FDUS Quick Update: Continued Dividend Increases

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

  • FDUS target prices/buying points
  • FDUS risk profile, potential credit issues, and overall rankings
  • FDUS dividend coverage projections (base, best, worst-case scenarios)


Previous FDUS Article Follow-Up

This article is an update to “I Bought Fidus Investment: 12% Yield And 35% Below Book” that hopefully convinced investors to start a position or buy more of Fidus Investment (FDUS) that has easily outperformed the S&P 500:

As mentioned in the previous article:

I believe that there’s a good chance for a total return potential of 30% or higher over the next 12 months.

The article provided the following rationale for expected returns including only the regular dividends paid plus price appreciation to $12.00 to $15.00 driving a total return between 30% to 60%.

Good News!

The stock is now $17.88 and the company has increased its regular dividend as well as paying special and supplemental dividends driving a total return approaching 90% after only 11 months. It should be noted that the article also discussed the reasons why I thought the company would increase and/or pay supplemental dividends which are discussed below as well.

Source: FDUS Q2 2021 Investor Presentation


FDUS Q2 2021 Dividend Coverage Update

For Q2 2021, FDUS easily beat its best-case projections covering 137% of its quarterly regular dividend due to lower-than-expected ‘Other G & A’ as well as an increase in origination, prepayment, and amendment fees, and higher dividend income due to increased levels of distributions received from equity investments.

Edward Ross, Chairman/CEO: “Our portfolio performed well in the second quarter, generating a 15% increase in adjusted NII year over year. As a result of this solid operating performance along with portfolio fair value appreciation, NAV reached $17.57 per share. Looking ahead, our healthy liquidity places Fidus in a very strong position to carefully build our portfolio of debt investments in lower middle market companies with resilient business models and positive long-term outlooks. Consistent with our track record of managing the business for the long term and deliberate investment selection, we intend to continue to emphasize quality over quantity while remaining focused on capital preservation and generating attractive risk adjusted returns.

Source: FDUS Q2 2021 Earnings Announcement


FDUS Equity Positions & Realized Gains

Most dividend coverage measures for BDCs use net investment income (“NII”) which is basically a measure of earnings. However, some BDCs achieve incremental returns typically with equity investments that are sold for realized gains often used to pay supplemental/special dividends.

FDUS has equity investments in almost 86% of its portfolio companies which is primarily responsible for net asset value (“NAV” or book value) growth of over 14% in the last 4 quarters and continued realized gains and dividend income to support special/supplemental dividends paid over the last 8 years.

Source: FDUS Q2 2021 Investor Presentation

During Q2 2021, there was another $2.2 million or $0.09 per share of realized gains mostly due to Wheel Pros as discussed in the previous report. During the previous quarter, FDUS had net realized gains of $3.2 million or $0.13 per share due to exiting other equity positions including Software Technology, Rohrer, and FDS Avionics.

Source: SEC Filing


On July 26, 2021, FDUS exited its debt and equity investments in Worldwide Express Operations, which was acquired by Worldwide Express resulting in additional realized gains of approximately $3.0 million or $0.12 per share. However, these gains will be partially be offset by a $1.0 million realized loss related to the exit of its debt and equity investments in Hilco Technologies on July 16, 2021.

Subsequent to the quarter end, Hilco Technologies sold. We took control of Hilco in the second quarter and exchanged a $10.3 million debt investment for an equity investment in a new holding company. In conjunction with the sale subsequent to quarter end, we received payment in full on our residual debt and converted equity investment and realized a net loss of approximately $1.0 million of our original equity investment in the company. Due to the Hilco restructuring and exchange of debt for equity, approximately $0.6 million of interest income was converted into dividend income.”

Source: FDUS Q2 2021 Earnings Call

There is the potential for significant realized gains related to the exit of certain equity investments including Pfanstiehl, Inc.Pinnergy, Ltd., and Global Plasma Solutions which were among the largest markups in 2020. If these investments were sold at the fair value as of June 30, 2021, would imply potential realized gains of $66.6 million or $2.73 per share which would likely drive a significant increase in supplemental dividends over the coming quarters. Also, these investments currently account for 9.4% of the portfolio fair value and could be reinvested into income-producing assets driving higher earnings and a potential increase in the regular dividend.

We have equity investments in approximately 85.5% of our portfolio company with an average fully diluted equity ownership of 7.4%. So we do have an expectation for additional realizations and quite frankly, on both the debt and the equity side of things, primarily driven by M&A and so. I think the outlook for realizing some of the portfolio is very positive from that perspective and we would expect that to continue and we are a lot of companies that are pretty right if you will for M&A or some type of transaction. So I view the outlook from a natural perspective to be very good. When I look at the companies we control, we control a couple of companies today and so and then we have impact on some other investments where, maybe the sponsors not in total control of the situation or if it would be a negotiation, if you will, amongst ourselves and other shareholders. I wouldn’t say we’re looking to go, sell those investments right now because there’s a good outlook. But at the same time, so as I think about things, it’s for a little long in equity today, just on a percentage basis. So there’s a balance you got to strike there because I don’t want to sell too early.”

Source: FDUS Q2 2021 Earnings Call


Comparison of Changes in NAV Per Share

The following table is ranked by changes in NAV per share over the last five years with most of the BDCs ranked higher having a larger portion of the portfolio invested in equity positions. Please keep in mind that some of these BDCs could easily experience NAV declines during a recessionary period as equity positions are marked back down (deflated). BDCs with higher amounts of first-lien positions have a much more stable NAV but also do not participate in the higher returns during periods such as this. Hopefully, these BDCs will be selectively trimming their equity positions (also known as harvesting) and reinvesting into income-producing assets improving dividend coverage and stabilizing NAV in case of an economic downturn.

Please note that many of the higher quality BDCs have been paying large special and supplemental cash dividends which directly impacts NAV (negatively). These BDCs will be discussed in this series of articles.


FDUS Leverage & Portfolio Yield

Management is targeting a debt-to-equity ratio (leverage) of 1.00 which I have taken into account with the updated projections:

Q. “Just remind us where you plan to take the business from a regulatory leverage perspective.”

A. “I think we have said one-to-one especially given the complexion of our portfolio, which was weighted more towards junior debt. As you know that the portfolio is changing or the complexion of the portfolio is changing to more first lien originations and the exit of some of the second lien investments just from, just as an in natural course, should I say? So hopefully that’s helpful, but that’s how we’ve kind of thought about it as, very comfortable around the one-to-one, but we have increased flexibility today due to the complexion of the portfolio changing.”

Source: FDUS Q2 2021 Earnings Call

Also taken into account is slightly lower portfolio yield but continued fee income from portfolio activity including new originations and prepayments:

“Yields are 12% to 12.2% for us on the debt portfolio. If they were to move, I would say it probably moved down a little bit just due to yield environment and competition. I don’t expect any major swings there, but that’s kind of the, where we are today and from a competitive standpoint. So until still yields start to move forward, I would expect that there may be some very modest drifting down, that makes sense.”

Q. “On fee income note, can be rather volatile quarter to quarter, but maybe in 2022 is activity moderates, would you expect 2022 fee income to be below 2021 levels?”

A. “There’s no change in strategy from our perspective that we would expect originations to continue to be healthy in 2022 and thus there would be something income with that. We also think there’ll be some repayments, but as you heard today, think one of the six investments we had repayment penalties so not all of them have. I mean they all have them, but they expire usually after a couple of three years. So, but I would expect at least whether we match the same level of fees in 2022 versus 2021, I don’t know, but I don’t expect it to be dramatically lower at this point at all. I wouldn’t, I don’t foresee that.”

Source: FDUS Q2 2021 Earnings Call

As shown in the following table, FDUS has lower leverage (debt-to-equity) combined with higher dividend coverage over the last four quarters. I have not included the dividend coverage averages for FCRD and PTMN because I do not cover these BDCs due to having higher risk portfolios and they are thinly traded. I cover NEWT but it has a very different business model as discussed in “Newtek Business Services: Initiating Coverage“.

AINVMRCC, and FSK have recently had higher dividend coverage only due to not paying incentive fees related to previous capital losses. Dividend coverage will decline once these companies start paying incentive fees. Also, BDCs such as SUNS with lower leverage have access to growth capital to improve dividend coverage and are likely just taking a cautious approach to rebuild their portfolios during the economic recovery.


Summary

FDUS has adopted a dividend strategy that includes an easily sustainable regular dividend as well as a variable portion to pay out the excess earnings as needed (similar to other BDCs) and was discussed on the recent call:

As a reminder, the board has devised a formula to calculate the supplemental dividend each quarter, under which 50% of the surplus and adjusted NII over the base dividend from the prior quarter, distributed to shareholders. For the third quarter, I am pleased to report that we are increasing the base dividend at $0.32 per share, and the surplus is $0.06 per share. In addition, we will pay a special dividend in Q3 of $0.04 per share. Therefore on August 2, 2021, the board of directors declared a base quarterly dividend of $0.32 per share, a supplemental quarterly cash dividend of $0.06 per share, and especial dividend of $0.04 per share.”

Source: FDUS Q2 2021 Earnings Call

On August 2, 2021, the Board increased its regular quarterly dividend from $0.31 to $0.32 per share, plus a supplemental dividend of $0.06 per share, and a special dividend of $0.04 per share for Q3 2021. FDUS has around $1.04 (previously $0.98) per share of spillover income (or taxable income in excess of distributions) that can be used for additional supplemental dividends.

I am expecting additional increases in the regular dividend plus continued supplemental/special dividends through the use of higher leverage and additional realized gains from equity positions combined with its generous 8% hurdle rate which is applied to “net assets” to determine “pre-incentive fee net investment income” per share before management earns its income incentive fees. As shown in the following table, the company will likely earn around $0.351 per share each quarter before paying management incentive fees covering around 110% of the previously increased dividend which is ‘math’ driven by an annual hurdle rate of 8% on equity. It is important to keep in mind that FDUS could earn less than $0.351 per share but management would not earn an incentive fee for that quarter as shown in the ‘worst case’ financial projections.


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

NMFC Quick Update: Likely A Strong Q3 Coming

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

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


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

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

The primary reason that NMFC is a ‘Tier 3’ is mostly due to needing higher amounts of leverage to cover the current dividend as well as previously realized losses of around $91 million over the last ~8 years which is around $0.94 per share using the current share count. However, NMFC’s net asset value (NAV or book value) has only declined by around $0.73 per share (since 2012) partially due to offsetting unrealized gains as well as over-earning the dividends. But of course, NMFC reduced its quarterly dividend from $0.34 to $0.30 starting in Q2 2020 as predicted in previous reports. At the time, the company had spillover or undistributed taxable income (“UTI”) which is typically used for temporary dividend coverage issues. Please do not rely on UTI as an indicator of a ‘safe’ dividend.

There is a chance that NMFC will be upgraded to ‘Tier 2’ over the coming quarters. I will be looking for continued improvement in credit quality including no new non-accruals, increased NAV per share, and realized gains mostly from Edmentum, Inc. (as discussed in this report). More importantly, I will be looking for earnings results closer to the ‘best case’ projections that take into account continued lower borrowing rates, and rotation out of equity positions into income-producing debt positions as discussed in this update.


NMFC Insider Purchases

Steve Klinsky, Founder, CEO and Chairman: “Together, New Mountain professionals have invested over $480 million personally into NMFC and New Mountain’s credit activities. I and management remain as NMFC’s largest shareholders. We have continued to add to our personal positions in the last 12 months and Rob, John, and I have never sold a share.”


NMFC Dividend Coverage Update

On May 4, 2021, NMFC entered into a fee waiver agreement and the Investment Adviser agreed to reduce the base management fees not exceed 1.25% of gross assets through December 31, 2022. Also, management has “committed to paying quarterly dividends of at least $0.30 over the next seven quarters” through additional fee waivers. There is a good chance that management would extend the fee waivers if the company was not covering its dividend but management seems confident that would not be needed.

