Sixth Street Specialty Lending (TSLX): Another Solid Quarter

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

  • TSLX target prices, buying points, and suggested limit orders (used during market volatility).
  • TSLX risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • TSLX dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


This update discusses Sixth Street Specialty Lending (TSLX) which remains one of the highest-quality BDCs that perform well during distressed environments. Management is very skilled at finding value in the worst-case scenarios, including distressed retail and energy investments.

TSLX often lends to companies with an exit strategy of being paid back even through bankruptcy/restructuring and is proficient at stress testing every investment with proper coverage and covenants. Management has prepared for the worst as a general philosophy and historically used it to make superior returns (as shown next). Out of 25 transactions, 9 have gone through the bankruptcy process with no capital losses, with an unlevered return of almost 21%. TSLX’s portfolio is 91% first-lien with an average of 1.9 financial covenants for each debt position, 82% with call protection, and 88% effective voting control.

Comparison of Return on Equity (“ROE”)

  • This information will be updated to take into account December 31, 2023, results.

The following table shows the changes in NAV per share and dividends paid between December 31, 2017, and September 30, 2023, as a simple proxy for return on equity (“ROE”) to shareholders. It is important to note that many BDCs prefer not to pay special or supplemental dividends unless necessary because they directly reduce NAV per share. Also, some BDCs purposely pay lower dividends relative to their earnings, which contribute to higher NAV per share. However, this table takes these into account along with the current price-to-NAV ratios, showing that investors pay higher multiples for BDCs that deliver higher returns to shareholders.

Most BDCs with higher ROEs have historically held higher amounts of equity investments, especially HTGC, GAIN, MAIN, FDUS, ARCC, GLAD, and CSWC. However, TSLX has relatively lower amount amounts of equity positions and a much higher first-lien currently around 91% but has still delivered higher returns to investors as shown below.


TSLX Quick Quarterly Update (December 31, 2023)

  • Earnings: Beat its best-case projections covering its regular dividend by 137% (excluding tax accrual) due to higher than expected portfolio growth and higher fee and prepayment-related income, including accelerated original issue discount (“OID”) accretion partially offset by a slight decline in the overall portfolio yield from 14.3% to 14.2%. Leverage increased due to portfolio growth and no shares issued through its ATM with a current debt-to-equity of 1.21 (net of cash).
  • Dividends: Maintained its base dividend of $0.46 plus another supplemental dividend of $0.08 for a total of $0.54 per share paid in Q1 2024, which was above the previous best-case projections of $0.53 per share.
  • Credit Quality: Only American Achievement remains on non-accrual status at 0.6% of the portfolio fair value with almost 96% of the portfolio fair value rated 1 or 2 (strongest credit quality). It should be noted that its debt position in Bed Bath and Beyond remains almost fully valued, implying confidence from management,as discussed in the previous report. TSLX management is very skilled at finding value in the worst-case scenarios, including distressed retail ABL and energy investments.
  • NAV Per Share: Increased by another 0.4% (from $16.97 to $17.04) due to overearning the dividends and accretive share issuances through the DRIP.
  • Other: Recently issued $350 million of 6.125% unsecured notes due March 2029, as the company is continuing to strengthen its balance sheet with more unsecured borrowings.
  • This information will be discussed in the updated TSLX Deep Dive Projection report.




 


What Can I Expect Each Week With a Paid Subscription?

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

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

Golub Capital (GBDC) Update: Lower Fee Structure Delivers

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

  • GBDC target prices, buying points, and suggested limit orders (used during market volatility).
  • GBDC risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • GBDC dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


Golub Capital (GBDC) is considered a lower-risk BDC  for many reasons, including its higher credit quality portfolio of mostly lower yield first-lien and one-stop loans with strong covenant and security protections in mostly non-cyclical sectors. The portfolio is lower-yielding 94% first-lien, highly diversified with very low concentration risk, an average investment size of 0.3% of the portfolio fair value, and the top 25 accounting for around 31%.

“GBDC’s portfolio remained highly diversified by obligor with an average investment size of approximately 30 basis points with 95% of our investment portfolio was comprised of first lien, senior secured floating rate loans and defensively positioned in what we believe to be resilient industries.”





GBDC Quick Quarterly Update (December 31, 2023)

  • Earnings: Reported between its base and best-case projections due to a higher-than-expected portfolio yield (increased from 11.9% to 12.2%) combined with higher dividend income and lower ‘Other G & A’. It should be noted that quarterly interest income has increased from $89 million to $162 million or 82%, increasing NII per share from $0.30 to almost $0.51 per share (excluding tax accrual) over the last 7 quarters.
  • PIK Interest Income: Decreased from 8% (during the previous quarter) to 7% of total income but remains higher than previous levels (around 5% to 6%).
  • Dividends: Recently its regular quarterly distribution from $0.37 to $0.39 per share plus a supplemental dividend of $0.07 per share for Q4 2023 (paid in Q1 2024), as expected in the previous best-case projections (shown below). Similar to other BDCs, GBDC has adopted a variable portion of its dividend policy to pay out the excess earnings as portfolio yields remain higher.
  • Share Repurchases: None likely due to trading closer to NAV and maintaining leverage.
  • NAV per Share: Increased by $0.01 (from $15.02 to $15.03) due to overearning the dividends (regular and supplemental) mostly offset by unrealized losses related to Oliver StreetElite Dental, and Rubio’s Restaurants
  • Credit Quality: Non-accruals decreased from 1.1% to 1.0% of the portfolio fair value mostly due to marking down Oliver Street (dba U.S. Dermatology Partners) and Elite Dental as well as completely writing off Rubio’s Restaurants. However, Bayside and Opening Day remain fully valued implying likely temporary and could be added back to accrual. The amount of investments rated Category 2 and 3 decreased from 14.9% to 14.1% (implies improved portfolio credit quality).
  • This information will be discussed in the updated GBDC Deep Dive Projection report.

As shown below, I was expecting $0.07 per share of supplemental dividends in the best-case projections as well as additional supplemental dividends over the coming quarters partially supported by the lower fee structure:



 


Non-accruals decreased slightly from 1.1% to 1.0% of the portfolio fair value mostly due to marking down Oliver Street (dba U.S. Dermatology Partners) and Elite Dental as well as completely writing off Rubio’s Restaurants. This will be discussed in the updated GBDC Deep Dive report along with the other non-accruals. GBDC has around 357 portfolio company investments, so a certain amount on non-accrual status is to be expected.

 


GBDC maintains a credit watch list with portfolio companies placed into one of five categories, with Category 5 being the highest rating and Category 1 being the lowest. The amount of Category 2 and 3 decreased from 14.9% to 14.1%.


Changes to GBDC Fee Structure & Financial Analysis

As mentioned later, GBDC’s investment adviser has agreed to reduce the income incentive fee and capital gain incentive fee rate from 20.0% to 15.0% effective as of January 1, 2024, and was taken into account with the previously updated projections. Also, in August 2023, GBDC announced the reduction of its base management fee from 1.375% to 1.000%.

GBDC now has one of the best fee agreements in the sector with the lowest base management fee (similar to BXSL, GSBD, and PFLT) combined with the highest hurdle rate at 8.00%, and a cumulative ‘total return’ hurdle or ‘look back’ provision when calculating income incentive fees to protect shareholders from capital losses. I would like to see other BDCs join this group of lower fee structures that would encourage larger institutional investors to sector driving higher multiples and returns for current shareholders. After taking into account the reduced fees, GBDC’s expense ratio declines from 33.5% to 26.8% which is among the lowest in the sector, especially compared to other externally managed BDCs (as shown later).

The following table shows the pro-forma changes and impact to earnings and dividend coverage. Please note that the reduced base management fee was already included in calendar Q3 and Q4 2023 results so the change in pro-forma earnings was around $0.03 per share compared to $0.05 per share for the previous quarters. Basically, GBDC is able to pay at least $0.20 per share annually taking into account the reduced fees. Also, given the previous increases in portfolio yield and maintaining credit quality, the company can easily support dividends of $0.50 per share per quarter (or $2.00 annually) which is taken into account with the GBDC’s target prices.


What Can I Expect Each Week With a Paid Subscription?

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

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

Ares Capital (ARCC): Another Solid Quarter!

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

  • ARCC target prices, buying points, and suggested limit orders (used during market volatility).
  • ARCC risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • ARCC dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


ARCC December 31, 2023, Quick Update

For Q4 2023, ARCC easily beat its best-case projections, mostly due to much higher-than-expected portfolio growth and continued higher amounts of dividend income (of $129 million), covering its regular dividend by 134% (excluding excise tax of $9 million). The company reaffirmed its regular dividend of $0.48 per share, as expected in the previous base case projections. The amount of payment-in-kind (“PIK”) interest income increased to 6.6% of total income with an average of around 6.4% for 2023. There was a slight decline in leverage with its debt-to-equity ratio declining from 1.02 to 1.01 (net of cash) due to the issuance of 12.0 million shares (accretive to NAV) through its “at the market” ATM equity program raising a total of $236 million in net proceeds.

Kipp deVeer, CEO: “Our record fourth quarter Core EPS and net asset value per share concluded another successful year for our company. We continue to drive strong credit and financial results using our extensive sourcing, underwriting and portfolio management capabilities. We believe we are heading into 2024 from a position of strength and will seek to build upon our 14-year track record of paying a stable regular quarterly dividend for our shareholders.”

It is important to point out that its regular dividend of $0.48 per share is adequately covered, especially given that the company has earned an average of almost $0.61 per share over the last five quarters. As mentioned in the weekly BDC sector updates, I am expecting fewer (and smaller) increases in the regular dividends, as BDCs prepare for potentially lower rates.

