TSLX October 2019 Update: Continued Best-of-Breed BDC

The following is from the TSLX Deep Dive 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”).

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TSLX Dividend Coverage Update

TSLX has covered its regular dividend by an average of 134% over the last four quarters, growing undistributed taxable income and capital gains to over $1.25 per share.

“As we said before, if we believe there is sustainable increase in the earnings power of the business by operating in our target leverage range for an extended period of time, then we would look to resize our base dividend in context of the underlying earnings power of the business to ensure we’re optimizing cash distribution and satisfying risk related distribution requirements. We will continue to monitor undistributed taxable income and gains closely as part of our ongoing review of our distribution strategy.”

TSLX announced a special/supplemental dividend of $0.04 per share payable in September and annualized ROE for the second quarter 2019 was 11.6% and 17.7% on a net investment income and a net income basis, respectively.

“Our Board also declared a $0.04 per share supplemental dividend to shareholders of record as of August 30, payable September 30. This marks the 10th consecutive supplemental dividend since we introduced this framework in Q1 of 2017. To date, we have declared a total of $0.58 per share in supplemental dividend to our shareholder for an increase of 15% over our base dividend level, while also growing net asset value per share by 4% over this period.”

During Q3 2019, there will likely be around $0.13 per share of realized gains related to the exit of its preferred equity investment in Validity, Inc. that will be used to support upcoming supplemental dividends. This investment was discussed on the recent call:

“Note that the increase in the fair value mark on our convertible preferred equity investment in Validity contributed a positive $0.13 per share to this quarter’s net unrealized gain. We continue to hold our convertible preferred equity investment and updated the fair value mark to reflect the valuation from the recent equity investment. We expect to realize our investment at current fair value mark in the near term. If realized, any gains on our equity position at the time of exit would be unwound from the balance sheet and recognized into net income, but won’t flow through to net investment income.”

I am expecting a conservative amount of $0.21 per share of supplemental dividends paid in 2019 (takes into account the $0.12 per share paid in Q1 2019) which will most likely be higher, especially given the likelihood of additional realized gains. Management gave 2019 NII guidance of $1.77 to $1.85 which is likely conservative, similar to 2017/2018 guidance.

“Based on the strength of our investment pipeline, the earnings power of the portfolio and our expectations for fee-related activity for the remainder of the year, we believe we remain on pace to achieve our 2019 NII per share target of $1.77 to $1.85.”

For Q2 2019, TSLX beat its best-case projections due to much higher-than-expected portfolio growth during the quarter driving higher leverage and covering its dividend by 125%.

Repayments and exits during Q4 2018 drove its debt-to-equity to a four year low of 0.59 that has increased to 0.86 in Q2 2019 due to stronger portfolio growth.

During Q2 2019, the company increased its revolving credit facility by another $75 million that will be used to refinance its higher rate 2019 convertible notes. However, I am expecting additional unsecured notes to be issued at some point as discussed by management. It should be noted that 100% of TSLX’s borrowings are at variable rates (based on LIBOR) but the company is adequately positioned for rising interest rates due to ‘match funding’ with 100% of debt investments at variable rates. The company still has $735 million of undrawn capacity on its revolving credit facility for additional growth in 2019.

“Shifting to the right side of our balance sheet, during the quarter, we upsized our revolving credit facility by $75 million to $1.245 billion, with the addition of a new lender to our bank group. At quarter end, we had significant liquidity with $735 million of undrawn revolver capacity. Given the ample liquidity and low marginal cost of funding under our revolver, our base case is to repay the $115 million of convertible notes that mature in December with this facility. As a reminder, by swapping our fixed rate debt to floating rate, we provide net interest margin expansion for our business in falling rate environment once LIBOR dips below the floor on our portfolio.”

There was another decline in its portfolio yield (from 11.6% to 11.4%) due to new investments at lower yields.

“The weighted average total yield on our debt and income-producing securities at amortized cost was 11.4% compared to 11.6% at March 31. The decrease was primarily driven by the movement in LIBOR during the quarter on our floating rate debt portfolio.”

TSLX management continues to produce higher returns by investing in distressed companies through excellent underwriting standards that protect shareholders during worst-case scenarios including call protection, prepayment fees and amendment fees backed by first-lien collateral of the assets. Historically, higher returns have been partially driven by these strong financial covenants and call protections during periods of higher amounts of prepayments (discussed below) and worst-case scenarios (discussed at the end of this report). However, similar to previous reports, the base case projections do not include large amounts of fee and other income related to early repayments.

“Given our direct origination strategy, 99% of our portfolio by fair value was sourced through non-intermediated channels. At quarter-end, we maintained effective voting control on 83% of our debt investments and averaged 2.1 financial covenants per debt investment consistent with historical trends. And we continue to have meaningful call protection on our debt portfolio of 103.4 as a percentage of fair value as a way to generate additional economic should our portfolio get repaid in the near term.”

It also important to point out that the company is able to cover dividends with recurring sources as discussed by management on previous calls:

“As we’ve said in the past, in environments where we receive elevated levels of prepayments and a decrease in our financial leverage ratio, we would expect elevated levels of other fees. However, if repayment activity were to decline, then we would expect to leg back into our target leverage ratio, contributing more rapidly to our interest and dividend income line.”

As discussed in previous reports, Ferrellgas Partners remains its largest investment and is currently valued almost $6 million over cost or $0.09 per share and will likely drive another large special dividend.

Previous call: “Ferrellgas is a publicly-traded distributor of propane with an enterprise value of $2.3 billion. The company has a defensive core business with high return on invested capital and a strong management team but faced refinancing difficulties given the challenging regulatory environment for banks. Due to our ability to provide a fully underwritten financing solution through co-investments from affiliated funds we were able to structure a first lien last out position at a low attach point of 0.2X at a low net leverage of 1.7X with highly attractive adjusted returns.”

In October 2018, TSLX’s shareholders overwhelmingly approved the proposal to allow the company to increase leverage by approving the application to the company of a minimum asset coverage ratio of 150% effective October 9, 2018. TSL Advisers, LLC intends to waive a portion of the management fee in excess of an annual rate of 1.0% on assets financed with higher leverage and revised its target debt-to-equity range from 0.75-0.85 to 0.90-1.25.

“If we get to the 1.25 times debt-to-equity ratio, which I am not seeing we are going to get there anytime soon. Earnings per share as it’s kind of at $2.25 to $2.35 range. It feels like we are on our way. I don’t think, we’ll be at 1.25 by the end of the year. And that the sense is that, if there is churn and financial leverage, we’ll have an increase in fee income that supports our ROE.”

The table below illustrates the impact on ROEs at differing levels of leverage (debt-to-equity) with higher and lower assets yields:

“As we said in the past, in periods where we see a decrease in our financial leverage, we would expect elevated levels of other fees from repayment activity to support our ROEs. We believe our revised financial policy will allow us to drive incremental ROEs for our shareholders as we reached the higher end of our leverage target.”

“We’ve added Slide 16 to our presentation material this quarter to isolate the impact of balance sheet leverage on the earnings power of our business. The table at the top of the page shows our unit economics based on annualized results for the first quarter. Below that, the sensitivity table illustrates that for each asset level yield, holding constant operating expense ratio and increasing financial leverage corresponds to an increase in ROE. We know that this concept is relatively intuitive. So the sensitivity table is really meant to help people calibrate the magnitude of leverage on ROE for our business. Looking ahead to Q2, based on the increase in our leverage from an average of 0.66 times in Q1 to our estimate of 0.83 times today, we would expect to experience approximately 70 basis points of annual ROE expansion even if we have seen the same low level of activity-related fees and asset yields as Q1.”

The following are the investment-grade ratings from Fitch, S&P and Kroll under the new target leverage range of 0.90x-1.25x debt-to-equity.

TSLX Risk Profile Update

TSLX continues to selectively growing its portfolio using prudent amounts of leverage, onboarding higher-than-average credit quality first-lien investments at higher-than-market yields and providing better-than-average dividend coverage and returns to shareholders. As discussed earlier, TSLX has excellent underwriting standards that protect shareholders during worst-case scenarios including voting control, call protection prepayment fees and amendment fees backed by first-lien collateral of the assets.

“Given our direct origination strategy, 99% of our portfolio by fair value was sourced through non-intermediated channels. At quarter end, we maintained effective voting control on 83% of our debt investments and averaged 2.1 financial covenants per debt investment consistent with historical trends. And we continue to have meaningful call protection on our debt portfolio of 103.4 as a percentage of fair value as a way to generate additional economic should our portfolio get repaid in the near term.”

“Our portfolio’s diversification profile benefit from this quarter’s funding activity, quarter-over-quarter, the number of portfolio companies increased from 48 to 56, our average investment size decreased slightly from $38 million to $37 million and our top 10 borrower concentration decreased from 37.8% to 34% of the portfolio at fair value. We continue to be late cycle minded with our exposure to non-energy cyclical industries at an all-time low of 3% of the portfolio at fair value. As a reminder, this figure excludes our retail asset based loan investments, which are supported by liquid collateral values and are not underwritten based on enterprise value, which tends to fluctuate.”

As of June 30, 2019, 100% of the portfolio was meeting all payment and covenant requirements. First-lien debt remains around 97% 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%.

During Q2 2019, TSLX’s net asset value (“NAV”) per share increased by $0.34 or 2.1% (from $16.34 to $16.68) due to overearning the dividends by $0.07 per share after excluding excise tax, unrealized gains on its interest rate swaps of $0.09 per share and $0.19 per share of changes in portfolio valuations including Validity, Inc. discussed earlier and Ferrellgas Partners, L.P. (FGP) together accounting for around $0.17 per share of unrealized gains:

There were some additional markdowns in the three ‘watch list’ investments Mississippi Resources, Vertellus Specialties, and IRGSE Holding Corp. but mostly related to the equity positions as shown in the following table. However, its first-lien position in Mississippi Resources was marked down to 92% of cost and needs to be watched:

“The difference between this quarter’s net investment income and net income was primarily driven by net unrealized gains specific to individual portfolio companies and net unrealized mark to market gains related to our interest rate swaps given the change in the shape of the forward LIBOR curve.”

