistent with prior years, we spilled over all of the undistributed NII into 2020 as we believe the cost of the spillover in the form of the excise tax is a small price to pay relative to the much higher cost of issuing new equity if we had to replace that amount.”

As a part of the merger agreement, Goldman Sachs Asset Management (“GSAM”) has agreed to waive a portion of its incentive fees and was discussed on the recent call:

Q, “And just a reminder on the fee waivers that you proposed for GSBD related to this transaction, are those still independent on schedule? Or is there any time…”

A, “Yes, all of those are — all of those kind of are part of the merger agreement, and there’s been — yes, there’s been no change to that merger agreement. So all those fee waivers would continue to apply through the course of 2020.”

Q. “But if the merger doesn’t happen, do they reverse?”

A. “Well, so again, we’re looking at the way the merger document is structured today. There’s basically a concept called the outside date by which something has to happen or termination provisions start to kick in. That’s really not until December of 2020. And so we have no expectation or no reason to think that in the short term, anything would change to that dynamic, which would cause us to change the fee waivers.”

On June 11, 2020, GSAM announced that it will waive a portion of its incentive fee for the four quarters of 2021 (Q1 2021 through and including Q4 2021) payable pursuant to the Investment Advisory Agreement for each such quarter in an amount sufficient to ensure that GSBD’s net investment income per weighted average share outstanding for such quarter is at least $0.48 per share. This waiver helps to ensure that the distributions paid to GSBD’s stockholders are not a return of capital for tax purposes.

For Q1 2020, there were no incentive fees paid and the portfolio yield continues to decline due to lower LIBOR and investments at lower yields.

On February 6, 2020, GSBD issued $360 million of unsecured notes due 2025 at a very low rate of 3.750% trading under CUSIP: 38147UAC1. Also, on February 27, 2020, the company reduced the borrowing rate on its credit facility to LIBOR +1.875% from LIBOR + 2.00% and extended to February 25, 2025 which is taken into account with updated projections.

“We favorably amended our senior secured revolving credit facility agreement to reduce the stated interest rate from LIBOR plus 2% to LIBOR plus 1.875% and to extend the final maturity date from February 2023 to February 2025. On February 10, 2020, we closed a public offering of $360 million aggregate principal amount of unsecured notes due 2025 and bearing interest at a fixed rate of 3.75%. We used the proceeds from the sale of notes to partially repay our senior secured revolving credit facility. This action left us with no near-term maturities until our convert comes due in 2022, while preserving almost $400 million in availability under our revolving credit facility.”

Previously, shareholders approved the reduced asset coverage ratio of at least 150% (potentially allowing a debt-to-equity of 2.00) and management reduced the base management fee from 1.50% to 1.00%, lowering expenses and improving dividend coverage as shown in the following table. However, the merger with MMLC will result in lower leverage and is taken into account with the updated projections. Also, management is acutely aware of needing lower leverage to retain its investment-grade rating and will likely be using repayments to deleverage as well prudently making new investments:

“When we endeavor to get a rating and issue the bonds, we articulated a leverage strategy where we’re now operating at the high end of what we articulated by virtue of adding a couple of assets in the quarter and, of course, marking down the NAV. And so we do think it’s smart to be thoughtful and prudent. The bar is certainly high for any new investments. And of course, we want to make sure that there’s capital available, if necessary, to support some of our portfolio companies. And so in that context, we think we’re overall in a very good position with the agencies, with our capitalization overall, and we wouldn’t expect just to take up leverage, to take on new opportunistic, higher-yielding opportunities because they’re availableOur hope is that they’ll be more organic deleveraging. That would give us that opportunity here.”


Updated Slides Related to the Merger With MMLC:


Previous GSBD Insider Purchases:


Full BDC Reports:

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

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

To be a successful BDC investor:

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

NMFC Preliminary Q2 2020 Results: Upcoming Public Article

The following information is from the NMFC Projections Update that 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”).


Quick Update:

As mentioned in “8% To 10% Balanced Portfolio Yield Investing In America: Part 2” on Seeking Alpha, I will be using this blog for additional updates on individual BDCs.