As expected, ARCC had a busy Q4 2023 with almost $2.4 billion of new commitments and almost $2.0 billion of total fundings. So far in Q1 2024, the company made new commitments of $705 million, of which $478 million were funded. However, there have already been $695 million of exits driving around $19 million or $0.03 per share of realized gains.

During Q4 2023, ARCC sold another $351 million of loans to IHAM that should continue to drive higher dividend income over the coming quarters and the overall portfolio yield has increased from 10.5% to 11.3% over the last four quarters:

In January 2024, the Board authorized an amendment to its existing $1.0 billion stock repurchase program to extend the expiration date from February 15, 2024 to February 15, 2025.

Non-accrual investments remain 0.6% of the total portfolio due to adding its watch list investment in Kellermeyer Bergensons (provider of janitorial and facilities management services) mostly offset by additional markdowns for Singer SewingSHO Holding (Shoes for Crews), and Supply Source Enterprises. Also, there was a very small position in Aventiv (Securus Technologies) added to non-accrual which is held by TCPC and PSEC. These investments have been discussed in previous reports and already included in ARCC’s watch list investments which will be discussed in the updated ARCC Deep Dive Projection report. Please note that ARCC has a very large portfolio with 505 portfolio companies valued at around $22 billion, so there will always be a certain amount of non-accruals.


There amount of higher-risk Grade 1 and Grade 2 credit-rated investments decreased slightly from 6.5% to 6.4% of the portfolio fair value and likely includes many of the previously discussed watch list investments. The weighted average grade of the portfolio at fair decreased from 3.2 to 3.1 (will also be discussed in the updated ARCC Deep Dive Projection report).


What Can I Expect Each Week With a Paid Subscription?

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

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

Prospect Capital (PSEC): Case Study For A Poorly Managed BDC

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

  • PSEC target prices, buying points, and suggested limit orders (used during market volatility).
  • PSEC risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • PSEC dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


Coverage of Lower-Performing BDCs

There are a handful of reasons to cover/follow the lower-performing BDCs including:

  • Establishing a range for key measures of quality in the sector which are used to assign price targets for each BDC. Also, it is helpful to see where how the other BDCs rank compared to others and then be able to tie to performance.
  • Identifying signs of lower quality management so that we know what to look for in other BDCs before there is a ‘real problem’. This is similar to watching the car in front of you drive off the road so that you do not make the same mistake.
  • There is always a chance that management will be able to improve performance as they are responsible for almost every aspect including credit quality, fee structure/waivers, dividend policy, marking the portfolio with appropriate valuations, timing of changes in the capital structure (equity and bond offerings), operating and borrowing expenses, etc.
  • Also, many investors will hold their investment-grade bonds rather than the common shares (including myself but not with PSEC).

I believe that Prospect Capital (PSEC) is an excellent ‘case study’ of a poorly managed BDC that we can all learn from.

Its “Operating Cost as a Percentage of Available Income” which measures operating, management, and incentive fees compared to available income has recently increased to over 50% (as shown later). “Available Income” is total income less interest expense and is the amount of income that is available to pay operating expenses and shareholder distributions. This means that over 50% is going to management rather than paying shareholders.

Also, the amount of PIK interest income for PSEC recently increased from 11.4% to 20.2% of interest income (from 9.8% to 18.6% of total income), which is now higher than FS KKR Capital (FSK) and Monroe Capital (MRCC) which is around 13% to 16 of total income.

As shown later, its top five investments account for $3.0 billion, or almost 40% of the total portfolio, and over 80% of NAV per share. If these investments were marked back down to cost, the current NAV per share would decline from $8.92 to $6.62.


 

PSEC Quick Quarterly Update (December 31, 2023)

  • Pricing: No change. I will reassess after updating the projections.
  • Earnings: Reported below its worst-case projections due to lower-than-expected income from its CLO investments and zero structuring fee income from National Property REIT combined with much higher ‘Other G & A expenses’.
  • Payment-in-Kind (“PIK”) Income: Increased from 11.4% to 20.2% of interest income (from 9.8% to 18.6% of total income), which is now higher than FSK and MRCC.
  • Dividends: Maintained its regular monthly dividend of $0.06 per share through April 2024 and expects to declare subsequent distributions in May 2024.
  • Credit Quality: Non-accrual investments remain 0.2% of the total portfolio at fair value and include only two of its loans to Uses Corp as the other remain fully valued and on accrual status. Other investments on non-accrual include Engine GroupStrategic Materials, and United Sporting Companies. Please note that Aventiv (Securus Technologies) remains on accrual status even though ARCC placed its second-lien position on non-accrual in Q4 2023.
  • NAV Per Share: Decreased by $0.33 or 3.6% (from $9.25 to $8.92) due to marking down its watch list investments in Securus TechnologiesNational Property REITFirst Tower FinanceCP Energy, and InterDent as well as issuing shares through its DRIP and conversion of its preferred stock (shown below). The markdowns in these five investments accounted for over $131 million of portfolio losses (as shown later) or around $0.32 per share but were partially offset by gains in Valley Electric.

As shown below, there were almost 4.2 million additional shares issued during Q4 2023 mostly through conversion of its preferred stock plus the dividend reinvestment plan (“DRIP”) at a 5% discount to the market price. The weighted average price of the newly issued shares was around $6.77 or a 24% discount to NAV per share:

As shown below, there was no restructuring fee income from National Property REIT during Q4 2023 compared to $15.5 million the previous quarter. Also,

PSEC’s total revenues have declined to levels before the recent rise in interest rates even though leverage has increased due to additional credit issues, declining income from CLOs, and lower amounts of non-interest income. Also, the “Operating Cost as a Percentage of Available Income” which measures operating, management, and incentive fees compared to available income increased to over 50%. “Available Income” is total income less interest expense and is the amount of income that is available to pay operating expenses and shareholder distributions.

Its NAV per share declined by $0.33 or 3.6% due to marking down its watch list investments in Securus TechnologiesNational Property REITFirst Tower FinanceCP Energy, and InterDent accounted for over $131 million of losses partially offset by gains in Valley Electric:

National Property REITFirst Tower Finance, InterDent, Valley Electric, and Credit.com/PGX, still account for $3.0 billion, or almost 40% of the total portfolio, and over 80% of NAV per share (as shown below). This is a very high-concentration risk, especially if management uses aggressive valuation measures. The following table shows the total amount of unrealized gains remains around $1 billion, which has added $2.30 to its NAV per share even after taking into account the continued markdowns. If these investments were marked back down to cost, the current NAV per share would decline from $8.92 to $6.62.

During an economic recession, this is a possibility for some of these investments, and investors should be prepared for a certain amount of markdowns. On September 28, 2023, PGX underwent a corporate restructuring with the new borrower being Credit.com Holdings. As part of the transaction, the first-lien term loan was restructured into new debt, resulting in a realized loss of $1.5 million, and the second-lien term loan was written off resulting in a realized loss of $180.0 million. In connection with a Chapter 11 process, PGX sold the majority of its assets to Credit.com Holdings, and PSEC was issued equity at Credit.com, through its Class B non-voting equity investment in PGX Topco.

There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, realized losses, fee structures including ‘total return hurdles’ taking into account capital losses, changes to portfolio yields, borrowing rates, the amount of non-recurring and non-cash sources of income including payment-in-kind (“PIK”). Higher amounts of PIK for lower-quality BDCs are typically a sign that portfolio companies are not able to pay interest expense in cash and could imply potential credit issues over the coming quarters.

Most BDCs have around 2% to 8% PIK income and I pay close attention once it is over ~5% of total interest income. The amount of PIK interest income for PSEC recently increased from 11.4% to 20.2% of interest income (from 9.8% to 18.6% of total income), which is now higher than FSK and MRCC which are around 13% to 16 of total income.

The following table shows many of the larger PIK positions for PSEC with the following notes:

  • PIK was due January 2, 2024 for Valley Electric Company, Inc. loans. The Maximum PIK rate that was capitalized into the balance of the First Lien Term Loan and First Lien Term Loan B was 10.00% and 8.00%, respectively.
  • On December 29, 2023, the Aventiv Technologies First Lien and Second Lien Term Loan were amended to allow a portion of interest accruing in cash to be payable in kind.
  • PIK was due October 2, 2023 for CP Energy Services loans. The Maximum PIK rate that was capitalized into the balance of the loans was 14.65%.
  • On September 28, 2023, the Credit.com First Lien Term Loan A and First Lien Term Loan B were amended to allow a portion of interest accruing in cash to be payable in kind.
  • On September 12, 2023, the Rising Tide Holdings, Inc. Exit Facility Term loan was amended to allow a portion of interest accruing in cash to be payable in kind.
  • On March 28, 2023, the USES Corp. First Lien Equipment Term loan was amended to allow interest accruing in cash to be payable in kind resulting in a maximum current PIK rate of 14.61%.
  • On January 6, 2023, the CP Energy Services Amendment No. 16 to Loan Agreement was amended to allow interest accruing in cash to be payable in kind resulting in a maximum current PIK rate of 14.65%.
  • On August 22, 2022, the Spartan Energy Services Amended and Restated Senior Secured Loan Agreement was amended to allow interest accruing in cash to be payable in kind resulting in a maximum current PIK rate of 13.61%.
  • On September 30, 2022, the Credit Central Senior Subordinated Loan Agreement was amended to allow interest accruing in cash to be payable in kind resulting in a maximum current PIK rate of 10.00%.
  • On December 30, 2022, the First Tower Finance Amendment No. 15 was amended to reduce the PIK rate to 5.00% and allow the interest accruing in cash to be payable in kind resulting in a maximum current PIK rate of 15.00%.

