Fidus Investment (FDUS) Update: Credit Issues & NAV Decline

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


For Q2 2019, Fidus Investment (FDUS) reported just above its worst-case projections only covering 88% of its dividend due to lower interest and fee income as shown in the following table. The lower interest income and NAV per share were due to its non-accrual investment in Oaktree Medical Centre (discussed later).

Edward Ross, Chairman and CEO: “With M&A activity picking up in the quarter, we continued to selectively build our portfolio of debt and equity investments in high quality lower middle market companies. Of the $48 million in originations we closed this quarter, $42.9 million was invested in new portfolio companies. However, the impact of a non-accrual investment weighed on adjusted net investment income for the quarter. We wrote-off this investment as we continue to proactively manage the portfolio. Our portfolio remains healthy overall and we continue to see opportunities to monetize several of our mature equity investments.”

On July 29, 2019, the Board declared a regular quarterly dividend of $0.39 per share payable on September 20, 2019, to stockholders of record as of September 6, 2019. I will reassess dividend coverage in the updated Deep Dive report.

During Q2 2019, NAV per share declined by 1.6% or $0.26 (from $16.55 to $16.29) due to its non-accrual investment in Oaktree Medical Centre being completely written off resulting in almost $11 million in unrealized losses or $0.45 per share. Management discussed Oaktree on the previous call:

“On Oaktree real quickly, business has been in the portfolio for a while. It’s a pain management business and also a toxicology testing business. The company has experienced some stress over the years, due primarily to a drop in reimbursement rate risk for several services, but incrementally and more recently, by certain unexpected exogenous events and so, company has been making some sound progress here recently. But the unexpected events that have taken place with regard to this investment has required us to be very active in this situation and obviously the valuation reflects the current risk profile of those investments.”

As of June 30, 2019, FDUS had debt investments in two portfolio companies on non-accrual status, which had an aggregate cost and fair value of $29.5 million and $6.2 million, respectively. However, Oaktree has been completely written down and will result in realized losses of $13.4 million or $0.55 per share in Q3 2019.

Edward Ross, Chairman and CEO: “Through diligent investment selection and an emphasis on quality over quantity, we remain focused on capital preservation and generating attractive risk adjusted returns, and on our primary goals of growing net asset value over time and delivering stable dividends to our shareholders.”

On July 19, 2019, FDUS exited its debt investment in Pinnergy, Ltd. and received payment in full of $4.0 million on our second lien debt. On July 31, 2019, FDUS invested $21.5 million in an additional subordinated debt investment in Allied 100 Group, Inc., an existing portfolio company. As of June 30, 2019, the company has estimated spillover income or taxable income in excess of distributions of $0.67 per share (previously $0.73 per share) and management is expecting additional realizations in 2019:

From previous call: “We do see an opportunity for some realizations this year. It doesn’t mean it’s going to be very near term, but there are more than a couple of situations of being worked on and we’re hopeful that some of the equity is realized. It is a strategic focus of ours. We recognize as we sit here today, it’s a nice problem to having, given the equity portfolio is performing very well, but monetizing it or to the extent we have the ability to, it makes a lot of sense in certain situations. And so we plan to do what we can to help monetize some of the investments.”

As of June 30, 2019, FDUS had $22 million in cash and cash equivalents and $71 million of unused capacity under its senior secured revolving credit facility and $25 million of unfunded SBA commitments. As mentioned in the previous report, on April 17, 2019, FDUS announced that had received its third SBIC license to borrow up to $175 million in additional SBA debentures for a maximum of $350 million excluded from debt for purposes of BDC asset coverage requirements. On April 24, 2019, the company amended its Credit Facility increasing the total commitments from $90 million to $100 million, extended from June 16, 2019 to April 24, 2023, and the pricing was reduced from LIBOR plus 3.50% to LIBOR plus 3.00%. The amendment also includes an expansion of the accordion feature to $250 million.

From previous call: “Since our last earnings call, we have achieved a significant milestone with the receipt of our third SBIC license, which gives us access of up to $175 million in long term debt capital and we have also completed an amendment to our senior credit facility, which increases the commitment from $90 million to $100 million, expands the accordion feature to $250 million and extends the maturity date to April 2023.”

On February 8, 2019, FDUS closed its offering of $60 million of 6.00% notes due 2024, and subsequently, the underwriters exercised their option to purchase an additional $9 million listed on the NASDAQ under the trading symbol “FDUSZ” and included in the BDC Google Sheets along with “FDUSL”.

From previous call: “We completed a public debt offering of $69 million in aggregate principal of 6% notes due 2024, raising net proceeds of approximately $66.5 million, including the exercise of the over allotment option. As of March 31, our liquidity and capital resources included cash of $26.2 million and $90 million of availability on our line of credit, resulting in total liquidity of $116.2 million.”

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

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

To be a successful BDC investor:

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


Main Street Capital (MAIN) October 2019 Quick Update

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


October 17, 2019: MAIN declared its semi-annual supplemental cash dividend of $0.24 per share payable in December 2019. This supplemental cash dividend is in addition to the previously announced regular monthly cash dividends that Main Street declared for the fourth quarter of 2019 of $0.615 per share, or $0.205 per share for each of October, November and December 2019. See more details below on Transitioning the Dividend Payments.

