BDC Market Update: March 2019

Previous Quick Market Update:

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

Quick BDC Market Update:

  • As predicted in previous updates, BDC prices have rebounded strongly in 2019 with the average BDC up 15% as compared to the S&P 500 up 11%.
  • I closely watch the yield spreads between BDCs and other investments including the ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that recently increased from 6.36% on October 1, 2018, to 8.45% on December 26, 2018.
  • However, these yields have been declining in 2019 and are currently around 6.82%.
  • The average BDC dividend yield is almost 10.4% and 3.6% higher than Corp B implying neither oversold or overbought conditions.
  • There is a chance for lower BDC prices potentially due to another ‘flight to safety’ and retail investor fear-related selling when they should be holding or buying.
  • I’m closely watching various economic and BDC fundamentals as well as ‘Corp B’ effective yield spreads looking for oversold conditions. This update outlines the two most likely general market scenarios and my potential purchase plans over the coming weeks.
  • BDC fundamentals remain strong including a healthy U.S. economy, low market defaults and most BDCs focused on protecting shareholder capital with first-lien assets with protective covenants as discussed in many Deep Dive

Business Development Companies (“BDCs”) were down sharply through December 31, 2018, likely due to final tax-loss harvesting and/or year-end position changes in various investment funds. As predicted and shown in the chart below, “BDCS” has rebounded from the recent lows. During previous years, the average BDC stock price typically declined from December through January/February and then rallied through May/September.

As predicted in the previous updates, most BDCs have been outperforming the S&P 500 so far in 2019, but still, have an average dividend yield of around 10%. The average BDC continually outperforms high-yield corporate bond ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK), and UBS ETRACS Wells Fargo Business Development Company ETN (BDCS). It should also be noted that the following table does not take into account returns from dividends paid.

BDC pricing is closely correlated to yield spreads including other non-investment grade debt and ‘BofA Merrill Lynch US Corporate B Index’ (Corp B). As shown in the chart below, I typically make multiple purchases when Corp B effective yields rise including January/February 2016, when the markets experienced concerns of slowing Chinese growth and increased energy sector defaults driving higher yield expectations, especially for non-investment grade debt. Also shown in the chart below, is the recent pullback in Corp B yields which is/was driving higher BDC pricing this year.

2019 BDC Buzz Plan:

The S&P 500 is still around 5% below its previous highs for various reasons, some of which are related to BDCs (including a potential economic slowdown), but the underlying fundamentals of the U.S. economy and BDCs remain strong.

There is a chance for lower BDC prices potentially due to returned flight to safety and fear-related selling when investors should be holding or buying. I believe that the following are the two most likely general market scenarios and what I will be doing in each case:

  • Continued/additional positive news regarding interest rate policy, U.S. and world economy driving a full rebound beyond previous levels where I will be making meaningful purchases on the way back up.
  • BDC prices continue to rebound or at least remain higher through May or even as late as September and then back down through December/January. In this scenario, I will be making select purchases of underpriced BDCs and then waiting to make meaningful purchases.

As discussed in the BDC Risk Profiles Rankings report, most BDCs have built their portfolios and balance sheets in anticipation of a recession with investments supported by high cash flow multiples and protected by protective covenants and first-lien on assets for worst case scenarios.

The following comment is from the recent ARCC call: “As we look at the portfolio and evaluate the economy, we continue to approach the market with the belief that we are late in a credit cycle, and that economic growth is slowing. As a lender, these are perfectly healthy conditions for underwriting and strong portfolio performance. However, we do believe that slowing economic growth can challenge weaker companies. And if this thesis proves itself out it should benefit Ares Capital as more differentiation among credit managers is a good thing for established companies like ours which has resources and access to capital that surpasses our peers. A more fundamental credit downturn can be a significant market opportunity for us. We have been able to consolidate market share during times of distress, and outperform other credit managers. And we’re positioning ourselves to take advantage of this if an opportunity arises.”

Are BDCs Overbought or Oversold?

Yield spreads are important to monitor as they can indicate when a basket of investments is overbought or oversold compared to other yield-related investments. However, general market yields can change at any time. Also, spreads change depending on the perception of risk and these are only averages that then need to be assigned a range for assessing individual investments/BDCs. BDCs can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher quality portfolio that will deliver consistent returns over the long-term.

I closely watch the yield spreads between BDCs and other investments including the ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that recently increased from 6.36% on October 1, 2018, to 8.45% on December 26, 2018. However, as discussed earlier, these yields have been declining in 2019 and are currently around 6.82%. This is meaningful for many reasons but mostly due to indicating higher (or lower) yields expected by investors for non-investment grade debt that will likely result in higher portfolio yields over the coming quarters.

The following chart uses the information from the previous chart showing the average yield spread between BDCs and Corp B. I consider BDCs oversold when the yield spread is 4.0% higher and overbought when it is 3.0% lower. As shown in the chart below, BDCs are appropriately priced which is confirmed by the average RSI discussed earlier. The average BDC is currently yielding around 10.4% compared to Corp B at 6.8% for a current yield spread of 3.6%.