As of December 31, 2023, around 18% of the portfolio was equity positions in a small group of investments, and 8% invested in the equity class of the collateralized loan obligation (“CLO”), which are considered non-qualified investments due to the amount of off-balance sheet leverage (typically 10 times) used to achieve returns. Together these account for almost 26% of the portfolio and banks will not allow these assets to be used as collateral for credit lines, which is why PSEC needs to use subordinated notes and preferred stock for most of its borrowings.


What Can I Expect Each Week With a Paid Subscription?

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

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

PNNT & PFLT: Q4 2023 Updates

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

  • PNNT and PFLT target prices, buying points, and suggested limit orders (used during market volatility).
  • PNNT and PFLT risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • PNNT and PFLT dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


PNNT Quick Quarterly Update (December 31, 2023)

  • Earnings: Reported between its base and best-case projections mostly due to higher than expected portfolio growth as well as continued higher dividend and other income partially offset by its portfolio yield declining from 13.0% to 12.6%, driving earnings of $0.246 per share (excluding provision for taxes) covering its dividends by 117%.
  • Leverage: Its debt-to-equity increased to 1.24 (net of cash and U.S. Government Securities) due to higher-than-expected net portfolio growth of $160 million.
  • Net Realized Gains: $1.8 million or $0.03 per share from exiting equity positions.
  • Dividends: Maintained its monthly dividend of $0.07 per share for February 2024 (or $0.21 per share per quarter), which was the previous base case projection, and will announce its March 2024 dividend next month.
  • Share Repurchases: No shares were repurchased during calendar Q4 2023.
  • Credit Quality: Only Mailsouth remains on non-accrual status which has been written off with no further negative impact on NAV per share.
  • NAV Per Share: Decreased by $0.05 (from $7.70 to $7.65) mostly due to marking down its watch list investments in Atlas Purchaser ($0.04 per share impact) and Pragmatic Institute ($0.01 per share impact).
  • This information will be discussed in the updated PNNT Deep Dive Projection report, along with its overall risk profile, full dividend, and financial projections, taking into account discussions with management on the upcoming earnings call.

As shown below, I am expecting additional dividend increases for Q2 2024 in the best and base-case projections. The following was from the previous call:

“Obviously, up until this quarter, I’ve raised the dividend for many, many quarters. As our income rose and as our default rate remain very, very limited. We pivoted to a monthly dividend a couple of months ago. So here, this quarter, we earned 24, we’re paying out $0.21 I think for now, we’re just going to let a percolate kind of keep a nice cushion to the monthly $0.07 per share dividend. We’ll come up for air in a couple of months and see how things are looking and see about the trends in the portfolio, see about interest rates. This PSLF JV has been really, really accretive to earnings and hopefully, we’ll continue to be very accretive to earnings. And no decisions, but it’s something we’re watching and we’re focused on.”

Arthur Penn, Chairman and CEO: “We are pleased to announce another quarter of solid net investment income, which is in excess of our dividend by a healthy margin. Our earnings stream continues to be robust and is driven in part by the excellent returns generated by our PSLF Joint Venture.”

For the three months ended December 31, 2023, we invested $231.1 million in 12 new and 32 existing portfolio companies at a weighted average yield on debt investments of 11.9% (excluding U.S. Government Securities). For the three months ended December 31, 2023, sales and repayments of investments totaled $71.0 million (excluding U.S. Government Securities). For the three months ended December 31, 2023, PSLF invested $81.0 million (including $50.8 million were purchased from the Company) in five new and seven existing portfolio companies at weighted average yield interest bearing debt investments of 12.7%. PSLF’s sales and repayments of investments for the same period totaled $29.1 million.


PFLT Quick Quarterly Update (December 31, 2023)

  • Suggested Pricing: No change. I will reassess after updating the projections using guidance from management.
  • Earnings: Reported between its base and best-case projections mostly due to much higher than expected portfolio growth, higher other income and dividend income from its PennantPark Senior Secured Loan Fund (“PSSL”), partially offset by higher ‘Other G&A’ and a slight decline in portfolio yield (from 12.6% to 12.5%), covering its dividends by 108%.
  • Leverage: Its debt-to-equity increased from 0.61 to 0.91 (net of cash) due to much higher-than-expected new investments of $303 million during the quarter.
  • Subsequent Events: Through February 2, 2024, PFLT invested another $103 million in 4 new and 23 existing portfolio companies at a weighted average yield of 13.0%. This is good news and will be taken into account with the updated projections.
  • Dividends: Maintained its monthly dividend of $0.1025 per share for February 2024, which was the previous base case projection, and will announce its March 2024 dividend next month.
  • Credit Quality: Non-accruals declined from 0.2% to 0.0% of the portfolio fair value due to restructuring Output Services Group and Lucky Bucks. Only its second lien position in Mailsouth remains on non-accrual status which has been written off with no further negative impact on NAV per share.
  • Net Realized Losses: $3.1 million or $0.05 per share due to restructuring Output Services Group and Lucky Bucks.
  • NAV Per Share: Increased by $0.07 or 0.6% (from $11.13 to $11.20) mostly due to unrealized portfolio appreciation which included some of its watch list investments being marked higher and the equity position of its PSSL as well as overearning the dividends.
  • This information will be discussed in the updated PFLT Deep Dive Projection report, along with its overall risk profile, full dividend, and financial projections, taking into account discussions with management on the upcoming earnings call.

Art Penn, Chairman/CEO: “We are pleased to have another quarter of solid performance from both a NAV and net investment income perspective. We are actively investing in this excellent vintage of new core middle market loans. Through the growing balance sheets of PFLT and our PSSL joint venture, we are driving meaningfully increased income.”

“For the three months ended December 31, 2023, we invested $302.6 million in 13 new and 34 existing portfolio companies at a weighted average yield on debt investments of 11.9%. Sales and repayments of investments for the same period totaled $103.8 million.”

As of December 31, 2023, our portfolio totaled $1,270.9 million, and consisted of $1,090.5 million of first lien secured debt (including $210.1 million in PSSL), $0.2 million of second lien secured debt and $180.3 million of preferred and common equity (including $52.1 million in PSSL). Our debt portfolio consisted of approximately 100% variable-rate investments. As of December 31, 2023, we had one portfolio company on non-accrual, representing 0.1% and zero percent of our overall portfolio on a cost and fair value basis, respectively.


What Can I Expect Each Week With a Paid Subscription?

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

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

GAIN & GLAD: Q4 2023 Updates

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

  • GAIN and GLAD target prices, buying points, and suggested limit orders (used during market volatility).
  • GAIN and GLAD risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • GAIN and GLAD dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


GAIN Quick Quarterly Update (December 31, 2023)

  • Earnings: Reported between its base and best-case projections due to success fee income of $1.4 million related to the exit of Counsel Press and ‘adviser fee credits’ driving lower ‘Other G & A’ partially offset another quarter of no dividend income. There are still no loans with a PIK interest component.
  • Realized Gains: Around $43.5 million or $1.27 per share during Q4 2023 due to the exit of Counsel Press, as discussed in previous reports/updates.
  • Leverage: Remains among the lowest in the sector with a debt-to-equity of 0.91 (net of cash) partially due to shares sold through its ATM program.
  • Dividends: Recently reaffirmed its monthly dividend of $0.08 per share.
  • Shares Issued: 1,456,279 shares under its ATM program at a weighted average price of $14.51 per share (compared to the previous NAV per share of $14.03).
  • NAV Per Share: Decreased by $1.02 or 7.3% (from $14.03 to $13.01) due to supplemental dividends of $1.00 per share and changes in the value of equity/debt positions that will be discussed in the updated GAIN Deep Dive Projection report. Please note that NAV per share has increased by over 17% over the last 12 quarters.
  • Credit Quality: No new non-accruals which remain 3.4% of the portfolio at fair value. However, its watch list investments in B+T Group and PSI Molded Plastics were marked lower again (shown below) and could be added to non-accrual status.
  • Subsequent Events: Issued another 538,206 shares at a weighted average price of $14.53 per share raising $7.7 million in net proceeds and increased the size of its credit facility from $135 million to $200 million.
  • One of my primary concerns is the amount of concentration risk in the portfolio with its top five investments (SEFGNocturne Luxury Villas, Old World Christmas, Dema/Mai Holdings, and Brunswick Bowling Products) accounting for $381 million, or 42% of the total investment portfolio at fair value as of December 31, 2023. However, this is partially due to being under-leveraged.
  • This information will be discussed in the updated GAIN Deep Dive Projection report, along with its overall risk profile, full dividend, and financial projections, taking into account discussions with management on the upcoming earnings call.


‘Core NII’ takes into account incentive fees related to capital gains:

 



GLAD Quick Quarterly Update (December 31, 2023)

  • Earnings: Reported slightly below its base case projections due to continued lower fee and dividend income partially offset by higher fee credits covering its monthly dividends by 111% with a slight increase in its portfolio yield from 13.8% to 13.9%. The amount of PIK interest income increased from 3.9% to 6.1% of total income.
  • Shares Issued: None due to only having $0.4 million of remaining capacity (but increased on January 17, 2024).
  • Leverage: Among the lowest debt-to-equity in the sector, currently 0.81 net of cash.
  • Dividends: Recently announced that it is maintaining its regular monthly dividend of $0.0825 per share for Q1 2024.
  • Credit Quality: Only its watch list investment in Edge Adhesives remains on non-accrual status and accounts for 0.4% of the portfolio fair value.
  • NAV Per Share: Increased by another $0.22 or 2.3% mostly due to realized/unrealized portfolio appreciation of $0.19 per share plus overearning the dividends by $0.03 per share. NAV per share has increased by almost 26% over the last three years.
  • This information will be discussed in the updated GLAD Deep Dive Projection report, along with its overall risk profile, full dividend, and financial projections, taking into account discussions with management on the upcoming earnings call.