It is important for investors to understand that one of TSLX’s strategies for higher IRRs is investing in distressed retail asset-based lending (“ABL”) as “traditional brick and mortar retail gives way to the rise of e-commerce”. Historically, borrowers have paid amendment fees to avoid even higher prepayment fees if they decided to refinance. Also, the amendments included an additional “borrowing base” providing increased downside protection on the investment. This strategy continues to drive higher fee income including prepayment and amendments fees. See the end of this report for previous examples.

“Retail ABL continues to be one of our various themes given the ongoing secular trends in our platform’s differentiated capabilities and relationships in this area. As the direct lending asset classes become increasingly competitive, we have continually developed and evolved our investment themes in order to generate a robust pipeline of strong risk-adjusted return opportunities.”

“This quarter’s portfolio activity highlights the distinct competitive advantage that our platform offers from a sourcing and scale perspective. Let me take a moment to provide a few examples. We were active on our retail ABL team during the quarter with new investments in Barneys, Maurices and Sable. Together, these three names comprise $200 million of originations, $85 million of which were allocated to affiliated funds or third parties. As we’ve said on our previous earnings calls, we continue to like being a solution provider in this space, given the ongoing secular trends from brick and mortar retailers and our platforms’ human capital expertise. Inclusive of this quarter’s repayment of the Payless DIP loan, we’ve generated an average gross unlevered IRR of 22% across our fully realized retail ABL investments.”

From previous call: “What really matters is, how we think the inventory will liquidate as it compares to what – where we are lending against it. Retail goes as well as the consumer. That is not the – that’s not what’s happening here, right. Consumer is in good health. There is a business model issue and a structural issue with retail, but more so given the fixed cost base and given the discerning mediation of both kind of fast brands and plus Amazon and omni-channel business models. And so, it’s really the liquidation value of inventory and the liquidation value of the inventory has held up great. So, we continue to hope for a decent amount of structural change. So we can provide capital and provide – be a solution provider into that space. And quite frankly, the liquidation values continue to hold up very, very, very well.

Similar to investing in distressed retail assets, the company is focused on increasing returns through investing opportunistically in oil/energy but only first-lien “with attractive downside protective features in the form of significant hedged collateral value at current price levels”. Management has mentioned that energy exposure would not exceed 10% of the portfolio and only first-lien using appropriate hedges. TSLX made “opportunistic” investments in Verdad Resources in Q2 2019, MD America Energy during Q4 2018, Ferrellgas Partners during Q2 2018 and Northern Oil & Gas in Q4 2017 that was previously repaid.

“Another transaction this quarter that highlights our platform’s capabilities is the $225 million term loan facility that we sold at an agent for the Verdad Resources, an upstream E&P company with primary operations in the DJ Basin. This opportunity was sourced with our energy team and coincided with our opportunistic approach of providing first lien reserve based loans to upstream companies situated low on their cost curves at current price levels. Our platform sector expertise and ability to act in size allows us to structure a customized one-stop solution for the company and its sponsor at pricing in terms that provide a strong risk return profile on our investment. Inclusive of the $42.2 million par value loan that we funded for Verdad, our portfolio’s total energy exposure of the quarter remained low at 3.8% of portfolio at fair value.”


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

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.

Capital Southwest (CSWC) Upcoming Deemed/Special Dividends

The following is from the CSWC Deep Dive 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”).

This update discusses Capital Southwest (CSWC) and its Baby Bond that trades publicly on the NASDAQ under the symbol “CSWCL” that are included in the BDC Google Sheets. CSWC is an internally managed BDC with a $533 million portfolio with mostly first-lien debt positions and equity investments providing realized gains especially in its lower middle market investments similar to Main Street Capital (MAIN). CSWC is among a handful of BDCs that I have purchased in 2019 as I am waiting for a general market pullback.

CSWC has 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 9.2% (MAIN is currently 6.7%) which takes into account the recently announced $0.40 quarterly regular dividend and quarterly supplemental dividends of $0.10.

Media Recovery, Inc. & Upcoming Deemed/Special Dividends:

There is a good chance that there will be a ‘deemed’ and/or special dividend related selling its final legacy equity position in Media Recovery, Inc. (“MRI”) driving around $48 million or $2.75 per share of realized gains that is expected to close later this year:

“Our last remaining legacy equity investment, Media Recovery, which does business under the banner SpotSee represents 10% of the portfolio and other equity co-investments as of the end of the quarter represented 6%. As we have mentioned on prior calls, Media Recovery is currently undergoing a sale process. The process is going well, and our expectation continues to be that this company will sell during the 2019 calendar year.”

“Media Recovery, Inc., dba SpotSee Holdings, through its subsidiary, ShockWatch, provides solutions that currently enable over 3,000 customers and some 200 partners in 62 countries to detect mishandling that causes product damage and spoilage during transport and storage. The ShockWatch product portfolio includes impact, tilt, temperature, vibration, and humidity detection systems and is widely used in the energy, transportation, aerospace, defense, food, pharmaceutical, medical device, consumer goods and manufacturing sectors. At June 30, 2019, the value of Media Recovery, Inc. represented 9.6% of our total assets.”

Management was asked about the use of proceeds related to the sale of MRI and mentioned that they will first “replenish the UTI bucket” which means that the quarterly supplemental dividends of $0.10 will be supported for the long-term. However, there will definitely be excess gains that will likely be partially retained as a ‘deemed distribution’ and partially paid as a special dividend above and beyond the quarterly supplemental dividends:

Q. “Do you have any updates on the decision once the sales process [of MRI] is complete? Or is that something you guys are still thinking about in terms of retaining versus paying out a special dividend?”

A. “The board is going to make that determination, and we’ll make that determination once it sells. So the answer is, no. We will replenish the UTI bucket, first and foremost, the gain will, obviously, most likely very likely be much in excess of that. So the remainder of the gain, we will we have options. We can either retain it and do a deemed distribution to the shareholders, pay a 20% tax or we can distribute it in a special dividend or a third option do a combination of both. And so the Board, like I said, will ultimately decide that once the sale is complete, and we’ll announce it.”

It should be noted that the recent increase in portfolio yield and dividend income during the recent quarter was partially due to MRI:

“The overall yield went up based on the dividend, one from MRI produced a larger dividend this quarter based on it having additional free cash flows.”

There is a good chance that the stock could back related to the announcement of 100% deemed dividend similar to GAIN as discussed in the previous GAIN Deep Dive report:

“On May 13, 2019, GAIN declared a deemed distribution of long-term capital gains of $50.0 million or $1.52 per share. Shareholders, including myself, were likely disappointed as the “deemed distribution” is not paid in cash to shareholders and is a way for the company to retain the capital with the exception of the taxes paid. It should be noted that if this dividend was paid in cash it would be classified as long-term capital gains to shareholders (20% tax rate).”

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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

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.

Solar Senior Capital (SUNS) Is A Sell At These Prices

The following is from the SUNS Deep Dive 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”).

On September 27, 2019, I sold my position in SUNS at an average price of $17.67 for the reasons mentioned in the updated SUNS Deep Dive report including likely NAV per share decline of 1.7% related to American Teleconferencing Services, increased reliance on fee waivers, current pricing well above its short-term target price and RSI of over 70 as shown in the BDC Google Sheets.



SUNS Risk Profile Update

During Q2 2019, SUNS’s net asset value (“NAV”) per share decreased slightly by $0.06 to $16.34 per share due to net unrealized losses including additional markdowns of its investment in American Teleconferencing Services and mostly writing off its only non-accrual investment Trident USA Health Services. SUNS had net realized gains of $0.1 million primarily related to the exit from its investment in Mavenir Systems, Inc.

Trident USA Health Services (cost of $7.0 million, fair value of $0.1 million) was previously added to non-accrual status and mostly written off during the recent quarter. Trident now accounts for 0.0% of portfolio fair value and is the only portfolio company with an “Internal Investment Rating 4” implying that the investment is “performing well below expectations and is no anticipated to be repaid in full.”

From previous call: “Trident is a health care provider in the mobile diagnostics business. To your point, it is a small position for us but we treat every position as if it’s our only position. And so we have been working this one. We’ve been an investor for a few years early on. We actually were a second lien lender a number of years ago. And in the health care sector, they’re not facing anything that is systematic to either the economy or the health care sector, they just have had some headwinds in terms of what’s going on at home health and some of the competitive dynamics there as well as some billing and collection issues, which we have seen from time to time in some of these health care rollouts. So it is very specific to Trident. And is not in any way an indication of what’s going on either in our portfolio, the economy or the health care sector broadly.”

The following is from the recent earnings press release and my primary concerns are the “Internal Investment Rating 3” which are investments “performing below expectations, may be out of compliance with debt covenants”:

“Our internal risk assessment maintained an approximately two rating when measured at fair market value based on our one to four risk rating scale with one representing the least amount of risk. And at June 30, our watch list represented approximately 4% of our portfolio.”

The following table shows my watch list investments which are likely the same “Internal Investment Rating 3” investments included in the previous table.

There is a good chance that American Teleconferencing Services (“ATS”) is still overvalued as other BDCs have the same investment valued at an average of 62% of cost compared to SUNS at 96% of cost. I am expecting additional unrealized losses in Q3 2019 related to this investment which will likely result in a 1.7% decline in NAV per share unless there are positive developments with this investment. However, it should also be pointed out that CSWCMAIN and PFLT have conservative valuation practices as mentioned in their respective reports.

