Author: BDC Buzz

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

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

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

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Introduction to Business Development Companies (“BDCs”)

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

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Comparison or BDC and REIT Returns Since 2015

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

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

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

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

• Newtek Business Services: Initiating Coverage
• Stocking Stuffer Or Sell The Recent Rally: GAIN
• Growing Dividends During A Pandemic: CSWC
• Top BDC Pick For 2020: TSLX
• ARCC: 9.4% Yield, Provides Preliminary Results
• Venture Debt Players Yielding 9% To 10% For Your Portfolio: HTGC/TPVG
• MAIN: New SEC Rules Could Improve Pricing For The BDC Sector
• I Bought FDUS: 12% Yield And 35% Below Book

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Comparison or BDC and REIT Returns Since 2019

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

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

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

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

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Why do REITs Underperform BDCs?

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

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

Source: ARCC Debt Investor Presentation

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

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

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Summary & Takeaways

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

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

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

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Full BDC Reports

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

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

 

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

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

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Summary

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

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PNNT Dividend, NAV Per Share & Management Fees Update

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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Full BDC Reports

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

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

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BDC Sector ETFs/ETNs

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

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

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

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

• FSK Quick Update: Please Be Careful
• MAIN: Remains on Probation
• AINV Projections: Potential Downgrade

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

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Full BDC Reports

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

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

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

Recent & Upcoming Ex-Dividend Dates

• TPVG, MRCC, NMFC,  and TCPC all have ex-dividend dates of June 15, 2021, which means that their prices will be around 2% lower (shown below) at the open of the markets this morning and could be a buying opportunity.

• AINV, PFLT, PNNT, GAIN, and GLAD also have ex-dividend dates this week.
• Please keep in mind tax considerations (income versus capital gains) and it might be a good idea to wait until the morning of the ex-dividend date to make additional purchases.

 

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Full BDC Reports

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

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

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

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As mentioned earlier this week in the “Updated BDC Dividend Coverage Levels”, 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 MAIN, GAIN, CSWC, PNNT, TPVG, HTGC, and TSLX.

Yesterday, MAIN announced that it recently exited its equity investment in American Trailer Rental Group (“ATRG”) which is a leading provider of trailer rental solutions to manufacturing, distribution, and third-party logistics (3PL) customers. MAIN realized a gain of $17.0 million on the exit of its equity investment in ATRG, with this realized value representing an increase of $7.8 million above MAIN’s fair market value for this investment as of March 31, 2021:

On a cumulative basis since Main Street’s initial investment in ATRG in June 2017, Main Street realized an internal rate of return of 60.9% and a 3.0 times money invested return on its equity investments in ATRG. On a cumulative basis including both Main Street’s debt and equity investments, Main Street realized an annual internal rate of return of 28.1% and a 1.7 times money invested return on its aggregate debt and equity investments in ATRG.

There will be around $0.25 per share of realized gains as well as a slight increase in NAV per share of around 0.5% related to the exit of ATRG. Management was expecting distributable net investment income of $0.59 to $0.62 per share for Q2 2021 compared to the regular dividends of $0.615 so this should be considered good news. However, the market did not respond to the news, and MAIN’s stock was down slightly (by 0.4%) yesterday likely due to the previous net realized losses that need to be taken into account including $15.7 million during Q1 2021. Also, the company does not typically does not announce exits that include losses so we need to wait and see the full quarter results. I will be updating the MAIN Projections & Pricing report later this month taking into account all changes to portfolio credit quality and expected dividend coverage which should continue to improve as discussed in the MAIN Q1 2021 Quick Update from last month as well as management on the recent call:

Based upon our results for the first quarter and the positive developments we have seen in our existing portfolio companies, coupled with the future benefits of our growing asset management business, the attractive new investment opportunities we are seeing in our lower middle market and private loan strategies, our efficient operating structure and strong liquidity position, we remain confident with our expectations for continued improvement in our DNII per share in 2021 and our expectation to resume consistently generating DNII in excess of our monthly dividends later this year, followed by the eventual growth of our monthly dividends, consistent with our long-term historical practices prior to the onset of the pandemic.”

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Full BDC Reports

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

 

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

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

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HTGC Distribution Update

As predicted in previous updates, HTGC declared additional supplemental cash distributions during 2021 due to the “record level of spillover at $0.94” and “the trajectory of the business for the course of 2021”. HTGC will be distributing $0.28 per share (more than I was expecting) evenly over the next four quarters starting with $0.07 per share for the first quarter of 2021 paid in May 2021.