 

Analyzing BDCs: 

 

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

BDC Total Returns For 2019

Previous BDC Market Updates:

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

BDCs will begin reporting results next week:

BDC Total Returns For 2019

It is important for investors to understand that BDC pricing can be volatile which is a good thing for investors that watch closely and take advantage of ‘oversold’ conditions measured using various methods including RSI as shown in the BDC Google Sheets.

This volatility drives very different returns depending on the time period used for measuring rather than using actual purchase prices.

I mostly cover stable predictable BDCs that hopefully require minimal trading for investors with the exception of buying more on the dips as I have done with my personal portfolio and discussed in the BDC Buzz Positions report. I will expand on this report to include my actual purchases as well as Suggested Portfolios with commentary.

FS KKR Capital (FSK) has been outperforming so far in 2019 due to being heavily discounted for the reasons discussed in the following article including an estimated decline in book value of 9.3% in Q4 2018:

Explanation of total returns: The Change in Price assumes you purchased the stock at the end of 2018. Dividends do not assume reinvestment and are calculated using the amounts paid (or accrued) divided by the purchase price.

 

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

GAIN & Overall BDC Market Update: January 23, 2019

Previous Quick Market Updates:

Relative Strength Index or RSI is an indicator that I use after I already know which BDCs I would like to purchase, but waiting for a good entry point. Please see the definition from Investopedia as well as the discussion of net interest rate spreads

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

Quick BDC Market Update:

Business Development Companies (“BDCs”) will begin reporting results in less than two weeks, starting with Gladstone Investment (GAIN), and the following article from earlier today discusses some of the items that investors should be watching:

As mentioned in previous updates, in December 2018, I purchased additional shares of multiple higher-quality Business Development Companies (“BDCs”) with risk-averse balance sheets prepared for a potential economic slowdown, including TCG BDC Inc. (CGBD) for the reasons discussed in “I Just Bought More TCG BDC, Which Is About To Rally With A Safe 13% Yield.” As investors jump back into financial stocks, the average BDC has easily outperformed the S&P 500 so far in 2019 but still have an average dividend yield of almost 11%:

 

Most BDCs were down sharply on December 31, 2018, likely due to final tax-loss harvesting and/or year-end position changes in various investment funds. As shown in the chart below, “BDCS” has rebounded from the recent lows. During previous years, the average BDC stock price typically declined from December through January/February and then rallied through May/September.

 

 

However, it should be pointed out that BDC pricing is closely correlated to yields spreads including other non-investment grade debt and the ‘BofA Merrill Lynch US Corporate B Index’ (Corp B). As shown in the chart below, I typically make multiple purchases when Corp B effective yields rise including January/February 2016, when the markets experienced similar concerns of slowing Chinese growth and increased energy sector defaults driving higher yield expectations, especially for non-investment grade debt (Junk bonds suffer a rare negative return in January). This also resulted in wider interest rate spreads and favorable lending conditions. Higher quality BDCs typically have much higher portfolio growth during these periods as they take advantage of higher market yields. Also shown in the chart below, is the recent pullback in Corp B yields which was driving higher BDC pricing this month.

 

 

Higher effective yields result in counter-intuitive pricing and usually the time when investors are discounting pricing for BDC stocks, expecting higher yields due to “a flight to safety mode”. The average BDC yield is around 11% which is higher-than-average over the last seven years:

 

 

The S&P 500 is still around 9% below its previous highs for various reasons, some of which are related to BDCs (including a potential economic slowdown), but the underlying fundamentals of the U.S. economy and BDCs remain strong. There is a chance for lower BDC prices potentially due to returned flight to safety and retail investor fear-related selling when they should be holding or buying. I now believe that the following are the two most likely general market scenarios and what I will be doing in each case:

  • ‘Dead cat bounce’ where stock prices continue to rebound but then continue back down to previous lows. In this scenario, I will be making select purchases and then waiting to make meaningful purchases of many BDCs likely in late February 2019.
  • A solid round of good news regarding interest rate policy, world economy and the end of the government shutdown driving a full rebound toward previous levels where I will be making meaningful purchases on the way back up.

Also, over the coming weeks, I will continue to monitor economic and BDC fundamentals as well as ‘Corp B’ effective yield spreads looking for oversold conditions and:

  • Actively purchase additional shares if economic and BDC fundamentals improve driving lower ‘Corp B’ effective yield.
  • Hold current positions and wait if economic and BDC fundamentals decline driving higher ‘Corp B’ effective yield.

As discussed in the BDC Risk Profiles Rankings report, most BDCs have built their portfolios and balance sheets in anticipation of a recession with investments supported by high cash flow multiples and protected by covenants and first-lien on assets for worst case scenarios.