As discussed in the recently updated CWSC Deep Dive report, ATS operates as a subsidiary of Premiere Global Services (“PGi”), offering conference call and group communication services. On January 28, 2019, Moody’s downgraded PGi’s debt to Caa2:

Moody’s: “The downgrade of the CFR reflects Moody’s view that PGi’s EBITDA will deteriorate significantly over the next 12 months. Given PGi’s challenges, Moody’s believes that the company’s ability to meet covenants beyond 2Q 2019 is highly uncertain and the capital structure is unsustainable. The risk of default and debt impairment is high given the continuing erosion in revenues and EBITDA. PGi has proposed amendments to its existing credit agreements to waive the total leverage covenant for 2Q 2019 and a potential going concern qualification requirement in its 2018 financial statements. The company also expects to complete the sale of certain non-core assets in the near term, which management believes, along with the equity support, will provide the company adequate liquidity through 2019 to execute on its plans to commercially offer a new UCaaS offering. The continuing support from financial sponsors’ is credit positive. However, Moody’s believes that the proposed amendment and equity infusion will only improve PGi’s liquidity on a short-term basis.”

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

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

ORCC Distributions & Risk Profile Update: September 2019

The following is a quick ORCC 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”).

Owl Rock Capital Corporation (ORCC) is now the second-largest publicly traded BDC (much larger than MAIN, PSEC, GBDC, NMFC, and AINV) with investments in 90 portfolio companies valued at $7.2 billion that are mostly first-lien secured debt positions. On July 22, 2019, ORCC closed its initial public offering (“IPO”), issuing 10 million shares of its common stock at a public offering price of $15.30 per share. Net of underwriting fees and offering costs, the company received total cash proceeds of $141.3 million. ORCC is one of the few BDCs rated by all of the major credit agencies. The common stock began trading on the NYSE under the symbol “ORCC” on July 18, 2019.

Upcoming ORCC Distributions

On May 28, 2019, the Board declared a distribution of $0.31 per share, for shareholders of record on September 30, 2019, payable on or before November 15, 2019. The Board also declared the following special distributions and newly offered shares WILL be entitled to receive these distributions (as well as the $0.31):

It should be noted that the special dividends are likely temporary and only due to the five quarters of waived management and incentive fees discussed later.

Assuming that the regular quarterly dividend remains at $0.31 per share would imply that new investors will receive a total of:

  • $0.33 per share for Q3 2019
  • $0.35 per share for Q4 2019
  • $0.39 per share quarterly in 2020

ORCC Risk Profile Update

As of June 30, 2019, based on fair value, the portfolio consisted of 81% first lien senior secured debt investments, 17% second lien senior secured debt investments, 1% investment funds and vehicles, and 1% in unsecured debt investments and equity investments.

There were no investments on non-accrual status with only minor markdowns in select investments including Feradyne Outdoors, Give and Go Prepared Foods and Accela, Inc. that need to be watched. However, these investments account for less than 3% of the total portfolio:



Credit quality remains strong with no previous non-accruals and only 5.7% with “Investments Rating 3” which is a borrower “performing below expectations and indicates that the loan’s risk has increased somewhat since origination or acquisition”:


The portfolio has oil, energy and gas exposure of around 4.6%.



Stock Repurchase Plan, Use of Leverage & Capital Structure

On July 7, 2019, the Board approved its 10b5-1 Repurchase Plan, to acquire up to $150 million in stock at prices below NAV per share starting August 19, 2019, ending on February 19, 2021 or “as the approved $150 million repurchase amount has been fully utilized.”

“The Company agent will repurchase shares of common stock on the Company’s behalf when the market price per share is below the most recently reported net asset value per share. This corresponds to a market price of $15.27 based on June 30, 2019 NAV per share of $15.28.”

“We intend to put the Company 10b5-1 Plan in place because we believe that, in the current market conditions, if our common stock is trading below our then-current net asset value per share, it is in the best interest of our shareholders for us to reinvest in our portfolio. The Company 10b5-1 Plan is intended to allow us to repurchase our common stock at times when we otherwise might be prevented from doing so under insider trading laws. Under the Company 10b5-1 Plan, the agent will increase the volume of purchases made as the price of our common stock declines, subject to volume restrictions.”

As of June 30, 2019, ORCC had a debt-to-equity ratio of around 0.24 with plenty of growth capital including the recent IPO proceeds of over $141 million, almost $230 million of unrestricted cash and $1.8 billion available under its credit facilities. Neither the Board nor the shareholders are being asked to approve a reduced asset coverage ratio which means a maximum debt-to-equity ratio of 1.00. Also, before incurring any such additional leverage, the company would have to renegotiate or receive a waiver from the contractual leverage limitations under the existing credit facilities and notes.


ORCC Management Fees

On February 27, 2019, the Adviser agreed at all times prior to the fifteen-month anniversary of an Exchange Listing (which includes the IPO), to waive any portion of the Management Fee that is in excess of 0.75% of the Company’s gross assets, excluding cash and cash equivalents but including assets purchased with borrowed amounts at the end of the two most recently completed calendar quarters, calculated in accordance with the Investment Advisory Agreement.

On February 27, 2019, the Adviser agreed at all times prior to the fifteen-month anniversary of an Exchange Listing (which includes the IPO), to waive the Incentive Fee (including, for the avoidance of doubt, the Capital Gains Incentive Fee).

The management fee is 1.5% and excludes cash and after the offering, the advisor is entitled to pre-incentive fees NII of 17.5% with a hurdle rate of 6% annually as well as 17.5% of cumulative realized capital gains:

“The second component of the incentive fee, the capital gains incentive fee, payable at the end of each calendar year in arrears, equals 17.5% of cumulative realized capital gains from the date on which the Exchange Listing becomes effective (the “Listing Date”) to the end of each calendar year, less cumulative realized capital losses and unrealized capital depreciation from the Listing Date to the end of each calendar year, less the aggregate amount of any previously paid capital gains incentive fee for prior periods.”

ORCC Pre-IPO Share Lock-Ups

There is the possibility for technical pressure on the stock price as pre-IPO shares start to become available in 2020. However, this was discussed on the recent earnings call and many of these shares are held by longer-term institutional investors. Management mentioned that they communicate with their larger shareholders frequently and expect that they will continue to support the stock.

Upon completion of this offering, we will have 383,193,244 shares of common stock outstanding (or 384,618,244 shares of common stock if the underwriters’ exercise their option to purchase additional shares of our common stock). The shares of common stock sold in the offering will be freely tradable without restriction or limitation under the Securities Act.

Any shares purchased in this offering or currently owned by our affiliates, as defined in the Securities Act, will be subject to the public information, manner of sale and volume limitations of Rule 144 under the Securities Act. The remaining shares of our common stock that will be outstanding upon the completion of this offering will be “restricted securities” under the meaning of Rule 144 promulgated under the Securities Act and may only be sold if such sale is registered under the Securities Act or exempt from registration, including the exemption under Rule 144. See “Shares Eligible for Future Sale.”

Following our IPO, without the prior written consent of our Board:

for 180 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber any shares of common stock held by such shareholder prior to the date of the IPO;

for 270 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber two-thirds of the shares of common stock held by such shareholder prior to the date of the IPO; and

for 365 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber one-third of the shares of common stock held by such shareholder prior to the IPO.

This means that, as a result of these transfer restrictions, without the consent of our Board, a shareholder who owned 99 shares of common stock on the date of the IPO could not sell any of such shares for 180 days following the IPO; 181 days following the IPO, such shareholder could only sell up to 33 of such shares; 271 days following the IPO, such shareholder could only sell up to 66 of such shares and 366 days following the IPO, such shareholder could sell all of such shares.

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

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

Sold AFC Baby Bond Today For The Following Reasons

The following is an 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”).

Recent Baby Bond Trade

Today, I sold my AFC Baby Bond Notes at $26.92 for the reasons discussed in this update and will use as an example for upcoming discussions.

BDC Baby Bond Sheets

The following information is included in the “Bond Info” tab from BDC Google Sheets:

  • BDC Baby Bonds trade “dirty” which means that there is a certain amount of accrued interest in the market price.
  • You need to own the Baby Bond one trading day before the ex-dividend date to be eligible for the full quarter of interest.
  • It is important to take into account which BDCs are “callable” and the potential for capital losses during the worst-case scenario.
  • The Call Risk Capital Loss refers to the worst-case scenario of the bond being called tomorrow and takes into account 30 days of additional interest accrued before being redeemed.
  • Breakeven Days refers to the number of days of interest needed to breakeven given the current market price.

The following sheet is from the “Baby Bond” sheet

As shown in the table below:

  • AFC goes ex-dividend soon and has $0.43 of accrued interest priced in.
  • AFC was callable on April 15, 2012.
  • AFC currently has Call Risk Capital Loss of $1.35
  • It would take 312 days of not being called before you would breakeven

Call Risk Capital Loss and Breakeven Days Calculations:

My Reasons For Selling AFC

I had some tax reasons for selling but it was mostly due to being overpriced with limited upside plus I wanted to lock in the following gains and will reinvest in something else.

Over the coming weeks, I will be spending more time discussing Baby Bonds that currently yield around 6% and much less volatile than stocks even during extreme scenarios experienced in December 2018 where I made multiple purchases of BDC stocks, bonds, and preferred shares. My personal portfolio includes various other bonds some of which are tax-related and likely not applicable to most but included in “Other” along BDC Baby Bonds shown below. Together these investments account for around 37% of my portfolio and this report will discuss all of my recent purchase and returns.

Subscribers of Premium Reports will receive real-time announcements of all upcoming purchases of BDC Baby Bonds and preferred shares but please be aware that these have lower returns and are not expected to outperform the S&P 500 or upcoming BDC stock purchases. However, these investments will easily outperform during volatility and/or downturn while continuing to provide a relatively safe and stable yield as they are senior to the common stocks. Also, I am constantly monitoring the balance sheets of BDCs which provide insight for bond risk measures including portfolio credit quality, changes to leverage, interest coverage ratios and redemption risk such as GAINM as discussed in the GAIN Deep Dive report.

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.

ARCC Risk Profile Update: September 2019

The following is a quick ARCC 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”).