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HTGC remains a higher dividend coverage BDC with the potential for supplemental dividends partially due to its internally-managed cost structure and equity investments historically providing realized gains and supporting supplemental dividends:

HTGC maintains a “variable distribution policy” with the objective of distributing four quarterly distributions in an amount that approximates 90% to 100% of the company’s taxable quarterly income or potential annual income. In addition, the company pays additional supplemental distributions to distribute approximately all its annual taxable income in the year it was earned, or it can elect to maintain the option to spill over the excess taxable income into the coming year for future distribution payments.

“We have a variable dividend policy, so it’s something that the Board evaluates on a quarterly basis, and we don’t just look short-term, we look long-term when we’re making those decisions. We’ve been very clear in terms of our public guidance on the last several calls that we see absolutely no risk to that $0.32 base distribution, and we would reiterate that guidance on this call now. If you think about what we’ve been able to do in terms of the special distributions, we’ve been able to deliver to our shareholders a supplemental or a special distribution in six of the last seven quarters on top of the $0.32 base distribution. And obviously, subject to market conditions, I think one of the things that we’re going to look at near-term here is trying to find a way to provide a little bit more consistency and continuity to those supplemental distributions. “

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Hercules Adviser LLC Update

On March 25, 2021, HTGC announced that Hercules Adviser LLC, a wholly-owned subsidiary of HTGC, had successfully closed its inaugural institutional private credit fund.

Scott Bluestein, CEO and CIO of HTGC: “We are very pleased to announce that Hercules Adviser has successfully raised and closed its first institutional private credit fund. This new private credit fund will allow us to continue to expand and broaden our investment platform while at the same time serving the growing needs of the venture and growth stage companies that we seek to partner with.”

Management has mentioned that this will allow the company to “expand and broaden” its investment platform allowing HTGC to access to “a lot of deals that we’re now able to do at the BDC level”. However, as the fund ramps up it will likely be “taking some investments away” over the short-term and sharing expenses reducing HTGC’s operating costs as well as eventually paying distributions to HTGC as “100% of the benefit from the RIA activities accrues and accretes to the shareholders of the public BDC”.

“After establishing Hercules Advisor as a wholly own registered investment advisor in 2020, we are very pleased to have raised and closed our first institutional private credit fund. Having this first fund and potentially future funds gives us the opportunity to expand and diversify our investment platform while enhancing our level of service and capabilities to our current and future venture growth stage companies. While we anticipate that it will take time to ramp up our activities under our RIA, we do expect that over the short term, Hercules Capital will benefit from being able to share certain expenses with Hercules Advisor and having a more diverse platform for the funding of new investments. Longer term and subject to the ultimate performance and size of the funds managed by Hercules Advisor, we expect Hercules Capital to potentially benefit from distributions from the advisor as that business ramps up.”

“On an initial basis as it ramps up potentially taking some investments away with the two caveats that we mentioned before. Number one, there are a lot of deals that we’re now able to do at the BDC level that we probably could not otherwise have done. If we didn’t have the private vehicle to be investing alongside us. And then no two, this is not an externally managed private fund. This is a private fund that’s managed by a wholly owned RIA. So 100% of the benefit from the RIA activities accrues and accretes to the shareholders of the public BDC. During Q1 we successfully closed our first private fund, and as a result, we allocated a portion of certain commitments and fundings to the initial private fund. This also allowed us to allocate certain expenses to Hercules Advisor, our RIA managing the private fund during the quarter.”

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HTGC March 31, 2021, Results

Hercules Capital (HTGC) reported just above its base case projections for Q1 2021 not fully covering its dividend (as expected). However, the company had around $0.94 of undistributed income for temporary shortfalls and has covered its dividend by an average of 110% over the last 8 quarters supporting the previously announced supplemental dividends. Also, as mentioned in the previous report, there were higher expenses related to payroll tax in Q1:

“SG&A expenses increased to $17.6 million from $16 million in the prior quarter. The increase was driven by higher compensation expenses related to the increase in fundings and first quarter payroll taxes which normally run higher in the first quarter. Net of truck costs recharged to the RIA, the SG&A expenses were $16.7 million. For the second quarter, we expect SG&A expenses of $16 million to $17 million slightly below the prior quarter, as Q1 always has higher employer payroll taxes. We expect our second quarter borrowing costs to decrease modestly.”

The effective yield was 13.2% during Q1 2021, down slightly compared to 13.3% for Q4 2020 due to lower early loan repayments (discussed next). Effective yields generally include the effects of fees and income accelerations attributed to early loan repayments and other one-time events. HTGC’s ‘Core Yield’ decreased from 11.8% to 11.6% and over 98% of its debt portfolio is now at its contractual interest rate floor.