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

Main Street (MAIN) Preliminary Estimates of Fourth Quarter 2018 Results

Main Street (MAIN) Preliminary Estimates of Fourth Quarter 2018 Results

Main Street’s preliminary estimate of fourth quarter 2018 net investment income (“NII”) is $0.68 to $0.69 per share. Main Street’s preliminary estimate of fourth quarter 2018 distributable net investment income (“DNII”), which is NII before non-cash, share-based compensation expense, is $0.71 to $0.72 per share.(1) The preliminary estimates of NII per share and DNII per share each include a non-recurring benefit of approximately $0.03 per share related to lower operating expenses. The preliminary estimate of DNII of $0.71 to $0.72 per share, or $0.68 to $0.69 per share as adjusted for the non-recurring benefit of $0.03 per share, significantly exceeds both the regular monthly dividends paid for the fourth quarter of 2018 of $0.585 per share and the previously provided DNII guidance range for the fourth quarter of 2018 of between $0.63 and $0.65 per share.

Main Street’s preliminary estimate of net asset value (“NAV”) per share as of December 31, 2018 is $24.04 to $24.14. After adjustment for the semi-annual supplemental dividend paid in December 2018

of $0.275 per share, this represents a decrease of approximately $0.28 to $0.38 per share, or 1.1% to 1.5%, from the reported NAV per share of $24.69 as of September 30, 2018. Main Street estimates that the decrease in NAV per share is primarily due to net unrealized depreciation relating to its Middle Market and Private Loan portfolio investments, which Main Street believes is in large part due to the widening of middle market credit spreads during the fourth quarter. This net unrealized depreciation is partially offset by net unrealized appreciation relating to its Lower Middle Market portfolio investments.

For target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs  (including this one) please see Premium Reports.

SEC Proposes Changes to Regulatory Framework of Fund of Funds Arrangements

Many BDC industry participants have recommended that the SEC’s Division of Investment Management remove or alter the line item titled “Acquired Fund Fees and Expenses” (“AFFE”) that is currently required to be included in a BDC’s prospectus fee table. AFFE disclosure requires acquiring funds to aggregate and disclose in their prospectuses the amount of total annual acquired fund operating expenses and express the total amount as a percentage of an acquiring fund’s net assets. The calculation of AFFE typically results in an overstated expense ratio because an acquiring fund’s indirect expenses are often significantly greater than the expense ratio of the BDC. As a consequence, some index providers removed BDCs from their indices, causing a significant reduction in institutional ownership of BDCs. On September 4, 2018, The Coalition for Business Development, Apollo Investment Management, L.P., and Ares Capital Management LLC submitted an application requesting that the SEC issue an exemptive order exempting BDCs from the AFFE disclosure. On December 19, 2018, as part of the release for Rule 12d1-4 described below, the SEC formally requested industry suggestions to improve AFFE disclosure. The BDC market would likely be receptive if the SEC takes action with respect to AFFE disclosure in 2019.

The Securities and Exchange Commission voted on December 19, 2018, to propose Rule 12d1-4 (proposed rule) and related amendments to the regulatory framework governing funds that invest in other funds (“fund of funds” arrangements). The proposed rule would allow a registered investment company or a business development company (acquiring fund) to acquire shares of any other registered investment company or business development company (acquired fund) in excess of the limitations currently imposed by the Investment Company Act of 1940 without obtaining individual exemptive relief from the SEC.

The SEC is also proposing to rescind Rule 12d1-2 under the 1940 Act as well as most exemptive orders granting relief from sections 12(d)(1)(A), (B), (C) and (G) of the 1940 Act. Further, the SEC is proposing to make related amendments to Rule 12d1-1 and Form N-CEN.

Although the proposed rule would allow fund groups to establish fund of funds arrangements without undergoing the costly and time-consuming process of obtaining individual exemptive relief from the SEC, the proposed rule and related amendments would, if adopted as proposed, limit a number of the fund of funds arrangements currently in place (namely, certain three-tiered fund of funds arrangements). However, the proposed rule would also permit new types of fund of funds arrangements, including fund of funds arrangements involving listed and unlisted business development companies (BDCs) and closed-end funds.

Further, in potential foreshadowing of the adoption of changes to the “Acquired Fund Fees and Expenses” (AFFE) disclosure requirements for which the BDC industry has been advocating since 2014, the Proposing Release solicits comments on potential revisions to these requirements, including whether the SEC should “exempt certain types of acquired funds from the definition of acquired funds for the purposes of AFFE disclosure” and “[i]f so, which types of acquired funds should be exempted and why[.]”

The comment period for the proposed rule is 90 days following its publication in the Federal Register. As of the date of this OnPoint, the proposed rule has not yet been published in the Federal Register.

BDC Market Update: January 3, 2019

Previous Quick Market Updates:

Relative Strength Index or RSI is an indicator that I use after I already know which BDCs I would like to purchase, but waiting for a good entry point. Please see the definition from Investopedia as well as the discussion of net interest rate spreads

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

Quick BDC Market Update:

On Wednesday, a series of purchasing managers’ indexes for December mostly showed declines or slowdowns in manufacturing activity, including much of Europe and Asia as the U.S.-led trade war and a slowdown in demand hit production. U.S. activity was a bit slower, but still expanding, in a sign that China has suffered more from trade issues than the U.S.