 


Subsequent events that will be taken into account with the updated projections:

  • Portfolio Activity: In January 2024, its investment in CHA Holdings, Inc. paid off at par for net cash proceeds of $3.0 million.
  • Registration Statement: New shelf registration statement was declared effective on January 17, 2024, and permits the company to issue up to an aggregate of $700 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities, and warrants to purchase common stock or preferred stock.

GLAD recently announced that it is maintaining its regular monthly dividend of $0.0825 per share for Q1 2024:

The largest markups during the quarter were its positions in Antenna Research, MCG Energy Solutions, Engineering Manufacturing Technologies, and Lonestar EMS partially offset by marking down FES ResourcesB+T Group, and NeoGraf Solutions. It is important to note that GAIN also has an investment in B+T that remains on its watch list and will likely be marked lower in Q4 2023 and could be added to non-accrual over the coming quarters.


What Can I Expect Each Week With a Paid Subscription?

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

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

Comparing BDC Credit Quality

Assessing Risk For BDCs

Assessing risk is critical when setting the target prices for each BDC focused on capital preservation, including NAV per share stability and portfolio strength, to sustain dividend coverage. This includes the ability of the portfolio to retain value during an economic downturn.

One of the best approaches to assessing risk in a BDC portfolio is using a “vintage analysis” that takes into account many aspects including the time frame that each loan was originated as well as asset class, maturity, directly originated vs. syndicated, industry sector, PIK vs. cash yields. BDCs that were lending during times of less protective covenants and higher leverage multiples while maintaining higher-than-average yields will likely have upcoming credit issues regardless of the overall economy

Assessing which vintages are potentially riskier than others is an evolving art and there are a few key indicators that we use, including historical market liquidity levels, default rates, leverage multiples, and covenant light trends. More importantly, we compare the cash/PIK yields of each loan by the time frame that they were originated, but also taking into account the asset class and company sector. Specifically, we are looking for “above market” yields that could imply higher risk. Another important indicator is loans that should have been refinanced at lower rates and are past their “prepayment penalty” windows. This would include loans with much higher than current market yields and could easily be refinanced unless the portfolio company has potential credit issues.

BDC ‘Watch Lists’

The Deep Dive Projection reports for each BDC are increasingly focused on portfolio investments that may have upcoming credit issues and comparing the amount of ‘watch list’ investments and the potential impact on net asset value (“NAV”) per share using various default and recovery rates.

What Are Watch List Investments?

We are continuously monitoring BDC portfolios to identify potential defaults, including loan performance, rating downgrades, specific company/sector news and events, etc. Watchlist investments are portfolio investments that may have upcoming credit issues.

What Is the Default Rate?

The default rate measures the number of loans that have gone into default, usually expressed as a percentage of the total number of loans in a portfolio. A default occurs when a borrower fails to make the required payments on a loan. The default rate is an indicator of the credit quality of a loan portfolio and can be used to assess the risk of a lender’s portfolio. Default rates can be affected by various factors, including the quality of the loan portfolio, the state of the economy, and the effectiveness of the lender’s loan underwriting and risk management practices.

What Is the Recovery Rate?

The recovery rate is a measure of the amount of capital that a lender can recover from a loan that has gone into default, typically expressed as a percentage of the original loan amount. The recovery rate reflects the ability of the lender to collect on a defaulted loan and can be used to assess the risk of a lender’s portfolio. A higher recovery rate generally indicates that the lender has taken steps to minimize its losses from defaulted loans, such as securing collateral, using loan guarantees, or taking legal action against the borrower. A lower recovery rate may indicate that the lender has not taken adequate steps to protect its interests and may result in higher losses from defaulted loans. The recovery rates on first-lien secured debt positions with appropriate covenants/protections/collateral will be much higher than junior/subordinated positions.

Comparing BDC Watch Lists

The following chart shows the potential impact on NAV per share for each BDC, assuming that 100% of watch list investments (including non-accruals) defaulted with 0% recovery. This is the worst-case scenario for this group of investments. It is important to note that the chart only takes into account watch list investments and any changes to other positions will also have an impact (positive or negative). BDCs with larger amounts of equity positions, most of which are not included in the watch lists, will likely have more NAV volatility (higher or lower).

The largest NAV declines over the last 4 quarters were mostly BDCs with larger amounts of watch list investments. Subscribers who believe the economy is headed for a ‘hard landing’ with a deep, broad, and/or extended recession should focus on the BDCs closer to the top left corner.


Last week, we updated the watch list for Trinity Capital (TRIN) which remains higher than average and includes companies with crypto, FinTech, and real estate exposure discussed in the updated TRIN Deep Dive report.

During Q3 2023, TRINs non-accruals increased from 2.0% to 2.5% of the portfolio fair value (2.6% of debt portfolio) due to adding its investments in Bowery Farming and Molekule partially offset by exiting Fernished, Inc.

Bowery Farming is a vertical farming company also held by FSK which has its first-lien position marked at 22% of cost but with an earlier maturity date and a PIK component (likely higher risk).

Molekule is an air purifier company that filed for bankruptcy in October 2023 and could be marked lower in Q4 2023.

GoFor Industries is a delivery company that was seeking capital through a SPAC merger that fell through and was previously added to non-accrual.

As mentioned earlier, TRIN’s stock price had recently declined likely for a few reasons including the drop in the price of bitcoin which has declined by over 15% since January 8, 2024. TRIN has equipment finance facilities with three companies (Core ScientificHut 8 Mining, and Cleanspark) in the crypto space representing around $49 million or 4.3% of the portfolio on a cost basis and $42 million or 3.8% on a fair value basis. These investments accounted for around $0.97 or 7.4% of its NAV per share and are included in its watch list.

Core Scientific is a Bitcoin company that suspended its equipment and other financing payments in October 2022 due to “a liquidity crunch and overextension of debt” and was placed on non-accrual “pending the outcome of future developments at the company”. In December 2022, the company filed for Chapter 11 but was marked higher in Q3 2023 as management was expecting the bankruptcy to be finalized in Q4 2023:

Q. “Can you provide an update on where the situation with Core Scientific stands? Obviously, we know what’s going on there with that investment at least from the backdrop. It looks like it was maybe written up slightly in the quarter but still remains at a heavy discount. There’s been a big move in Bitcoin prices. I’m not sure what the equipment has done. But just can you give an update on that investment? And — have you seen any changes in the underlying market recently given the big move higher in Bitcoin over the last several months?”

A. “There’s been a couple of significant updates within the quarter. The claim amount and our collateral amount, has been finalized with the company, which is obviously a positive thing. And the company has also come to agreement with the equipment lenders under three different restructuring options. So continues to move forward through the process. The collateral amount and the claim amount were finalized with the company. That’s what they’re bringing into court. We understand the company is very close to reaching agreement with convertible note holders, but as of right now, we haven’t heard that that’s finalized. The judge in the case needed to recuse themselves, there’s a new judge. We think the judgment date is at or around the end of the year. And so, we can’t really say what will happen, what the court judgment will make. But as Ron alluded to the agreement, the Trinity and the company have reached as well as all the other equipment lenders. The company has three debt repayment options, A, B, C, they can choose which suits them best. So we consider those three options do discounted cash flow analysis to value our holdings and still maintained relatively high discount rate just to account for the overall risk. We will have an equitization option as well to consider moving forward. The valuation and the exact terms of that are not completely clear at this time. So it’s impossible for us to say what we might pick. We expect to make that election within Q4. And we’re going to do what, we believe is in the best interest of our shareholders when we make that decision.”

Hut 8 Mining (HUT) is a publicly traded company that mines bitcoin and is constantly in the news including a recent short-sell paper last week from JCapital Research:

On January 24, 2024, HUT countered the activist short-selling report, asserting the allegations as misleading and affirming its financial stability and operational integrity:

“Hut 8 has assessed the claims set forth by the authors of the report and believes that the report is filled with inaccuracies, misrepresented data, speculative claims, and unfounded character attacks. The report appears to represent a deliberate attempt to spread misinformation about Hut 8, its operations, finances, management practices, and key executives. The statements made by the short seller expose an inadequate, distorted understanding of the Company, its operations, and its key executives. The report appears to have been made to distract from the Company’s achievements and progress since closing its merger of equals. The Company believes that the report was designed for the sole purpose of negatively impacting Hut 8’s share price for the short seller’s own benefit, at the expense of Hut 8’s shareholders, partners, and employees. The Company continues to focus on driving strong operating and financial results. On December 31, 2023, Hut 8 held 9,195 Bitcoin in reserve, with an approximate value of $390 million, and had North American-wide operations spanning 205,759 miners under management. In addition to its strong balance sheet, Hut 8 is distinguished from its peers by its diversified business, as approximately 30% of its revenue was generated from fiat revenue streams as of September 30, 2023.

Knockaway (Knock.com) remains on the watch list partially due to significant exposure to home sales which were previously declining was recently marked higher but its equity positions remain valued at zero.