 


Upcoming Public Article:

New Mountain Finance (NMFC) has recently released preliminary estimates for the quarter ended June 30, 2020, but has not been announced through the website or other news sources. I will have a public article during the week of June 28, 2020, discussing the information included in this update. NMFC’s dividend yield is currently 13.4% and remains above the average due to trading almost 20% below its book value that will likely be increasing as discussed below.

The information and presentation discussed in this update are from the SEC 8-K filing:

Link to NMFC press releases:

The most recent is from May 6, 2020, reporting March 31, 2020, results:

NMFC 1

 

As there was no formal announcement, most news sources did not pick it up including SA as shown below:

NMFC 2

 



NMFC Preliminary June 30, 2020 Update:

I recently updated the projections and pricing for NMFC to take into account the preliminary estimates provided by the company including:

  • Leverage decreasing from 1.56x to 1.35x as of June 30, 2020 = stronger balance sheet.
  • Increased NAV per share including a likely 2% increase in portfolio values which would drive leverage lower.
  • No material migration on Risk Ratings = stable credit quality.
  • No new non-accruals other than the one that was already discussed.
  • Q2 2020 earnings expected to be $0.30 per share covering the dividend.

 

NMFC 5

Analyst Earnings Expectations:

It should be noted that analysts are currently expecting earnings of just under $0.29 per share:

NMFC 6

Deleveraging and Cash Flow:

As shown below, the company had around $255 million of sales and repayments as compared to only $34 million of new investments as well as over-earning the dividend from cash sources. These allowed the company to reduce its borrowings/debt by $232 million.

NMFC 3

NMFC 7

NMFC 8



Previously Expected Dividend Reduction:

In previous reports, I discussed the expected dividend reduction which was announced early last month as the company is working to improve liquidity and cash flow:

NMFC 9

 

NMFC’s dividend yield remains above the average BDC:

 

NMFC 14

 



NMFC Risk Profile:

This where I spend most of my research efforts.

Public articles including “Building A Retirement Portfolio With 6% To 9% Yield: Part 4” have discussed NMFC’s previous “watch list” investments including Edmentum Ultimate Holdings, NHME Holdings, Permian Holdco, Ansira Holdings, AAC Holding, PPVA Black Elk, ADG LLC, York Risk Services and Sierra Hamilton.

However, given the various impacts from COVID-19, this list has obviously grown to include (among others) dental-related companies such as Affinity Dental, ADG, Affordable Care Holding, Benevis Holding, DCA Investment, Dentalcorp Health Services, Heartland Dental, and NM YI. There are plenty of other companies including CentralSquare Technologies that need to be watched and management provided the following detail in May 2020:

 

NMFC 13

NMFC 11

NMFC 12

 

It should be noted that some of the recent exits were below cost and will result in realized losses of around $0.05 per share. However, many of these exits were above the March 31, 2020, valuations which means that there will be an improvement to NMFC’s net asset value (“NAV”) per share related to these as well as the recent recovery of syndicated loans values as shown in an earlier slide above.

 

NMFC 4


Full BDC Reports:

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

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

To be a successful BDC investor:

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

GBDC Update: Dividend Coverage & Risk Profile

The following is from the GBDC 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”).


gbdc yield.png

GBDC Update Summary:

  • For the quarter ended December 31, 2019, GBDC hit its base case projections mostly due to its fee structure as discussed in previous reports.
  • As predicted, Oliver Street Dermatology was added to non-accrual status along with MMan Acquisition Co. that were previously considered ‘watch list’ investments.
  • However, portfolio credit quality remains strong with low non-accrual investments as a percentage of total investments at 1.2% fair value. GBDC has 250 portfolio companies, so a certain amount on non-accrual status is to be expected.
  • NAV per share decreased by $0.10 or 0.6% (from $16.76 to $16.66) mostly due to paying a special distribution of $0.13 per share.
  • Also predicted and discussed in the previous report, GBDC has decided to dissolve its SLF and finance the assets directly on its balance sheet (driving higher leverage) and will be taken into account with the updated projections.

For the quarter ended December 31, 2019, Golub Capital BDC (GBDC) hit its base case projections covering its dividend by 102%. As predicted, Oliver Street Dermatology was added to non-accrual status but total non-accruals remain low as discussed next.