It is important to note that BDCs mostly invest U.S. companies as they were created by Congress in 1980 “to fuel job growth and assist emerging U.S. businesses in raising funds“. The following chart shows the recent performance for U.S. Financial Select Sector SPDR ETF (XLF) and UBS ETRACS Wells Fargo Business Development Company ETN (BDCS) that have declined around 13% to 14% over the last three months. However, both have started to rebound:

 

The S&P 500 has declined by over 15% over the last three months for various reasons, some of which are related to BDCs (including a potential economic slowdown), but the underlying fundamentals of the U.S. economy and BDCs remain strong. In January/February 2016, the markets experienced similar concerns including slowing Chinese growth and increased energy sector defaults driving higher yield expectations, especially for non-investment grade debt as shown in the chart below (see Junk bonds suffer a rare negative return in January). This also resulted in wider interest rate spreads and favorable lending conditions. Higher quality BDCs typically have much higher portfolio growth during these periods as they take advantage of higher market yields.

 

 

However, this drives counter-intuitive pricing and is usually the time when investors are discounting pricing for BDC stocks, expecting higher yields due to “a flight to safety mode”. The average BDC yield is around 12% which is much higher-than-average over the last seven years:

 

 

 

There is a chance for continued lower BDC prices potentially due to continued flight to safety and retail investor fear-related selling when they should be holding or buying. The following are the three most likely general market scenarios and what I will be doing in each case:

  • ‘Dead cat bounce’ where stock prices start to rebound but then continue down. In this scenario, I will be making select purchases and then waiting to make meaningful purchases of many BDCs likely in late January or February.
  • Continued market declines through January/February 2019 where I will be waiting for the selling pressures to abate before making multiple purchases.
  • A solid round of good news regarding interest rate policy and the economy driving a full rebound toward previous levels where I will be making meaningful purchases on the way back up.

Also, over the coming weeks, I will continue to monitor economic and BDC fundamentals as well as ‘Corp B’ effective yield spreads looking for extreme oversold conditions and:

  • Actively purchase additional shares if economic and BDC fundamentals improve driving lower ‘Corp B’ effective yield.
  • Hold current positions and wait if economic and BDC fundamentals decline driving higher ‘Corp B’ effective yield.

As predicted in previous updates, BDC prices continued lower and as shown in the chart below, “BDCS” is now near the previous lows from January/February 2016. Also shown in the chart, the average BDC stock price typically declines from December through January/February and then rallies through May or September. Clearly, this could be coincidence but BDCs are largely retailed-owned and pricing often does not follow the fundamentals which are strong as most companies are beating expectations, with higher NII/NAV and special dividends. There have been a handful of BDCs reporting new credit issues including MRCC, FSIC, TCRD but I view these idiosyncratic. There is a good chance that I will be holding off on making significant purchases until February 2019 but could make smaller individual purchases over the coming weeks.

Are BDCs Overbought or Oversold?

I closely watch the yield spreads between BDCs and other investments including the ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that has increased from 6.36% to 8.40% since October 1, 2018. This is meaningful for many reasons but mostly due to indicating higher yields expected by investors for non-investment grade debt that will likely result in higher portfolio yields over the coming quarters as discussed earlier.

Yield spreads are important to monitor as they can indicate when a basket of investments is overbought or oversold compared to other yield-related investments. However, general market yields can change at any time. Also, spreads change depending on the perception of risk and these are only averages that then need to be assigned a range for assessing individual investments/BDCs. BDCs can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher quality portfolio that will deliver consistent returns over the long-term. As you can see, the average BDC yield is still trending higher:

 

I consider BDCs oversold when the yield spread is 4.0% higher and overbought when it is 3.0% lower.

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

BDC Market Update: 3 Most Likely Scenarios & My Plan For Purchases

Previous Quick Market Updates:

Relative Strength Index or RSI is an indicator that I use after I already know which BDCs I would like to purchase, but waiting for a good entry point. Please see the definition from Investopedia as well as the discussion of net interest rate spreads

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

Quick BDC Market Update:

As predicted in previous updates, the BDC sector continues to pull back and as shown in the chart below, BDCS is now near the previous lows from January/February 2016. The following are three mostly likely general market scenarios and what I will be doing in each case:

  • ‘Dead cat bounce’ where stock prices start to rebound but then continue down. In this scenario, I will be making select purchases and then waiting to make meaningful purchases of many BDCs likely in January/February 2019.
  • Continued market declines through January/February 2019 where I will be waiting for the selling pressures to abate before making multiple purchases.
  • A solid round of good news regarding interest rate policy and the economy driving a full rebound back to previous levels where I will be making meaningful purchases on the way back up.

As shown in the chart below, the average BDC stock price typically declines from December through January/February and then rallies through May or September. Clearly this could be coincidence but BDCs are largely retailed-owned and pricing often does not follow the fundamentals which are strong as most companies are beating expectations, with higher NII/NAV and special dividends. There have been a handful of BDCs reporting new credit issues including MRCC, FSIC, TCRD but I view these idiosyncratic. There is a good chance that I will be holding off on making significant purchases until January but could make smaller individual purchases over the coming weeks. I am expecting continued lower BDC prices partially due to tax-loss harvesting and then retail investor fear-related selling. These are the “chicken little” sellers fearing the worst and selling when they should be buying.