Nexii Building Solutions designs and manufactures low-carbon buildings which also held by HRZN and continues to be marked lower likely related to liquidity issues. During Q3 2023, TRIN provided a small short-term loan through December 31, 2023, likely for working capital, and could indicate upcoming credit issues. As mentioned in other reports, many BDCs with healthcare-related exposure have experienced credit issues mostly related to staffing shortages.

Nomad Health is a platform for travel nurses that reduced its staff by 25% in October 2023 following a previous reduction of 17% earlier that year and could be added to non-accrual.

One of my primary concerns for TRIN is Petal Card which provides cards for consumers who are new to credit and is reportedly exploring “a number of options following several months of struggle”. Some of these reports say Petal is expected to “go out of business” if it does not find a buyer, while others say that outcome is unlikely. As mentioned earlier, the loans to Petal have been extended and partially converted to PIK including its largest loan during Q3 2023. Please note that its loans to Petal remain fully valued accounting for around 3% of the portfolio and over 5% of NAV per share.

As shown below, we have added Petal Card to TRIN’s watch list investments that increased from 13.5% to 16.8% of the portfolio at fair value (18.5% of the portfolio at cost), which is higher than the average BDC, as shown in the previous comparison chart.


Some of my primary concerns for FS KKR Capital (FSK) include many of its health care (similar to other BDCs), asset based finance (“ABF”), capital goods, and software investments as well as real estate and aircraft leasing exposure (similar to previous declines from Global Jet). It is important to note that FSK management could restructure or sell watch list loans resulting in realized losses rather than placing it non-accrual. This has the optics of lower non-accruals but results in realized losses similar to Pure Fishing during Q3 2023 and is a potential sign of lower quality management (if it is a common occurrence).

Even after taking into account the recent and previous exits/repayments/restructuring of Pure Fishing, Angelica, Gracent, Hilding Anders, Arrotex Australia, Misys (Finastra), Monitronics International, NBG Home, One Call Care Management, and ThermaSys, the amount of watch list investments remains 15.5% of the portfolio fair value (19.8% at cost) and around 33% of NAV per share, which is more than most BDCs. This is one of the reasons that FSK typically trades at a 20% to 30% discount to NAV.

There is a good chance for additional credit issues potentially related to Advania, Avida, Constellis, Industria Chimica, JW Aluminum, Miami Beach Medical, Prime ST, and Reliant Rehab Hospital. These 8 investments account for around $775 million of the portfolio at cost or around $576 million at fair value which is around $2.06 per share or 8.6% of NAV per share.

As mentioned earlier, FSK has experienced net realized losses of $990 million or $3.53 per share over the last 9 years after including the most recent $66 million in Q3 2023. Also, its NAV per share has declined by 34% over the last 6 years:

The following table shows the potential impact on FSK’s NAV per share using a range of default rates only for its watch list and non-accrual investments, but also considering a range of potential recovery rates.

For example:

  • If 100% of these investments defaulted with 0% recovery, the negative impact on NAV per share would be around $8.13 or 32.7%. This is the worst-case scenario for this group of investments.
  • If 50% of these investments defaulted with a 50% recovery, the negative impact on NAV per share would be around $1.35 or 5.4%.
  • If 20% of these investments defaulted with an 80% recovery, the positive impact on NAV per share would be around $0.11 or 0.5%.

It is important to understand that FSK’s watch list is currently marked at a weighted average of 75% of cost and any changes to other investments (especially equity positions) will also have an impact (positive or negative).

Portfolio Allocations: Where Do BDC Stocks & Bonds Fit?

Summary

  • Many investors ask where BDC stocks and bonds fit into their overall portfolio and this update should help.
  • To keep it simple, this update uses oversimplified asset classes of cash, treasuries, corporate bonds/notes, other stocks (general market equities), and higher-yield investments (including BDCs).
  • The table below uses what I consider to be conservative estimates for annual total returns (dividends plus capital gains) and takes into account current price levels.

As discussed in previous updates, one of the many reasons that I like to invest in the BDC sector is taking advantage of market volatility to lower my weighted average purchase prices, driving much higher returns. Please see the previous update which discussed the BDC Google Sheets with real-time pricing and recommendations to help in identifying actionable opportunities during market volatility using the following tabs:


Typical Steps to Creating a Retirement Portfolio

A typical advisor charges 1% or more of the portfolio value per year for what most people can do themselves.

  1. Set a realistic budget.
  2. Calculate the amount of pre-tax income needed from your investment portfolio.
  3. Assess risk tolerance including asset allocations.

Many subscribers ask where BDC stocks and bonds fit into their overall portfolio. Your portfolio allocations depend on a few factors, including your age, overall risk appetite, investment time frame, and need to access capital.

Historically, investment advisors used the “100 minus your age” axiom to estimate the stock portion of your portfolio. However, that was likely when the average life expectancy was 65 to 70 compared to the current 85 or higher depending on many factors, and has been revised to 120.

  • For example, if you’re 60, 60% of your portfolio should be in stocks.

Clearly, BDCs are for longer-term investors so please allow an investment time frame of at least 3 years.

The following charts use the oversimplified asset classes of cash, treasuries, corporate bonds/notes, other stocks (general market equities), and higher-yield investments (including BDCs/CEFs) along with some examples of allocations and my personal portfolio (not exact):

The table below uses what I consider to be conservative estimates for annual total returns (dividends plus capital gains) and takes into account current price levels. As shown later, the average BDC has provided annualized returns of 58% for investors who purchased shares near the lows in March 2023.

 

As shown in the previous table, we have broken out the BDCs selected for ‘Risk Averse’ investors.  Please see the “Introduction To BDC Google Sheets” for a discussion of the Risk-Averse portfolio.

 

The following table shows the changes in stock prices from the March 2023 lows (most of which were on March 13, 2023) plus dividends accrued/paid. The average return is around 26% over the last 6 months (annualized returns of 58%), excluding PSEC, which continues to underperform.

 


BDC Position Categories & Building Your Portfolio

Category A: This is for starter and smaller positions. We suggest starting a position with a smaller number of shares closer to its target price and then continuing to “buy more on the dips”. I recently did this with TRIN.

Category B: This is for current positions that you want to grow into a full/proper allocation for a diversified portfolio. We suggest adding to these positions using the suggested ‘High’ and ‘Low’ limit order prices discussed earlier.

Category C: This is for investors that already have larger positions and would likely only add at opportunistic prices near the suggested ‘Low’ limit order prices, potentially during market volatility/pullbacks. Active traders might choose to sell these shares for capital gains at a later date to re-balance the portfolio.

What is a “full position”? A full position would be the amount you want to invest into a particular stock based on the total amount available and considering the rest of your portfolio. I suggest having at least 5 BDC positions and up to 15 or 20 positions for larger portfolios. This will help with portfolio stability when select BDCs report disappointing quarters (they all do at some point). For investors with only 5 positions, this means that around 20% of the amount allocated to BDCs is considered a “full position/allocation”. I typically have 16 to 20, so a full position is around 5% to 6% of my BDC portfolio.

Over the years, I have carefully built a portfolio that I continually adjust. For investors who are looking to build a BDC portfolio, please consider the following suggestions:

  • Identify BDCs that fit your risk profile by reading the individual Deep Dive Projection reports for each BDC.
  • Use the BDC Google Sheets during market volatility to identify opportunities.
    • Starter Positions: It is important for new investors to be patient and start with a smaller amount of shares using limit orders. Initiating a position will help with gaining interest and following the stock (also management team and credit platform) to develop a comfort level for future purchases
    • Diversify: I suggest having at least 5 BDC positions and up to 15/20 positions for larger portfolios. This will help with portfolio stability when select BDCs report disappointing quarters (they all do at some point).
    • Opportunity Cost: Keep in mind that while you are waiting for lower prices, BDCs are paying healthy amounts of dividends.
    • Dollar Averaging Purchases: There will continue to be general market and/or sector volatility driving lower prices, providing opportunities to lower your average purchase prices.

Introduction To BDC Google Sheets

Summary:

  • This article discusses the BDC Google Sheets with real-time pricing and recommendations to help in identifying actionable opportunities during market volatility.
  • For new subscribers, we discuss Suggested BDC Portfolios and Ranking Tiers as well as how to build a portfolio using the BDC Google Sheets.
  • For lower-risk investors building a balanced 60/40 portfolio (stocks and bonds), the “BDC Notes” tab includes Interest Expense Coverage and Asset Coverage ratios.
  • We continually update the “Buzz Returns” tab, which shows the total returns for each of the 121 trades over the last 8 years.
  • We continually assess “oversold” or “overbought” conditions looking for buying opportunities using the “Volatility” tab which displays key market indicators in real-time along with recommended limit order prices, RSI, Short-Term and Longer-Term target prices, and recent/previous lows for each BDC.

You can sign up for the BDC Google Sheets using the following link:

This update discusses the BDC Google Sheets with real-time pricing and recommendations to help in identifying actionable opportunities during market volatility using the following tabs, as discussed below:

  • All BDC Stocks (includes BDC Buzz ‘Buy & Hold’ allocations)
  • Dividend Detail & Expectations (for each BDC)
  • BDC Charts
  • Ranking Tiers & Leverage
  • Suggested BDC Portfolios (Risk Averse, Total Return, Recommended Higher-Yield, & High Yield)
  • Volatility (important for building current positions)
  • BDC Buzz Total Returns (121 trades over the last 8 years)
  • BDC Notes (with continually updated coverage ratios)
  • All Baby Bonds/Preferreds
  • Risk Rankings for Baby Bonds/Preferreds


BDC Buzz Total Returns

We continually update the “Buzz Returns” tab, which shows the total returns from my recent and previous trades:

Please note that the details for each of the 121 trades over the last 8 years are included below the table, showing the total returns, all of which are in positive territory after taking into account the dividends paid. My annualized returns are currently over 19% partially due to making purchases during general market volatility, as discussed in the Upcoming BDC Buzz Purchases report.