 

Portfolio credit quality remains strong with low non-accrual investments as a percentage of total investments at 1.2% and 1.5% of fair value and cost, respectively. As discussed in previous updates, U.S. Dermatology Partners has defaulted on a $377 million financing provided by a group of investment firms, according to people with knowledge of the matter. The dermatology practice owner is now reviewing its options, including a recapitalization or debt-for-equity swap with its current lenders, Golub Capital, The Carlyle Group Inc. and Ares Management, according to the people, who asked not to be identified because they aren’t authorized to speak about it. During the previous earnings call, GBDC management was asked about its related investment in Oliver Street Dermatology:

Q. “I saw the — a change to the mark and addition of a PIK component to Oliver Street Dermatology. So wanted to ask what’s going on there?”

A. “I’m going defer discussing a specific situation like Oliver Street. I don’t think it is an appropriate topic for this call.”

During the most recent call, GBDC management discussed additional non-accruals (including Oliver Street Dermatology) mentioning that they are “cautiously optimistic that in respect of both companies, we are on a good path toward good recoveries”:

“So non-accruals at cost and fair value increased in the most recent quarter to 1.6% and 1.3%, respectively. Whenever we think about non-accruals, we feel a degree of concern, right. We are naturally worriers. We worry about everything. One of the things we worry about is non-accruals. I want to make sure, though, that everyone keeps our concerns in appropriate context. So first, this quarter GBDC continued its strong track record of generating positive net realized and unrealized gains on investments. And that’s the metric that we think is, over time, the most important indicator of credit performance. That’s why we focus so much in our earnings presentation each quarter on the chart in our presentation depicting NAV per share over time. A second way we look at credit and overall credit quality is based on risk ratings, I think they show a great deal of stability quarter-over-quarter and for many quarters in a row. And the third contextual point I will make is that the latest figures indicate that even with this small increase, we are still in the low end of the range of the industry and we are in our historical range in respect of non-accruals at cost. So I don’t want to make any of this sound like it’s more dramatic than it is. With that said, we are working hard with the managements of the two companies that we put on non-accrual this quarter and I can’t get into the details of either of the two situations, but what I can say is, I am cautiously optimistic that in respect of both companies, we are on a good path toward good recoveries.

Oliver Street Dermatology and MMan Acquisition Co. were previously considered ‘watch list’ investments (please see GBDC Deep Dive report for discussions) and were added to non-accrual status during the recent quarter. The Sloan Company, Advanced Pain Management, and Paradigm DKD Group were added to non-accrual status during the previous quarter and the two other investments that remain on non-accrual are Aris Teleradiology Company and Uinta Brewing Company.

 

 

 

It is important to remember that GBDC has 250 portfolio companies, so a certain amount on non-accrual status is to be expected.

 

As mentioned in the previous report, there was a meaningful increase in GBDC’s net asset value (“NAV”) per share during the previous quarter mostly due to the accretive acquisition of Golub Capital Investment Corporation (“GCIC”). During the three months ended December 31, 2019, NAV per share decreased by $0.10 or 0.6% (from $16.76 to $16.66) mostly due to paying a special distribution of $0.13 per share.

 

GBDC has predictably boring quarterly NII of $0.33/ $0.32 mostly due to its fee structure combined with strong portfolio credit quality. The financial projections use a wide range of assumptions but because of the incentive fee hurdle, the dividend is consistently covered by design. This calculation is based on “net assets” per share which will increase due to the merger driving a higher amount of “pre-incentive fee net investment income” per share before management earns its income incentive fees.

