BDC Market Update & MRCC Issuing Shares Below NAV

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


Quick Update:

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

 


Quick BDC Market Update

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

Annotation 2020-07-12 231552

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

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

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

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

Annotation 2020-07-12 231308

 



 

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

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


Issuing Shares Below NAV:

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

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

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

Source: ARCC SEC Filing

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

The following information was included in a recent SEC filing:

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

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

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

Source: MRCC SEC Filing

 


Previous Insider Purchases & Ownership:

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

Source: Gurufocus

 


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

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

Please see the following links from Investopedia for more information:

 

 


MRCC Dividend Update

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

Annotation 2020-07-12 230508

 


My Current BDC Investment Plan

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

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

Annotation 2020-07-12 230233


Full BDC Reports:

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

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

To be a successful BDC investor:

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

Goldman Sachs BDC (GSBD) Merger Update: June 2020

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


Quick Update:

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

 


GSBD Merger With MMLC Update

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

Why are the terms of the Merger being amended?

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

What are the key changes from the original merger terms?

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

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

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

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

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

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

What are the benefits of the Merger to GSBD stockholders?

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

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

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

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

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

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


GSBD Dividend Update

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Updated Slides Related to the Merger With MMLC:


Previous GSBD Insider Purchases:


Full BDC Reports:

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

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

To be a successful BDC investor:

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

NMFC Preliminary Q2 2020 Results: Upcoming Public Article

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


Quick Update:

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

 


Upcoming Public Article:

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

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

Link to NMFC press releases:

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

NMFC 1

 

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

NMFC 2

 



NMFC Preliminary June 30, 2020 Update:

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

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

 

NMFC 5

Analyst Earnings Expectations:

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

NMFC 6

Deleveraging and Cash Flow:

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

NMFC 3

NMFC 7

NMFC 8



Previously Expected Dividend Reduction:

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

NMFC 9

 

NMFC’s dividend yield remains above the average BDC:

 

NMFC 14

 



NMFC Risk Profile:

This where I spend most of my research efforts.

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

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

 

NMFC 13

NMFC 11

NMFC 12

 

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

 

NMFC 4


Full BDC Reports:

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

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

To be a successful BDC investor:

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

GBDC Update: Dividend Coverage & Risk Profile

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


gbdc yield.png

GBDC Update Summary:

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

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

 

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

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

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

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

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

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

 

 

 

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

 

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

 

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

 

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

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

 

 

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

 

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

 

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

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

 

 


 

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

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

To be a successful BDC investor:

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

PNNT Update: Dividend Coverage & Risk Profile

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


pnnt yield.png

PNNT Update Summary:

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

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

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

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

 

 

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

 

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

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

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

 

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

 

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

 

 

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

 

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

 

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

 

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

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

 

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

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

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


 

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

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

To be a successful BDC investor:

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

GLAD Update: Dividend Coverage & Risk Profile

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


glad yield.png

GLAD Update Summary:

  • GLAD hit base case projections covering its dividend that remains stable but reliant on continued management fee waivers.
  • There was a meaningful decline in its portfolio yield from 12.5% to 11.3% and its debt-to-equity remains near historical levels.
  • NAV per share decreased by $0.14 or 1.7% (from $8.22 to $8.08). Most of the largest markdowns during the quarter were equity investments including Defiance Integrated Technologies that was previously marked $3.7 million above cost.
  • As predicted, New Trident and Meridian Rack & Pinion were exited resulting in realized losses but did not impact NAV due to being mostly written off.
  • The company sold 705,031 shares at a weighted-average price of $10.37 (26% premium to previous NAV) through its ATM program.
  • In October 2019, GLAD redeemed its Series 2024 Term Preferred Stock and completed a public debt offering of $38.8 million of 5.375% Notes due 2024 for net proceeds of approximately $37.5 million.
  • First-lien debt accounts for around 50% of the portfolio and oil & gas investments now account for around 7.9% (previously 8.7%) of the portfolio fair value due to markdowns and increased overall portfolio size.