For Q2 2019, Main Street Capital (MAIN) reported between its base and best case projections with NII per share of $0.63, covering its regular dividends by 105% with lower-than-expected portfolio growth and lower portfolio yield. Distributable net investment income was $0.67 per share for the quarter compared to regular dividends of $0.60. On April 17, 2019, the company priced its public offering of $250 million of 5.20% notes due 2024 driving slightly higher interest expense. There was a decrease in the amount of share issuances likely due to lower portfolio growth and keeping consistent leverage (debt-to-equity ratio) as shown in the following table:


Net asset value (“NAV”) per share decreased by $0.24 or 1.0% (from $24.41 to $2424.17) due to the semiannual supplemental dividend of $0.250 per share and income tax provision of $3.4 million or $0.055 per share partially offset by appreciation in its lower middle market portfolio, accretive share issuances and overearning the regular dividends during the quarter.


Dwayne L. Hyzak, CEO: “We are pleased with our operating results for the second quarter, a quarter during which the continued execution of our differentiated investment strategy and the leverage of our efficient, low cost operating structure facilitated favorable operating performance and financial results. As a result of our performance, we again generated distributable net investment income per share in excess of our regular monthly dividends, exceeding the regular monthly dividends paid during the quarter by approximately 12%. We believe that the advantages of our differentiated investment strategy and efficient operating structure, and our conservative capital structure and significant liquidity position, have us very well positioned for continued future success.”

There was a slight decline in yield from its lower middle market (“LMM”), middle market (“MM”), and Private Loan (“PL”) portfolios as shown in the following table.


MAIN remains a ‘Level 1’ dividend coverage BDC implying that it has the ability to increase and/or pay semiannual dividends. Historically, the company has grown its per-share economics year-over-year which is the primary driver for continued higher returns to shareholders. However, there was a slight decline this quarter partially due to slower portfolio growth and lower yields as discussed earlier.


As of June 30, 2019, there were seven investments on non-accrual status (up from six the previous quarter), which increased from the previous quarter to 1.5% (previously 0.9%) of the total investment portfolio at fair value and 4.4% (previously 3.6%) at cost.


Transition of Dividend Payments:

Over the next five years, MAIN will be transitioning its semiannual dividend into its monthly dividend which started in Q2 2019.

  • The previous semiannual/supplemental dividends of $0.55 per year is being reduced incrementally and fully absorbed into its monthly dividends
  • By the end of the transition period, the monthly dividend payout rate will be at least $0.05 per month higher than the current payout rate
  • This transition will make the dividend policy easier to understand and allow all third-party stock price services “to correctly indicate and reflect our dividend yield”
  • Management plans “to continue to grow our total annual dividends at a level consistent with what we have delivered in the past”

October 17, 2019: MAIN declared its semi-annual supplemental cash dividend of $0.24 per share payable in December 2019. This supplemental cash dividend is in addition to the previously announced regular monthly cash dividends that Main Street declared for the fourth quarter of 2019 of $0.615 per share, or $0.205 per share for each of October, November and December 2019. Including the regular monthly and supplemental cash dividends declared to date, Main Street will have paid $27.14 per share in cumulative cash dividends since its October 2007 initial public offering at $15.00 per share. Based upon the regular monthly dividend rate of $0.205 per share for the fourth quarter of 2019 and the current semi-annual supplemental dividend rate of $0.24 per share, Main Street’s current annualized run-rate for cash dividends is $2.94 per share. Main Street also expects that its Board of Directors will declare regular monthly dividends for the first quarter of 2020 during early November.


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

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

To be a successful BDC investor:

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

TSLX October 2019 Update: Continued Best-of-Breed BDC

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

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TSLX Dividend Coverage Update

TSLX has covered its regular dividend by an average of 134% over the last four quarters, growing undistributed taxable income and capital gains to over $1.25 per share.

“As we said before, if we believe there is sustainable increase in the earnings power of the business by operating in our target leverage range for an extended period of time, then we would look to resize our base dividend in context of the underlying earnings power of the business to ensure we’re optimizing cash distribution and satisfying risk related distribution requirements. We will continue to monitor undistributed taxable income and gains closely as part of our ongoing review of our distribution strategy.”

TSLX announced a special/supplemental dividend of $0.04 per share payable in September and annualized ROE for the second quarter 2019 was 11.6% and 17.7% on a net investment income and a net income basis, respectively.

“Our Board also declared a $0.04 per share supplemental dividend to shareholders of record as of August 30, payable September 30. This marks the 10th consecutive supplemental dividend since we introduced this framework in Q1 of 2017. To date, we have declared a total of $0.58 per share in supplemental dividend to our shareholder for an increase of 15% over our base dividend level, while also growing net asset value per share by 4% over this period.”