“We implemented a dividend support program for at least until December 31, 2022, by pledging to charge no more than 1.25% management fee on all assets. For that period, we also pledged to reduce our incentive fee if needed to support the $0.30 per share dividend. We do not currently anticipate needing to use this pledge, but want shareholders to have greater confidence in the dividend.”

Contributing to its dividend coverage is the generous 8% hurdle rate which is applied to “net assets” to determine “pre-incentive fee net investment income” per share before management earns its income incentive fees. As shown in the following table, the company will likely earn around $0.267 per share each quarter before paying management incentive fees covering around 89% of the quarterly dividend which is ‘math’ driven by an annual hurdle rate of 8% on equity. It is important to keep in mind that NMFC could earn less than $0.267 per share but management would not earn an incentive fee for that quarter and the calculation is based on the net asset values from the previous quarter.


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

“Equity portfolio with things like Edmentum, Benevis and UniTek and we actually believe there is tremendous potential in those names to create real economic value, but of course for every dollar that’s in a non-yielding piece of equity at non-cash and non-income yielding piece of equity that obviously is a dollar that’s not earning NII in the quarter. Our outlook continues to brighten for those names, and from a timing perspective. The timing of those uncertain right like will you because it’s a lumpy will you exit one of those and convert that into cash, that’s redeployed in NII generative traditional debt securities we just don’t know.”

Subsequent to June 30, 2021, NMFC sold around 34% of its equity position in Edmentum, Inc. which is a good thing for shareholders as management can reinvest the proceeds into other assets with higher income. As shown in the following table, NMFC’s investment is currently valued at over $154 million and accounts for 5.0% of the portfolio. NMFC received total proceeds of almost $48 million and realized gain of around $21 million or $0.22 per share.

“After quarter end, we monetized a portion of our position in Edmentum at an attractive gain, and we remain optimistic about potential gains at other existing portfolio companies. We sold approximately 34% of our equity position to Vistria and their co-investors at that same value, which will show as realized in Q3. We could have rolled our entire position. But we did think it was important to take some chips off the table. The value has grown so meaningfully, it just gets uncomfortable. And there was definitely demand in the newer investor group, even at this higher valuation. But it’s important just from a diversity standpoint, because you use it once and you never know what’s going to happen, right. The twin goals of one, de-risking and monetizing and bringing some cash in that can earn NII as opposed to equity on the one hand versus not selling too early and what I think is an incredibly strong cyclical winner with great execution capabilities.”


It should be noted that NMFC has historical net realized losses and might not need to pay out the gains to shareholders. Management was asked on the recent call and mentioned “we’ll have much more to say on that after the end of the third quarter”:

Q. “On Edmentum, it looks like this puts you in a undistributed earnings situation in some way. I don’t know if it’s how the split is between the ordinary and capital income, but if you can give any color on that, and most importantly, will you be able to retain the spillover or is that something that you’re – will this push you into a higher undistributed income situation?”

A. “It’s a great question and we’re still running the accounting on that as the third quarter evolves. And we’ll have much more to say on that after the end of the third quarter.”

Management has guided for increased amount repayments over the coming quarters which will likely drive lower leverage and has been taken into account with the updated projections:

“Page 23 shows the strength of our new deal activity since the end of the quarter, reflecting the active market that I mentioned in my opening comments. So far in the quarter, we have committed to new investments of $229 million consisting mostly of high quality private financings offset by $151 million of repayments yielding net originations of $78 million. Given the active deal environment, we do have a long list of companies on our repayment watch list, which we believe could be exiting our portfolio throughout the next quarter. These loan repayments represent a material source of cash to fund both our commitments and forward pipeline of new deals.”


There will likely be additional onetime income including accelerated OID related to the prepayments that could drive results closer to the ‘best case’ projections:

Q. “Should we expect potentially an increase in accelerated OID or fees associated with these prepayments that could increase the portfolio yield of these in the near term or are these kinds of more longer dated assets where some of those accelerated fees have kind of already run off?”

A. “There will be a lot of repayments on existing assets. And that’s life as a lender and especially life as a lender that tries to target really quality assets. We do feel very confident, that we can very successfully fill any gaps that are left from repayments, or prepayments, et cetera. And I think on the point around accelerated OID and just extra income that comes from prepayments, that is definitely true. And it’s a mixed bag. Some are going to be longer lived assets and some are going be shorter lived assets. And so I think as velocity is our friend when it comes to releasing a certain amount of modest income. So, that is – I would call it a modest tailwind.”

As discussed in the previous report, management is working to improve its net interest margins by reducing borrowing expenses. In June 2021, the company extended and reduced the borrowing rates on its NMFC Credit Facility. The company redeemed its 5.75% Baby Bond “NMFCL” on March 8, 2021, using the proceeds from its recent private placement of $200 million of 3.875% notes due 2026. These notes were also used to redeem its 5.31% unsecured notes due May 2021.

“On June 4, we amended and extended our NMFC credit facility pushing out our maturity to 2026, while decreasing our applicable spread materially by 40 basis points.”

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

Management has guided for a debt-to-equity ratio of 1.20 to 1.25 less cash and excluding SBA borrowings and is taken into account with the updated ‘base case’ projections:

“Page 14 shows that we continue to manage our statutory leverage ratio at a very comfortable level. Gross debt for the first quarter increased by $68 million, but the increase in net asset value of $48 million resulted in a relatively flat statutory leverage ratio of 1.19 times. We continue to have a number of portfolio companies currently in active sale processes. The anticipated culmination of which will give us additional financial flexibility to either reinvest or further delever. Our intention remained to manage the business at a statutory leverage ratio, net of cash of 1.0 to 1.25 times.”


As discussed in previous reports and shown in the table below, NMFC has limited downside and potential upside to rate increases similar to most BDCs:

“As you can see, the vast majority of our assets are floating rate loans, while our liabilities are 55% fixed rate and 45% floating rate. NMFC’s current bounce sheet mix offers our shareholders consistent and stable earnings in all scenarios where LIBOR remains under 1%. If base rates rise above 1% as the economy normalizes or accelerates, there is meaningful upside to NMFC’s net investment income. For example, assuming our current investment portfolio and existing liability structure, if LIBOR reaches 2%, our annual NII would increase by 8.4% or $0.10 per share. At 3% LIBOR, earnings would increase by 19% or $0.23 per share. We believe this positive interest rate optionality offers meaningful value to our shareholders.”

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

For Q2 2021, NMFC hit best-case projections covering its dividend simply due to the previously discussed fee waivers. There was a slight decline in its portfolio yield offset by increased portfolio growth and dividend income but leverage remains. Around 95% of dividend coverage is from recurring sources which is an increase from previous quarters.

“95% of total investment income is recurring and cash income remains strong at 80% this quarter. We believe this consistency shows the stability and predictability of our investment income.”



What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

OCSL Quick Update: Continued Dividend Increases

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

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


Oaktree Specialty Lending (OCSL) – Quick History

  • On October 17, 2017, Oaktree Capital (OAK) took over management from Fifth Street Asset Management as the investment advisor to OCSL formerly known as Fifth Street Finance (FSC), and OCSI, previously known as Fifth Street Senior Floating Rate (FSFR).
  • On November 29, 2017, OCSL announced calendar Q3 2017 results including a 14% decline in net asset value (“NAV”) per share (from $7.17 to $6.16).
  • On February 8, 2018, OCSL announced a 32% decrease in the quarterly dividend (from $0.125 to $0.085).
  • Over the last ~3.5 years, NAV has increased back to $7.22 and the quarterly dividend is $0.145.
OCSL NAV Per Share

OCSL Dividend Coverage Update

As discussed in the public article “Still Waiting For a Dividend Increase From Oaktree,” I have been expecting OCSL to increase its dividend for a while. The article came out in 2019 and management finally started increasing the dividend in 2020. This was also discussed earlier this year in Growing Dividends During A Pandemic: OCSL.

It should be noted that over the last 14 quarters OCSL has covered the dividend by an average of 127%. This means that management was purposely over-earning the dividend (underpaying the shareholders) which was responsible for around $0.40 per share of NAV growth/reflation.

OCSL Dividend

In March 2021, OCSL closed its merger with Oaktree Strategic Income (OCSI). In connection with the merger agreement, Oaktree has agreed to waive $750,000 of base management fees payable in each of the eight quarters following the closing.

For the quarter ended June 30, 2021, OCSL easily covering its quarterly dividend by 144% due to higher prepayment fees and accelerated OID mostly from William Morris Endeavor:

Adjusted net investment income per share was $0.19, up from $0.14 for the prior quarter, driven by higher adjusted investment income that included higher prepayment fees and OID acceleration. We received $171 million from paydown and exits in the quarter. This included our position in William Morris Endeavor, which generated $7 million of prepayment income that contributed to earnings.”

Source: Q3 2021 Results – Earnings Call Transcript (Emphasis Added by Author)

Oaktree Specialty Lending Financials

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

We remain focused on positioning the portfolio for an improved yield by rotating out of lower-yielding investments and into higher-yielding proprietary loans. We made good progress on this in the third quarter, exiting $39 million of these types of investments. As of quarter end, $142 million of senior secured loans priced at or below LIBOR plus 4.5% remained in the portfolio, including approximately $67 million of loans that we acquired in the OCSI merger. Our new investments during the quarter came in at attractive yields which means there is significant improvement in yield on that portion of the portfolio that can be realized over time. We exited some low-yielding investments and made further progress on exiting noncore investments, monetizing $19 million across 3 equity positions. Noncore investments represented just 6% of the portfolio at fair value at quarter end. The weighted average yield on our new debt investment commitments was an attractive 9.2% and compares favorably to the average yield of 6.1% on investments that we exited.”

Source: Q3 2021 Results – Earnings Call Transcript (Emphasis Added by Author)

Oaktree Specialty Lending

Source: Q3 2021 Results – Earnings Presentation


We also have the opportunity to further optimize both of our joint ventures. We can accomplish this by selectively rotating out of lower-yielding investments into higher-yielding ones as well as increasing leverage at the JVs. We made good progress on this front in the quarter, growing the JV portfolios by $36 million. The Kemper JV had $387 million of assets invested in senior secured loans to 57 companies. This compared to $352 million of total assets invested in 55 company’s last quarter. Leverage at the JV was 1.4x at quarter end, up slightly from 1.3x in the March quarter. Given the strong balance sheet and earnings power at the Kemper JV, OCSL received a $450,000 dividend this quarter. We anticipate we will receive a dividend in this amount going forward. The Glick JV had $148 million of assets at June 30. These consisted of senior secured loans to 38 companies. Leverage at the JV was 1.1x at quarter end. OCSL subordinated note in the Glick joint venture totaling $55 million continues to be current. We expect to receive ongoing coupon interest and principal repayments of approximately $1.3 million per quarter on a run rate basis going forward.”

Source: Q3 2021 Results – Earnings Call Transcript (Emphasis Added y Author)

Oaktree Specialty Lending Joint Ventures

Source: Q3 2021 Results – Earnings Presentation


On May 11, 2021, OCSL announced that it had priced $350 million of 2.700% of unsecured notes due January 15, 2027, taken into account with my updated projections. OCSL had growth capital available given its historically low leverage with a debt-to-equity ratio of 0.79 (net of cash) as of June 30, 2021.

Another opportunity for us to increase ROE is by deploying more leverage at the portfolio level. As of June 30, our net leverage was below the low end of our long-term target of 0.85 to 1.00. We would expect to continue to enhance returns as we make incremental investments and deploy higher leverage.”