December 31, 2019 Results:

Gladstone Capital (GLAD) hit its base case projections covering its dividend due to continued management fee waivers. There was a meaningful decrease in its portfolio yield from 12.5% to 11.3% and its debt-to-equity remained near historical levels. The company sold 705,031 shares at a weighted-average price of $10.37 (26% premium to previous NAV) through its at-the-market (“ATM”) program. In October 2019, GLAD redeemed its Series 2024 Term Preferred Stock and completed a public debt offering of $38.8 million of 5.375% Notes due 2024 for net proceeds of approximately $37.5 million.

Bob Marcotte: “We started fiscal 2020 on a strong note with a healthy level of net originations and a reduction in our financing costs on the quarter which combined to lift our core net interest income despite the pressure associated with the decline in LIBOR. Today, our modest leverage and the added flexibility of BDC leverage relief (with the recent preferred stock redemption), afford us the opportunity to continue to grow our investment portfolio and lift our net interest earnings in the coming quarters to enhance the returns to our shareholders.”

 

For the three months ended December 31, 2019, net asset value (“NAV”) per share decreased by $0.14 or 1.7% (from $8.22 to $8.08) with realized losses of almost $6 million or $0.19 per share mostly due to exiting New Trident (cost of $4.4 million, fair value of $0.0 million). Also, in January 2020, GLAD exited its non-accrual investment in Meridian Rack & Pinion, Inc. (cost of $5.6 million, fair value of $0.0 million) and realized a loss of $5.6 million or $0.18 per share offset by the sale of its investment in The Mochi Ice Cream Company, which resulted in a realized gain of approximately $2.5 million or $0.08 per share.

Most of the largest markdowns during the quarter were equity investments including Defiance Integrated Technologies that was previously marked $3.7 million above cost but marked down by $2.7 million:

 

Secured first-lien debt increased from 44% to 50% of the portfolio fair value:

 

Management previously indicated that it would slowly increase its targeted debt-to-equity ratio from 0.80 to 1.00. In January 2020, GLAD invested:

  • $5.5 million in Lignetics, Inc., an existing portfolio company, through a combination of secured second lien debt and preferred equity.
  • $3.0 million in Edge Adhesives Holdings, Inc., an existing portfolio company, in the form of preferred equity.

Oil & gas investments declined to 7.9% (previously 8.7%) of the portfolio fair value due to marking down FES Resources Holdings again as well as a larger overall portfolio.

As discussed in previous reports, Francis Drilling Fluids (“FDF”) was restructured in December 2018 upon emergence from Chapter 11 bankruptcy protection. As part of the restructure, its $27 million debt investment in FDF was converted to $1.35 million of preferred equity and common equity units in a new entity, FES Resources Holdings, LLC (“FES Resources”). GLAD also invested an additional $5.0 million in FES Resources through a combination of preferred equity and common equity and was marked down by $3.1 million during calendar Q3 2019.

In March 2019, two of its energy-related portfolio companies, Impact! Chemical Technologies, Inc. (“Impact”) and WadeCo Specialties, Inc. (“WadeCo”), merged to form Imperative Holdings Corporation (“Imperative”). In connection with the merger, GLAD received a principal repayment of $10.9 million and its first-lien loans to Impact and WadeCo were restructured into one $30.0 million second lien debt investment in Imperative.

Distributions and Dividends Declared:

In January 2020, the Board of Directors declared the following monthly distributions to common stockholders and monthly dividends to preferred shareholders:

 


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

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

To be a successful BDC investor:

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

 

 

FDUS Baby Bonds FDUSZ (Buy), FDUSG (Hold) & FDUSL (Sell)

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


Annotation 2020-02-16 171839.png


Baby Bonds “FDUSG”, “FDUSZ” and “FDUSL”:

On October 16, 2019, FDUS announced the closing of its $55 million of its 5.375% notes due 2024 under the trading symbol “FDUSG” “within 30 days of October 16, 2019” that has been added to the BDC Google Sheets along with “FDUSL” and “FDUSZ” already included.