 

The annualized quarterly return from its Senior Loan Fund LLC (“SLF”) and GCIC SLF were 2.4% and 10.1%, respectively, for the quarter ended December 31, 2019. However, as predicted and discussed in the previous report, GBDC has decided to dissolve its SLF and finance the assets directly on its balance sheet (driving higher leverage) and will be taken into account with the updated projections:

“On January 1, 2020, the Company entered into a purchase agreement with RGA, Aurora, SLF, and GCIC SLF (the “Purchase Agreement”). Pursuant to the Purchase Agreement, RGA and Aurora (together the “Transferors”) agreed to sell their LLC equity interests in SLF and GCIC SLF, respectively, to the Company, effective as of January 1, 2020. As consideration for the purchase of the LLC equity interests, on or before March 2, 2020, the Company has agreed to pay the Transferors an amount, in cash, equal to the net asset value of their respective LLC equity interests as of December 31, 2019 (the “Net Asset Value”) along with interest on such Net Asset Value accrued from the date of the Purchase Agreement through, but excluding, the payment date at a rate equal to the short-term applicable federal rate. As a result of the Purchase Agreement, on January 1, 2020, SLF and GCIC SLF became wholly-owned subsidiaries of the Company. In addition, the capital commitments of the Transferors to the SLFs were terminated. As wholly-owned subsidiaries, the assets, liabilities, profit and losses of the SLFs will be consolidated into the Company’s financial statements and notes thereto for periods ending on or after January 1, 2020, and will also be included for purposes of determining the Company’s asset coverage ratio.”

 

 

There was another decline in overall portfolio yield from 8.4% to 8.0% due to new investments at lower yields of 7.4% as shown in the following table.

 

New investment commitments totaled $271 million and were primarily one-stop loans at lower yields similar to the previous quarter:

 

GBDC’s liquidity and capital resources are primarily debt securitizations (also known as collateralized loan obligations, or CLOs), SBA debentures, and revolving credit facilities.

On October 28, 2019, the company increased the borrowing capacity from $40 million to $100 million on its GC Adviser Revolver On October 11, 2019, the company entered into an amendment to the documents governing its credit facility with Morgan Stanley Bank, which increased the borrowing capacity from $300 million to $500 million.

 

 


 

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

  • GBDC target prices and buying points
  • GBDC risk profile, potential credit issues, and overall rankings
  • GBDC 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.

PNNT Update: Dividend Coverage & Risk Profile

The following is from the PNNT 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”).


pnnt yield.png

PNNT Update Summary:

  • PNNT reported just below its worst-case projections mostly due to lower-than-expected portfolio yield and “the timing of purchases and sales” only covering 87% of the dividend but should improve next quarter.
  • Portfolio growth was much higher-than-expected with almost $174 million of new investments during the quarter but likely weighted toward the end of the quarter.
  • Its debt-to-equity is around 1.40 after taking into account almost $63 million “payable for investments purchased” and around 1.16 excluding SBA debentures.
  • There was another decline in the overall portfolio yield but management is improving earnings through portfolio growth, rotation out of non-income producing assets and increased leverage available with its “green light” letter for its third SBIC license.
  • NAV per share increased by $0.11 or 1.3% (from $8.68 to $8.79) mostly due to marking up some of its equity positions including AKW Holdings and RAM Energy. Also, there was a meaningful markup of its first-lien position in AKW.
  • There are still no investments on non-accrual status and energy, oil & gas exposure decreased from 12.2% to 11.3% of the portfolio due to the increase in the overall size of the portfolio and marking down its investment in ETX Energy by almost $3.4 million partially offset by the markups in RAM Energy.
  • Also, PNNT finally exited its publicly traded shares U.S. Well Services (USWS) driving most of the $12 million of realized losses for the quarter.
  • One of my concerns is the recent markup of PNNT’s equity position in RAM Energy that continues to operate at a loss according to the SEC filings

PennantPark Investment (PNNT) reported just below its worst-case projections mostly due to lower-than-expected portfolio yield and “the timing of purchases and sales”. Portfolio growth was much higher-than-expected with almost $174 million of new investments during the quarter but likely weighted toward the end of the quarter. This means that the company did not receive the full benefit from interest income during the quarter. Also, it should be noted that there was almost $63 million “payable for investments purchased” which is not included in the borrowings and leverage amounts for quarter-end. The debt-to-equity ratio increased from 1.20 to 1.28 or almost 1.40 after taking into account the amounts payable.

Art Penn, Chairman and CEO: “We are pleased with the progress we are making in several areas. Our activity and selectivity have resulted in a more senior secured portfolio, which should result in even more steady and stable earnings. Additionally, our earnings stream should improve over time based on a gradual increase in our debt to equity ratio and the potential for a joint venture, a new SBIC, and the exit of successful equity investments.”