Source: Q3 2021 Results – Earnings Call Transcript (Emphasis Added by Author)

On August 5, 2021, OCSL announced a $0.145 per share for Q3 2021, up 11.5% from the prior quarter paid on September 30, 2021, to stockholders of record on September 15, 2021.

Armen Panossian, CEO and CIO: “The third quarter was highlighted by strong earnings and continued robust portfolio performance. Adjusted net investment income was $0.19 per share, up 58% from the same quarter a year earlier. This reflected new origination activity at attractive yields over the prior year and the successful exit of one of our opportunistic investments made in the wake of the pandemic. NAV grew again this quarter to $7.22 per share, a 1.8% increase from March 31, 2021, as the portfolio continues to perform well and our credit quality remains excellent.”

Source: Q3 2021 Results – Earnings Call Transcript


Summary

As mentioned earlier, OCSL’s earnings will continue to improve through the use of higher leverage, continued rotation into higher yield investments, accretive impacts from the merger including fee waivers as well as higher returns from its joint ventures. Even after taking into account the recent increase in the regular quarterly dividend from $0.130 to $0.145 per share, OCSL is still paying less dividends as a % of NAV (equity/book value) than the average BDC. The average BDC pays around 9.3% of NAV per share in distributions each year which would be around $0.168 per share per quarter for OCSL (using the current NAV of $7.22). I am currently projecting additional dividend increases to $0.16 per quarter or $0.64 annually which would imply a dividend yield of 8.8% based on the current price of $7.24 (as of August 26, 2021).

As shown in the following table, OCSL has lower leverage (debt-to-equity) combined with higher dividend coverage over the last four quarters. I have not included the dividend coverage averages for FCRD and PTMN because I do not cover these BDCs due to having higher risk portfolios and they are thinly traded. I cover NEWT but it has a very different business model as discussed in “Newtek Business Services: Initiating Coverage“.

AINVMRCC, and FSK have recently had higher dividend coverage only due to not paying incentive fees related to previous capital losses. Dividend coverage will decline once these companies start paying incentive fees. Also, BDCs such as SUNS with lower leverage have access to growth capital to improve dividend coverage and are likely just taking a cautious approach to rebuild their portfolios during the economic recovery.

OCSL Dividend Coverage, yield

What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

GBDC Quick Update: Excellent Portfolio Growth

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

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


Golub Capital (GBDC)

Golub Capital is considered a lower risk BDC for many reasons including its higher credit quality portfolio of mostly lower yield first-lien and one-stop loans with strong covenant and security protections in mostly non-cyclical sectors. Also, the portfolio is well diversified with very low concentration risk and with an average investment size of less than 0.4% of the portfolio and the top 10 accounting for around 16%.

Golub Capital Portfolio

Source: GBDC Earnings Presentation


GBDC Conservative Management and Fee Structure

It should be noted that GBDC is for lower yield investors with conservative management, lower yield portfolio investments, and investor-friendly fee structure including a base management fee of 1.375% of average adjusted gross assets (compared to 1.50% to 2.00%, for most) excluding cash and cash equivalents. GBDC’s fee structure includes a “total return hurdle” which means that its incentive fee structure protects total returns to shareholders by taking into account capital losses when calculating the income portion of the fee. Also, incentive fees are only paid after the hurdle rate is reached, requiring a minimum return on net assets of 8% annually. However, GBDC currently is below the 8% hurdle so management was not paid an incentive fee for the quarter ended June 30, 2021, as discussed later.

During the early stages of the COVID crisis, management took various measures to strengthen the balance sheet including a ‘rights offering’ as well as reducing the quarterly dividend from $0.33 to $0.29 per share. As shown in the previous chart 100% of GBDC’s loans are at floating rates which were impacted as the Fed reduced rates.

To be completely honest I think the rights offering was not needed as GBDC already had relatively lower leverage/stronger asset coverage coupled with higher quality assets (to support higher leverage). However, management was likely just taking a conservative approach not knowing the full extent of the impacts of the pandemic on its portfolio companies which might need additional capital drawing on the unfunded commitments which was a large concern at the time.

Golub Capital Rights offering

Source: GBDC Earnings Presentation

On May 14, 2020, GBDC announced the final results of its transferable rights offering, which entitled holders of rights to purchase one share of common stock for every right held at a subscription price of $9.17 per share.

GBDC rights offering

Source: GBDC Announcement

Along with most of my subscribers, I took full advantage of the offering easily outperforming the S&P 500 over the last 17 months:


Operating Cost as a Percentage of Available Income

As a part of assessing BDCs, it’s important to take into account expense ratios. BDCs with lower operating expenses can pay higher amounts to shareholders without investing in riskier assets.

“Operating Cost as a Percentage of Available Income” is one of the many measures that I use which takes into account operating, management, and incentive fees compared to available income.

  • “Available Income” is total income less interest expense from borrowings and is the amount of income that is available to pay operating expenses and shareholder distributions.

Many BDCs have been temporarily waiving fees or have fee agreements that take into account previous capital losses that are ending this year. The following table shows the average adjusted operating cost ratios for each BDC over the last four quarters without the benefit of temporary fee waivers with examples for GBDC and PSEC.

Golub Capital Financials

GBDC Dividend Coverage

I’m expecting improved dividend coverage for GBDC over the coming quarters for many reasons including portfolio growth through increased leverage, lower borrowing rates, and improved net interest margins, as well as recent/continued increases in its net asset value (“NAV”) per share.

The following table shows the “pre-incentive fee net investment income” per share before management earns income incentive fees based on “net assets.” GBDC will likely earn around $0.30 per share each quarter before paying management incentive fees which is “math” driven by an annual hurdle rate of 8% on equity. It’s important to note that the calculation is based on the net asset values from the previous quarter.

GBDC dividend

As mentioned earlier, GBDC is currently below the 8% hurdle so management was not paid an incentive fee for the quarter ended June 30, 2021. As you can see in the following table, GBDC’s earnings/NII per share has been improving even with similar amounts of total income mostly due to lower incentive fees paid to management as NAV continues to increase as discussed later in this report.

Golub Capital Income

GBDC Leverage and Portfolio Growth

BDCs with higher quality portfolios can support higher leverage. Around 96% of GBDC’s portfolio is bank-like quality debt positions at much lower yields than typical BDCs:

Golub Capital Leverage

Source: SEC Filing

The following table shows each BDC ranked by its debt-to-equity ratio net of cash along with its portfolio mix. The “Other” column includes everything that is NOT first or second-lien secured debt. I typically do not cover most of the higher-risk BDCs for many reasons but mostly because these are NOT typically buy-and-hold investments. PTMNFSKFCRD, PSEC, and OXSQ have higher risk portfolios due to higher amounts of non-secured debt, joint ventures, senior loan programs, CLOs, and/or equity positions that all carry much higher external leverage.

Many of the BDCs with lower leverage also have lower dividend coverage over the last four quarters including GBDC. I’m expecting improved dividend coverage for many BDCs as leverage increases as well as higher amounts of first-lien positions (to support higher leverage).

BDCs portfolios

Management is expecting higher portfolio growth over the coming quarters partially due to lower amounts of prepayments:

Q. “I know you guys were just slightly below the low end of your hurdle rate this quarter and therefore, did not earn the incentive fee. I’m just curious, are you OK with, I guess, operating around that area kind of right at or even below the low end of your hurdle, or would you – is the goal to essentially generate an ROE that’s maybe above that 8%. I’m just trying to get your thoughts around the hurdle rate.”

A. “I think this quarter was a bit of an anomaly because the degree of repayments was as high as it was. My expectation is that we’re going to see growth in the size of the portfolio that in turn will grow net investment income and will give us more pre-incentive fee net investment income. I think when we look backwards, we’ll see this quarter as a bit of an anomaly in the respect that you’re mentioning. I think it’s good for shareholders, if we can operate in or above the catch-up as opposed to below the catch-up, provided we can do so without taking too much credit risk.”

“Let’s look together at page 12 of the presentation and the second line in the table, exits and sales of investments. And you can see that the June 30, 2021 quarter at $583.5 million is the outlier on this chart. It’s literally more than twice the December 31 quarter, 1.5 times the March 31 quarter. So, if you ask me to make a prediction, my prediction is that we will not see a sustained level of exits and sales of investments at the June 30th level. Over time, in my experience, our assets tend to have a weighted average life between 2.5 and 3 years. The $583.5 is effectively a weighted average life that’s closer to 2. I think we’re going to be able to continue to make good progress on originations. I think exits and sales will moderate, and we’ll start seeing some portfolio growth.”

Source: GBDC Earnings Call

GBDC exits and sales of investments

Source: GBDC Earnings Presentation


Reading The Tea Leaves

On Oct. 7, 2021, GBDC priced $200 million of notes due 2026 (YTM of 2.667%) and $100 million of notes due 2024 (YTM of 1.809%). These are excellent fixed rates for flexible unsecured borrowings due 2026 and 2024.

It’s important to note that GBDC has not announced the note offering on its website and there was no press release as of the writing of this article and this information was only available through the associated SEC filings which included:

As of October 4, 2021, we had approximately $2.6 billion of debt outstanding, approximately $1.2 billion of which was unsecured senior indebtedness (represented by the 2024 Notes, the Existing Notes, and the 2027 Notes) that will rank equal to the Notes, approximately $954.7 million of which was indebtedness secured by substantially all of the assets of our subsidiaries and that will be structurally senior to the Notes, and approximately $472.1 million of which was indebtedness secured by substantially all of our assets and that will be effectively senior to the Notes. As of October 4, 2021, we had no amounts outstanding under the debentures of the SBIC Fund, or the SBA Debentures.”

Source: SEC Filing

This information is important as is it implies that GBDC had an active calendar Q3 2021 with plenty of portfolio growth that I have taken into account with the updated financial projections. As shown in the table below, GBDC had $2.1 billion in debt outstanding and $154 million in cash (as of June 30, 2021) which is above the average cash balance of around $30 million for the previous quarters. This implies that GBDC had portfolio growth of around 10% or $400 million to $500 million which would be its largest quarter of net originations (after taking into account repayments) but of course we do not have the amount of cash available and other items that could temporarily impact the amount debt. However, there’s a very good chance that GBDC had an excellent quarter with significant portfolio growth for improved earnings over the coming quarters.

GBDC income statement

As shown in the table below, $2.6 billion in debt would be meaningfully higher than previous quarters:

Golub Capital debt

Why Is This Information Important?

Great question and the easy answer is “a meaningful improvement in dividend coverage” over the next two quarters. How meaningful? This is where you need to do your own due diligence to assess the impacts on dividend coverage. Obviously, you’re busy and maybe do not have time to put together a financial projection which is why many people use various research services that cover BDCs which can be difficult to find. Especially services focused on BDCs as they are very different from other income-oriented investments.

First of all, you need a service that will keep you up to date on information contained in the SEC filings as well as when BDCs start to report results which is starting next week. Please make sure that your service provides detailed financial projections for each of the BDCs that you plan to invest in because historical coverage is not a good indicator of upcoming coverage. For each BDC I use a “Base” case projection along with “Best” and “Worst” cases over the next three quarters. I find that going out much further than three quarters is pointless as BDC balance sheets change constantly adapting for upcoming economic conditions.

I typically do not provide financial projections in public articles but below is a quick example of the ‘base case’ projections for GBDC taking into account the previously discussed information as well as the rest of the information provided in this article including changes to borrowing rates, net interest margin, and management fee agreement.

Again, historical dividend coverage is not a good indicator of upcoming coverage for many reasons including access to growth capital and temporary fee waivers (discussed earlier) so please make sure that you’re getting this information before investing in BDCs.