ARCC Risk Profile Update

I consider ARCC to have one of the safer BDC risk-profiles with consistently lower non-accruals, historical net realized gains and net asset value (“NAV”) per share growth. During Q2 2019, NAV per share increased by 0.3% or $0.06 per share from $17.21 to $17.27 due to overearning the dividend(S) by $0.07 per share partially offset by net unrealized depreciation. Some of the largest markdowns were investments on my watch list including Indra Holdings Corp.Ivy Hill Asset Management (was previously marked up), Alcami CorporationCentric Brands, Urgent Cares of America Holdings, SiroMed Physician Services, and ADF Capital.

My primary concern is that only 3 of the 20 companies on my watch list that are not on non-accrual showed improvement (Panda Liberty, AEP Holdings, and Instituto de Banca y Comercio) during Q2 2019. ARCC’s second-lien position in Shock Doctor was refinanced and is now considered first-lien but the equity portion is still valued at 22% of cost as shown in the following table and needs to be watched.







Non-accruals remain low and decreased slightly due to the previously discussed markdowns of Indra Holdings Corp. and ADF Capital as well as Javlin Three. However, its $25 million second-lien loans to WASH Multifamily and Coinamatic were added to non-accrual status during Q2 2019 and are still marked around 98% of cost as shown below. If non-accruals were completely written off, it would impact NAV per share by around $0.12 or 0.7%:

My primary concern is additional unrealized losses from companies that have been previously marked down (including equity positions) and shown in the previous and following tables.

The following table summarizes the information from the previous tables and I will update each quarter as well as tracking the details for each company and provide updates to subscribers of Premium BDC Reports when available.

The information in the following table was provided by the company showing the grade of the investments in the portfolio at fair value but does not include detail by portfolio company:

It is important to note that ARCC has investments in around 345 companies so there will always be a certain amount of credit issues but historically non-accruals have remained low:

During the 2008/9 financial crisis, ARCC had non-accruals of around 2.5% and much lower than the average leveraged lender:

Its portfolio asset mix continues to shift from first-lien positions toward second-lien and its SDLP now with 41% first-lien (was 47% as of Q4 2018), 33% second-lien (was 29% as of Q4 2018), 7% of subordinated certificates of the SDLP (was 5% as of Q4 2018), 5% of senior subordinated loans, and 14% in other and preferred equity securities that should decline over the coming quarters due to portfolio rotation out of non-core assets.

However, It should be pointed out that ARCC’s second-lien investments are likely safer with better security than other BDCs as discussed by management:

Q. “Can you give us some color on your appetite for second lien? Obviously, it’s been — it increased over the last year a tiny bit as a percentage of portfolio not much. But obviously also your weighted-average EBITDA has been going up.”

A. “Yes, generally, we’ve said this to you in the past most of our large second lien deals are in companies that have been with the portfolio for a longer period of time. We tend to be in larger businesses that we think have better downside protection and they tend to be in industries that we think of as very defensive and not cyclical.”

“Credit quality continues to be very stable. Our portfolio continues to generate weighted average EBITDA growth of 4% over the past 12 months. We do not add any new portfolio of companies to non-accrual in the second quarter and our non-accruals remain stable at 2.3% of the total portfolio like amortized cost and 0.2% at fair value.”

“In these types of aggressive markets, we become even more selective. Our selectivity ratio this quarter was 2% which is about half of our historical average of approximately 4% and we refer to that in terms of the percentage of deals that we see — that we close rather versus those that we see. It has been trending lower over time and that’s reflective of our disciplined approach. We’re trying to stick to the playbook that we’ve had for a long time of having conservative structure with real covenants and loan documents that actually allow us to enforce in a position, where we need to. And I think it’s allowed us to achieve better recoveries and fewer losses than competitors.”

“We think that industry selection is key. And we think not being frankly in unsecured positions at this stage in the cycle are the two keys and to stay away from cyclical industries and frankly stay away from sub-debt for now. And we’ve been spending years as it continues to be late in the cycle trying to exit the companies from our portfolio that were not performing to plan. So we’re happy with where we are. We don’t see anything here in the near term that’s kind of change what today is an attractive place to invest where there’s a lot of income relative to the risk-free rate and good credit quality.”

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

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

BDC Baby Bonds/Preferreds Update: Upcoming Coverage And Balancing Your Portfolio

The following is an update that was previously provided to subscribers of Premium Reports providing 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”).

Over the coming weeks, I will be spending more time discussing Baby Bonds that currently yield around 6% and much less volatile than stocks even during extreme scenarios experienced in December 2018 where I made multiple purchases of BDC stocks, bonds, and preferred shares. My personal portfolio includes various other bonds some of which are tax-related and likely not applicable to most but included in “Other” along BDC Baby Bonds shown below. Together these investments account for around 37% of my portfolio and this report will discuss all of my recent purchase and returns.

Subscribers of Premium Reports will receive real-time announcements of all upcoming purchases of BDC Baby Bonds and preferred shares but please be aware that these have lower returns and are not expected to outperform the S&P 500 or upcoming BDC stock purchases. However, these investments will easily outperform during volatility and/or downturn while continuing to provide a relatively safe and stable yield as they are senior to the common stocks. Also, I am constantly monitoring the balance sheets of BDCs which provide insight for bond risk measures including portfolio credit quality, changes to leverage, interest coverage ratios and redemption risk such as GAINM as discussed in the GAIN Deep Dive report.

Bond pricing is closely correlated to expected investment yields including other non-investment grade debt and ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that previously increased to 8.45% on December 26, 2018.

As discussed in previous updates, these yields have been declining in 2019 and are currently around 5.89%. This is meaningful for many reasons but mostly due to indicating higher (or lower) yields expected by investors for non-investment grade debt.

 

Baby Bonds Basics:

  • BDC Baby Bonds trade “dirty” which means that there is a certain amount of accrued interest in the market price. I have included the amount of accrued interest that updates daily.
  • The ‘effective yield’ is based on the current price less accrued interest.
  • Investors should use limit orders when purchasing exchange-traded debt such as Baby Bonds.
  • You need to own the Baby Bond one trading day before the ex-dividend date to be eligible for the full quarter of interest.
  • It is important to take into account which BDCs are “callable” and the potential for capital losses during the worst-case scenario.
  • I do not actively cover some of the BDCs with baby bonds, especially if they are thinly traded.

I will discuss various details related to investing in Baby Bonds and preferred shares over the coming weeks including redemption risks and the timing of purchases as well as my upcoming purchases and limit orders. One of the metrics used to analyze the safety of a debt position is “Interest Expense Coverage” ratio which measures the ability to pay current borrowing expenses. From Investopdia:

“The interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. The ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by the company’s interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

“The ratio measures how many times over a company could pay its outstanding debts using its earnings. This can be thought of as a margin of safety for the company’s creditors should the company run into financial difficulty down the road. The ability to service its debt obligations is a key factor in determining a company’s solvency and is an important statistic for shareholders and prospective investors.”

I have included the “Interest Expense Coverage” ratio in the Leverage Analysis and financial projections for GLAD and GAIN using net investment income before interest expense divided by interest and debt expenses for each quarter. GLAD has a historical ratio between 3.2 and 3.8 and projected to be between 3.1 and 3.4 in the coming quarters. It should be noted that this is higher than GAIN historically between 2.0 and 3.3 and projected to be between 2.4 and 3.0 in the coming quarters.

Over the coming weeks, I will include this ratio for all BDCs that have Baby Bonds so that subscriber can compare.

BDC Baby Bonds and Preferred Stocks are currently averaging 6.07% yield as shown in the following table including some that are considered investment grade. Please read “Baby Bonds For BDCs: Price Stability” for previous discussions and information about these investments.

The following is from the BDC Google Sheets and is what I use to make purchases when increasing allocations:

 

How much of your portfolio should be in stocks and bonds?

Your portfolio allocations depend on a few factors including your age. Historically, investment advisors used the “100 minus your age” axiom to estimate the stock portion of your portfolio.

  • For example, if you’re 50, 50% of your portfolio should be in stocks.

That has been updated to 110/120 due to the change in life expectancy and lower interest rates for risk-free and safer investments. Today, 10-year treasury-bill yields just over 2% annually compared to 10% in the early 1980s. Please see Bloomberg article “U.S. Is Heading to a Future of Zero Interest Rates Forever“.

The previous table uses 120 as I believe interest rates will remain low given the changes to various policies from central banks and investors will continue to have equity investments for an adequate yield from their portfolios.

The following chart uses a different approach that seems more aggressive and is discussed in “Is your retirement portfolio too heavily invested in equities?” from MarketWatch.

General Bond Funds

There are plenty of choices when it comes to bonds including government bonds such as treasuries, municipal bonds, or corporate bonds. Within each of those categories, there is a wide variety of maturities to select from, ranging from a matter of days to 30 years or more. And there is a full range of credit ratings, depending on the strength of the bond’s issuer.

To make it easy, many investors use a bond-based mutual fund or ETF that fits their needs. The primary reasons for allocating a portion of your portfolio to bonds are to offset the stock volatility and a reliable income stream as compared to capital gains or beating the market.

There are plenty of higher yield bond funds that typically invest in non-investment grade assets such as HYG and JNK that were discussed in a previous article “Search For Yield: Bond Funds Vs. BDCs Paying 10%+“. Currently, HYG and JNK are yielding 5.2% and 5.6%, respectively.

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.

PFLT Earnings & Risk Profile Update: Resolving Credit Issues

 

The following is a quick PFLT Update that was previously provided to subscribers of Premium 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”).

Recent PFLT Insider Purchases

As shown below, Art Penn (Chairman and CEO) was actively purchasing shares last month at prices between $11.55 and $11.73:

 

PFLT Risk Profile Update

I consider the recent portfolio credit issues to be idiosyncratic (as compared to systematic) implying that they are not indicative of general underwriting issues within the portfolio. These investments have been discussed in many of the previous reports as management was clearly marking their values. PFLT has not experienced non-accruals over the last two years and “it’s unfortunate that they all happened in this one quarter”:

From previous call: “Look, we haven’t had a non-accrual and over two years, it looks lumpy here and we’re certainly disappointed, but non-accruals are part of this business. It’s unfortunate that they all happened in this one quarter. But we normally, they’d be smoothed out overtime and we had, as you said, we already had already marked them down by and large. So, this should not have been a big surprise to people to know for them were exhibiting weakness in the past.”