There is a good chance that FDUSL will be redeemed this year as it carries a rate of 5.875% and became redeemable as of February 1, 2020.

—————–

One of the metrics used to analyze the safety of a debt position (including Baby Bonds) is its “Interest Expense Coverage” ratio which measures the ability to pay current borrowing expenses. From Investopdia:

“The interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. The ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by the company’s interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable. The ratio measures how many times over a company could pay its outstanding debts using its earnings. This can be thought of as a margin of safety for the company’s creditors should the company run into financial difficulty down the road. The ability to service its debt obligations is a key factor in determining a company’s solvency and is an important statistic for shareholders and prospective investors.”

The following table shows the last four quarters of FDUS’s earnings with an average interest coverage ratio of 3.4 implying that the company can easily cover its debt payments:

Annotation 2020-02-16 172728.png

—————–


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

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

To be a successful BDC investor:

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

OCSL Update:Dividend Coverage & Risk Profile

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


Annotation 2020-02-16 171527.png


OCSL Update Summary:

  • OCSL reported below its base case projections due to a meaningful decline in portfolio yield and interest income as well as lower fee income.
  • NAV per share remained stable due to realized/unrealized gains combined with operating earnings covering the dividend for the quarter.
  • OCSL has covered its dividend by an average of 121% with average earnings of around $0.115 per share over the last four quarters partially due to reduced borrowing rates.
  • However, dividend coverage has been trending lower and I will reassess pricing after the earnings call and updating the projections.
  • The company has growth capital available given its historically low leverage with a current debt-to-equity ratio of 0.58. Moody’s and Fitch have recently assigned OCSL investment-grade credit ratings (Moody’s, Baa3 / Stable, and Fitch, BBB- / Stable).
  • Management has made meaningful progress shifting the portfolio from ‘non-core’ legacy assets that account for 13% of the portfolio (previously 16%).
  • First-lien investments account for 57% of the portfolio and non-accruals are very low at 0.03% due to mostly being written off.

 

OCSL Dividend Coverage Update:

For the quarter ended December 31, 2019, Oaktree Specialty Lending (OCSL) reported below its base case projections due to a meaningful decline in portfolio yield and interest income as well as lower fee income. OCSL has covered its dividend by an average of 121% with average earnings of around $0.115 per share over the last four quarters partially due to reduced borrowing rates. The company has growth capital available given its historically low leverage with a current debt-to-equity ratio of 0.58. Moody’s and Fitch have recently assigned OCSL investment-grade credit ratings (Moody’s, Baa3 / Stable, and Fitch, BBB- / Stable).

Armen Panossian CEO/CIO: “OCSL delivered another quarter of strong performance, highlighted by our eighth consecutive quarter of NAV growth. While leverage grew as a result of these originations, we remain below our target range and have ample dry powder and liquidity to invest opportunistically. In addition, we were recently assigned investment-grade credit ratings by Fitch and Moody’s, reflecting the strength and quality of Oaktree’s credit platform, the progress that we have made in reducing exposure to non-core investments and our significant borrowing capacity.”

 

Net realized and unrealized gains were $6 million for the quarter “primarily reflecting realized gains from the sale of a portion of its investment in Yeti Holdings, Inc. and unrealized appreciation on certain debt and equity investments.” OCSL is currently considered a ‘Level 1’ dividend coverage due to its rebounding NAV per share, realized gains and the potential for improved coverage through portfolio growth and rotating out of non-core investments redeployed “into proprietary investments with higher yields”:

“Over time, the Company intends to rotate out of the remaining investments it has identified as non-core investments, which were approximately $174.0 million at fair value as of December 31, 2019. It will also seek to redeploy non-income generating investments comprised of equity investments, limited partnership interests and loans currently on non-accrual status into proprietary investments with higher yields.”