GBDC base case scenario

GBDC Improved Net Interest Margin

Similar to all BDCs, management is working to reduce borrowing rates including the recently issued notes and lower-cost credit facilities. On Aug. 3, 2021, GBDC issued $350 million of unsecured notes at 2.050% (yield-to-maturity of 2.274%) due in 2027 using a portion of the proceeds to redeem $189 million of notes with a weighted average interest rate of 3-month LIBOR + 2.44%. This is an excellent fixed rate for flexible unsecured borrowings due 2027. In April 2021, the company amended its revolving credit facility with Morgan Stanley reducing the interest rate on borrowings to 1-month LIBOR + 2.05% from 1-month LIBOR + 2.45%.

GBDC net interest margin

Source: GBDC Earnings Presentation

On August 3rd, we issued $350 million of unsecured notes, which bear a fixed interest rate of 2.05% and mature on February 15, 2027, bringing unsecured debt up to approximately 50% of GBDC’s total funding mix. The $350 million issuance of new unsecured notes mature in February 2027 and have a fixed interest rate of 2.05%, the lowest coupon ever achieved by a BDC at the time.”

Source: GBDC Earnings Call

GBDC debt capital structure

Source: GBDC Earnings Presentation

As shown in the following chart, the net interest margin (green line) increased to 5.1% due to the continued decline in the weighted average cost of borrowings.

This graph summarizes portfolio yields and net investment spreads for the quarter, focusing first on the light blue line. This line represents the income yield or the actual amount earned on our investments, including interest and fee income, but excluding the amortization of upfront origination fees and the GCIC purchase price premium. The income yield decreased by 10 basis points to 7.4% for the quarter ended June 30, 2021. The investment income yield or the dark blue line, which includes the amortization of fees and discounts, also decreased by 10 basis points to 7.9% during the quarter. Our weighted average cost of debt, or the aqua blue line, decreased by 20 basis points to 2.8%, primarily due to the early redemption of $165 million in higher-priced SBIC debentures in the prior quarter. Our net investment spread, the green line, which is the difference between the investment income yield and the weighted average cost of debt, increased by 10 basis points to 5.1%.”

Source: GBDC Earnings Call

GBDC dividend coverage

Source: GBDC Earnings Presentation


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

TCPC Quick Update: Likely Upgrade Next Month

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

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


TCPC Dividend Coverage Update

Similar to most BDCs, management continues to improve or at least maintain its net interest margin through reducing its borrowing rates including its SVCP Credit Facility reduced to L+1.75% announced on June 24, 2021, and an additional $150 million of 2.850% notes due 2026 issued on August 27, 2021, used to redeem $175 million of 4.125% notes due 2022. Both Fitch and Moody’s reaffirmed the Company’s investment-grade rating with a stable outlook.



As of June 30, 2021, available liquidity was approximately $373 million, including $388 million in available capacity under its leverage program, $18 million in cash and cash equivalents, and $34 million in net outstanding settlements of investments purchased.


During Q2 2021, leverage decreased during the previous quarter and remains below its targeted debt-to-equity ratio currently at 1.03 excluding SBA debentures giving the company some cushion for upcoming portfolio growth and improved earnings.

I am expecting dividend coverage to improve over the coming quarters through continued lower borrowing rates (discussed earlier), rotation out of equity positions into income-producing debt positions (discussed next), and reduced incentive fees. As mentioned in previous reports, management was not paid an incentive fee for Q1 2020 and deferred the cost evenly over the following six quarters which added around $643,000 of additional expense each quarter. The good news is that Q3 2021 is the last quarter for these deferred expenses which is taken into account with the previous projections:

“Incentive fees related to our income from the first quarter of 2020 were deferred when our performance temporarily fell below the total return hurdle. We voluntarily deferred the amount over 6 quarters through September of this year, subject to our cumulative performance remaining above the hurdle. We believe this deferral further aligns our interest with our shareholders and demonstrates our confidence in the strength of our portfolio and its earnings capacity over time.”


I am expecting continued dividend income including from Edmentum, Inc. (not as much as Q1 2021) which was discussed by management on the recent call:

“Dividend income in the Second Quarter included $1.1 million or $0.02 per share of recurring dividend income on our equity investment in Edmentum.”

Subsequent to June 30, 2021, TCPC sold around one-third of its equity position in Edmentum which is a good thing for shareholders as management can reinvest the proceeds into other assets with higher income. As shown in the following table, TCPC’s investment is currently valued at over $103 million and accounts for 5.7% of the portfolio. Management did not mention which shares they sold but using an average would imply proceeds of around $34 million and realized gain of around $15.5 million or $0.27 per share. It should be noted that TCPC has historical net realized losses and will not need to pay out the gains to shareholders.


Management discussed Edmentum on the recent call:

Q. “Following up on the question regarding Edmentum, can you repeat your comments there? I believe you said you had a $1.1 million of recurring income in the second quarter from that investment. Should we expect future income from Edmentum? And then how does that look regarding post-sale of a portion of your position, as well as on top of that, when you sold down a 1/3 of your position, how did that amount come about? Why was it not a full exit or why did you guys not choose to hold all? Why did you guys just right size it down to just selling off 1/3?”

A. “It is a recurring dividend income. We’re invested both in a preferred equity tranche and then the common equity as well. And as you recall, last quarter we had somewhat elevated level of dividend income, but this was more normalized recurring. But as you mentioned, we did sell down a portion of that equity position. This comes as a result of a nice run-up in the valuation, and also realized exit in part at those elevated valuations. The benefit here is we can take those proceeds and obviously redeploy it into our more normative investment profile for interest income. We do believe, obviously, as part of a sell-down, that it was important to manage the position size. Being an equity owner of a business is not the normative strategy. Doing so as a way to really fully realize the work effort and the benefits of that work and the position was part of the sell-down philosophy. We are still excited about the business. It’s well-positioned. There’s been a lot of work to get it to where it is today. I do think there are ongoing positive winds in the sails, so to speak, for the business. You have new institutional investors who have come in, as well as part of this transaction. So we want to be a part of that success on an ongoing basis, but we want to balance it with what the core part of the strategy is, as well as managing a diverse and well-diversified book with the growth in net position. And that is a combination of things that led us to partially exit, take some chips off the table, but also be a part of the future success of the business.”

Management was asked about selling some of the other equity investments on the recent call:

Q. “Just looking at the overall asset mix of the portfolio, you’ve clearly benefited from the strong performance on the equity side, and I believe equity is now 11% of assets after the event on sales. Be great if you could get a little color around how you’re thinking about, the asset mix moving forward. Do you think that we should expect to see more monetization of the equities position?”

A. “We are focused on credit instruments. It is the primary strategy where we have equity. It’s a function of either some ability to have warrants or things that convert into that or it’s a function of something like inventing somewhere. The path to defending our capital is defined by converting to a different instrument, which is really the exception, not the rule. Fortunately, those — a number of those have worked out, in some cases very well. But I would say, in terms of normal course activity, you should expect this to be a debt — primarily a senior secured debt portfolio, occasionally, things need a little bit of different type of work or activity that may result in equity, but if that is really not the primary focus, that is a function of protecting the portfolio versus deploying it in an original investment.”

As shown below, equity investments have grown from $109 million to $218 million partially due to marking up Edmentum and accounted for around 11.9% of the portfolio as of June 30, 2021. There is a good chance that management will be monetizing some of these investments which will drive additional recurring interest income and is taken into account with the ‘best case’ financial projections shown earlier.


On a previous earnings call, management was asked about resetting the dividend higher (closer to the previous level) and mentioned the lumpy nature of fee, dividend and prepayment-related income, “investors take comfort from dividend stability” and “great pride and comfort from knowing that we’ve got good dividend coverage”. I agree but there is a chance that the amount of recurring/stable earnings could increase enough to support a higher dividend due to continued lower borrowing rates, reduced incentive fees, and rotation out of equity positions into income-producing debt positions. Again, these are taken into account with the ‘best case’ projections.

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

A “So yes, we did this during the lockdown. But we were also reacting to the very significant change in LIBOR, and the math is set out. And so when we made that decision, it was really primarily looking at LIBOR as opposed to events in the portfolio. We’re very proud of having earned our dividend every quarter. We think investors take comfort from dividend stability, knowing that it’s well-earned and appropriately covered. And that’s really been our focus. I think the other thing is, as you look at our earnings, we benefited from prepayment fees. And as we discussed earlier on the call, those are lumpy. We take great pride and comfort from knowing that we’ve got good dividend coverage. But we also know that there’s a certain lumpiness to the extra earnings from additional fees, dividends and prepayments.”

Historically, the company has consistently over-earned its dividend with undistributed taxable income. Management will likely retain the spillover income and use for reinvestment and growing NAV per share and quarterly NII rather than special dividends. On August 2, 2021, the Board declared a third quarter dividend of $0.30 per share payable on September 30, 2021, to stockholders of record as of the close of business on September 16, 2021.


For Q2 2021, TCPC reported slightly below its base-case projections due to lower-than-expected dividend and other income as well as lower portfolio yield covering its dividend by 103%. The amount of payment-in-kind (“PIK”) income continues to decline from 7.6% in Q2 2020 to 2.4% in Q2 2021 the lowest level of PIK income in three years.

“Investment income for the Second Quarter was $0.72 per share. This included recurring cash interest of $0.61, recurring discount and fee amortization of $0.03, and PIK income of $0.02. Notably, PIK income is at a lowest level in more than 3 years. As a reminder, 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.”

On July 29, 2021, the Board re-approved its stock repurchase plan to acquire up to $50 million of common stock “at prices at certain thresholds below our net asset value per share”. There were no additional shares repurchased during Q2 2021.


Previous reports correctly predicted the reduction of TCPC’s quarterly dividend from $0.36 to $0.30 which was at the top of my estimated range of $0.28 to $0.30. At the time, the company had spillover or undistributed taxable income (“UTI”) of around $0.78 per share. However, this is typically used for temporary dividend coverage issues. Please do not rely on UTI as an indicator of a ‘safe’ dividend. The previously projected lower dividend coverage was mostly due to lower LIBOR and portfolio yield combined with management keeping lower leverage to retain its investment-grade rating. Again, the previous declines in LIBOR were mostly responsible for the decline in portfolio yield with “limited exposure to any further declines”.

“Since 12/31/2018, LIBOR has declined 265 basis points or by 95%, which has put pressure on our overall portfolio yield. However, 87% of our floating rate loans are currently operating with LIBOR floors. And given that 94% of our loans are floating rate, we are well-positioned to benefit when rates eventually rise.”


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:

“Our recurring income is spread broadly across our portfolio and is not reliant on income from any one company. In fact, over half of our portfolio companies each contribute less than 1% to our recurring income.”


TCPC Risk Profile Quick Update

There were no additional loans added to non-accrual status that remain low representing 0.3% of the portfolio at fair value and 0.7% at cost. CIBT Solutions, Inc. remains on non-accrual status (was added during Q3 2020) and is a provider of expedited travel document processing services serving multinational corporations, global travel management companies, tour and cruise operators, government agencies, and Do-It-Yourself travelers. GlassPoint Solar, Inc. was exited during Q1 2021 and Avanti Communications remains on non-accrual. If these investments were completely written off the impact to NAV per share would be around $0.11 or 0.8%.


As discussed in the previous report, Edmentum is a provider of online learning programs that was acquired by Vistria Group resulting in a full recovery. Similar to NMFC, TCPC chose to re-invest a meaningful portion of the proceeds ($54.4 million) and “remain a significant shareholder of Edmentum, due to strong conviction in the continued growth”. As mentioned earlier, TCPC sold a third of its equity position in Edmentum and will record a realized gain in Q3 2021.