“Our credit quality since inception eight years ago has been excellent. Out of 357 companies in which we have invested since inception, we’ve experienced only nine non-accruals. Since inception, PFLT has made investments totaling about $3 billion at an average yield of 8.1%. This compares with an annualized loss ratio, including both realized and unrealized losses of only about 8 basis points annually.”

PFLT remains a component in the suggested ‘Risk Averse’ portfolio due to its portfolio of mostly higher quality, first-lien senior secured investments at floating rates.

“The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense continue to be healthy 2.8 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.8 times, another indication of prudent risk. In our core market of companies with 15 million to 50 million of EBITDA, our capital is generally important to the borrowers and sponsors. We are still seeing attractive risk reward, and we are receiving covenants, which help protect our capital.”

During calendar Q2 2019, its net asset value (“NAV”) per share declined by $0.17 or 1.3% (from $13.24 to $13.07) due to the previously discussed investments shown in the following table. Country Fresh Holdings is still not considered a ‘non-accrual’ but was restructured during the quarter resulting in realized losses of $7.2 million. PFLT now has $2.3 million of first-lien, $5.2 million of second-lien and $10.5 million of non-income producing common equity fair valued at $8.6 million. The other meaningful realized loss came from exiting its non-accrual investment in New Trident HoldCorp resulting in another $7.0 million of realized loss for the quarter.

“New Trident was certainly a big driver. The other ones were [Hollander], which remains a problem, that was one of the non-accruals; and Country Fresh, which got restructured into our quarter. Those were the negative drivers. We do have some very nice co-invest like By Light, DecoPac, Cano Health and Walker Edison, which have been performing well, which, you know, the theme here of course is we are going to make mistakes from time to time; we are going to have non-accruals; and these equity co-invest investments are meant to have some upside that could, you know, in part or in full, you know, fill some of those gaps. So, New Trident certainly was a negative outcome for sure.”

 

Hollander Sleep Products, Quick Weight Loss Centers, and LifeCare Holdings remain on non-accrual status and were marked down again during the recent quarter but still account for $10.1 million in fair value or 0.9% of the portfolio. If the current non-accruals were completely written off, the impact to NAV per share would be around $0.26 or 2.0% (previously $0.38 or 2.8%). However, management mentioned that there were only two companies on non-accrual as of the earnings call on August 8, 2019:

“Credit quality has improved since last quarter. Today, we only have two non-accruals on the books, representing only 1.4% of the portfolio at cost, and 0.5% end market. As of June 30, we had three non-accruals, which represented about 2.3% of our overall portfolio cost and 0.8% at market. We are pleased with the progress we are making on this front.”

That would imply that Quick Weight Loss Centers was likely restructured or exited during calendar Q3 2019. American Teleconferencing Services was marked down again but is still considered to be performing asset that could be restructured and/or added to non-accrual status over the coming quarters.

As discussed in the previous report,Hollander and LifeCare filed for bankruptcy in May 2019 and are both working to reduce costs to improve overall profitability and/or selling assets. Hollander cited “across-the-board increase in costs, including new tariffs, rising material, labor and shipping costs and the costs of integrating a competitor it acquired last year had left it in a severe liquidity squeeze”. In June 2019, Hollander announced that it could be closing its plant in Thompson, Georgia. In addition, Hollander has been spending money to integrate Pacific Coast Feather Co., which it acquired in 2017.

On September 4, 2019, a New York bankruptcy judge approved the $102 million sale of Hollander to private equity firm Centre Lane Partners. In the motion asking for approval of the new plan, Hollander said negotiations since the filing produced a global creditor settlement that was approved by the court on August 15, 2019. Under the terms of the settlement, Hollander and the plan sponsors will put up $1.25 million to be paid to the company’s unsecured creditors, it said. While the settlement negotiations were happening, the company said it was also soliciting bids for its assets. Ten initial expressions of interest were narrowed down to the one acceptable bid from Bedding Acquisition, it said.

A revised plan with a “toggle” feature to allow switching to an asset sale was put to a vote by the impaired creditors and received approval from the holders of all of the company’s $173.9 million in term loan debt and the holders of more than 95% of its $38.5 million in unsecured debt, it said. Hollander noted that additional changes to the plan include that the providers of the company’s $90 million in debtor-in-possession funding have agreed to accept less than full repayment and to cede repayment priority to Hollander’s prepetition term loan creditors, as well as the establishment of a $1 million wind-down reserve fund.

CEO Marc Pfefferle said “Upon emergence [from bankruptcy], we will have a stronger balance sheet and the financial flexibility needed to compete in today’s dynamic business environment now and over the long-term.”

Montreign Operating Co. is owned by Empire Resorts (NYNY) and operates a resort casino in Monticello, New York that previously received $130 million of additional equity capital from its sponsor as discussed in the previous report. On August 19, 2019, NYNY announced that it was being acquired by Kien Huat Realty and Genting Malaysia Berhad. Kien Huat has agreed to provide incremental credit support to Empire Resorts, “which will enable the company to meet its debt obligations as we continue to execute on our business strategy”.

Ryan Eller, President and CEO of Empire Resorts, said, “With the resources and support of Kien Huat and Genting Malaysia, Empire Resorts will be better positioned financially and operationally, which will help us advance our mission of delivering a winning combination of luxury facilities, quality entertainment and exceptional customer service. This transaction is a win-win for all our stakeholders, including our stockholders, customers, employees, creditors and the communities in which we operate.”

The transaction is expected to close in the fourth quarter of 2019 and I am expecting PFLT’s investment in Montreign to be marked back up to 100% over the coming quarters which would positively impact NAV per share by around $0.13 or 1.0%. Management discussed Montreign on the recent call:

Q. “I believe on the last call you mentioned activity from the sponsor up at Montreign, the casino in the Catskills, and with the announcement over the last few days about the sponsor possibly taking out the minority shareholders, I’m wondering how does that all flows through to your holding in it and the value you assign to that holding?”

A. “Montreign is – the equity there is controlled by an entrepreneur, and KT Lim, is well-known in the gaming sector. He controls Genting, which is a large gaming company. Montreign is owned in a public company called the New York-New York, NYNY is the ticker. KT Lim has made an announcement that he wants to take NYNY private. He already owns 80% plus of it. At the enterprise value that he’s proposed to take the company private; it values the equity around $300 million. That $300 million of equity of course is junior to $500 million of debt. We own a piece of the Montreign debt, which, today is marked in the mid-80s or so. We still think this is par. Obviously, if the entrepreneur behind it is valuing the equity of $300 million beneath the debt, we think the debt is par, the entrepreneur is indicating that he thinks the debt is par, you know, we’ll see. We think we have a fairly full position right now in PFLT, so we’re not going to add any more debt, but for all those of you in the market who want to buy what we think is very attractive piece of paper, that is broker dealer quoted in the mid-80s, Montreign first lien debt is and we think it’s going to end up being a par piece of paper.”

The portfolio remains predominantly invested in first-lien debt at around 76% portfolio and the PSSL has grown from 9% to 16% (previously 18%) over the last four quarters. It is important to note that its PSSL is 100% invested in first-lien debt.

“Although PFLT was not in existence back then, PennantPark as an organization was, and at that time was focused primarily on investing in subordinated and mezzanine debt. Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million, again primarily in subordinated debt. During the recession, the weighted average EBITDA of those underlying portfolio companies, declined by 7.2% at the trough of the recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%. As a result, the IRR of those underlying investments was 8% even though they were done prior to the financial crisis and recession. We are proud of this downside case track record on primarily subordinated debt.”

From previous call: “We underwrite as if it is the peak of the credit cycle. We do our downside cases in our investment memos assuming a recession hits next year. On average, the equity cushions from the financial sponsors are 40%, 50%. So, we’re underwriting as if we’re at the peak of the credit cycle.”

“We can be extremely selective about what we ultimately invest in. We are only investing in about 2% of the deals that we have shown. We remain primarily focused on long term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.”

PFLT Dividend Coverage Update

PFLT continues to increase leverage, growing its portfolio and overall yield through ramping of its PennantPark Senior Secured Loan Fund (“PSSL”).

Art Penn, Chairman and CEO. “Due to our activity level and the maturation of PSSL, we are pleased that our current run rate net investment income covers our dividend. Our earnings stream should have a nice tailwind based on gradual increase in our debt to equity ratio, while still maintaining a prudent debt profile. As of September 30, our spillover was $0.31 per share.”

On August 26, 2019, PFLT announced that it had priced its $301.4 million debt securitization in the form of a collateralized loan obligation (“CLO”) which is a lower-cost alternative to its credit facility as well as longer-term and more flexible. The company will retain all of the Class D Notes and Subordinated Notes through a consolidated subsidiary.

“You know CLO financing, you know, has a nice long term and longer than our credit facility. So, we’re actively assessing that option, and as we, you know, think about gradually and prudently increasing leverage of that, that could be a key element of doing that really doing CLO financing, contributing assets to that, and then fraying up the revolver to finance future growth.”

On April 5, 2018, the Board approved the application of the modified asset coverage requirements reduced from 200% to 150%, effective as of April 5, 2019. Management is targeting a debt-to-equity ratio of 1.40 to 1.70 that will “take several quarters”:

“Over time, we are targeting a debt to equity ratio 1.4 to 1.7 times. We will not reach this target overnight. We will continue to carefully invest and it may take us several quarters to reach the new target. Given the seniority of our assets, in the near-term we’re actively considering utilizing CLO financing to help achieve the target.”

For the quarter ended June 30, 2019, PFLT reported just above base case projections with much higher-than-expected portfolio growth partially offset by continued lower portfolio yield. During the quarter, the company invested $183 million of in 14 existing portfolio companies with a weighted average yield of 9.3% with sales and repayments of $67 million. As expected, the company continues to increase leverage with a debt-to-equity of 1.09 utilizing its Board approved reduced asset coverage ratio, effective as of April 5, 2019. It should be pointed out that the company had $36.5 million of ‘payables for investments purchased’ that is not included in the current borrowing.