S&P Volatility Index:

As shown below, the volatility index is approaching levels where I like to make multiple purchases similar to earlier this year discussed in the BDC Buzz Positions report.

Stocks Near New Lows:

The following table shows the current pricing for each BDC compared to the closing lows over the last 52 weeks. As you can see, most companies are trading at new lows as well as the S&P 500 and high-yield corporate bond ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays High Yield Bond ETF (JNK). Also, the average RSI is now below 25 indicating that BDCs are seriously oversold.

Current BDC Yields:

As mentioned in previous updates, we have recently experienced windows of wider interest rate spreads for non-investment grade debt and higher quality BDCs typically have much higher portfolio growth during these periods as they take advantage of higher market yields. This drives counter-intuitive pricing and is usually the time when investors are discounting pricing for BDC stocks.

The average BDC yield is around 11.7% which is much higher-than-average over last seven years:

Are BDCs Overbought or Oversold?

I closely watch the yield spreads between BDCs and other investments including the ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that has increased from 6.36% to 7.57% since October 1, 2018. This is meaningful for many reasons but mostly due to indicating higher yields expected by investors for non-investment grade debt that will likely result in higher portfolio yields over the coming quarters as discussed earlier.

 

 

Yield spreads are important to monitor as they can indicate when a basket of investments is overbought or oversold compared to other yield-related investments. However, general market yields can change at any time. Also, spreads change depending on perception of risk and these are only averages that then need to be assigned a range for assessing individual investments/BDCs. BDCs can be volatile and timing is everything for investors that want to get the “biggest bang for their buck” but still have a higher quality portfolio that will deliver consistent returns over the long-term. As you can see, the average BDC yield is still trending higher:

 

 

The following chart uses the information from the previous chart showing the average yield spread between BDCs and Corp B. I consider BDCs oversold when the yield spread approaches 4.0% higher and overbought when it is closer to 3.0%. As shown in the chart below, my recent purchase of multiple BDCs in October 2018 was the last time the yield spread was 4.0% but is now again these levels. The average BDC is currently yielding around 11.68% compared to Corp B at 7.57% for a current yield spread of 4.1% and I will be making purchases of individual BDCs over the next few weeks as discussed earlier and in the Upcoming BDC Buzz Purchases: December 2018 report.

 

 

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

CGBD Special Dividend & Recent Insider Purchases

 

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs  (including this one) please see Deep Dive Reports.

As predicted in the recently updated CGBD Deep Dive report, CGBD announced a special dividend of $0.20 per share yesterday payable on January 17, 2019 to stockholders of record as of December 28, 2018.

“We are pleased to announce a year end special dividend to our shareholders of $0.20 per share. We have also paid/declared $1.48 per share in regular dividends in 2018 year to date.” commented Michael Hart, Chairman and Chief Executive Officer.

Also, the CEO, CFO & Treasurer have made additional purchases this week:

CGBD Pricing & Recommendations:

For target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs  (including this one) please see Premium Reports.

CGBD Reduced Asset Coverage Ratio:

On June 6, 2018, CGBD had its 2018 Annual Shareholder Meeting and the Board was asking stockholders to approve the application of the 150% minimum asset coverage ratio. As shown below, the “required majority” of shareholders voted for Proposal 3 and the 150% minimum asset coverage ratio became effective as of June 7, 2018.

What does this mean for shareholders and upcoming dividend coverage?

Clearly more leverage implies higher risk and hopefully higher returns. It mostly comes down to how much additional leverage and the quality of assets in the portfolio. However, there are a few other considerations:

  • Reduced base management fee to 1.00% on assets financed with debt-to-equity over 1.0
  • Less need for frequent equity offerings as management can increase leverage during periods of lower stock prices
  • Ability to take on lower yielding assets
  • Larger portfolio would likely result in more diversification and/or the ability to take on larger (usually higher quality) investments
  • Higher leverage will likely require BDCs to diversify funding sources using ‘matching’ and a mix of lower cost utilized credit lines (less unused fees)

On the previous call, CGDB management discussed the potential for increased leverage:

“In April, our Board of Directors unanimously approved the adoption of the new BDC leverage bill and our shareholders overwhelmingly approved its adoption through a proxy process that coincided with our year-end annual shareholder meeting, and resulted in the 150% asset coverage ratio becoming affective on June 7th this year. As we’ve mentioned previously we don’t anticipate the adoption to the reduced asset coverage requirement to influence or change of the investment thesis that we’ve applied since our company’s inception. We’ll continue to invest where we see best relative value and our portfolio construct shouldn’t change in any material way going forward.”