“Unrealized gains primarily reflected a $40.7 million gain on our investment in Edmentum, as a result of an additional equity investment committed to the company in the second quarter. Edmentum continues to benefit from the dramatic increase in demand for online education. Additional equity investment also resulted in the sale of approximately one-third of our investment in the Company post-quarter end. Unrealized gains in the second quarter also reflected overall spread tightening and continued market recovery, as well as improved investor sentiment following the significant market dislocation in the first half of last year, as a result of the pandemic.”

During Q2 2021, TCPC’s net asset value (“NAV”) per share increased by another $0.65 or 4.8% (from $13.56 to $14.21) primarily driven by additional gains on its investment in Edmentum (similar to previous quarters) partially offset by markdowns for Amteck and Fishbowl Inc.

“In the second quarter, our net asset value increased 4.8%, and the year-over-year, net asset value is up 16.4%. This is our fifth consecutive quarter of net asset value increases, and builds on the positive net asset value accretion we had during 2020, a result of which we are extremely proud. The increase in NAV in Q2 was primarily driven by a $41 million unrealized gain on our investment in Edmentum together with more modest increases in value across the portfolio.”

“Unrealized gains were partially offset by the reversal of $7.6 million of unrealized gains on Amtech, and $5.3 million in unrealized losses from Fishbowl. Fishbowl provides marketing software and services to restaurants, and these are only direct exposure to the restaurant industry. Given Fishbowl’s exposure to this industry, the Company has been slower to recover. Substantially, all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent valuation services, and our process is also subject to rigorous oversight, including back testing of every disposition against our valuations.”


“Our portfolio is also weighted towards companies with established business models in less cyclical industries. The portfolio remains diverse at quarter-end and was made up of investments in 108 companies. As the chart on the left side of slide 6 shows of the presentation, our recurring income is spread broadly across our portfolio and is not reliant on income from any one company. In fact, over half of our portfolio companies each contribute less than 1% to our recurring income. 87% of our debt investments are first-lien, providing significant downside protection, and 94% of our debt investments are floating rate, positioning us well for when interest rates eventually rise.”


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

 

GSBD Quick Update: Dividend Coverage to Improve

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

  • GSBD target prices/buying points
  • GSBD risk profile, potential credit issues, and overall rankings
  • GSBD dividend coverage projections (base, best, worst-case scenarios)


GSBD Dividend Coverage Update

GSBD has covered its dividend by an average of 105% over the last 8 quarters growing spillover/undistributed income to around $0.46 per share for temporary dividend coverage shortfalls but the company will likely retain rather than use to pay special dividends.

From previous call: “The company had $46.6 million in taxable accumulated undistributed net investment income at quarter end, resulting from net investment income that has exceeded our dividend historically. Pro forma for the completion of the merger at the end of Q3, this equates to $0.46 per share.”

GSAM is waiving a portion of its incentive fee for the four quarters of 2021 (Q1 2021 through and including Q4 2021) in an amount sufficient to ensure that GSBD’s net investment income per weighted average share outstanding for such quarter is at least $0.48 per share per quarter. However, as shown in the previous financial projections, there is a good chance that the company will be able to cover the dividend without the need for fee waivers.

On August 5, 2021, the Board reaffirmed its regular dividend of $0.45 per share payable to shareholders of record as of September 30, 2021. Previously, the company paid a special dividend of $0.05 per share in May 2021 which is the second of its three quarterly installments of special dividends aggregating to $0.15 per share in connection with the merger.

For Q2 2021, GSBD reported slightly above its best-case projections due to much higher-than-expected portfolio yield driven by an increase in accelerated accretion related to repayments partially offset by lower portfolio growth (decline) and lower fee and dividend income. Leverage (debt-to-equity) again declined to a new near-term low of 0.91 (net of cash) giving the company adequate growth capital for increased earnings potential.

“For the third consecutive quarter, GSBD experienced a new high watermark for repayment activity, which amounted to $277 million of market value across 12 different portfolio companies this quarter. Fortunately, our powerful origination engine has largely kept pace during this active repayment environment. We expect to resume balance sheet growth in the back half of the year moving closer to more normalized net debt to equity ratios from this quarter and level of 0.91 times.”

However, management is not expecting the same level of repayments over the coming quarters:

“I do think that we will start to see a bit of a moderation at least in the short-term of some of that repayment activity relative to our pipeline of investment activity. And that should give rise to some portfolio growth.”


Similar to other BDCs, GSBD has been lowering its borrowing rates as well as constructing a flexible balance sheet including the public offering of $500 million of 2.875%unsecured notes due 2026. On August 13, 2021, amended its Truist Revolving Credit Facility to reduce the asset coverage required to reduce the stated interest rate from LIBOR plus 2.00% to LIBOR plus 1.875%. Previously, the company issued $360 million of unsecured notes due 2025 at 3.750%. As of June 30, 2021, 63% of its borrowings were unsecured with $1.1 billion of availability under its credit facility and $120 million in cash. Fitch’s reaffirmed GSBD’s investment grade rating of BBB- and revised the outlook to stable.

“At quarter end, 63% of the company’s outstanding borrowings were unsecured debt and $1.1 billion of capacity was available under GSBD’s secured revolving credit facility. Given the current debt position and available capacity, we continue to feel we have ample capacity to fund new investment opportunities with borrowings under our credit facility.”

On October 12, 2020, GSBD completed its merger with Goldman Sachs Middle Market Lending (“MMLC”) which doubled the size of the company including significant deleveraging. This created more capacity to deploy capital while adding a greater margin of safety to maintain GSBD’s investment-grade credit rating. Previously, shareholders approved the reduced asset coverage ratio of at least 150% (potentially allowing a debt-to-equity of 2.00) and management reduced the base management fee from 1.50% to 1.00%.


GSBD Risk Profile Quick Update

On June 11, 2021, its non-accrual investment in GK Holdings, Inc. (Global Knowledge) was partially repaid due to a SPAC-related merger with a competitor resulting in a small realized loss of $0.01 per share but reduced non-accruals. As of June 30, 2021, investments on non-accrual status accounted for 0.0% and 0.3% of the total investment portfolio at fair value and cost, respectively. It should be noted that GSBD has placed only one portfolio company on non-accrual status over the last six quarters.

“This decline in non-accrual is primarily a result of the repayment of our investment in GK Holdings. On June 11, GK Holdings consummated a merger with competitor in conjunction with incremental capital from a SPAC. As a result, GSBD received partial repayments on both first lien and second lien positions and received past due interest on the first lien position. GSBD rolled a portion of the existing loan into a new loan to the combined company, which is called Skillsoft in a deleveraged structure. Subsequent to quarter end, Skillsoft refinance its capital structure and repaid that remaining loan. So as a result of these transactions, we have fully exited our investment. And while we’re never placed an investment on non-accrual, we do think that this transaction is a demonstration of the care and effort that we put into our underperforming positions


During Q1 2021, there was around $7.5 million or $0.07 per share in realized gains related to the sale of its equity investment in Wrike, Inc in March 2021.


There has been continued improvement in the amount of investments considered ‘Rating 3’ to have “risk has increased materially” and/or “out of compliance with debt covenants” from 15.6% to 5.6% of the portfolio over the last three quarters.

Rating 3 investments indicate that the risk to our ability to recoup the initial cost basis of such investment has increased materially since origination or acquisition, including as a result of factors such as declining performance and non-compliance with debt covenants; however, payments are generally not more than 120 days past due;

“The underlying performance of our portfolio companies overall was stable quarter-over-quarter. The weighted average net debt to EBITDA of the companies in the portfolio was 5.9 times at quarter end, which is a slight improvement from 6 times at the end of the last quarter. The weighted average interest coverage of the companies in our investment portfolio was 2.6 times, again, a slight improvement from the 2.5 times at the end of the prior quarter. Consistent with our history, none of our investment activity this quarter was in so-called covenant-lite structures. Furthermore, in certain positions where we were the incumbent lender, we opted not to roll into new deals that did not meet our standards for risk reward characteristics sometimes based on rate and other times based on structure and document integrity.

“The focus of the platform continues to be that heart of the middle markets that business that does maybe up to $50 million of EBITDA focusing on sectors where could be bigger capital structures in parts of, for example, the technology and software space but the nature of the underwrite, the nature of the growth trajectory of those businesses requires a little bit of a more structured credit investment and we’ve been doing that for quite a long period of time. Even in those bigger cap opportunities, our history, our position of that market allows us to continue to be quite successful there.”

During Q2 2021, GSBD’s net asset value (“NAV”) per share increased slightly by 0.3% due to over-earning the dividends.

“Net asset value per share increased to $16.05 per share as of June 30, an improvement of approximately 30 basis points from the end of the first quarter. Against the accommodative overall market backdrop, the NAV increase resulted from ongoing stable to improving performance our portfolio companies offset slightly by the impact of $0.50 per share specialty event paid during the quarter.”


As discussed in the previous report, Animal Supply Holdings and Convene 237 Park Avenue have been recently marked down and need to be watched. During Q3 2020, its first-lien debt investment, preferred and common equity in Animal Supplywere exchanged for second lien debt, common equity and a right to purchase additional first-lien debt, second lien debt, and common equity, which resulted in a realized loss $0.89 per share. Convene focuses on shared meeting spaces directly impacted by the pandemic but has recently received additional capital from its equity shareholders and junior capital (below GSBD’s first-lien position).

“So Convene is focused on providing shared meeting space services and leading — it’s a first lien investment in top of the capital structure, very well structured, leading into the pandemic, really performing quite, quite well, broadly benefiting from a trend around people wanting to optimize their real estate footprints. One of the least efficient uses of your real estate is a big shared meeting space that gets used on a less frequent basis, so big secular tailwinds driving their business. But of course, in the lockdown environments, a lot of challenges within that business, really, a remarkable, I would say, management effort to get the business’s cost structure down significantly to reduce the rent payments quite significantly as well. In addition, we’ve had significant support from the equity shareholder base that has infused additional liquidity into the company. So we, like you, are looking forward to a bit more of a normalization of behavior more broadly. And I think in the current environment, appropriate to mark that investment down. But like I noted, we do take comfort in junior capital beneath us coming into the business and more broadly, the vaccine rollouts that are really starting to take hold here, resulting in a very different return to office, for example. And I think just more significant social interaction.”


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

 

PNNT Quick Update: Waiting On A Dividend Increase

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

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


PNNT Dividend, NAV Per Share & Management Fees Update

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

“With regard to growing net investment income, we have a three-pronged strategy, which includes; number one, growing assets on balance sheet at PNNT as we move towards our target leverage ratio of 1.25x, debt-to-equity from 0.8x; number two, growing our PSLF JV with Pantheon to about $550 million of assets from approximately $400 million of assets through balance sheet optimization, including a potential securitization; and three, the opportunity to rotate out of our equity investments over time into yield instruments. Equity investments held for the past 12 months have appreciated by approximately 45%, driven by many of the companies previously mentioned. Our long-term goal continues to target that percentage down to about 10% of the portfolio. As we monetize the equity portfolio, we are looking forward to investing the cash and to yielding debt instruments to increase net investment income.”

As predicted in the previous report, there was $41.7 million or $0.62 per share of realized gains during Q2 2021. Please keep in mind that the company is only paying $0.12 per share of quarterly dividends so this is a significant amount and was predicted in previous reports.

“We are making substantial progress on the exit of those equity investments. Additionally, we have been actively investing in new loans since the most recent quarter end and the outlook in our view for continued growth is excellent. During the quarter, we generated $51 million of cash proceeds from the equity portfolio, including proceeds from Wheel Pros, Walker Edison, DecoPac, WVB, Cano, and others.”

There is a good chance that PNNT will be selling its equity positions in Cano Health, Inc. (CANO), PT Networks, and Walker Edison Furniture over the next 12 to 18 months. These investments account for over $130 million or 11.4% of the portfolio with the proceeds to be reinvested into income-producing assets.