 

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

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

MRCC Earnings & Risk Profile Update: Continued Downgrades

 

The following is a quick MRCC Update that was previously provided to subscribers of Premium 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”).

MRCC Risk Profile Update:

As mentioned in the BDC Risk Profiles report, MRCC was downgraded last year due to potential/continued credit issues including adding Education Corporation of America (“ECA”) to non-accrual status, previous markdowns of Rockdale Blackhawk and realized losses from TPP Operating, Inc. During Q2 2019, its net asset value (“NAV”) decreased by $0.15 or 1.2% (from $12.67 to $12.52) mostly due to additional markdowns in previously discussed investments including American Community Homes, Inc. (“ACH”) as well as its retail-related investment in The Worth Collection, Ltd.

 

 

My primary concern is the potential for additional non-accruals and markdowns of the investments listed in the previous table that currently account for around 15% of the portfolio and 36% of NAV per share. The worst-case projections take into account additional credit issues that could result in a dividend reduction of around 25% as discussed later.

“We’re in an uncertain market and things are happening very often beyond our control as investors. And some of the things that happen from time to time that are beyond our control very really affect industries, in particular, companies in those industries, and it’s very hard to predict. So, we’re going to continue to do that, and we’ll be back to you next quarter with a report. Hopefully, we’ll see more stability in world affairs and other things that are happening that are the more uncontrollable factors.”

The total fair value of investments on non-accrual declined to $14.0 million (previously $16.7 million) and account for around 2.2% of the portfolio fair value and $0.69 per share or around 5.5% of NAV. ECA was added to non-accrual status during Q4 2018 and are ‘junior secured loans’ and preferred stock as compared to first-lien positions. Other non-accruals include its Curion Holdings promissory notes, Incipio, LLC third lien tranches, Millennial Brands LLC (previously Rocket Dog Brands LLC), and Rockdale. The Curion promissory notes and the Incipio third lien tranches were obtained in restructurings during 2018 for no cost.

“The other non-accruals just as a reminder, because this is a constant source of confusion. We have a couple of names where a portion of the holding is on non-accrual because there are situations in which we took over a piece of debt or a piece of paper that we didn’t pay for as part of a restructuring. That includes the promissory note at Curion and a third lien piece at Incipio, and those are the only parts of those that are on non-accrual. There was really no cost associated with those two. And so I don’t know. The only time those would ever really go in accrual would be, if there was a massive recovery in the business. But because those are no cost, I mean, it doesn’t make any sense to put them on accrual status. And then there’s a small piece of preferred Millennial Brands that we don’t really expect to ever see value from. Those are all the non-accruals.”

During Q2 2019, MRCC participated in a credit bid to acquire the assets of New England College of Business (“NECB”), which was a subsidiary of ECA resulting in a 20.8% equity stake in NECB in exchange for a $1.5 reduction of secured loan position in ECA. Management mentioned “the ECA situation is going to be ongoing for an [extended] period of time”:

Q. “A quick on Education Corporation of America, can you give like just some color on what drove the write-down there this quarter and then the outlook for just the rest of your non-accruals in general and the timing of the resolution?”

A. “So, yeah, I think what you have to look at there is ECA has basically been split into two investments now. So that’s the confusion here. ECA had an asset that’s called NECB, New England College of Business, which is a performing school that’s was – that’s doing okay and was a good ongoing asset. And so basically, through the receivership situation there, we’ve credited a bit some of the debt and taken over NECB. So when you look at the marks, you sort of have to look at it by combining ECA and NECB. And more or less, when you look at it that way, the valuation hasn’t really changed quarter-to-quarter. The ECA situation is going to be ongoing for a period of time, that’s going to be extended”

As discussed in previous reports, American Community Homes, Inc. (“ACH”) is still on accrual status (discussed later) and needs to be watched as it still accounts for around $0.73 per share or 5.9% of NAV. In October 2014, MRCC funded a senior credit facility to support the recapitalization of Towne Mortgage Corporation by ACH. Based in Troy, Michigan, Towne originates and services mortgage loans on residential properties located primarily in Michigan, Minnesota and Wisconsin. ACH has been marked down in previous quarters and during Q1 2019, MRCC invested another $3.3 million. Also mentioned in the previous report, MRCC has put in place new management and was discussed on a previous call:

“American Community Homes just to be more clear is that was a compliance in the mortgage servicing business and general the mortgage servicing rights on a fair value from dollar in the industry and so what we did and our third-party valuation firm did more importantly is they looked at industry norms for valuation of mortgage servicing rights there. You know I don’t believe that there is any deterioration in the overall enterprise value or the value of the Company, but when you value particular companies based on underlying rights or commodity items its right to do what they did. So we took the adjustment on that, but at the end of day as you mentioned, we have no additional non-accrual and I believe our portfolio is stable. There has been a change in management, we have put a new management, there is some things that could be done on the operating basis to make a company more profitable and better, we feel we have done all that and from here it looks really good in terms of the company’s valuation. We feel solid in the future should be very strong, because we have done a lot to change the management team there and how they approach the business and it looks good in the future even if we have a protracted slowdown in mortgage originations, which appears to be the case right now. We still think there is value being created in the business.”

Previously, management discussed its investment in ACH including having “significant downside protection” and “our expectation is that the company can be improved and that we will enjoy a full recovery”:

From previous call: “Our expectation is that we have significant downside protection through this fairly large portfolio of mortgage servicing rights, the only trouble of the business is because the mortgage origination business is slow and liquidity became a little tight it’s harder for the company to retain as many new mortgage servicing rights as they would have liked, which would have created a more value for us. But long-term, we expect the recovery here, sponsor here has made significant changes to management and as advisors in who have made fairly large cost cuts to the business, which we don’t think will impact the business profitability going forward negatively, but only positively. And our expectation is that the company can be improved and that we will enjoy a full recovery. And we also have some equity in this business as well, which has some potential upside in the future as well, but for now this is the fair market value on the loans. There were some additional funding I mentioned on the term loan during the period, which is what you are seeing with regards to the increase in funding.”

The fair value of its investment in Rockdale Blackhawk, LLC (“Rockdale”) remained stable but previously filed for bankruptcy as part of a restructuring process. MRCC’s total investment in Rockdale accounts for almost $18 million (around 2.8% of the portfolio) and $0.88 (or 7.0%) of NAV per share. Management

Q. “The fair value in Rockdale went up a little quarter-over-quarter, was that simply change in the discount rate?”

A. “It’s really in the margin, I think. It’s not a particularly material change. So, I wouldn’t read much into it. It’s just as you go through sort of a waterfall analysis and look at how things sort of play out on the valuation side, they have small shifts up and down. So there was some, I think, in the estate some realization of certain assets in the estate, so that has something to do with it as well. The Rockdale situation ought to have some resolution in the next quarter or two. It’s – the arbitration there is happening as we speak, and we’ll see – it’ll take some time for that case to get through all the arguments, and then the arbitrator has some time to make a decision on what he wants to do. So I would expect to see that resolve itself, if not in the third quarter, maybe into the early part of the fourth quarter.

 

 

Previously, management mentioned that its Rockdale investment was valued appropriately but that “there is a range of outcome some of which are considerably higher and some of which are lower”:

From previous call: “We are required to mark every assets to what we believe is a fair market value in every quarter, based on the available information. And we use independent third-parties to assist us in that and we have done nothing different this period than any other period and nothing different with this investment than other investments. We have given all the information we have to an independent third-party evaluation firm who has done What Ted has described, which is try to put reasonable probability of outcomes on the assets and the liquidation of assets and the recovery of assets and sales of business units and things of that nature. And I will just say probably there is a range of outcome some of which are considerably higher and some of which are lower. So, this is the best expectation of what we think the fair value of the loan is today based on the view of the independent third-party and all the contingencies.”

MRCC’s portfolio remains primarily of first lien loans, representing around 90% of the portfolio and its investment in the SLF (discussed next) remains around 6% of the portfolio:

“Our portfolio is heavily concentrated in senior secured loans, and specifically first lien secured loans. 92.9% of our portfolio consists of secured loans, and approximately 90% is first lien secured. We are pleased with the construction, diversity and the senior secured nature of our investment portfolio at this point in the credit cycle.”

Grade 4: Includes an issuer performing materially below expectations and indicates that the issuer’s risk has increased materially since origination. In addition to the issuer being generally out of compliance with debt covenants, scheduled loan payments may be past due (but generally not more than six months past due). For grade 4 investments, we intend to increase monitoring of the issuer.

Grade 5: Indicates that the issuer is performing substantially below expectations and the investment risk has substantially increased since origination. Most or all of the debt covenants are out of compliance or payments are substantially delinquent. Investments graded 5 are not anticipated to be repaid in full and we will reduce the fair market value of the loan to the amount we expect to recover.

MRCC Dividend Coverage Update:

MRCC was previously downgraded in the Dividend Coverage Levels report due to continued credit issues driving increased reliance on fee waivers to cover its dividend. Over the last three quarters, the company has covered its dividend only due to the ability to use higher leverage through its SBIC license and management willing to waive incentive fees to ensure dividend coverage. Previously, MRCC had higher dividend coverage only due to the ‘total return requirement’ driving no incentives fees paid. The following was from a previous earnings call:

It has everything to do with where the NAV of the portfolio is in any given quarter and the performance on NII and dividends paid to shareholders. So it just depends on what happens each quarter going forward. And it’s a formulaic, as you said it’s formulaic. And so it’s difficult for me to predict today with any certainty where incentive fees would be on. And as you probably know it’s not a binary trigger either. They could be on it partially, or they could be on fully. It just depends on where we are with regards to NAV. It’s possible, there could be some incentive fee earned in the first quarter, if NAV was flat. I wouldn’t expect we’d be in a position to earn an entire incentive fee. And I would think that everything else was equal than probably in the second quarter is when you could start seeing an incentive fee payable.”