“Our debt-to-equity at the end of the second quarter was 0.76 up modestly from the 0.70 ratio at the end of the first quarter. We previously provided guidance the outer boundary for our owned businesses leverage would be in the area of 1.30 to 1.40. Obviously we’re comfortably inside those levels currently, but we continue to believe that those are prudent out our boundaries given the overall risk in our portfolio today. Retroactively to July 1st of this year our investment advisor and has reduced the base management fee from 1.5% to 1% on all assets financed with greater than 1:1 leverage. This reduction in management fee, which as you know has been implemented post the shareholders approval of the new leverage guidelines is another good example of Carlyle’s philosophy around shareholder alignment.”

BDC Tax-Loss Harvesting & Potential Rally

Summary

  • Over the last 3 months, the average BDC stock price has declined by over 10%. However, the declines started in early September due to investors seeking higher yields.
  • BDCs started to rally as many reported strong Q3 results, followed by another decline that could have been partially due to tax-loss harvesting and could keep prices lower through mid-December.
  • This creates an opportunity to take advantage of potential gains as ‘discount reversion’ takes place in the early part of 2019 helped by the ‘January Effect’.
  • I will be updating the Upcoming BDC Buzz Purchases report later this week to take into account the Q3 2018 reported results, identifying the BDCs that I plan on purchasing before the end of the year and what I am looking for before making purchases.

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all business development companies (“BDCs”) please see Deep Dive Reports.

Tax-Loss Harvesting

Tax loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. The sold security is replaced by a similar one, maintaining an optimal asset allocation and expected returns.

Over the last two to three months, the average BDC stock price has declined by over 10%. However, the decline started in early September due to investors seeking higher yields on non-investment grade debt as discussed in previous updates and shown below:

The following table shows the change in stock prices before BDCs began reporting Q3 2018 results in late October 2018.

BDCs started to rally as many reported strong Q3 2018 results as shown below, followed by another decline that could have been partially due to tax-loss harvesting and could keep prices lower through mid-to-late December:

Continued lower prices in November/December could lead to greater opportunities as more investors use tax-loss harvesting strategies to realize losses for the 2018 tax year. This creates an opportunity to take advantage of potential gains as ‘discount reversion’ takes place in the early part of 2019.

The January Effect & Potential BDC Rally

The January effect is a seasonal increase in stock prices during the month of January. Analysts generally attribute this rally to an increase in buying, which follows the drop in price that typically happens when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off. Another possible explanation is that investors use year-end cash bonuses to purchase investments the following month.

For BDC target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs please see Premium Reports.

PNNT: USWS Merger Agreed & Share Repurchases

Summary

  • PNNT reports results later this week and this update was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, etc.
  • On November 5, 2018, Matlin & Partners Acquisition Corporation (NASDAQ: MPAC, MPACU, MPACW), announced that shareholders have approved MPAC’s merger with U.S. Well Services, (“USWS”). PNNT’s loans will be refinanced and its equity position will be publicly traded.
  • PNNT is a component in the ‘Recommended Higher Yield’ portfolio due to its current yield of 10.1%, higher quality management, stable dividend, and trading over 5% below its short-term target price.
  • As predicted, PNNT has been actively repurchase shares including almost 1.1 million (1.5% of outstanding shares) from May 1, through June 30, at a 19.2% discount to its previous NAV.
  • NAV per share increased by 1.0% (from $9.00 to $9.09) partially due to accretive share repurchases and net realized/unrealized gains of over $5.1 million.
  • More importantly, the company continues to deliver net “realized” gains from exiting investments including $17.4 million during the recent quarter and a total of $43.0 million over the last three quarters.
  • Continued accretive share repurchases should improve earnings/NII per share along with portfolio growth and use of leverage as well as monetizing (selling and reinvesting) its equity investments that could result in a dividend increase at some point.
  • There were no investments on non-accrual as of June 30, 2018, and energy, oil & gas remains around 14% of the portfolio.

 

The following is a quick update that was previously provided to subscribers of Premium Reports along with target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs  (including this one) please see Deep Dive Reports.

Dividend Coverage Update

PNNT has historically covered its dividends through the previously discussed reduced management fees, the ability to use higher leverage with SBA borrowings, and rotating the portfolio into higher earning assets from upcoming monetizations:

“So we feel good about the opportunity to deploy capital to live within the 80% leverage ratio at this point, utilize our enhanced platform, and continue to drive income that covers the dividends. As I said in my remarks, our recovering NII today covers our dividend, and that excludes the other income that we typically get between $0.01 and $0.03 per share per quarter, to enhance that recurring income. So we feel very good about the dividend coverage. Feel good about the economies of portfolio and we’re on the mission to monetize the equity investments and energy investments over time hopefully can provide upside.”

I am expecting continued share repurchases given that the stock is still trading at a 20%+ discount to its NAV per share and the company had over $107 million in cash. These purchases will be accretive to earnings/NII per share along with continued portfolio growth and use of leverage as well as monetizing (selling and reinvesting) its equity investments that could result in a dividend increase at some point:

“We are pleased with the progress we are making on several fronts. Adding people to our platform has resulted in a significantly enhanced deal flow which puts us in a position to be both more active and selective. Our activity level in the quarter ended June 30, 2018, along with the increase in LIBOR, has resulted in a more senior secured portfolio with a current run rate net investment income which covers our dividend,” said Arthur H. Penn, Chairman and CEO. “We believe that with a generally stable underlying portfolio we should be able to provide investors with an attractive dividend stream along with potential upside as our equity investments are monetized.”