As shown in the following table, the company will likely earn at least $0.099 per share each quarter covering 104% of the current dividend which is basically ‘math’ driven by an annual hurdle rate of 6% on equity before paying management incentive fees.

“The payment of the incentive fee on income is subject to payment of a preferred return to investors each quarter (i.e., a “hurdle rate”), expressed as a rate of return on the value of the Company’s net assets at the end of the most recently completed quarter, of 1.50% [6% annualized], subject to a “catch up” feature.”

This calculation is based on “net assets” per share which have continued to grow driving a higher amount of “pre-incentive fee net investment income” per share before management earns its income incentive fees. As shown in the analysis below, the “Minimum Dividend Coverage” continues to grow along with NAV:

—————–

Management was previously asked about a potential dividend increase due to continuing to overearn the dividend and mentioned:

“In terms of the dividends, we were, as we discussed, we’re focused on the stable kind of cash earnings and the dividend has generated from the — they come from the portfolio to payout the dividend. So we’re thoughtful about that as we think about our dividend and capital strategy.”

As of December 31, 2019, OCSL had almost $22 million of cash and $322 million of undrawn capacity on its credit facility. On June 28, 2019, shareholders approved the reduced asset coverage requirements allowing the company to double the maximum amount of leverage effective as of June 29, 2019. The investment adviser reduced the base management fee to 1.0% on all assets financed using leverage above 1.0x debt-equity. Management mentioned “we have no near-term plans to increase our leverage above our target range of 0.70 to 0.85 times”:

From previous call: “As you will recall last quarter, we received Board approval to increase our leverage, effective in February 2020, unless we were to receive shareholder approval before then. While we have no near-term plans to increase our leverage above our target range of 0.70 to 0.85 times, this is an opportunity cost efficiently seeks shareholder approval in the events, but in the future, we deem the appropriate to deploy higher leverage. In connection with this, our base management fee will be reduced to 1% on all assets, finance using leverage above 1.0 times debt to equity once the new leverage limits are in effect.”

Management previously amended its revolving credit facility terms including extending the reinvestment period and modifying the asset coverage ratio covenant.

 

OCSL Risk Profile Update:

As shown below, management has made meaningful progress shifting the portfolio from ‘non-core’ legacy assets that now account for around 13% (previously 16%) of the portfolio fair value.

Armen Panossian CEO/CIO: “We successfully exited three non-core positions and added $134 million of new investments, the majority of which were privately placed to businesses that align with our late-cycle approach to investing.

—————–

Three investments remain on on-accrual status but have already been written down and are now only 0.03% of the portfolio fair value:

—————–

As of December 31, 2019, 57% of the portfolio was first-lien as 90% of the new investments during the recent quarter were first-lien.

—————–

NAV per share remained stable due to the previously discussed realized/unrealized gains combined with operating earnings covering the dividend for the quarter:


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

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

To be a successful BDC investor:

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

 

CGBD Article Preview & Why I Sold

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


Annotation 2020-02-15 164405.png

Annotation 2020-02-15 172813.png


 

CGBD Update Summary:

  • The following is a preview for a Seeking Alpha article coming out early next week discussing the pros and cons of investing CGBD including conservative asset valuations/dividend philosophy, share repurchases, new management, and investor perceptions of recent credit issues likely driving its discounted stock price.
  • CGBD reported Q3 2019 results on November 6, 2019, and I sold my position due to the additional declines of valuations in ‘watch list’ investments as shown below.
  • Later this month, CGBD will likely report an additional investment on non-accrual which was previously considered its largest ‘watch list’ investment. Investors should be prepared for volatility.

TCG BDC (CGBD) is a business development company (“BDC”) externally managed by Carlyle GMS Investment Management and part of the Carlyle Group, which is a global alternative asset manager with $222 billion of AUM across ~360 investment vehicles providing CGBD access to scale, relationships and expertise, which has advantages including incremental fee income and higher investment yields.