The last two quarters of higher-than-expected portfolio growth have driven its debt-to-equity ratio from 1.24 to 1.61 and its regulatory debt-to-equity ratio (excluding SBA debentures) has increased from 0.79 to 1.16. However, dividend coverage has not improved due to additional non-accruals and restricted cash which was discussed on the recent call:

“I think, if you look at where we are in NII coverage today and if all things being equal, if we could get the cash to work in the SBIC subsidiary, which we’re working hard to do, and if we could try to get some of the money that’s locked up in non-accruals out and reinvest it in accrual assets, our visibility for coverage looks really good.”

“What we’re trying to work on doing is getting some of the cash that’s sitting in the SBIC today to work over the next couple of three quarters. Obviously, it’s difficult to find deals in a competitive environment that are SBIC eligible. But we’re hopeful that we can find some good deals in the pipeline, and there are a couple now that look like they could qualify, and so getting that cash to work is really going to be a good help in driving NII performance, because right now, we’re just sitting on cash.”

Management also mentioned increasing its regulatory debt-to-equity ratio to 1.25 to 1.30:

“We’ve said for a while since the change in the rules that we intended to go above 1:1. So that shouldn’t be a big surprise. Maybe the velocity with which we were able to do it is surprising to you, but it’s not surprising to me because Monroe has always had a very, very active pipeline. We are, I believe, taking on deals that are maybe on the margin less risky than what we had done in the past. And we continue to expect to grow our regulatory leverage over the next couple of quarters, I’d say. I don’t know where we’ll wind up. It really depends on how the portfolio shakes out in the new origination shakeout, but I’d say think of it as maybe up to 1.25 to 1.3 times kind of regulatory leverage as a next target.”

As mentioned earlier, my primary concern is the potential for additional non-accruals and markdowns of certain investments that currently account for around 15% of the portfolio and 36% of NAV per share. The worst-case projections take into account additional credit issues and could result in a dividend reduction of around 25% as “the Board will revisit it in the future, and we’ll continue to think about it and look at it”:

From previous call: “We continue to believe that our adjusted NII can cover our dividend assuming no other material changes in our portfolio.”

“A lot of BDCs have cut dividends over the last several years. We never cut a dividend. We’ve only increased it once and have never cut. If we can cover the dividend and continue to cover it with room, over a long period of time, I feel like we’re doing a pretty good job for shareholders. But we’ll watch it, we’ll monitor it. And the Board will revisit it in the future, and we’ll continue to think about it and look at it. But to-date, we haven’t made a determination.”

It should also be noted that there has been a meaningful increase in the amount of non-cash payment-in-kind (“PIK”) interest income from around 2.2% to 7.5% and included many of the “watchlist” investments discussed earlier including American Community Homes, The Worth Collection, Luxury Optical Holdings, and Curion Holdings:

 

Management was asked about potentially lowering the fees paid to management based on higher leverage and the response was mixed:

Q. “with the increased leverage, you’re talking 1.25 and maybe, obviously, you can go up to 2, but I know you wouldn’t take it there. But obviously, it drives more assets, and I know other BDCs have reduced some of their management fees for assets above the 1:1 ratio. I mean have you given that kind of any thought of reducing the base management fee on any level of assets?”

A. “Yes. So we’re really focused on delivering returns to shareholders in the form of NII-covering dividend. And so, what we have chosen to do to date is to look at waiving fees voluntarily to make sure we’re covering. And we’re going to continue to monitor, sort of, our performance level, and we’ll make decisions about that in the future if we think that it’s warranted based on our ability to cover. You got to remember that we have a business model, as Ted just went through, that includes a lot of people. We’ve really invested in infrastructure of people here to generate the unique deal flow. And I think if you look at a lot of other BDCs our size, you’ll find that their employee base is considerably smaller than ours.”

The company still has around $0.48 per share of undistributed net investment income for temporary dividend coverage shortfalls. For the quarter ended June 30, 2019, MRCC reported slightly below base-case projections with continued portfolio growth and expected slightly lower portfolio yield mostly covering its dividend for the 21st consecutive quarter.

Theodore L. Koenig, CEO: “We are pleased to report another quarter of consistent net investment income, with Adjusted Net Investment Income of $0.35 per share, representing the 21st straight quarter where per share Adjusted Net Investment Income met or exceeded our quarterly per share dividend. We have also made our 27th consecutive quarterly dividend payment to our shareholders. As of quarter end, our portfolio totaled $630.8 million in investments at fair value, which represented a $33.9 million increase in the portfolio during the second quarter, or about a 6% increase. Portfolio growth during the quarter was funded primarily utilizing the available capital under our revolving credit facility. We would expect to continue to selectively grow our portfolio, including utilizing additional leverage capacity available to us under our revolving credit facility. We would expect recent and continued portfolio growth to positively contribute to our earnings in future quarters.

 

 

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:

  • 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.

 

TCPC Earnings & Risk Profile Update: September 2019

 

The following is a quick TCPC Update that was previously provided to subscribers of Premium 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”).

TCPC Dividend Coverage Update:

BlackRock TCP Capital (TCPC) continues to consistently over-earn its dividend growing its undistributed taxable income to almost $39 million spillover or $0.66 per share.

“We generated net investment income in the second quarter of $0.41 per share again exceeding our dividend of $0.36 per share. This extends our more than seven-year record of covering our regular dividend every quarter since we went public. Over this period on a cumulative basis, we’ve out-earned our dividends by an aggregate $39 million, or $0.66 per share based on total shares outstanding at quarter end.”

Dividend coverage for TCPC 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.

“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.”

Previously, management indicated that the company will likely retain the spillover income and use for reinvestment and growing NAV per share and quarterly NII rather than special dividends:

“As we talked with shareholders we reached the conclusion although opinions weren’t universal on this that most people didn’t seem to value them that much and we thought that retaining the spill-over income seem to be better received.”

“So while we do look at our dividend from time-to-time and want to make sure it’s an appropriate level, our primary focus is on continuing to make sure that we keep up that record of covering our dividend each quarter.”

However, management indicated that the recent shareholder approval to increase leverage will likely drive higher earnings and “will continue to assess our dividend policy going forward”:

“As you’re aware, our shareholders just voted overwhelmingly to give us the ability to increase leverage, and we’ve been earning our dividend very comfortably without that. So as we talk about our board we will continue to assess our dividend policy going forward. As our balance sheet and income statement may change over time, we will continue to analyze that have discussions with our board reflect the views of other important constituents and continue to reassess our dividend policy. ”

For the quarter ended June 30, 2019, TCPC reported between base and best case projections covering its dividend by 113% that included $0.05 per share of income related to prepayment premiums and accelerated original issue discount amortization. However, there was a meaningful increase in the amount payment-in-kind (PIK) income (from 5% to 10% of total income) and needs to be watched.

Howard Levkowitz, TCPC Chairman/CEO: “We out-earned our dividend for the 29th consecutive quarter, generating strong investment income and robust originations in the second quarter. Originations totaled $232 million for the quarter. We leveraged our existing relationships with borrowers and deal sources as well as the BlackRock platform’s resources to deepen relationships with existing clients and to engage new borrowers.”

“New investments during the quarter had a weighted average effective yield of 9.7% and the investments we exited had a weighted average effective yield of 12.3%. While our average new investments were lower-yielding than the investments we exited this quarter, we would caution against viewing any one quarter as a trend. The overall effective yield on our debt portfolio at quarter end was 11% compared to 11.4% at the end of the last quarter. If you look at the overall change in yields about half of that is just decreases in LIBOR. And some of the rest of it particularly the pronounced difference on the exits include a couple of higher-yielding things like Envigo that we mentioned earlier.”

The non-accrual loans to Fidelis Acquisitions, LLC (discussed later) were partially taken out of investment income during Q2 2019 and was easily offset by higher-than-expected portfolio growth and dividend income during the quarter.

Q. “Is a full quarter taken out of the second quarter earnings, or is only a partial quarter of Fidelis taking out of quarterly earnings?”

A. “We stopped accrual at the end of May. So there’s two months of Fidelis. But I would note, when we computed the incentive fees it was excluding, anything that we accrued.”

 

 

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

 

 

On August 6, 2019, the Board re-approved its stock repurchase plan to acquire up to $50 million of common stock at prices below NAV per share, “in accordance with the guidelines specified in Rule 10b-18 and Rule 10b5-1”. During Q1 2019, there were only 9,000 shares repurchased and in 2018, the company repurchased only 73,416 shares for a total cost of $1.0 million. There is a good chance that the company will repurchase additional shares if the stock price declines below NAV again which is now $13.64 (reduced asset coverage ratio and higher leverage can be used for accretive stock repurchases).

On February 8, 2019, shareholders approved the reduced asset coverage ratio allowing higher leverage and reduced management fee to 1.00% on assets financed using leverage over 1.00 debt-to-equity, reduced incentive fees from 20.0% to 17.5% and hurdle rate from 8% to 7% as well as “continue to operate in a manner that will maintain its investment grade rating”.

TCPC continues to lower its cost of capital and in May 2019, expanded its credit facilities by $50 million each for a total increase in capacity of $100 million as well as reducing the rate on its SVCP Facility by 0.25% to LIBOR + 2.0% and extended its maturity to May 6, 2023.

“During the second quarter we also reduced the interest rate on our SVCP facility by 25 basis points to LIBOR plus 200, and extended the maturity of both facilities to May 2023. The increased capacity reduced cost and extended maturities of our credit facilities further expand our diverse leverage program which includes two low-cost credit facilities, two convertible note issuances, a straight unsecured note issuance and an SBA program.”

As of June 30, 2019, available liquidity was $237 million, including $227 million in available leverage capacity and $22 million in cash and cash equivalents, reduced by approximately $12 million in net outstanding settlements of investments purchased. However, effective August 6, 2019, the company expanded the total capacity of its SVCP Facility by $50.0 million to $270.0 million. On November 7, 2018, Moody’s Investors Service initiated an investment grade rating of Baa3, with stable outlook. On November 8, 2018, S&P Global Ratings reaffirmed its investment grade rating of BBB-, with negative outlook. Both ratings include consideration of the Company’s reduced asset coverage requirement.