The “Annualized” return shown does not use a simple average but shows the actual compounding of annual returns. This is the true return each year. Below the main table, there are details for each of the 121 trades broken out by BDC.

See below for examples of two of my relatively newer positions OBDC (4 years) and OCSL (2 years):


“All BDCs” Tab

The “All BDCs” tab includes links to the most recent Deep Dive Projection reports on each BDC. Also included:

  • Recommendations for Short-Term (“ST”) and Longer-Term (“LT”) target prices
  • Ex-Dividend Dates
  • Current Dividend Yields
  • Price-to-NAV Multiples
  • Trading Volumes With Indicators (Light, Normal, High, Heavy)
  • Relative Strength Index (“RSI”, discussed below)
  • 52-Week Lows and Highs
  • Moving Averages (50 and 200 days)
  • BDC Buzz Portfolio Allocations

General BDC Target Pricing Assumptions

  • Short-Term (“ST”) Target Price = Assumes an extended market pullback (potentially due to expectations of an economic downturn).
  • Longer-Term (“LT”) Target Price = Over the next 12 to 24 months and based on returning to normal market conditions.
  • Recession Case (“RC”) Target Price = Assumes a deep, broad, and/or prolonged recession.

BDCs are currently trending closer to or below their Short-Term (“ST”) target prices. However, BDC pricing reacts quickly and could eventually trend back to their Longer-Term (“LT”) targets again if inflation moderated to a point where the Fed took a less aggressive approach coupled with maintained economic indicators.

Trading Volume

The sheets measure the average volume being traded for all BDCs to see if it is an active or slow trading day for the sector (considering the time of day) and then identify BDCs that are trading above or below that average (also given the time of day). This is important because investors should know when volumes might indicate something meaningful is occurring with the stock (positive or negative).

Relative Strength Index

The Relative Strength Index or RSI is an indicator that I use only after I already know which BDC I would like to purchase but waiting for a good entry point. I consider target prices to be much more important when adding to current positions. Also, I would suggest that investors ignore RSI when starting small positions and then use it for timing additional purchases to build their position. Previously added was a column showing “RSI Implies” using:

  • 40 or below = “Buy”
  • 41 to 69 = “Hold”
  • 70 or higher = “Overbought”

This is a complicated formula that takes into account changes in daily pricing over a rolling 365 days. The RSI values are color-coded with green showing closer to 30 (indicating oversold), yellow showing near 50, and red showing closer to 70 (indicating overbought).

Definition from Investopedia:

The relative strength index is a momentum indicator developed by noted technical analyst Welles Wilder, that compares the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a security. It is primarily used to attempt to identify overbought or oversold conditions in the trading of an asset. Traditional interpretation and usage of the RSI is that RSI values of 70 or above indicate that a security is becoming overbought or overvalued, and therefore may be primed for a trend reversal or corrective pullback in price. On the other side of RSI values, an RSI reading of 30 or below is commonly interpreted as indicating an oversold or undervalued condition that may signal a trend change or corrective price reversal to the upside.”


Dividend Detail & Expectations

The “Dividends” tab shows the current and expected dividends for each BDC, including the base, best, and worst-case scenarios. This information is important, as it is one of the primary drivers for target prices (along with portfolio credit quality).

This information is continually updated as the projections for each BDC are adjusted to take into account reported results:

  • Regular and total dividend yields
  • Pay frequency
  • Previous and upcoming ex-dividend dates
  • Current regular dividend
  • Base, Best, Worst Case projected quarterly dividends
  • Base, Best, Worst Case projected special dividends

We have recently added Trinity Capital (TRIN) and continue to update the projected dividends for Q3 and Q4 2023 as well as total expected dividends for 2023, as each of the Deep Dive Projection reports are updated:


Charts to Help Take Advantage of Market Volatility

The following tab is one of my favorites, as it provides charts to help investors take advantage of upcoming/continued volatility:


The following chart shows in real-time if the sector is overbought or oversold. When the entire sector is oversold, there’s nothing wrong with “your stock” and it means that you may want to buy more at these levels. BDC pricing is often driven by changes in investors’ attitudes about risk.

BDC prices continue to rally from the March 2023 lows likely due to reporting strong Q1 2023 results with average dividend coverage of around 125% even after taking into account the massive amount of dividend increases for the sector (90% of all BDCs have increased their dividends recently). Also, most BDCs reported stable to growing NAV per share.

As shown below, the average RSI has rebounded again from the most recent low in March 2023. Also shown are my previous purchase points, as I continue to take advantage of market volatility to make additional purchases of my smaller positions, which have provided excellent returns that will be discussed in upcoming articles.

BDC RSIs


BDC Ranking Tiers

It is important to understand the Ranking Tiers are based on a relative basis, meaning that just because a company is ranked as ‘Tier 2’ or ‘Tier 3’ does not imply that it is a ‘bad’ stock. I own many Tier 3 companies, some of which might be upgraded over the coming weeks. The Ranking Tiers combine the results from many of the reports available at the link provided earlier and are primarily responsible for driving the target pricing assigned to each BDC focused on capital preservation, including NAV per share stability and portfolio strength, to sustain dividend coverage.

This includes the ability of the portfolio to retain value during an economic downturn. One of the best approaches to assessing risk in a BDC portfolio is using a “vintage analysis” that takes into account many aspects including the time frame that each loan was originated as well as asset class, maturity, directly originated vs. syndicated, industry sector, PIK vs. cash yields. BDCs that were lending during times of less protective covenants and higher leverage multiples while maintaining higher-than-average yields will likely have upcoming credit issues regardless of the overall economy

Assessing which vintages are potentially riskier than others is an evolving art and there are a few key indicators that I use, including historical market liquidity levels, default rates, leverage multiples, and covenant light trends. More importantly, I compare the cash/PIK yields of each loan by the time frame that they were originated, but also taking into account the asset class and company sector. Specifically, I am looking for “above market” yields that could imply higher risk. Another important indicator is loans that should have been refinanced at lower rates and are past their “prepayment penalty” windows. This would include loans that have much higher than current market yields and could easily be refinanced unless the portfolio company has potential credit issues.

The “Debt-to-Equity” ratio excludes cash, which is important for BDCs with meaningful amounts of cash relative to their borrowings.

The “Expense Ratio” is the average “Operating Cost as a Percentage of Available Income” measuring operating, management, and incentive fees compared to available income over the last four quarters. “Available Income” is total income less interest expense from borrowings and is the amount of income that is available to pay expenses, including shareholder distributions. BDCs with lower operating expenses can pay higher amounts to shareholders without investing in riskier assets.

  • Also, the quality of the credit platform and management is critical when determining which Tier is assigned to each BDC. These are ‘qualitative’ measures that do NOT fit into boxes in the table below.


Suggested BDC Portfolios

Risk-Averse:

This portfolio is for investors concerned with capital preservation (especially during a recession) and seeking less volatility along with solid dividends. These BDCs typically have lower-than-average yields due to lower-yielding and safer investments. Many of these companies have lower fee structures to ensure dividend coverage with safer investments. Many of the lower-risk BDCs have higher pricing multiples contributing to lower-than-average yields, but during recessions, they tend to outperform the others with less volatility and still pay a healthy dividend with long-term capital appreciation.


Total Return:

This portfolio is appropriate for longer-term investors concerned with tax-adjusted returns from dependable regular dividends and the potential for special dividends as well as long-term capital appreciation from increased stock values. Overall returns will probably be higher and have more favorable tax treatments (depends on the year, changes frequently for some). However, many of these BDCs are also priced at a premium with correspondingly lower dividend yields and may involve more risk due to higher amounts of equity investments needed for NAV per share growth and the potential for realized gains to pay special dividends.


Recommended Higher-Yield:

This portfolio could also be called ‘Cruising Altitude BDCs’, meaning that most of these BDCs have reached a fully ramped dividend (Level 2) and are now focused on portfolio maintenance. These BDCs may have lower dividend coverage potentially supported by management willing to waive fees to ensure coverage, hopefully giving them more sustainable dividends than other higher-yielding BDCs. I will be making changes to this portfolio mostly based on pricing and updated projections included in the Dividend Coverage Levels report.


High-Yield:

This portfolio could also be called ‘Underdogs’ and is for investors that are willing to take on more risk with less capital appreciation (over the long-term), but higher dividend yields. These stocks usually have higher volatility, offering the potential for higher returns depending on investment timing. Most of these companies trade at lower multiples, typically at a meaningful discount to NAV.


Taking Advantage of Market Volatility

We continually assess overall BDC Pricing relative to other yield-related investments looking for “oversold” or “overbought” conditions. This includes general sector and individual BDCs keeping subscribers up to date on potential buying opportunities.

Volatility is your friend, invest in higher quality, constantly monitor the fundamentals, and don’t freak out when you see your investments going on sale for no reason. Most BDCs continue to report strong results due to previously improved earnings and balance sheets, relatively low leverage, maintaining excellent credit quality, previously reduced borrowing rates, dividend increases, management carefully deploying capital into first-lien assets of non-cyclical companies with strong covenants, etc.