“The decline in both total investment income and net investment income was consistent with our guidance, and due to the lower debt portfolio balance attributable to the record Q4 payoffs, and lower fee income as a result of a lower level of prepayments during the first quarter. Core yield, a non-GAAP measure, was 11.6% during Q1 2021, within the Company’s expected range of 11.0% to 12.0%, and decreased slightly compared to 11.8% in Q4 2020. Hercules defines core yield as yields that generally exclude any benefit from income related to early repayments attributed to the acceleration of unamortized income and prepayment fees and includes income from expired commitments. During Q1, we continue to see strength in terms of portfolio company exits, and portfolio company liquidity events. This combined with continued very strong performance across our portfolio, again drove high levels of early pay-offs. Early loan repayments were at the high end of our guidance of $150 million to $200 million at over $191 million, but decreased from $282 million in Q4.”

HTGC ended Q1 2021 with $550 million of available liquidity, including $75 million in unrestricted cash and cash equivalents, and $475 million in available credit facilities. HTGC had pending commitments of $153 million as of April 27, 2021, and since the close of Q1 2021, the company has closed new debt and equity commitments of $135 million and funded $25 million.

“For Q2, we again expect prepayments to be between $150 million and $200 million, although this could change materially as we progress in the quarter.”

In March 2021, the company issued an additional $50 million 4.50% Notes due March 2026 and $50 million 4.55% Notes due March 2026.

“Our leverage includes the March issuance of $50 million five-year notes in a private placement with a fixed coupon of 4.55%. This was the second tranche of the arrangement announced in November 2020, totaling up $100 million in private placement financing.

In October 2020, the company announced that it had received approval for its third SBA license. It should be noted that this was quicker than expected and will provide an additional $175 million of fixed-rate borrowings at very attractive 10-year rates.

“In addition, we have started to utilize our third SBA license drawing down $37.5 million of debentures and has attractive annual interest rate of 0.77%.”

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During Q1 2021, the company did not issue additional shares through its At-the-Market (“ATM”) Equity Distribution Agreement. HTGC continues to target a regulatory debt-to-equity ratio between 0.95 to 1.25 and will likely use the ATM program to maintain leverage while growing the portfolio. As of March 31, 2021, approximately 16.2 million shares remain available for issuance and sale

“Moving on to discuss leverage. Our GAAP and regulatory leverage was 94.6% and 89.2%, respectively, which decreased compared to the prior quarter due to the partial repayment of the two securitizations, which are now in runoff. Netting out leverage with the cash on the balance sheet, our GAAP and regulatory leverage was 88.9% and 83.5% respectively, putting us in a very strong position heading into the next quarter.”

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Full BDC Reports

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

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 and worst-case scenarios

This update discusses Goldman Sachs BDC (GSBD) and was previously posted on our new platform with updated target prices, dividend projections, rankings, and recommendations:

• Full GSBD Report: GSBD Updated Projections/Pricing

 

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GSBD will likely experience additional selling pressure during the first and second week of July 2021 potentially driving the stock price closer to its ST target of $18.50 and I will send out reminders before the last lock-up expires.

“….upon the closing of the Merger that generally restricted all stockholders who received shares of our common stock in the Merger from transferring their respective shares of our common stock for at least 90 days following the date of the closing of the Merger (the “Closing Date”), subject to a modified lock-up schedule thereafter (lock-up restrictions on 1/3 of the Affected Stockholders’ shares will lapse after 90 days from the Closing Date, lock-up restrictions on an additional 1/3 of the Affected Stockholders’ shares will lapse after 180 days from the Closing Date, and lock-up restrictions on the remaining 1/3 of the Affected Stockholders’ shares will lapse after 270 days from the Closing Date).

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GSBD Dividend Coverage Update

For Q1 2021, GSBD reported slightly above its base-case projections due to higher-than-expected dividend and other income partially offset by lower portfolio growth driving slightly lower interest income. However, leverage (debt-to-equity) declined to a new near-term low giving the company plenty of growth capital for increased earnings potential. GSBD has covered its dividend by an average of 105% over the last 8 quarters growing spillover/undistributed income. Previously, GSAM announced that it will waive a portion of its incentive fee for the four quarters of 2021 (Q1 2021 through and including Q4 2021) for each such quarter in an amount sufficient to ensure that GSBD’s net investment income per weighted average share outstanding for such quarter is at least $0.48 per share.