As shown in the table below, these investments are marked well above cost and will likely result in a total of $107 million or $1.60 per share of realized gains.


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

“We are pleased that we have significant equity investments in several of these companies, which can substantially move the needle of our NAV. I would like to highlight some of those companies; the companies are Cano, Walker Edison, PT Network, and JF Petroleum. These companies are gaining financial momentum in this environment and our NAV should be solidified and bolstered from these substantial equity investments as their momentum continues.”

“PT Network is the leading physical and occupational therapy provider in the Mid-Atlantic States. Our equity position has a cost of $23 million and a fair market value of $60 million as of June 30. MidOcean JF Holdings or JF Petroleum, is a leader in the distribution, installation and servicing of vehicle fueling, and related equipment to retail fueling locations in the U.S.”

“Walker Edison is a leading e-commerce platform focused on selling furniture exclusively online through top e-commerce companies. Our equity position has a cost of zero and a fair market value of $9.5 million as of June 30. Due to two capital transactions, one in dividend recap and another in equity financing by Blackstone, we have received cash equal to 4x our capital on our equity position.”

“Cano Health is a national leader in primary healthcare, who is leading the way in transforming healthcare to provide high-quality care at a reasonable cost to a large population. Our equity position has a cost and fair market value on June 30 of zero and $61 million, respectively.”

PNNT’s incentive fee “hurdle rate” of 7.0% is applied to “net assets” to determine “pre-incentive fee net investment income” per share before management earns its income incentive fees. As shown in the following table, over the coming quarters the company will likely earn around $0.16 to $0.17 per share each quarter before paying management incentive fees covering around 140% which is ‘math’ driven by an annual hurdle rate of 7% on equity. It is important to note that PNNT could earn less but management would not be paid an incentive fee.


Management is expecting lower amounts of repayments coupled with higher amounts of originations for calendar Q3 2021 which has been taken into account with the updated projections driving higher leverage:

“Since June 30, PNNT has had new originations of $69 million. Although in the June quarter, repayments on loans roughly equaled new loan originations and the September quarter so far repayment activity has abated and new originations have accelerated.”

There is a chance that the company could start repurchasing shares using some of the proceeds from selling equity positions especially given that the stock is trading 32% below its NAV per share and was discussed on the recent call;

Q. “Is there any consideration towards even a modest share repurchase program to take advantage of the discount? I mean, it’s the highest in the peer group and yet your returns seem to be improving and NAV is clearly improved and perhaps that would be a useful way to take advantage of it for shareholders?”

A. “Yes. It’s a great question, and we’re always considering and I think as we generate a $51 million of proceeds on from equity investments this past quarter. I’m hopeful that as – those continue and get even greater. So hopefully it will be a lot greater than the $51 million and dedicate a portion of that over time to buying back the stock. So we got to play it out. We got to start generating these proceeds over the coming quarters. And I would certainly, if the stock price continues to be where it is certainly consider – we would certainly consider dedicating a portion of hopefully bigger proceeds to very worthwhile investment of the stock.”

My primary concerns for PNNT are mostly related to the recent increase in payment-in-kind (“PIK”) interest income from 13% to 20% of total income over the last three quarters and the commodity-related exposure combined lack of a “total return hurdle” incentive fee structure to protect shareholders from capital losses. However, management consistently “does the right thing” including continued fee waivers and previously reducing its base management (from 2.00% to 1.75%) and incentive fees (from 20.0% to 17.5%).


PNNT June 30, 2021 & Risk Profile Update

PennantPark Investment (PNNT) reported between its base and best case projections with ‘core NII’ of $0.141 per share and 118% coverage of the quarterly dividend adjusting for $1.1 million of expenses related to the early repayment of SBA debentures and $0.2 million provisions for taxes. There was a slight increase in interest and dividend income from its recently formed joint-venture PennantPark Senior Loan Fund (“PSLF”) which is expected to grow over the coming quarters. Also the company has started exiting some of its non-income-producing assets which will likely be reinvested into “yield generating debt instruments”:

Art Penn, Chairman/CEO: “We are pleased with the substantial increase in net asset value this past quarter due to material appreciation in the value of several equity investments. We believe that we can generate increased income over time as we grow the PNNT and PSLF balance sheets and by rotating equity positions into debt instruments. We are making substantial progress on the exit of those equity investments. Additionally, we have been actively investing in new loans since the most recent quarter end and the outlook in our view for continued growth is excellent.”


PNNT has plenty of borrowing capacity especially after taking into account its SBA leverage at 10-year fixed rates (current average of 3.2%) that are excluded from typical BDC leverage ratios. Previously, PNNT received a “green light” letter for its third SBIC license for an additional $175 million of SBA financing but withdrew the application and will be paying down a portion of its second license:

“We have withdrawn our application for a new SBIC at this time. We intend to gradually pay down SBIC 2, while also providing — proving out our portfolio through COVID, before reassessing.”

On April 14, 2021, PNNT announced the pricing of a public offering of $150 million in its 4.50% unsecured notes due May 1, 2026. These notes were priced just below par driving a yield-to-maturity of 4.625% and will slightly increase the overall borrowing rates but also a more flexible balance sheet for future portfolio growth.

As mentioned in previous reports PRA Events, Inc. and MailSouth, Inc. were added back to accrual status resulting in no non-accrual investments as of December 31, 2020. However, the interest payments from these investments are payment-in-kind (“PIK”) which now accounts for 20% of total income (compared to 13.0% previously) and needs to be watched

As expected its NAV per share grew by another 3.8% mostly due to equity investments driving PNNT’s leverage (debt-to-equity) well below historical levels (0.70 net of SBA debentures) giving the company plenty of growth capital for increased earnings potential.

“Our portfolio performance remains strong. As of June 30, average debt-to-EBITDA on the portfolio was 4.6x and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 3.4x. We have no non-accruals on our books in PNNT and PSLF.”

Equity investments now account for 35% of the portfolio and over the coming quarters, I am expecting the company to sell a good portion of these investments (including energy/oil-related) and reinvested into first-lien income-producing assets that should support a higher dividend payment to shareholders.


The fair value of energy, oil & gas portfolio exposure is currently around $82.6 million and now only accounts for 7.2% of the portfolio. If PNNT completely marked down its oil/energy-related investments the impact to NAV per share would be around $1.23 or 12.8%. This is more than priced into the stock that is currently trading at a ~32% discount to its NAV/book value of $9.59 per share.


Previously, PNNT recapitalized RAM Energy and converted all of its remaining debt obligations to equity. As mentioned in previous reports, both RAM and ETXhave reduced all nonessential capital expenditures, expenses and personnel. As shown below, the total expenses for RAM continue to decline and the company is now profitable:


Management discussed RAM on the recent call mentioning “we look forward to that day and we will try to optimize value and as expeditious a timeframe as possible”:

“PNNT has among its lowest percentage of energy investments since 2013. Energy investments represent only 7% of the overall portfolio. RAM is now on stable operational and financial footing and has benefited from higher prices and production. The company is free cash flow positive after debt service and plans to use any cash flow to repay debt. As of June 30, equity represented approximately 35% of the portfolio. RAM has a very well delineated acreage and 12 holes in the ground that had been very productive that’s a really good use of shareholder investor cash to buy RAM. So now everyday you’re reading the newspapers, the big companies are being very judicious and careful, they’re not drilling and they’ve got the discipline and all this other stuff. We are waiting for them to feel a little bit more expansive about doing things, whether that be drilling, whether that be M&A and we look forward to that day and we will try to optimize value and as expeditious a timeframe as possible.”


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

 

SUNS Quick Update: Low Leverage

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

  • SUNS target prices/buying points
  • SUNS risk profile, potential credit issues, and overall rankings
  • SUNS dividend coverage projections (base, best, worst-case scenarios)


SUNS Dividend Coverage Update

On September 9, 2021, SUNS reaffirmed its monthly distribution of $0.10 per share for the month of September 2021 payable on October 1, 2021, to stockholders of record as of September 23, 2021.

The following table shows the “pre-incentive fee net investment income” per share before management earns income incentive fees based on “net assets”. SUNS will likely earn around $0.278 per share each quarter before paying management incentive fees covering around 93% which is ‘math’ driven by an annual hurdle rate of 7% on equity. As shown in the previous tables, there were no incentive fees paid for the quarter ending June 30, 2021. It is important to note that the calculation is based on the net asset values from the previous quarter.

  • Please note that SUNS will likely have lower earnings per share over the coming quarters due to being underleveraged but management will not earn an incentive fee.

I am expecting improved earnings over the coming quarters mostly through increased leverage and portfolio growth as well as the recent purchase of Fast Pay Partners, a Los Angeles-based provider of asset-backed financing to digital media companies.

“SLR Business Credit acquired Fast Pay a factoring platform that provides working capital solutions to digital media firms across the U.S. led by an experienced team with a strong track record Fast Pay operates in a high growth industry and offers us an expanded product suite in geographic coverage, which should continue to fuel our growth. In conjunction with the acquisition of Fast Pay SLR business credit, amended its credit facility, increased its size, reduced its pricing and created additional flexibility. This transaction is expected to be accretive to business credits income. At quarter end, Fast Pay had a $72 million portfolio consisting of 34 our borrowers.”

It should be noted that the recent lack of portfolio growth was partially due to government stimulus programs that enabled borrowers to significantly reduce the funded balances on their revolving credit facilities. However, as these programs continue to taper off SUNS should experience increased borrowing activity driving portfolio growth:

“We anticipate meaningful portfolio growth during the second half of 2021 as we execute on our robust pipeline. Our sponsor finance business is capitalizing on increased middle-market deal volume, supported by the rebounding U.S. economy, and our specialty finance businesses are seeing greater capital needs from their borrowers as government stimulus tapers off. Utilization rates under business credit loans have been lower during COVID due to many of the borrowers benefiting from government stimulus programs, and using that liquidity to pay down our revolvers. As economic conditions continue to normalize, we expect these borrowers to redraw on our existing credit lines. Pipeline remains strong heading into the second half of the year driven both by increased utilization rates of our facilities, as well as new investment opportunities. We believe that the improved investment opportunities that expanded through SLR business credits acquisition of Fast Pay will continue to increase as companies require financing solutions for working capital and growth initiatives.”

“Now let me turn to our Healthcare ABL segment. The portfolio was $73 million representing nearly 13% of our total portfolio was comprised of loans to 38 borrowers with an average investment of approximately $2 million was 100% performing and had no defaults since the start of COVID. The weighted average yield was just under 12%. In the second quarter, they funded $10 million of new investments have repayments of just over $2 million. Similar to business credit Healthcare ABL was impacted by stimulus programs that enable borrowers to significantly reduce the funded balances on their outstanding revolving credit facilities. These programs have begun to roll off which should result in our borrowers drawing more of their facilities and moving our portfolio closer to its pre-COVID size.”

For Q2 2021, SUNS did not fully cover its dividends due to no fee waivers (same as the previous quarter) combined with being under-leveraged. However, leverage continues to increase and there was a meaningful increase in the portfolio yield.

“We are pleased with the 15% growth in SUNS’ comprehensive portfolio during the second quarter, predominantly driven by an increase in our asset-based lending verticals. Additionally, net investment income increased 25%, and we are optimistic about further earnings growth in the coming quarters.”

As mentioned in previous reports, shareholders approved the reduced asset coverage ratio allowing for higher leverage and management is targeting a range of 1.25 to 1.50 debt-to-equity.

“As a reminder SLR’s in senior’s and target leverage ratio is 1.25 times to 1.50 times net debt to equity under the reduced asset coverage requirement.” “SLR Senior Investment Corp.’s second quarter results benefited from both portfolio expansion and strong overall fundamentals. At June 30, our net debt to equity was 0.51 time, up from 0.4 times at March 31, an approximately 62% as SLR’s senior funded debt was comprised of unsecured term notes. We have over $325 million of available capital to support future earnings growth, and importantly, the economic climate has improved considerably in our pipeline across all four business verticals is very attractive. We expect portfolio growth to continue in the coming quarters from first lien cash flow, as well as asset based investment opportunities.”