The “Volatility” tab displays key market indicators in real-time along with recommended limit orders, RSI, ST and LT targets, and recent/previous lows for each BDC:


The table below shows the real-time volatility indicators as well as the following details for each BDC:

  • Current BDC prices and yields
  • Daily change and volume indicators (discussed earlier)
  • Recommended “limit orders” (Low and High)
  • Current price compared to the recommended ‘Low’ and ‘High’ limit orders
  • RSI and what it implies (Buy, Hold, Overbought)
  • ST and LT targets and current difference to the actual price
  • 52-week lows and highs
  • BDC Sector Pricing Score (discussed below)
  • BDC Sector Yield Score (discussed below)
  • Recent stock price lows (far right, not shown in this example)
  • BDC Buzz allocations (far right, not shown in this example)

 

BDC Position Categories & Building Your Portfolio

Category A: This is for starter and smaller positions. We suggest starting a position with a smaller number of shares closer to its target price and then continuing to “buy more on the dips”.

Category B: This is for current positions that you want to grow into a full/proper allocation for a diversified portfolio. We suggest adding to these positions using the suggested ‘High’ and ‘Low’ limit order prices as discussed later.

Category C: This is for investors that already have larger positions and would likely only add at opportunistic prices near the suggested ‘Low’ limit order prices, potentially during market volatility/pullbacks. Active traders might choose to sell these shares for capital gains at a later date to re-balance the portfolio.

We have developed a scoring system to keep subscribers updated on the current conditions of the BDC sector using pricing (most important), RSI (least important), and yields. This system should help subscribers identify the current market conditions for those who are using this volatility to build portfolios.

BDC Pricing Score (Relative to Targets)

  • Score 100 = the average BDC trading at its LT targets
  • Score 50 = the average BDC trading at its ST targets
  • Score 0 = the average BDC trading at its RC targets

The suggested range for limit orders is between the ‘Low’ and ‘High’, giving subscribers an idea of how low a stock can go during market volatility. Start near the high and then set others lower down to the low. Use odd amounts, like $0.01 or $0.06. Each lower price should have more shares as you go.

The table is ranked in real-time by an average of the current price compared to both the recommended ‘Low’ and ‘High’ limit order prices. This means that better deals are at the top of the table. Another feature is highlighted prices for each in “green” when they are under or very close to the recommended ‘Low’ or ‘High’ limit orders.

The following charts use this information from the previous table to provide a more visual format for finding buying opportunities.

You can sign up for the BDC Google Sheets using the following link:


Tradeable BDC Notes

  • Please see the end of this update for a discussion of how to trade BDC notes.

As mentioned in previous updates, many BDCs have investment grade (“IG”) bonds/notes for lower-risk investors building a balanced 60/40 portfolio (composed of 60% to 70% stocks/equities and 30% to 40% bonds or other fixed-income offerings). Stock market volatility will likely remain elevated, and these bonds/notes allow investors to lock in 6% to 9% annualized returns with maturities ranging from 1 to 8 years.

Why the recent focus on BDC Notes?

Great question. They were previously overpriced, and prices continue to decline because of the recent and expected rise in interest rates.

As mentioned in the HTGC Deep Dive Projection report, HTGC has two publicly traded investment grade bonds/notes (CUSIPs: 427096AH5 and 427096AJ1) recently trading at prices with yield-to-maturities of over 8%.

Each of the updated Deep Dive Projection reports includes the projected interest expense coverage and asset coverage ratios with best, base, and worst case. Please see the following links from Investopedia for more information:

  • Interest Expense Coverage
  • Asset Coverage Ratio

The following sheet includes links so that subscribers can pull up the most recent trades, pricing, and yield information for each. As you can see, we have added quite a few and will continue to add for each BDC.

The following chart can be found just below the table, showing the current yield-to-maturity and years to maturity.

The following are some options that BDC management teams have before potentially defaulting on a debt obligation:

  • Reducing leverage by not reinvesting repayments from portfolio companies
  • Reducing the dividend to common shareholders
  • Reducing or waiving management and incentive fees
  • BDCs have permanent equity capital (no “runs on the bank” to force the liquidation of undervalued assets)
  • Raising equity capital: common or preferred, even dilutive if absolutely necessary
  • External manager/credit platform can provide additional capital if needed

For these reasons, no BDC has defaulted on a debt obligation.


Baby Bonds & Preferred Stock Sheets

The following information is included in the “Bond Info” sheet:

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

Recommendations Based on “If Called” and “To Maturity”:

  • “If Called” – assumes that the Baby Bond is called in the near future.
  • “To Maturity” – assumes that you hold until maturity.

Previously we made a few changes to the Baby Bond tabs including adding recommendations based on “If Called” and “To Maturity” (discussed below) along with “Suggested Buy” prices (see below) that change daily based on accruing interest and days to call/maturity. This means if you are using them to set limit orders you need to adjust weekly as well as take into account the ‘Ex-Div Date’, which is quarterly and the price will probably change on the following day, which might trigger your limit order. I will discuss this in upcoming updates. This pricing is mostly driven by the “call date’ as I firmly believe that the largest risk for investors is the “redemption risk”. There has never been a default on a BDC Baby Bond as there are many levers management can pull before this worst-case scenario.

The “Suggested Buy” price takes into account the call date and ensures that investors get a minimum of around 5% annual returns for lower risk and 6% for higher-risk Baby Bonds if the company decides to redeem early (on the “Call Date” or in 30 days for the ones that are currently callable).

The recommendations change in real-time based on current pricing, ex-distribution date, call/redemption date, maturity date, etc.


The “Bond Risk” Tab:

The “Bond Risk” tab includes a summary of metrics used to analyze the safety of a debt position, such as the “Interest Expense Coverage” ratio, which is used to see how well a firm can pay the interest on outstanding debt. Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm. A higher coverage ratio is better, although the ideal ratio may vary by industry. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

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

The Bond Risk tab is ranked by Default Risk with notification of Call Risk Capital Loss, which changes based on the current pricing. Also included are ‘Buy’, ‘Hold’, or ‘Overpriced’ indicators for each Baby Bond/Preferred that is driven by real-time pricing (taking into account accrued interest), which BDCs are “callable” and the potential for capital losses during the worst-case scenario, and effective yields. The ‘Overpriced’ indicator is for BDCs with a higher risk of Capital Losses mostly due to being called at current prices.



BDC Position Categories & Building Your Portfolio

 

Category A: This is for starter and smaller positions. We suggest starting a position with a smaller number of shares closer to its target price and then continuing to “buy more on the dips”.

Category B: This is for current positions that you want to grow into a full/proper allocation for a diversified portfolio. We suggest adding to these positions using the suggested ‘High’ and ‘Low’ limit order prices as discussed later.

Category C: This is for investors that already have larger positions and would likely only add at opportunistic prices near the suggested ‘Low’ limit order prices, potentially during market volatility/pullbacks. Active traders might choose to sell these shares for capital gains at a later date to re-balance the portfolio.

What is a “full position”? A full position would be the amount you want to invest into a particular stock based on the total amount available and considering the rest of your portfolio. I suggest having at least 5 BDC positions and up to 15 or 20 positions for larger portfolios. This will help with portfolio stability when select BDCs report disappointing quarters (they all do at some point). For investors with only 5 positions, this means that around 20% of the amount allocated to BDCs is considered a “full position/allocation”. I typically have 16 to 20, so a full position is around 6% of my BDC portfolio.

Investors will continue to need equity investments (stocks) to generate an adequate portfolio yield (to keep up with inflation and/or higher yield expectations). BDCs pay higher-than-average yields with the average BDC currently yielding around 11%. Safer BDCs typically yield between 8% and 10%, but patient investors can get higher yields by taking advantage of volatility.

Over the years, I have carefully built a portfolio that I continually adjust. For investors that are looking to build a BDC portfolio, please consider the following suggestions:

  • Identify BDCs that fit your risk profile by reading the individual Deep Dive Projection reports for each BDC.
  • Use the BDC Google Sheets during market volatility to identify opportunities.
    • Starter Positions: It is important for new investors to be patient and start with a smaller amount of shares using limit orders. Initiating a position will help with gaining interest and following the stock (also management team and credit platform) to develop a comfort level for future purchases.
    • Diversify: I suggest having at least 5 BDC positions and up to 15/20 positions for larger portfolios. This will help with portfolio stability when select BDCs report disappointing quarters.
    • Opportunity Cost: Keep in mind that while you are waiting for lower prices, BDCs are paying healthy amounts of dividends.
    • Dollar Averaging Purchases: There will continue to be general market and/or sector volatility driving lower prices, providing opportunities to lower your average purchase prices.

You can sign up for the BDC Google Sheets using the following link:


What Can I Expect Each Week With a Paid Subscription?

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

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

ARCC Equity Offering & Updated Projections (With Watch List)

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

  • ARCC target prices, buying points and suggested limit orders (used during market volatility).
  • ARCC risk profile, potential credit issues, changes in NAV, and overall rankings. Please see BDC Risk Profiles for additional details.
  • ARCC dividend coverage projections (base, best, worst-case scenarios). Please see BDC Dividend Coverage Levels for additional details.


ARCC Quick Update:

  • ARCC recently announced a perfectly timed equity offering which is relatively small, which will be used for its only 2023 unsecured note maturity on February 10.
  • More importantly, ARCC provided preliminary results for Q4 earnings and NAV as well as portfolio activity during the quarter which have been taken into account with the updated projections.
  • Basically ARCC had an active quarter likely generating fee income driving higher earnings with reduced leverage but slightly reduced NAV.
  • As we enter an environment of increased recessionary concerns, these reports will continue to focus on risk profiles, including any changes to ‘watch list’ investments and the potential impact on NAV using various default and recovery rates as we have done for ARCC

Ares Capital (ARCC) announced an equity offering of 9.0 million shares and then upsized the offering to 10.5 million shares (plus underwriters’ option to purchase up to an additional 1.575 million shares). ARCC had around 518 million shares outstanding as of December 31, 2022, taking into account the equity offering in November 2022 and ATM share issuances.