“The increase quarter-over-quarter was primarily due to the timing of the merger at close in Q4 as well as increased income from GSBD’s historic origination activity during Q4. On a per share basis, GAAP and adjusted net investment income were $0.57 and $0.48 per weighted average share, respectively, as compared to $0.59 and $0.48, respectively, in the fourth quarter of 2020. The per share decrease is the result of an increase in post-merger weighted average shares outstanding.”

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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 (CUSIP: 38147UAD9) in November 2020. Previously, the company issued $360 million of unsecured notes due 2025 at 3.750% (CUSIP: 38147UAC1). As of March 31, 2021, 63% of its borrowings were unsecured with $1.1 billion of availability under its credit facility. 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 deleveraging creates more capacity to deploy capital into today’s attractive investment environment while adding a greater margin of safety to maintain GSBD’s investment-grade credit rating and comply with regulatory and contractual leverage ratio requirements.

The Board reaffirmed its regular dividend of $0.45 per share payable to shareholders of record as of June 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.

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Full BDC Reports

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

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

Each quarter I assess BDC risk rankings that takes into account portfolio credit quality and vintage, quality of management, effective leverage ratios, portfolio mix and diversification, rate sensitivity, historical credit, and NAV performance, and the need to reach for yield to sustain dividends.

Typically BDCs with higher portfolio credit quality can use higher amounts of leverage partially offsetting the lower yields (from safer investments). There is a large difference between a BDC with a higher debt-to-equity ratio and mostly first-lien assets as compared to investments that might be subordinated to other debt or use off-balance-sheet leverage for higher returns. Effective leverage takes this into account.

The following table is an oversimplified view of portfolio investments. BDCs use similar terminology but would likely refer to the “Senior” as “first-lien” and the “Stretch” as “second-lien.” However, many contributors on Seeking Alpha lump first and second-lien together and call it senior because the detail is often hard to find for BDCs as there are very few standardized reporting requirements. It is also important to note that many of the higher-risk BDCs will originate with lower protective covenants and/or security in exchange for higher yields, so not all first-lien is the same. “Mezzanine” is typically referred to as “subordinated debt”. BDCs with higher amounts of first-lien loans and/or lower debt-to-equity ratios have much lower effective leverage.

BDC Leverage Versus Portfolio Mix & Dividend Coverage Update

The following table shows each BDC ranked by its simple (not effective) debt-to-equity ratio net of cash (non-restricted) along with its portfolio mix. The “Other” column includes everything that is not first or second-lien secured debt. A few items to note:

• AINV and CSWC have not reported March 31, 2021, results and will be updated later this month.
• PTMN, FSK, FCRD, PSEC, and OXSQ have higher risk portfolios that require lower leverage and I have separated from the others. These companies are discussed below.
• PNNT previously sold a large amount of first-lien loans to the PSLF as well as markups of some of its equity investments which had a meaningful impact on its portfolio mix. Also, there have been meaningful markups in its equity positions that can fluctuate in value.
• ARCC and ORCC invest in larger middle market companies that would likely outperform in an extended recession environment. A good portion of ARCC’s ‘Other’ investments is its SDLP.
• MAIN, CSWC, GAIN, and FDUS prefer to have a lower portion of their portfolio invested in equity positions of their portfolio companies providing them with realized gains and dividend income to support supplemental dividends.
• NMFC also has higher ‘Other’ investments that include the SLPs and Net Lease program.
• SUNS has the lowest leverage and the ‘Other’ investments are mostly its equity positions in SLR Business Credit and SLR Healthcare ABL.
• TPVG likely has the lowest effective leverage due to 91% secured debt combined with lower leverage.

Many of the BDCs with lower leverage also have lower dividend coverage over the last four quarters including SUNS, GAIN, GBDC, MAIN, ORCC, and PFLT. Dividend coverage should improve over the coming quarter especially ORCC that has been actively growing the portfolio each quarter as discussed earlier this month in “ORCC Quick Update: Q1 2021”. It also should be noted that almost every BDC has decreased leverage (not ORCC) over the last few quarters partially due to NAV increases but also due to conservative management carefully selecting new investments as the economy recovers. PNNT had the largest decrease in leverage from a debt-to-equity (net of cash) of 1.71 to the current 0.87.

I am expecting improved dividend coverage for most BDCs as leverage increases as well as higher amounts of first-lien positions (to support higher leverage). So far this year there have been 9 BDCs that have increased dividends and/or announced supplemental dividends.

I do not cover most of the higher-risk BDCs for many reasons but mostly because these are not typically buy-and-hold investments. PTMN, FSK, FCRD, 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. Typically these assets do not qualify for lower cost BDC credit lines and revolvers which is why many of these BDCs have higher cost unsecured notes as well as using less leverage to maintain credit ratings.