On May 14, 2019, Michael A. Hart, CGBD’s Chairman of the Board and the Chief Executive Officer, informed the Board that he had determined to resign from the Board and as the Chief Executive Officer of the Company, effective December 31, 2019, to pursue other interests.

Linda Pace basically assumed the new role of President shortly after the announcement and formally took over on January 1, 2020. Overall, I see this as a positive for the company as she has added “more people, focus, and resources to the BDC platform”.

Previous Declines in CGBD’s Stock Price

CGBD was formerly known as Carlyle GMS Finance, Inc. and closed its IPO on June 19, 2017, selling 9 million shares with four lockup periods each releasing 25% of an additional ~52 million pre-IPO shares. On April 24, 2019, the Board unanimously voted to accelerate the elimination of the final transfer restriction (the “Lock-Up”) applicable to shares purchased by investors prior to the company’s initial public offering (“Pre-IPO Shares”). The final “Release Date” resulted in additional technical pressure driving lower prices similar to previous Release Dates as shown below.

As discussed in previous articles, my last purchase of CGBD shares was during the December 2018 decline which was a combination that included the previous general market pullback as discussed by management on a previous call:

There is the release of the pre-IPO shares. As you probably also remember that puts enormous technical pressure on the stock. It had previously and history has shown that it did again here, but that’s also complemented or contributed with the overall sell-off in the BDC space as well as the overall general sell-off in the broader market.

BDC Buzz Sale of CGBD

As mentioned in each article, it is important for investors to closely watch the reported quarterly results for BDCs including potential credit issues that could result in lower net asset values (NAV/book values) as well as non-accruals that could result in lower dividend coverage. CGBD reported Q3 2019 results on November 6, 2019, and I sold my position at $14.25 due to the additional declines of valuations in ‘watch list’ investments as shown below:

 

Derm Growth Partners

My last public article discussing CGBD was “Building A Retirement Portfolio With 6% To 9% Yield: Part 2” with an updated watch list for CGBD showing the recent declines including Derm Growth Partners at the top of the table (and largest). This investment has been continually marked down and as shown in the previous table, it was marked down to 70% of cost in Q3 2019.

Also, it was recently reported by Bloomberg that U.S. Dermatology Partners:

defaulted on a $377 million financing provided by a group of investment firms, according to people with knowledge of the matter. The dermatology practice owner is now reviewing its options, including a recapitalization or debt-for-equity swap with its current lenders, Golub Capital, The Carlyle Group Inc. and Ares Management, according to the people, who asked not to be identified because they aren’t authorized to speak about it.

Pieces of the loan, which matures in May 2022 and carries interest at 7.25% over Libor, are held in private credit vehicles called business development companies for Golub and Carlyle, according to regulatory filings. The BDCs were most recently marking the debt at about 69 cents to 74 cents on the dollar as of Sept. 30, the filings show.

On February 7, 2020, I sent out multiple updates to subscribers mentioning “this could be a good time to sell some CGBD near recent highs” and ” I will hold my GBDC” due to the impact to the following loans:

  • “Derm Growth Partners” for CGBD – $39 million FV or around $0.66/share = 4% maximum impact to NAV.
  • “Oliver Street Dermatology Holdings, LLC” for GBDC – $23 million FV or around $0.17/share = 1% maximum impact to NAV.

As shown below, volume picked up quite a bit on February 7, 2020, with most subscribers getting out higher or near $14.00.

 

As of September 30, 2019, Derm Growth Partners accounted for around 4% of CGBD’s NAV:

 

CGBD management discussed Derm Growth Partners on the previous call:

Q. “Okay, thank you. Could you also talk about, I think, Derm Growth Partners III, that’s something another one that you’re carrying, bit of a discount to costs. I’m not sure if there’s something incremental that happened this quarter or if you could just give an update on the company. Thank you.”