On September 07, 2018, PNNT declared a distribution of $0.18 per share, paid on October 2, 2018 and the company has approximately $0.26 per share of taxable spillover income and gains and I believe that the current dividend is sustainable after taking into account the new fee structure as shown in the Leverage Analysis.

“As of September 30, we had taxable spillover of $0.26 per share, which provides further dividend cushion. With a generally stable underlying portfolio and substantial spillover, we believe that PNNT stock should be able to provide investors with an attractive dividend stream, along with potential upside as our equity investments mature.”

For the quarter ended June 30, 2018, PNNT reported just above my base case projections and was not expected to cover its dividend due to the previous quarter with “larger-than-expected decline in portfolio investments driving a historical low regulatory debt-to-equity of 0.46”. However, the company covered 92% of its dividend during the recent quarter and has covered by an average of 111% over the last 6 quarters. As predicted, there was another decline in the overall portfolio yield from 11.5% to 11.4% as the company invests in safer assets at lower yields including the most recent investments at an average yield of 10.5%.

“As we move up the capital stack, our overall yield in the portfolio has come down a bit. That said, we’re starting to get some offset from LIBOR. And then again rotating our equity and energy investments into cash paying debt securities over time should be a positive. And so, look, we think there is upside you saw this quarter on our run rate, our recurring NII, before our other income is covering our dividend now. And we think it has a reasonable shot continue to grow as LIBOR, it goes up over time, as we rotate those energy in equity investments, and we should provide a very solid comfortable hopefully cushion to our dividend stream.”

I have assumed continued declines in its portfolio yield as shown in the projections and going as low as 10.2% in the Leverage Analysis as management is expecting “into the 10% to 11% zone”:

“Over time given our strategy if that’s going to go down into the 10% to 11% zone as we continue to move up capital structure and derisk the portfolio although we are starting to get some benefit from LIBOR which is nice, so that will mitigate some of that.”

The company has significant borrowing capacity due to its SBA leverage at 10-year fixed rates (current average of 3.2%) that are excluded from typical BDC leverage ratios. Management was recently asked increasing leverage through reducing its required asset coverage ratio and mentioned that they would like “to maintain our investment-grade ratings”.

As discussed in previous reports, I am expecting minimal portfolio growth as the company is keeping a conservative leverage policy of GAAP leverage (includes SBA debentures) near 0.80 until it can rotate the portfolio into safer assets. However, as mentioned earlier, the company has over $107 million in cash for debt-to-equity ratio of 0.57 after excluding cash, implying that there is available capital for share repurchases and portfolio growth over the coming quarters.

“As you all know, the Small Business Credit Availability Act was signed into law on late March. At the current time, we’re not going to increase leverage at PNNT. Our intention is to maintain our investment-grade ratings or bonds through their maturity in October 2019. As we get closer to October 2019, we will assess the investment at financing landscape and evaluate our strategy with the goal of maximize long-term value for our stakeholders. We remain comfortable with our target regulatory debt-to-equity ratio of 0.6 times to 0.8 times. We’re currently at about 0.5 times regulatory debt-to-equity. On an overall basis, we are targeting GAAP leverage of 0.8 times.”

Management is focused on maintaining its net interest margin and dividend coverage, even as its portfolio yield continues to decline, through selling most of its equity positions and rotating into income producing investments and reduced borrowing rates by redeeming its 6.25% Baby Bond.

“We look forward to continuing to monetize the equity portion of our portfolio. Over time, we’re targeting equity being between 5% to 10% of our overall portfolio. As of June 30, it was 16% of the portfolio.”

The company has applied for its third SBIC license and subsequent to quarter-end, the company previously repaid $15 million of SBA debentures:

“We’re gradually paying down SBIC I. We’re down to $30 million in SBIC I. We’ll continue to gradually pay that off. And we’re into the SBA with an application for SBIC III. And we’re hopeful that at some point we can move forward on that.”

Risk Profile Update:

As mentioned earlier, management is in the process of “de-risking” the portfolio which is currently invested 43% in senior secured first-lien debt, 38% in second-lien secured debt, 3% in subordinated debt and 16% in preferred and common equity. Management has its “three-point plan” that includes rotating the portfolio into higher credit quality first and second-lien lower yielding debt that will likely result in continued lower portfolio yields:

“We are focused on lower risk, primarily secured investments, thereby reducing the volatility on our earnings stream. Investments secured by either a first or second lien are about 81% of the portfolio. We are also focused on reducing risk from the standpoint of diversification. So number two, as our portfolio rotates, we intend to have a more diversified portfolio with generally modest bite sizes, relative to our overall capital. And number three, we look forward to continuing to monetize the equity portion of our portfolio. Over time, we’re targeting equity being between 5% to 10% of our overall portfolio. As of June 30, it was 16% of the portfolio. Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio is performing well. We have a cash interest coverage ratio of 2.6 times and a debt to EBITDA ratio of 5.1 times at cost on our cash flow loans.”