PSEC is an excellent example and management often mentions their “conservative leverage” but this is likely due to the quality of assets. PSEC has huge concentration risks with its top four investments accounting for 39% of the portfolio or over 62% of NAV per share as they have been marked up well over cost likely using aggressive valuation methods. If one or two of these investments had serious issues it would have a large impact on its debt-to-equity ratio. Also, 13% of its portfolio is invested in CLOs that typically have around 10 times leverage on top of their equity positions.

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Full BDC Reports

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

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

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

This update discusses TCG BDC (CGBD) and was previously posted on our new platform with updated target prices, dividend projections, rankings, and recommendations:

• Full CGBD Report: CGBD Recent Pullback, Updated Projections & Pricing

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Summary

• We have recently updated the dividend coverage projections and target pricing to take into account March 31, 2021, reported results as well as guidance provided by management on the recent earnings call.
• Included in the projections are the expected upcoming supplemental dividends.
• CGBD is currently one of the highest-yielding BDCs even compared to higher-risk companies such as PSEC, AINV, MRCC, and FSK.
• As shown below there was a recent pullback in the stock price on May 25, 2021, with increased trading volumes (around five times the average daily volume).
• Non-accruals remain around 3.3% of the portfolio but I am expecting improvements for Direct Travel and Derm Growth which account for a majority.
• PIK increased during Q1 2021 (now 5.2% of total income) and needs to be watched.

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Recent CGBD Pullback

As discussed last week, there was a recent pullback in CGBD’s stock price on May 25, 2021, with increased trading volumes (around five times the average daily volume). The pullback was likely just a selling shareholder followed by profit-taking maybe fear-driven due to the spike in volume.

The recent drop is responsible for CGBD currently having one of the lowest RSIs and highest yields in the sector.

CGBD Distributions Quick Update

On May 4, 2021, the company announced a regular quarterly common dividend of $0.32 plus a supplemental dividend of $0.04, which are payable on July 15, 2021, to common stockholders of record on June 30, 2021. It should be noted that this was slightly below my base projected supplemental of $0.05.

On previous calls, management has mentioned “paying out a majority of the excess income above the $0.32 and we would anticipate doing the same going forward”:

“We generated net investment income of $0.36 per common share and declared a total dividend of $0.36. This includes the base dividend of $0.32 and a $0.04 supplemental dividend. As we have noted before, we expect earnings to continue to be well in excess of our $0.32 base dividend.”

“Similar to last quarter, as we look forward to the rest of 2021, we remain very confident in our ability to comfortably deliver the $0.32 regular dividend, but continue the sizable supplemental dividends. In line with the $0.04 to $0.05 we have been paying the last few quarters.”

Previous reports predicted a reduction in the regular quarterly dividend (from $0.37 to $0.32 per share) due to lower income from its Credit Fund I, declines in portfolio yield and interest income primarily due to the decrease in LIBOR and additional loans placed on non-accrual as well as the need to reduce leverage.

Upcoming CGBD Share Repurchases

On November 2, 2020, the Board authorized an extension as well as the expansion of its $150 million stock repurchase program at prices below NAV per share through November 5, 2021. The company previously repurchased around $86 million worth of shares but “paused” in Q2 2020. CGBD has reduced its debt-to-equity ratio increasing liquidity and management “intends to pursue the appropriate balance of both share repurchases and attractive new investment opportunities”. During Q1 2021, the company repurchased 0.5 million common shares at an average price of $12.03 per share, or $5.6 million, resulting in accretion to net assets per share of $0.03. As of March 31, 2021, there was $47.6 million remaining under the stock repurchase program. Management discussed on the recent call including less share repurchases as the stock price continues higher and I have taken into account with the updated projections:

“Additionally, we repurchased almost $6 million of our common stock at an average discount of 22% of our net asset value. This resulted in $0.03 of accretion to net asset value. We continue to be consistent active repurchasers of our shares. We continue to be consistent re-purchasers of it, but we will obviously scale those who purchases based on how accretive they are overall, and that will fluctuate as our as our stock price fluctuates. So, it shouldn’t be a surprise that we purchased a bit less this quarter. Repurchasing our shares was a bit less accretive this quarter than it had been in prior quarters. But nevertheless, again we continue to see great value in our shares. So, you should continue to see repurchases at least in the near future. And we have just as a side note, we have plenty of room and plenty of time left on our repurchase authorization that the Board gives us each year.”

 

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Full BDC Reports

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