“Non-recurring net debt-related costs” and provision for taxes of $0.3 million are not included when calculating ‘Core NII’ resulting in net investment income (“NII”) per share of $0.156 which only covered 87% of the dividend but should improve next quarter.

 

 

There was another decline in its portfolio yield from 9.8% to 9.6% but management will be offsetting the impact from lower yields through the rotation out of non-income producing assets as well as increasing leverage. The company has significant borrowing capacity due to its SBA leverage at 10-year fixed rates (current average of 3.1%) that are excluded from typical BDC leverage ratios. As mentioned in the previous report, PNNT received “green light” letter for its third SBIC license for an additional $175 million of SBA financing.

 

Previously, PNNT was keeping a conservative leverage policy of GAAP debt-to-equity (includes SBA debentures) near 0.80 until it can rotate the portfolio into safer assets.” However, the company has already increased the amount of first-lien debt from 40% to 57% of the portfolio over the last two years and is slowly increasing its regulatory debt-to-equity (excludes SBA debentures) to 1.50:

“Over time we are targeting a regulatory debt-to-equity ratio of 1.1 to 1.5 times. We will not reach this target overnight, we will continue to carefully invest and it may take several quarters to reach the new target. A careful and prudent increase in leverage against primarily first lien assets should lead to higher earnings.”

As mentioned earlier, the company had higher-than-expected portfolio growth during the previous quarter driving its debt-to-equity to almost 1.40 after taking into account the amounts payable and around 1.16 excluding SBA debentures. On September 4, 2019, PNNT amended its SunTrust Credit Facility increasing the amount of commitments from $445 million to $475 million and amended the covenants “to enable us to utilize the flexibility and incremental leverage provided by the SBCAA.

 

“We are pleased that in early September we amended the credit facility enabling us to use the incremental flexibility provided by the new guidelines. Additionally, at the end of September and in early October we completed an $86 million offering of 5.5% unsecured notes. In early October, we also received the green light for our SBIC number three. We are extremely gratified that our long-term track record and excellent relationship with the SBA will result in attractively priced long-term financing for the company.”

 

On September 25, 2019, PNNT priced its public offering of $75 million of 5.50% unsecured notes due October 15, 2024, trading under the symbol “PNNTG” and are included in the BDC Google Sheets and currently considered a ‘Hold’.

 

 

As shown below, equity investments are now around 18% of the portfolio due to the recent markups discussed next. PNNT will likely continue to use higher leverage as it increases the amount of first-lien positions that account for 57% of the portfolio (up from 40% two years ago).

 

PNNT’s net asset value (“NAV”) per share increased by $0.11 or 1.3% (from $8.68 to $8.79) mostly due to marking up some of its equity positions including AKW Holdings and RAM Energy.

 

Also, there was a meaningful markup of its first-lien position in AKW as shown below:

 

There are still no investments on non-accrual status and energy, oil & gas exposure decreased from 12.2% to 11.3% of the portfolio due to the increase in the overall size of the portfolio and marking down its investment in ETX Energy by almost $3.4 million partially offset by the markups in RAM Energy. Also, PNNT finally exited its publicly traded shares U.S. Well Services (USWS) driving most of the $12 million of realized losses for the quarter.

One of my concerns is the recent markup of PNNT’s equity position in RAM Energy that continues to operate at a loss according to the SEC filings:

 

PT Networks was also marked up likely due to improved financials:

Again, there were no additional share repurchases due to only around $0.5 million of availability. Previously, PNNT purchased 1 million shares during the three months ended March 31, 2019, at a weighted average price of around $7.10 per share or a 22% discount to its previously reported NAV per share.

Previous call: “We purchased $7 million of a common stock this quarter as part of our stock repurchase program, which was authorized by our board. We’ve completed our program and have purchased $29.5 million of stock. The stock buyback program is accretive to both NAV and income per share. The accretive effect of our share buyback was $0.03 per share.”


 

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

  • PNNT target prices and buying points
  • PNNT risk profile, potential credit issues, and overall rankings
  • PNNT 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.