SUNS remains a component in the ‘Risk Averse’ portfolio due to “true first-lien” positions diversified across cash flow, asset-based lending, and life science verticals, historically stable net asset value (“NAV”) per share, and low non-accruals. Management has a history of doing the right thing including waiving fees to cover the dividend without the need to “reach for yield” and deploying capital in a prudent manner.

Michael Gross, Co-CEO: “I’m pleased to report that SLR Senior Investment Corp’s, or SUNS, portfolio continues to be 100% performing, which continues to support our investment thesis at a diversified portfolio across asset-based loans in niche markets, in first lien cash flow loans to upper middle-market companies provides meaningful downside protection during challenging economic periods. Credit quality portfolio continues to be strong, and our watch list remains at historic lows. Approximately 57% of our portfolio was invested in asset-based and life science lending strategies and the remaining 43% was in senior secured cash flow loans. Our largest industry exposures were digital media, healthcare services, and insurance. The average investment per issue was $2.5 million or less than one half of 1%. At June 30, approximately 100% of our portfolio consisted of first lien loans with no second lien loan exposure and a de minimis amount of equity.”

There was an increase in the amount of investments with “Internal Investment Rating 3” which are investments “performing below expectations, may be out of compliance with debt covenants” to 5.2% of investments (previously 2.2%):


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

 

MRCC Quick Update: Remains Tier 4 For Now

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

  • MRCC target prices/buying points
  • MRCC risk profile, potential credit issues, and overall rankings
  • MRCC dividend coverage projections (base, best, worst-case scenarios)

This update discusses Monroe Capital (MRCC) which is considered a higher risk BDC due to previous/potential credit issues, historical realized losses, higher operating expense ratios, the need for higher leverage, and increasing percentage of payment-in-kind (“PIK”) income. MRCC has experienced realized losses of over $30 million (around $1.42 per share) over the last 3 to 4 years driving a 29% reduction in its quarterly dividend (as predicted in previous reports). Also, as discussed later, the total amount of investments considered non-accrual or related as well as on the ‘watch list’ account for over $130 million or 25% of the portfolio with ‘investment performance risk rating’ of 3 to 5 that need to be watched. The total amount of PIK interest income for MRCC increased from 7.9% to 15.9% of total interest income over the last five quarters and could result in a downgrade especially if there is another round of credit issues taken into account with the ‘worst case’ projections. Higher amounts of PIK is typically a sign that portfolio companies are not able to pay interest expense in cash and could imply potential credit issues over the coming quarters.





MRCC Previous Insider Purchases & Ownership

  • It should be noted that the most recent insider purchases were at prices below $7.00 followed by two sales near previous price peaks in December 2020 and August 2021.

Temporary Fee Adjustments & Waivers

It is important to point out that many BDCs have been either temporarily waiving fees or have fee agreements that take into account previous capital losses that are ending this year.

  • FSK, AINV, and MRCC have paid very little (or none) incentive fees over the last four quarters due to their ‘total return’ hurdles that are partially or fully coming to end in Q3 2021.
  • GSBD is temporarily waiving certain fees through 2021.
  • ORCC’s fee waivers expired on October 18, 2020.
  • SUNS discontinued its fee waivers starting in 2021.
  • OCSL has agreed to waive $750,000 of base management fees payable in each of the eight quarters following the closing of the merger with OCSI.

As mentioned in previous reports, MRCC has only covered its dividend only due to management waiving incentive fees to ensure dividend coverage, and its ‘total return requirement’ incentive fee structure driving no incentive fees paid. The following table shows the impact on its dividend coverage and its expense ratios (from 38.0% to 46.4%) if the company paid the full incentive fee.


Adjusted Operating Expense Ratios

The following table shows the average operating cost % for each BDC over the last four quarters as well as the adjusted ratios taking into account all fees without the benefit of temporary fee waivers. It should be noted that NMFC and GLAD also have fee waivers but are mostly permanent and part of the actual fee agreement so I have not adjusted for these BDCs.

As you can see, all of the higher-risk BDCs that I cover have the highest expense ratios including MRCC, PSEC, FSK, and AINV. It is not a coincidence that these BDCs trade at a lower multiple of NAV driving higher yields. There is a good chance that these companies also have higher risk assets to achieve higher portfolio yields to offset their higher fee structures. As shown in the “Total Return Updates Comparing BDCs & REITs” update, AINV and FSK are among the worst-performing BDCs that I cover likely due to previous dividend cuts that were partially driven by their higher fee structures.


Monroe Capital (MRCC) Dividend Coverage Update

There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, potential portfolio growth using leverage, fee structures including ‘total return hurdles’ taking into account capital losses, changes to portfolio yields, borrowing rates, the amount of non-recurring and non-cash income including payment-in-kind (“PIK”). Most BDCs have around 2% to 8% PIK income and I start to pay close attention once it is over ~5% of interest income.

Higher amounts of PIK is typically a sign that portfolio companies are not able to pay interest expense in cash and could imply potential credit issues over the coming quarters. The total amount of PIK interest income for MRCC increased from 7.9% to 15.9% of total interest income over the last five quarters and could result in an eventual downgrade to ‘Level 3’ or ‘Level 4’ dividend coverage especially if there is another round of credit issues taken into account with the ‘worst case’ projections shown earlier.

Historically, the company has only covered its dividend only due to the ability to use higher leverage through its SBIC license, management willingness to waive incentive fees to ensure dividend coverage, and its ‘total return requirement’ incentive fee structure driving no incentive fees paid previous quarters. MRCC was previously upgraded from ‘Level 4’ to ‘Level 2’ dividend coverage due to the expected quarterly dividend reduction of almost 30% (from $0.35 to $0.25) but also due to additional capital provided from repayment activity during the quarter, including the realization on RockdaleBlackhawk as well as the previous decline in non-accrual investments. On September 2, 2021, MRCC reaffirmed its quarterly distribution of $0.25 per share for the third quarter of 2021.

For Q2 2021, MRCC reported just below its base case projections due to a continued decline in the amount of recurring interest income (now below $11 million per quarter) driving total income to its lowest level since 2017. Same as the previous quarter, net investment income (“NII”) would have been around $0.22 per share without the benefit of fee waivers covering 88% of the quarterly dividend. Also, the amount of non-cash/PIK income continues to increase and now accounts for 16% of interest income as discussed earlier.

Also, MRCC currently has among the highest leverage ratios relative to most BDCs with a debt-to-equity of 1.40 or 1.32 net of cash compared to the average BDC at around 0.90.

Chief Executive Officer Theodore L. Koenig: “We are pleased to report another quarter of strong financial results. During the second quarter, we reported our fifth consecutive quarterly increase in our Net Asset Value. These positive results are consistent with the success we have enjoyed at Monroe Capital LLC over our 18-year history. We continue to cover our dividend with per share Adjusted Net Investment Income and our new deal pipeline remains strong. The M&A market is very active and we are a significant player in providing private credit in the lower middle market. As always, we continue to be focused on the interests of our shareholders and will remain focused on generation of Net Investment Income, preservation of capital and creation of shareholder value.”

Non-accrual investments currently account for $26.5 million or 5.0% of the total portfolio fair value and if completely written off would negatively impact NAV per share by around $1.24 or 11%. However, there are over $130 million or 25% of the portfolio with ‘investment performance risk rating’ of 3 to 5 and needs to be watched.

As of June 30, 2021, MRCC had 12 borrowers with loans or preferred equity securities on non-accrual status (BLST Operating Company, LLC (“BLST”), California Pizza Kitchen, Inc. (“CPK”), Curion Holdings, LLC (“Curion”), Education Corporation of America (“ECA”), Incipio, LLC (“Incipio”), Luxury Optical Holdings Co. (“LOH”), NECB Collections, LLC (“NECB”), Parterre Flooring & Surface Systems, LLC (“Parterre”), SHI Holdings, Inc. (“SHI”), The Worth Collection, Ltd. (“Worth”), Toojay’s Management, LLC (“Toojay’s OldCo”) and Valudor Products, LLC (“Valudor”) preferred equity), and these investments totaled $26.5 million in fair value, or 5.0% of the total investments at fair value.

Q. “Any idea you can give us in terms of when we might start seeing the overall volume of non-accrual start to go down relative to the overall size of the portfolio?”

A. “It’s a great question. It’s one that’s difficult to answer because not all of these are deals that we control, although a lot of them are. And it really has to do with performance. And as we see these deals, many of them mark up, that’s an indication that performance is improving. So we would expect that for some of these deals that are non-accrual status in that group that they would start to be in a position to start to generate accrued interest, either because they turn back on from an accrual standpoint or because they get realized and that capital can be reinvested in new performing assets that accrue. But it’s difficult to give you any real timing guidance on that at this time. But we are seeing, as we said, significant improvements in many of those names. And so we would expect some of those to do one of two things that I described, either start to accrue again or be monetized and be reinvested in accrual assets.”

It should also be noted that MRCC has around 19% of the portfolio with ‘investment performance risk rating 3’ which includes investments “performing below expectations and indicates that the investment’s risk has increased somewhat since origination” and “the issuer may be out of compliance with debt covenants”. This likely includes some of its investments in Apotheco, LuLu’s Fashion Lounge, VPS Holdings, Answers Finance, and Familia Dental Group Holdings, as well as its preferred shares in California Pizza Kitchen that are still on accrual. This has been taken into account with MRCC’s target prices and I will look for signs of improvement.


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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

 

 

 

 

 

TSLX Quick Update: Likely Strong Q3 & Q4

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

  • TSLX target prices/buying points
  • TSLX risk profile, potential credit issues, and overall rankings
  • TSLX dividend coverage projections (base, best, worst-case scenarios)


Sixth Street Specialty Lending (TSLX) is considered a higher quality BDC that performs well during distressed environments with management that is very skilled at finding value in the worst-case scenarios including previous retail and energy investments. TSLX often lends to companies with an exit strategy of being paid back through bankruptcy/restructuring and proficient at stress testing every investment with proper coverage and covenants. Management has prepared for the worst as a general philosophy and historically used it to make superior returns.

Over the last six years, TSLX has provided investors with annualized returns of 15% and likely headed higher as the company continues to pay special/supplemental dividends.



TSLX Supplemental/Special Dividends

On August 4, 2021, the company reaffirmed its regular quarterly dividend of $0.41 plus another supplemental dividend of $0.02 per share which was just below the previous base case projections of $0.03. TSLX still has around $1.36 per share of undistributed/spillover income.

When calculating supplemental dividends, management takes into account a “NAV constraint test” to preserve NAV per share. This is one of the reasons that management prefers not to pay large supplemental dividend payments even though the amount of undistributed/spillover income continues to grow. However, management also likes to avoid paying excessive amounts of excise tax by “cleaning out” the spillover as it “creates a drag on earnings” which is why the company paid a total of $1.30 per share in supplemental/specials during Q1 2021. Over the last five years, TSLX has increased the amount of supplemental dividends paid:

Most dividend coverage measures for BDCs use net investment income (“NII”) which is basically a measure of earnings. However, some BDCs achieve incremental returns typically with equity investments that are sold for realized gains often used to pay supplemental/special dividends. These BDCs include TSLX, FDUS, GAIN, CSWC, PNNT, TPVG, HTGC, and MAIN.