ARCC has an upcoming maturity of its $750 million of unsecured notes due on February 10, 2023, compared to around ~$225 million of net offering proceeds from the recently announced equity offering. It is important to point out that this is the only unsecured note maturity in 2023.

Also, the company provided the following preliminary estimates for Q4 2022, which have been taken into account with the updated projections:

  • Core EPS between $0.61 and $0.63 per share (compared to analyst estimates of $0.54)
  • NAV per share between $18.35 and $18.43 (1% decline, to previously $18.56)
  • Net realized gains of $0.05 per share
  • $2.2 billion of new commitments funded with an average yield of 11.0% (at cost)
  • $2.3 billion of exited/repaid investments with an average yield of 9.4% (at cost)

Core EPS is a non-GAAP financial measure. Core EPS is the net increase (decrease) in stockholders’ equity resulting from operations less net realized and unrealized gains and losses, any capital gains incentive fees attributable to such net realized and unrealized gains and losses and any income taxes related to such net realized gains and losses.

As shown below, the consensus earnings estimates previously ranged between $0.47 and $0.58 per share with an average of $0.54 per share compared to like $0.62 per share:


ARCC Risk Profile Quick Update

During Q3 2022, its net asset value (“NAV”) per share declined by 1.3% mostly due to a widening of credit spreads and markdowns for TibCo Software, SHO Holding, Eckler Industries, Potomac, and AthenaHealth Group, partially offset by overearning the dividend.

“Our NAV per share declined modestly by 1% as we took net unrealized losses, largely due to the declining prices in the credit and equity markets. Despite this, the fundamental performance of the portfolio remains solid, even as a more difficult economic backdrop appears inevitable.”

ARCC’s NAV per share has increased from $14.43 in Q4 2004 to the current $18.56 even after taking into account the financial crisis of 2008 and the recent COVID crisis.

“Two measures of portfolio credit quality, our nonaccrual rate at cost and the weighted average portfolio grade both remained static quarter-over-quarter and show stronger metrics than our historical averages. The stability in these credit metrics is supported by a healthy level of weighted average EBITDA growth of 13% year-over-year. By historically focusing our efforts on upper middle market companies with high free cash flows that operate in more resilient, less cyclical industries, we believe we’ve been able to reduce some of the credit risks that come from operating in a more difficult environment with higher market interest rates. While we are closely monitoring these risks, we believe they are manageable.”

 

Non-accrual investments increased slightly to 0.9% of the total portfolio fair value due to adding SHO Holding (known as Shoes for Crews, manufacturer and distributor of slip-resistant footwear) and Center for Autism and Related Disorders (also held in the SDLP, autism treatment and services provider specializing in applied behavior analysis therapy) partially offset by exiting Teligent Inc. ($31 million loss) and PhyMED ($55 million loss). Please note that ARCC had offsetting realized gains $66 million during Q3 2022 from exiting Primrose Holding, IRI Holdings, and Bearcat Buyer, Inc.

As discussed in the previous report, Teligent Inc. (pharmaceutical company that develops, manufactures and markets injectable pharmaceutical products) officially went out of business as its plan of liquidation became effective on July 26, 2022. PhyMED was marked at 2% of cost likely driving around $0.11 per share of realized losses but no additional impact to NAV per share during Q3 2022.

Visual Edge Technology was added to non-accrual during Q2 2022 and is a provider of outsourced office solutions with a focus on printer and copier equipment and other parts and supplies. Also, MailSouth, Inc. and API Commercial are smaller non-accrual investments from the direct lending portfolio of Annaly Capital acquired during Q2 2022. RugDoctor (manufacturer/marketer of carpet cleaning machines) was added during Q1 2022 and is a legacy investment from the ACAS acquisitions. As mentioned in previous reports, Eckler Industries was considered a ‘watch list’ investment and was added to non-accrual status in Q4 2021 and remains on non-accrual. Please note that ARCC has a very large portfolio with 458 portfolio companies valued at over $21 billion, so there will always be a certain amount of non-accruals.

“Augmenting the strong credit profile of our portfolio companies is our approach to portfolio diversification. Our $21.3 billion portfolio at fair value is diversified across 458 portfolio companies. This means that any single investment accounts for just 0.2% of the portfolio on average. And our largest investment in any single company, excluding SDLP and Ivy Hill, is just 1.4% of the portfolio.”

The following table shows many of ARCC’s ‘watch list’ investments which remains around 8% of the portfolio fair value (10% of cost) that are likely many of the higher-risk Grade 1 and Grade 2 credit rated investments mentioned later. Many of these investments are included in the previous table showing non-accrual investments. It should be noted that most of the watch list investments, which are not on non-accrual, remain marked over 80% of cost. See later for discussions of some of the larger watch list investments.

The following table shows the potential impact on ARCC’s NAV per share using a range of default rates only for its watch list and non-accrual investments, but also considering a range of potential recovery rates.

For example:

  • If 100% of these investments defaulted with 0% recovery, the negative impact to NAV per share would be around $3.43 or 18.5%. This is the worst-case scenario for this group of investments.
  • If 50% of these investments defaulted with 50% recovery, the negative impact to NAV per share would be around $0.68 or 3.6%.
  • If 20% of these investments defaulted with 80% recovery, the slightly negative impact to NAV per share would be around $0.02 or 0.1%.

It is important to understand that ARCC’s watch list (includes its non-accruals) is currently marked at an average of 82% of cost and any changes to other investments will also have an impact (positive or negative).

 


H-Food Holdings(Hearthside Food Solutions) is an investment also held by ORCC and was previously downgraded by Moody’s partially due to supply chain and inflationary issues but affirmed its credit ratings:

“The outlook revision to negative from stable reflects Moody’s expectation that Hearthside’s operating performance will remain weak and free cash flow will remain negative in the next 12 months as the company faces inflationary headwinds, labor issues, and supply chain challenges. An inability to execute an operational turnaround and reduce leverage will make it challenging to refinance approaching maturities (revolver in November 2024 and first lien term loan in May 2025) and would increase default risk. Moody’s nonetheless affirmed the ratings because the company should be able to reduce Moody’s adjusted debt-EBITDA leverage to below 8x within the next 12 to 18 months through EBITDA growth in 2023, as recently implemented price increase help to offset inflationary headwinds. In addition, employee wage increases have helped to improve the fill rates at its plants and should eventually reduce employee turnover. Hearthside’s supply chain issues could persist in the next 6 to 12 months. However, Moody’s believes the company should be able to restore EBITDA growth in 2023 due to implemented price increases that will help offsett inflationary headwinds despite continued supply chain challenges.”

Global Medical Response (“GMR”) is an emergency air medical services provider that could be impacted by the “No Surprises Act”. The previous table shows the total value of its first and second lien, as well as equity positions currently marked at 90% of cost. However, its second-lien position is $95.4 million and currently valued at $83 million or 87% of cost.

No Surprises Act: “Starting on January 1, 2022, you generally won’t be responsible for balance bills or out-of-network cost-sharing when getting emergency care, non-emergency care from out-of-network providers at certain in-network facilities, or air ambulance services from out-of-network providers. When this happens, instead of you paying for unexpected out-of-network costs, you’ll generally only need to pay your normal in-network costs.”

SelectQuote, Inc.(SLQT) is a publicly traded online insurance platform (that is also held by BXSL) was marked lower again in Q3 2022. Its credit agreement was recently amended to tighten covenants (a good thing for creditors):

“amend the Company’s existing financial covenant to better align with its business plan and add an additional minimum liquidity covenant, terminate certain delayed draw term loan commitments and reduce the revolving line under the Credit Agreement form $135 million to $100 million, introduce a minimum asset coverage ratio for any borrowing of revolving loans that would result in a total revolving exposure of more than $50 million and provide certain lenders with the right to appoint a representative to observe meetings of the Company’s board of directors.”

CoreLogic, Inc. provides analytics, software and other outsourced services primarily to the mortgage, real estate and insurance sectors and is one of ARCC’s larger investments that need to be watched especially given the recent markdowns of its second lien and equity positions.

SSE Buyer (Supply Source Enterprises) is a manufacturer and distributor of personal protection equipment, commercial cleaning, maintenance, and safety products that recently announced layoffs starting last month:

“Supply Source Enterprises, has submitted a WARN with the Ohio Office of Workforce Development. The letter explains that the company will carry out a reduction in force at its Toledo distribution center at 2840 Centennial Road in Toledo. The first separations are expected to occur within the 14-day period beginning on December 26, 2022.”

Tibco Software (Citrix Systems) is a new investment in a provider of server, application and desktop virtualization, networking, and cloud computing technologies which was added to the list in Q3 2022 and includes its first and second lien, as well as equity positions.

“In a deal closed in August, Citrix Systems was acquired in a deal led by Vista Equity Partners. To finance the deal, the newly emerging combination of TIBCO software and Citrix launched offerings in the high-yield and leverage loan markets for a combined $8.5 billion. Ultimately, the offerings were heavily discounted to yield 10%. On the transaction Wall Street reportedly lost $700 million. In the same quarter as the Citrix note losses, quarterly institutional issuance in the leverage loan market fell to its lowest level since late 2009.”


What Can I Expect Each Week With a Paid Subscription?

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

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

This information was previously made available to subscribers of BDC Buzz Premium 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, including setting target prices using the portfolio detail shown in this article (at a minimum) as well as financial dividend coverage projections over the next three quarters, as discussed earlier.