“We had total liquidity of $237 million at quarter end. This included available leverage of $227 million and cash of $22 million reduced by net pending settlements of $12 million. Since the beginning of the second quarter, we have expanded our credit facility capacity by a total of $150 million, which includes an incremental $50 million on our SVCP facility that we added earlier this week.”

“Outstanding draws on our $150 million SBA program increased to $118 million at June 30 as we added two new portfolio companies to the SBIC. The increased leverage flexibility following shareholder approval of our reduced regulatory coverage ratio allowed us to take advantage of attractive investment opportunities during the quarter.“Regulatory leverage at quarter end which is net of SBIC debt was 0.99 times common equity on a gross basis and 0.98 times net of cash and outstanding trades. Our investment-grade rating was reaffirmed by Moody’s in June and we’re proud to continue to be one of only three BDCs with both 2:1 leverage flexibility and an investment-grade rating from both Moody’s and S&P.”

TCPC management continues to take a higher quality approach including selective portfolio growth, with adequate protective covenants, at higher yields for improved dividend coverage. I am expecting the company to maintain its portfolio yield over the coming quarters:

“Both new and exited investments during the quarter co-incidentally had a weighted average effective yield of 10.1%. The overall effective yield on our debt portfolio at quarter end remained unchanged from the prior quarter at 11.4%.”

TCPC currently does not have a “joint venture” or “senior loan program” that uses off-balance sheet leverage to increase its overall portfolio yield. BDCs are allowed a maximum of 30% of investments to be considered ‘non-qualified’ that would include these types of investments:

From previous call: “We may consider doing some other things with 30% bucket. We’ve just have a very cautious approach to how we use that and wanted to make sure that it’s something that really fit with our strategy. So, the way we think about it is, it really is a continuation of what we’ve been doing, albeit with the resources of the world’s largest asset manager in many ways to help us do what we’ve been doing.”

Previously, TCPC completed a direct equity offering of 2.3 million shares in an effort to increase the ownership of longer-term institutional investors similar to the converted $30 million note and institutional support from CNO Financial Investments Corp. (CNO). CNO is an NYSE listed insurance holding company with over $30 billion in assets and is committed to investing more than $250 million of capital that will be deployed over time in TCP’s managed funds.

TCPC Risk Profile Update:

TCPC’s net asset value (“NAV”) per share declined by $0.54 or 3.8% (from $14.18 to $13.64) mostly due to unrealized losses related to adding Fidelis Acquisitions, LLC (“Fidelis”) to non-accrual resulting in $28.6 million or $0.49 per share of losses. Previously discussed Green Biologics was marked down an additional $3.2 million or $0.05 per share. Fidelis still accounts for around 1.3% of the portfolio and $0.37 per share of NAV.

Howard Levkowitz, TCPC Chairman and CEO: “While our overall portfolio is strong, our net asset value declined 3.8% in the quarter, almost entirely due to one underperforming investment. Looking ahead, we have a solid pipeline of new investment opportunities and believe we are well-positioned to continue to deliver attractive risk-adjusted returns to our shareholders.”

“Net unrealized losses of $34.6 million or $0.59 per share were primarily attributed to the write-down of our investment in Fidelis, most of which we placed on non-accrual during the quarter and which comprised 1.1% of our portfolio at fair value at June 30. No other loans were on non-accrual at quarter end and the credit quality of our portfolio is strong.”

Management discussed Fidelis on the recent call including making changes to management:

“While our investment portfolio remained strong overall, our net asset value declined 3.8% during the second quarter. This decline was almost entirely due to a write-down of our investment in Fidelis, a cyber security solutions provider that has significantly underperformed our expectations. Our initial investment in Fidelis, which we made in 2015 was at a relatively low loan-to-value and was made alongside a well-regarded private equity firm whose cash equity investment was nearly three times our debt. Fidelis initially performed to plan, but subsequently struggled in an increasingly competitive sector. After implementing several growth initiatives, customers are reacting favorably and sales have increased. However, liquidity is challenging, as revenue growth has yet to outpace costs. During the second quarter, it became clear, that notwithstanding several add-on investments from the sponsor, the company’s liquidity position no longer support its valuation. As a result, we recorded a $28.6 million unrealized loss and place the loans on non-accrual. We are disappointed by this result and are continuing to work closely with management and the sponsor to maximize value. The credit quality of the remainder of our portfolio is strong. Across the middle market, we are seeing mostly isolated credit events that appear to be more idiosyncratic and not indicative of widespread issues.”

“The company faced some challenges. Partly this was the marketplace, but to be honest a lot of it was self-inflicted issues from management. And leveraging our sort of experience and working with companies from our such a situation heritage and the owners we really worked to improve those shortfalls. And that included a change in management. That included several additional fundings on the business. And what we have seen since that time over the last several quarters is the impact — the positive impact on that from improvements in revenue bookings all the things you want to see happen on the income statement. The challenge and really to answer your question is the balance sheet challenges and the impact of that shortfall on continuing this recovery was notable and perhaps during the quarter became more evident and more pronounced where one impacts the other. And this isn’t a valuation that hasn’t changed over time.”

“It has changed over the last several years, but really where you saw the impact — where it’s less evident was in the equity of the junior tranches. And this quarter with the mitigation of our coverage and actually reduction of our coverage in the junior tranche — the C tranche you’re seeing a more pronounced and disproportionate effect in our piece, but the valuation has declined over time partly due to performance and partly due to just the market multiples which have also come down. So I think it’s harder to see that in any one quarter because of what we disclosed and what the overall valuation decrease has been. But you are seeing in this quarter a more notable impact where we’re affected in a straight waterfall to your point that over time where the equity has eaten more of the valuation deterioration. The term loan C; the increase is a function of PIK interest. Part of our — one of our latest efforts with the company and a restructuring of our position had us have a PIK position that is accretive into the C. So we did fund some additional money into the business but that is in the term loan A. So but specifically to your question on the amount of the C that was written down, that was not new funding. That was accretion. ”

The overall credit quality of the portfolio remains strong, with 92% of the portfolio in senior secured debt (mostly first-lien positions) and low non-accruals and low concentration risk:

“Our largest position represented only 3.2% of the portfolio and taken together our five largest positions represented only 14.9% of the portfolio. Furthermore, as the chart on the left side of slide 6 illustrates, our recurring income is distributed across a diverse set of portfolio companies. We are not reliant on income from any one portfolio company. In fact, on an individual company basis well over half of our portfolio companies, each contribute less than 1% to our recurring income. We have been pleased and surprised, in fact, with how little we’re hearing from companies about the impact of tariffs. In fact, there’s only one company that was directly citing it as being a material issue for their business. Now having said that, it’s still early in this next round and it’s not always immediately clear to people. And sometimes the impacts may be two or three layers away, and so it may take a while to filter through. But so far our emphasis on non-cyclical companies with a more domestic focus, I think, has benefited us pretty significantly with respect to tariffs.”

 

 

As mentioned in the previous report, its debt investments in Green Biologics were restructured into common equity and discussed on a previous call: “Green Bio missed projections, but received an equity infusion from its strategic owner during the quarter.” Kawa Solar Holdings was previously on non-accrual but restructured in Q3 2018 and is now in the process of “winding down”. Other investments that need to be watched include Securus Technologies, Inc., Conergy, Utilidata, Inc. and Avanti Communications Group.

 

As mentioned earlier, management has been slowly growing the portfolio (or shrinking if needed) and only investing in “the right type of structures with protections including covenants”.

“The direct relationships we form with borrowers as part of this process help to protect TCPC and its shareholders. The BlackRock TCP team is structured so that deal team members source, structure and monitor investments to ensure interests are aligned over the life of an investment. And finally, our team has deep experience in both performing and distressed credit, and we draw upon this expertise to structure deals that are downside protected. In closing, we remain relentlessly focused on generating superior risk adjusted returns for our investors, while preserving capital with downside protection.”

 

“TCPC has outperformed the Wells Fargo BDC Index by 33% over the same period. Over the past few years we have seen many new entrants into direct lending and substantially more capital seeking investment opportunities in the middle market. Against this backdrop being part of the world’s largest global asset manager greatly enhances our ability to source deals and build upon TCP’s successful 20 year track record in direct lending.”

Quality of Management & Fee Agreement:

The primary advantages for TCPC investors are its investor-friendly fee structure protecting total returns to shareholders on a cumulative basis by taking into account capital losses when calculating the income incentive fees (“total return hurdle”) and lower cost of capital, which have resulted in superior dividend coverage, previous special dividends and growing undistributed ordinary income.

As mentioned earlier, on August 6, 2019, the Board re-approved its stock repurchase plan to acquire up to $50 million of common stock at prices below NAV per share, “in accordance with the guidelines specified in Rule 10b-18 and Rule 10b5-1”. During Q1 2019, there were only 9,000 shares repurchased and in 2018, the company repurchased only 73,416 shares for a total cost of $1.0 million. There is a good chance that the company will repurchase additional shares if the stock price declines below NAV again which is now $13.64 (reduced asset coverage ratio and higher leverage can be used for accretive stock repurchases).

From previous call: “With our stock trading at a small discount to NAV during the quarter we made modest share repurchases under our algorithm based share repurchase program.”

The company has the ability to issue shares below NAV but I do not see this as a “red flag” given the quality of management.

“Consistent with prior years and in line with many of our BDC peers, we have included in our proxy a proposal for shareholder approval to issue up to 25% of our common shares on any given date over the next 12 months at a price below net asset value. The purpose of the below NAV issuance proposal in our proxy is to provide flexibility. To be clear, at this point, we do not intend to issue equity below NAV, and certainly not unless it is accretive to our shareholders. This is basically an insurance policy, which our shareholders have approved every year since we went public.”

I consider TCPC to have higher quality management for many reasons including its updated fee agreement, conservative dividend and accounting practices (recognizing fee income over the life of the investment), insider ownership, strong underwriting standards and measured approach when raising and deploying capital.

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

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.