“In this environment, we have not only been extremely selective, but we have generally moved up capital structure to more secured investments. Reminder about our long-term track record, PNNT was in business since 2007, then as now focused on financing middle-market financial sponsors. Our performance through the global financial crisis and recession was solid. Prior to the onset of the global financial crisis in September 2008, we initiated investments, which ultimately aggregated $480 million. Average EBITDA of that underlying portfolio was down about 7% to the bottom of the recession. Our focus continues to be on companies and structures that are more defensive, have a low leverage, strong covenants and are positioned to weather different economic scenarios.”

For the quarter ended June 30, 2018, net asset value (“NAV”) per share increased by 1.0% (from $9.00 to $9.09) partially due to the previously discussed accretive share repurchases and net realized/unrealized gains of over $5.1 million. More importantly, the company continues to deliver net “realized” gains from exiting investments including $17.4 million during the recent quarter and a total of $43.0 million over the last three quarters.

“During the quarter ended June 30, unrealized loss from investment was $14 million, or $0.20 per share. Unrealized gains on our debt instruments was $2 million or $0.02 per share. We had about $17 million or about $0.25 per share of realized gains. The accretive effect of our share buyback was about $0.03 per share, excess dividends over income was about $0.01 per share. Consequently, NAV per share went from $0.09 per share to $9.09 per share.”

Total direct exposure to oil and energy-related investments account for around $137 million or 13.4% of the portfolio fair value.

 

 

On November 5, 2018, Matlin & Partners Acquisition Corporation (NASDAQ: MPAC, MPACU, MPACW), announced that shareholders have approved MPAC’s merger with U.S. Well Services, (“USWS”). PNNT’s loans will be refinanced and its equity position will be publicly traded and was discussed on the recent call:

“As a result of the proposed merger, our $10 million loan will be refinanced. The equity position we made for $7 million of cost was marked at about $12 million at June 30, approximating the value of the stock in the proposed merger. Based on this valuation, our overall investment in U.S. Well has generated an IRR of 18% and 1.7 times multiple on invested capital.”

Q. “On your investment in U.S. Well Services. I’m just curious, after that transaction is completed, I think, you said, you expect fourth quarter of this year. Do you expect to be able to exit your equity position shortly after or is there any sort of mandatory lockup period that follows close?”

A. “So there is 50% lockup for six months and another 50% at 12 months. Look, I think, if you look at the comps, we think U.S. Well even at this price is cheap and as a reasonable start to trade up in generally more NAV upside for our shareholders.”

RAM Energy and ETX Energy have previously sold non-core assets to generate liquidity/stability. As discussed in previous reports, its investment in RAM Energywas restructured to reduce the amount of PIK income and ETX Energy was previously restructured resulting in realized losses but potential equity upside potential. These investments will likely be monetized/sold at some point and were discussed on the recent call:

“With regard to our two remaining equity names, RAM and ETX they have been aided by the higher oil and gas prices, it will take time for us to maximize our recovery. We are encouraged that the energy markets are rebounding, this enhances the M&A environment in the section and our ability to evaluate strategic options for our remaining equity related companies.”

“With regard to our energy related portfolio, we are pleased we continue to make progress monetizing those investments on reasonable values. We started 2018 with four investments in energy with the stated goal of monetization over time. We held these investments over the last several years during the energy downturn with the goal of maximizing value over the long run. We believe that we are starting to see the fruits of that strategy. You may remember that last quarter, we exited the first of those names, American Gilsonite, which ended up generating an 8.6% IRR and 1.4 times multiple on invested capital of our whole period of 5.5 years.”

There were no investments on non-accrual as of June 30, 2018:

“We’ve had only 12 companies going non-accrual out of 204 investments since inception over 11 years ago. Further, we are proud that even when we had those non-accruals we’ve been able to preserve capital for our shareholders, through hard work, patients, judicious additional investments in capital and personnel in those companies, we’ve been able to find ways to add value. Based on the values as of June 30, today we have recovered about 80% of capital invested on the 12 companies that have been on non-accrual since inception of the firm. We currently have no investments on non-accrual.”

The company will likely use higher leverage in the coming quarters and continue to increase the amount of first-lien positions that recently increased from 40% to 43% of the portfolio. Also, as shown in the table below, the company has reduced the amount of subordinated debt from $121 million to $34 million, or from 10% to 3% of the portfolio, over the last three quarters.

“Our overall portfolio consisted of 51 companies with an average investment size of $20.1 million, had a weighted average yield on interest bearing debt investments of 11.4% and was invested 43% in first lien secured debt, 38% in second lien secured debt, 3% in subordinated debt and 16% in preferred and common equity”

 

PNNT Pricing & Recommendations:

For target prices, dividend coverage and risk profile rankings, credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions on all BDCs  (including this one) please see Premium Reports.