“We’ve always been opportunistic about our equity co-invest program. We’ve invested about $160 million of equity over time. And we’re currently at like, 1.7 times NOM, and my guess that will grow because we have a whole bunch of stuff in the book still. So it’s been a decent source of returns. I think the average return on fully realized has been in the 40% range. So we’ll continue to take our shots. I would say that it’s very specific, so we’re not asking for equity co-invest in every deal. If it fits into a sector where we have a deep fundamental view of the business and think there are the prospects are good, and the valuation is good, we will ask for it. But it’s more rifle than the shotgun and its more I would say actively managed versus kind of a passive strategy of equity co-invest and taking kind of private equity returns across the cycle.”

Over the last two quarters, TSLX had an additional $16.6 million or almost $0.23 per share of net realized gains (mostly due to the sale of its equity position in Capsule Technologies to Philips) to support additional special/supplemental dividends. Equity positions increased from 4% to 6% of the portfolio due to continued appreciation including Caris Life Sciences and Sprinklr, Inc. (CXM) as discussed below.

“Primarily by the unrealized gains and the debt equity conversion of certain investments upon milestone events this quarter, our portfolios equity concentration increased slightly from 4% to 6% on a fair value basis.”

“In May, Caris Life Sciences completed a growth equity round at nearly $8 billion post money valuation, led by Sixth Street’s healthcare and Life Sciences team. Since 2018, TSLX has made relatively small investment in the company’s capital structure alongside our affiliated funds, and receive warrants as part of these transactions. Based on the valuation of Caris latest financing round, the fair value of our junior debt, warrant and preferred equity positions increased significantly quarter-over-quarter, contributing to this quarter’s unrealized gain.”

As shown below, Caris Life Sciences, Sprinklr, Inc., Validity, Inc., SMPA Holdings and Motus, are marked well above cost and could result in an additional $0.46 per share if sold/exited at previous fair values. It should be noted that Sprinklr, Inc. (CXM) is currently trading 25% below where it was on June 30, 2021, and there is a 180 lockup on the shares.

Sprinklr, Inc., another one of our portfolio companies and a provider of customer experience management solutions completed its IPO on June 23. We made a small investment in Sprinklr convertible notes, alongside affiliated funds last May. And upon completion of the IPO, our notes automatically converted into common equity. The quarter-end fair value market of our equity position reflects a discount to the company’s June 30 closing share price, given the trading restrictions on our equity security, but still represents a 2.5x NOM on our capital invested.”


For Q2 2021, TSLX reported just below its base case projections due to lower-than-expected fee and other income partially offset by a record amount of interest income of almost $60 million. It is important to point out the most of the income during the quarter was recurring (as compared to onetime fee and other income).

“Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs were $2.2 million, compared to $8 million in the prior quarter. Other income was $1.1 million compared to $2.3 million in the prior quarter. The slowdown in portfolio turnover this quarter, and net portfolio growth allowed us to generate a higher quality of earnings from interest income. For reference 95% of this quarter’s total investment income was generated through interest in dividend income, compared to 79% across 2020, and 88% across 2019.”

However, management is expecting increased portfolio activity in Q3 and Q4 2021 including new investments driving higher fee income and interest income which are taken into account with the updated financial projections.

“We have a strong backlog for the second-half of this year, including agent roles on three large financings that total over $1.5 billion in facility size. As you can expect, we’re partnering with our affiliated funds and other managers on these transactions, which provides us the flexibility to determine the optimal final hold sizes for TSLX.”

“I would expect that we continue to leg into our financial leverage. We’re kind of in the lowest to middle of our financial leverage range. I would expect activity levels to — activity level fees and some portfolio turnover in the second-half of the year. So, we’re going to work hard continue to stay kind of in the one plus range, and we’ll given the economic backdrop, I think we’re wanting to take it up to 1.15 to 1.25 in this environment.

Also, there will likely be higher amounts of prepayment related income similar to previous quarters (not Q1 2021) likely driving results closer to the best-case projections:

“In the second-half, we expect some rebound in portfolio repayment activity, which would drive a more normalized level of activity related fees for our business. Based on where we stand today, we believe we are on track to meet the high-end or exceed our previously stated guidance range for full year 2021, which corresponds to return on equity of 11.5% to 12%.”


TSLX Dividend Coverage Update

TSLX has covered its regular quarterly dividend by 112% excluding excise taxes and approximately $0.08 per share of capital gains incentive fees which is also excluded by management.

“Our Q2 figures include approximately $0.08 per share of capital gains incentive fees that were accrued, but not paid or payable, related to cumulative unrealized capital gains in excess of cumulative net realized capital gains less any cumulative unrealized losses and capital gains and incentives paid inception to date. Since capital gain incentive fee accrual is a GAAP-related, non-cash item, we believe the adjusted NII and NI, which excludes the impact of the accrual, more accurately portrays the core earnings power of our business.”


TSLX has been improving its net interest margin through lower cost of borrowings including using its revolving credit facility to fund new investments:

“Our weighted average interest rate on debt outstanding decreased slightly quarter-over-quarter by 4 basis points to 2.26%, as a result of a funding mix shift to greater usage of our secured revolver.”

Also, Q2 2021 was the first quarter the company used leverage with a debt-to-equity ratio over 1.00 reducing its base management fee to 1.00%:

“Lastly on expenses, you’ll notice that we applied for the first time a fee waiver on base management fees related to this quarter’s portion of average gross assets financed with greater than one times leverage. Above that leverage level, base management fees are reduced to an annualized level of 1%. This is the first time since our stockholders approved the application of a 150% minimum asset coverage ratio in 2018, but we have reached this threshold.”


On February 3, 2021, the company issued $300 million of unsecured notes that mature on August 1, 2026 “at a spread to Treasury of 225 basis points”. On February 5, 2021, the company completed an amendment to its revolving credit facility, which increased the commitments from $1.335 billion to $1.485 billion, increased the accordion to allow for commitments of up to $2.00 billion, and extended the maturity to February 4, 2026. As of June 30, 2021, TSLX had $1.1 billion of undrawn capacity on its revolving credit facility.

TSLX maintains a strong balance sheet with 71% unsecured debt with the nearest debt maturity in August 2022 at $143 million, and the weighted average remaining life of investments funded with debt was ~2.4 years, compared to a weighted average remaining maturity on debt of ~4.1 years.

TSLX has around $143 million of convertible notes that could be converted into shares at some point. Management discussed on the recent call and will likely used to “optimize the impact on our NAV per share, ROEs, financial leverage and liquidity position”:

“As mentioned on our last earnings call, we have the flexibility under our 2022 convertible notes indenture to settle in cash or stock or a combination thereof. These notes are not eligible for conversion today, but when it comes time to make a determination on settlement method, our decision will be one that, among other considerations, optimizes the impact on our NAV per share, ROEs, financial leverage and liquidity position.”


TSLX Risk Profile Quick Update

Total non-accruals declined during Q1 2021 due to its first-lien position in American Achievement added back to accrual status. However, the small subordinated position remains on non-accrual.

“Our investments on non-accrual status remains minimal at 0.02% of the portfolio at fair value, representing our restructured sub notes in American Achievement, as discussed on our call in May.”

As discussed in the previous report, American Achievement is a company that manufactures and supplies yearbooks, class rings and graduation products and was discussed on the previous call:

“Our first lien loan for American Achievement remained outstanding post reorg and the interest that we received, while the loan was on non-accrual status, was applied to our loan principal. As part of the restructuring, the lender group received a majority stake of the common equity and subordinated notes in the restructured business. At quarter end, these subordinated notes accounted for all of our outstanding investments on non-accrual status at fair value.”


During Q2 2021, TSLX’s net asset value (“NAV”) per share increased by 2.3% mostly due to equity positions including Caris Life Sciences and Sprinklr, Inc. as discussed earlier.

“Gains on investments drove strong net asset value per share growth. If we were to look at the growth in our net asset value since the onset of COVID through today, which would require adjusting for the impact of special and supplemental dividends, we’ve grown that asset value per share by 12.2% since year-end 2019.”


Over 92% of the portfolio (up from 85.5% the previous quarter) is categorized as ‘Performance Rating 1’ which are “performing as agreed and there are no concerns about the portfolio company’s performance or ability to meet covenant requirements. For these investments, the Adviser generally prepares monthly reports on investment performance and intensive quarterly asset reviews.”


First-lien debt accounts for around 94% 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%.

From previous call: “We believe the relative resilience of our portfolio is mostly a result of a deliberate shift we made in late 2014 towards a more defensive portfolio construction. Today, 95% of our portfolio by fair value is first lien and nearly 75% of our portfolio by fair value is comprised of mission critical software businesses with sticky predictable revenue characteristics. These businesses also tend to have variable cost structures that it can be fluxed down to support debt service and protect liquidity in cases of challenging operating environments.”

Management is very skilled at finding value in the worst-case scenarios including previous retail and energy investments. TSLX often lends to companies with an exit strategy of being paid back through bankruptcy/restructuring and proficient at stress testing every investment with proper coverage and covenants. On a previous call, management discussed some of its recent returns from retail investments including Neiman Marcus and J.C. Penney:

“With a strong market backdrop in late March, Neiman issued notes in the high-yield market to refinance its exit term loan, which had call protection of [1.10] at the time of repayment. This call protection, in addition to the acceleration of unamortized OID on our loans, contributed meaningfully to our fees this quarter. Recall on our Q3 2020 earnings call, we disclosed that approximately $4 million of backstop fees related to our exit term loan commitment were booked as OID and that these fees were payable in common stock of the reorg company. Post quarter end, we sold our entire Neiman equity position at a price above our March 31, 2021 mark, thereby fully exiting all of our Neiman investment. Looking back, we’ve been a provider of liquidity and transitional capital for the retailers – for the retailer as its management team navigated through a pandemic and a Chapter 11 process. We believe this has been a fruitful partnership that has allowed both parties to create value for our respective stakeholders. Based on our total capital invested in Neiman since 2019, we’ve generated a gross unlevered IRR of approximately at 25% on our fully exited investments, which includes a post quarter-end sale of TSLX equity position.”

“Turning now to a quick update on J.C. Penney. Recall that in December, upon the company’s emergence from Chapter 11, our prepositioned debt and dip loan positions were converted to non-interest paying instruments, but with rights to immediate and future distributions and cash and other securities. During the quarter, our $13.3 million fair value dip loan position was extinguished in connection with the closing of a PropCo. And we received a small cash distribution, along with equity interest in the PropCo.

At quarter end, our PropCo equity interest had a level 2 fair value mark of $18.1 million. Across Q1, our J.C. Penney investments drove $5.4 million of net realized and unrealized gains or a positive $0.08 per share impact to our NAV this quarter.

“At quarter end, our portfolio’s retail and consumer exposure was 11.4% at fair value, and nearly 80% of this consisted of asset based loans. Cyclical names, which exclude our asset-based retail loans and energy investments, continue to be limited at 4% of the portfolio. And our energy exposure at quarter end was 1.7%.”


What Can I Expect Each Week With a Paid Subscription?

Each week we provide a balance between easy to digest general information to make timely trading decisions supported by the detail in the Deep Dive Projection reports (for each BDC) for subscribers that are building larger BDC portfolios.

  • Monday Morning Update – Before the markets open each Monday morning we provide quick updates for the sector including significant events for each BDC along with upcoming earnings, reporting, and ex-dividend dates. Also, we provide a list of the best-priced opportunities along with oversold/overbought conditions, and what to look for in the coming week.
  • Deep Dive Projection Reports – Detailed reports on at least two BDCs each week prioritized by focusing on ‘buying opportunities’ as well as potential issues such as changes in portfolio credit quality and/or dividend coverage (usually related). This should help subscribers put together a shopping list ready for the next general market pullback.
  • Friday Comparison or Baby Bond Reports – A series of updates comparing expense/return ratios, leverage, Baby Bonds, portfolio mix, with discussions of impacts to dividend coverage and risk.

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