A. “Yeah, the update I’d give on that credit is we’re working through some operational and financial performance challenges with the sponsor and the company, but unlike some of the other positions such as dimensional which was the other large mark down this quarter. This is a first lien tranche, so we expect in the situation a very different outcome than we had on dimensional which obviously being junior debt, in a underperforming situation, the recovery prospects on that one is much difference, that’s an important distinction I would draw between the two borrowers.”

As mentioned in previous articles, management takes a conservative approach to valuing its portfolio:

When we held our initial earnings call as a public company back in August of 2017, I highlighted that based on our robust valuation policy, each quarter you may see changes in our valuations based on both underlying borrower performance as well as changes in market yields and that movement evaluations may not necessarily indicate any level of credit quality deterioration.

Source: CGBD Q4 2018 Earnings Conference Call Transcript

Golub Capital (GBDC) is also invested in this asset under the name Oliver Street Dermatology Holdings, LLC which was placed on non-accrual status during Q4 2019 as announced last week. During the most recent call, GBDC management discussed additional non-accruals (including Oliver Street Dermatology) mentioning that they are “cautiously optimistic that in respect of both companies, we are on a good path toward good recoveries”:

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

Source: GBDC Q1 2020 Results – Earnings Call Transcript

GBDC’s investment in Oliver Street Dermatology was marked at 79% of cost which is above CGBD’s 9/30 valuation at 70% implying that this asset was conservatively marked even before CGBD adds to non-accrual. This is a sign of quality management which is why I will be closely watching upcoming results for CGBD.

 

CGBD Share Repurchases, Management & Fee Agreement

I consider CGBD to have higher quality management for various reasons including the previously discussed conservative asset valuations, share repurchases, previously waived management fees, conservative dividend policy driving continued/potentially additional special dividends and a shareholder friendly-fee structure of 1.50% base management fee (compared to 2.00%) and an incentive fee of 17.5% (compared to the standard 20.0%). However, the current fee agreement is not best-of-breed as it does not include a ‘total return hurdle’ to take into account capital losses when calculating the income incentive fees.

On November 4, 2019, the Board authorized a 12-month extension of its $100 million stock repurchase program at prices below reported NAV per share through November 5, 2020, and in accordance with the guidelines specified in Rule 10b-18 of the Exchange Act. The company has repurchased around $52 million worth of shares representing approximately $0.14 in NAV accretion for shareholders.

We continue to be active in share repurchases during the third quarter as we do not believe our valuation reflects the intrinsic value of our company with a broad capabilities of the Carlyle platform. We repurchased $17 million of shares during the quarter and inception to-date, the $52 million in repurchase activity has led to $0.14 in accretion to NAV. We have approximately $48 million remaining on our $100 million repurchase authorization which earlier this week, our board extended for another year. It is our intent to continue repurchasing shares at or near our current valuation.”

Source: CGBD Q3 2019 Results – Earnings Call Transcript


Conclusion and CGBD Recommendations

  • If you are like me, a conservative investor that does not like surprises, you likely already sold CGBD. Those that have not should be ready for volatility over the next two weeks.
  • If you are a more aggressive investor looking for higher returns and yield, you may have been buying including when the stock was trading at $13.15 (20%+ discount to NAV of $16.58) waiting for the company to report positive results and NAV reflation.

Items to keep in mind:

  • On January 1, 2020, Linda Pace formally took over as CEO. Overall, I see this as a positive for the company as she has “added more people, focus, and resources to the BDC platform”.
  • Previously, CGBD repurchased around $52 million worth of shares and hopefully continued to repurchase shares in Q4 2019 that will have a positive impact to NAV.
  • CGBD takes a conservative approach to valuing its portfolio assets.
  • CGBD had already marked Derm Growth Partners at 70% of cost as of September 30 compared to GBDC that marked it down to 79% of cost as of December 31.

My best guess is that CGBD’s stock price will drop after the company reports Q4 2019 results on February 25, 2020 (see table below) due to continued overreaction as this is a relatively new public company and has already reported a few quarters with credit issues.

What will I be doing?

I will be doing the same thing that I mentioned in the CGBD Deep Dive from November 2019:

I will not be repurchasing shares until after the company reports Q4 2019 results.

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

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

BDCs have started to report calendar year-end results. Investors should be watching for potential portfolio credit issues that could lead to credit rating downgrades. Lower ratings would likely drive higher borrowing expenses that could put downward pressure on net interest margins and dividend coverage over the coming quarters.

Annotation 2020-02-15 165805.png

To be a successful BDC investor:

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

AINV Update: Risk Profile & Dividend Coverage

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


Annotation 2020-02-13 024415.png


AINV Update Summary:

  • AINV beat its best-case projections, covering its dividend but only due to additional markdowns (same as previous quarter) resulting in minimal incentive fees paid. AINV would have only covered 97% of its dividend if the full incentive fees had been paid.
  • NAV per share declined by another $0.42 or 2.3% (from $18.69 to $18.27) due to additional markdowns mostly due to its ‘non-core legacy assets’.
  • Total realized/unrealized losses were partially offset by accretive share repurchases (adding $0.02 per share) and overearning the dividend.
  • On January 31, 2020, Fitch downgraded AINV’s senior unsecured debt rating to ‘BB+’ from ‘BBB-‘ but with ‘Stable Outlook’ that was previously ‘Negative’.
  • Portfolio growth was higher-than-expected and the company repurchased 0.5 million shares at a 16% discount to the previously reported NAV resulting in an increased debt-to-equity ratio of 1.47 as the company utilizes its access to higher leverage.
  • The “core strategies” portion of the portfolio now accounts for 88% of all investments.
  • However, the average leverage during the quarter was 1.27 implying higher earnings in the coming quarter.
  • In 2020, AINV has not repurchased shares “given the recent rally in the stock”.
  • Total non-accruals account for 0.7% of total investments at fair value (previously 1.0%) and 2.0% of total investments at cost (previously 2.1%). If these investments were completely written off, it would impact NAV by another $0.31 or 1.7%.

For calendar Q4 2019, Apollo Investment (AINV) beat best-case projections but only due to minimal incentive fees paid during the quarter driven by the ‘total return hurdle’:

“Net investment income for the quarter was $0.54 cents per share reflecting the net portfolio of growth and they were total return feature in our incentive fee structure, which resulted in a nominal incentive fee for the quarter.”

I was expecting a portion of credits to the incentive fees for calendar Q4 2019 but there were additional markdowns related to its ‘non-core’/oil and gas investments resulting in lower incentive fees paid during the quarter. As shown in the following table, the company would have only covered 97% of its dividend if the full incentive fees had been paid. The Board maintained its distribution of $0.45 per share.

Net asset value (“NAV”) per share declined by another $0.42 or 2.3% (from $18.69 to $18.27) due to additional markdowns mostly due to its ‘non-core legacy assets’ partially offset by accretive share repurchases (adding $0.02 per share) and overearning the dividend.

“Net asset value per share was 18.27 at the end of December down 2.3% quarter over quarter. The $0.42 net reduction in NAV per share was due to a $.54 net loss on the portfolio partially offset by net investment income in excess of the distribution of $0.09, and a $0.02 accretive impact from share repurchases. Noncore and legacy assets accounted for $.51 or 95% of the net loss, oil and gas accounted for $0.19 of loss, legacy assets for $0.18, renewable $0.13 and shipping $0.01.”

There were no new non-accruals that declined due another markdown of its oil and gas investment in Spotted Hawk. Total non-accruals currently account for 0.7% of total investments at fair value (previously 1.0%) and 2.0% of total investments at cost (previously 2.1%). If these investments were completely written off, it would impact NAV by another $0.31 or 1.7%.

“No investments were placed on or removed from nonaccrual status. At the end of December investments on nonaccrual status represented 0.7% of the portfolio fair value down from 1% last quarter and 2% at cost down from 2.1% last quarter.”

Portfolio growth was higher-than-expected and the company repurchased 0.5 million shares at a 16% discount to the previously reported NAV resulting in an increased debt-to-equity ratio (leverage) of 1.47 as the company utilizes its access to higher leverage. However, the average leverage during the quarter was 1.27 implying higher earnings in the coming quarter:

“It is important to note that average leverage for the quarter was 1.27 times and client at the larger portfolio will continue to drive earnings growth in the current quarter.”

In February 2019, the Board approved a new stock repurchase plan to acquire up to $50 million of the common stock. The new plan was in addition to the existing share repurchase authorization that was fully utilized during the quarter. Since the inception of the share repurchase program, AINV has repurchased over 12 million shares at a weighted average price per share of $16.83 for a total cost of almost $208 million. Since the end of the quarter, AINV has not repurchased any shares.

“Given the recent rally in the stock, no shares have been purchased since early November. We believe that stock buybacks are the most accretive use of shareholder capital when the stock is trading at a meaningful discount on that. Our board has authorized $50 million plans for total authorization of $250 million. Today we have repurchased over $208 million of stock below NAV, which has accreted $0.68 to NAV per share. We believe the combination of AINV fee structure changes and active stock repurchase program demonstrate our commitment to creating value for our shareholders.”

 

As mentioned in previous reports, the company is in the process of repositioning the portfolio into safer assets including reducing its exposure to oil & gas, unsecured debt, and CLOs. The “core strategies” portion of the portfolio now accounts for 88% of all investments:

Mr. Howard Widra, AINV’s CEO commented, “We continued to successfully implement our plan to prudently grow our portfolio with first lien floating rate corporate loans sourced by the Apollo Direct Origination platform, while continuing to reduce our exposure non-core and legacy assets as well as second lien loans. We believe the risk profile of our portfolio continues to improve which allows us to operate at a higher leverage ratio. In addition, this quarter was an important inflection point in the makeup of our non-core portfolio. The non-core portfolio decreased by approximately $67 million through the combination of repayments and unrealized losses, reducing non-core assets to 12% of the portfolio. In addition, the risk attributable to our remaining non-core portfolio has decreased due to the successful restructuring of our investment in Carbonfree Chemicals. The combination of this restructuring and the accretive impact of the reinvestment of the proceeds received from non-core and legacy repayments has allowed us to have a smaller and better collateralized non-core portfolio while improving the overall earnings profile of Apollo Investment.

 

On January 31, 2020, Fitch downgraded AINV’s senior unsecured debt rating to ‘BB+’ from ‘BBB-‘ but with ‘Stable Outlook’ that was previously ‘Negative’. This will be discussed in the updated Deep Dive report.

“The ratings downgrade reflects the increase in balance sheet leverage, which has not been sufficiently offset by a reduction in portfolio risk, and Fitch’s expectation that Apollo’s leverage (debt/equity) could increase above the previously articulated maximum target of 1.40x; as well as an increased reliance on secured debt funding, which reduces the firm’s funding flexibility. Apollo’s ratings remain supported by its affiliation with the AGM platform; which provides access to investment resources and deal flow; the firm’s experienced management team; and improving portfolio risk profile, including above- average portfolio exposure to first lien investments compared to rated BDC peers. Rating constraints include Apollo’s weaker-than-peer track record in credit; the continuation of execution risk associated with the portfolio mix shift given the firm’s mixed track record and the highly competitive environment; and continued exposure, albeit declining, to certain non-core and legacy investments, which include energy, shipping, renewables.”

AINV previously amended its Senior Secured Facility increasing commitments by $70 million which increased the size of the facility to $1.71 billion.

 

Its aircraft leasing through Merx Aviation remains the largest investment but is now below 13% of the portfolio and continues to pay dividend income. As mentioned in previous reports, AINV has been reducing its concentration risk including reducing its exposure to Merx. Energy, oil and gas investments account for around 4.0% of the portfolio (due to recent markdowns) as compared to 4.8% during the previous quarter:


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

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

To be a successful BDC investor:

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