During Q3 2019, there will likely be around $0.13 per share of realized gains related to the exit of its preferred equity investment in Validity, Inc. that will be used to support upcoming supplemental dividends. This investment was discussed on the recent call:

“Note that the increase in the fair value mark on our convertible preferred equity investment in Validity contributed a positive $0.13 per share to this quarter’s net unrealized gain. We continue to hold our convertible preferred equity investment and updated the fair value mark to reflect the valuation from the recent equity investment. We expect to realize our investment at current fair value mark in the near term. If realized, any gains on our equity position at the time of exit would be unwound from the balance sheet and recognized into net income, but won’t flow through to net investment income.”

I am expecting a conservative amount of $0.21 per share of supplemental dividends paid in 2019 (takes into account the $0.12 per share paid in Q1 2019) which will most likely be higher, especially given the likelihood of additional realized gains. Management gave 2019 NII guidance of $1.77 to $1.85 which is likely conservative, similar to 2017/2018 guidance.

“Based on the strength of our investment pipeline, the earnings power of the portfolio and our expectations for fee-related activity for the remainder of the year, we believe we remain on pace to achieve our 2019 NII per share target of $1.77 to $1.85.”

For Q2 2019, TSLX beat its best-case projections due to much higher-than-expected portfolio growth during the quarter driving higher leverage and covering its dividend by 125%.

Repayments and exits during Q4 2018 drove its debt-to-equity to a four year low of 0.59 that has increased to 0.86 in Q2 2019 due to stronger portfolio growth.

During Q2 2019, the company increased its revolving credit facility by another $75 million that will be used to refinance its higher rate 2019 convertible notes. However, I am expecting additional unsecured notes to be issued at some point as discussed by management. It should be noted that 100% of TSLX’s borrowings are at variable rates (based on LIBOR) but the company is adequately positioned for rising interest rates due to ‘match funding’ with 100% of debt investments at variable rates. The company still has $735 million of undrawn capacity on its revolving credit facility for additional growth in 2019.

“Shifting to the right side of our balance sheet, during the quarter, we upsized our revolving credit facility by $75 million to $1.245 billion, with the addition of a new lender to our bank group. At quarter end, we had significant liquidity with $735 million of undrawn revolver capacity. Given the ample liquidity and low marginal cost of funding under our revolver, our base case is to repay the $115 million of convertible notes that mature in December with this facility. As a reminder, by swapping our fixed rate debt to floating rate, we provide net interest margin expansion for our business in falling rate environment once LIBOR dips below the floor on our portfolio.”

There was another decline in its portfolio yield (from 11.6% to 11.4%) due to new investments at lower yields.

“The weighted average total yield on our debt and income-producing securities at amortized cost was 11.4% compared to 11.6% at March 31. The decrease was primarily driven by the movement in LIBOR during the quarter on our floating rate debt portfolio.”

TSLX management continues to produce higher returns by investing in distressed companies through excellent underwriting standards that protect shareholders during worst-case scenarios including call protection, prepayment fees and amendment fees backed by first-lien collateral of the assets. Historically, higher returns have been partially driven by these strong financial covenants and call protections during periods of higher amounts of prepayments (discussed below) and worst-case scenarios (discussed at the end of this report). However, similar to previous reports, the base case projections do not include large amounts of fee and other income related to early repayments.

“Given our direct origination strategy, 99% of our portfolio by fair value was sourced through non-intermediated channels. At quarter-end, we maintained effective voting control on 83% of our debt investments and averaged 2.1 financial covenants per debt investment consistent with historical trends. And we continue to have meaningful call protection on our debt portfolio of 103.4 as a percentage of fair value as a way to generate additional economic should our portfolio get repaid in the near term.”

It also important to point out that the company is able to cover dividends with recurring sources as discussed by management on previous calls:

“As we’ve said in the past, in environments where we receive elevated levels of prepayments and a decrease in our financial leverage ratio, we would expect elevated levels of other fees. However, if repayment activity were to decline, then we would expect to leg back into our target leverage ratio, contributing more rapidly to our interest and dividend income line.”

As discussed in previous reports, Ferrellgas Partners remains its largest investment and is currently valued almost $6 million over cost or $0.09 per share and will likely drive another large special dividend.

Previous call: “Ferrellgas is a publicly-traded distributor of propane with an enterprise value of $2.3 billion. The company has a defensive core business with high return on invested capital and a strong management team but faced refinancing difficulties given the challenging regulatory environment for banks. Due to our ability to provide a fully underwritten financing solution through co-investments from affiliated funds we were able to structure a first lien last out position at a low attach point of 0.2X at a low net leverage of 1.7X with highly attractive adjusted returns.”

In October 2018, TSLX’s shareholders overwhelmingly approved the proposal to allow the company to increase leverage by approving the application to the company of a minimum asset coverage ratio of 150% effective October 9, 2018. TSL Advisers, LLC intends to waive a portion of the management fee in excess of an annual rate of 1.0% on assets financed with higher leverage and revised its target debt-to-equity range from 0.75-0.85 to 0.90-1.25.

“If we get to the 1.25 times debt-to-equity ratio, which I am not seeing we are going to get there anytime soon. Earnings per share as it’s kind of at $2.25 to $2.35 range. It feels like we are on our way. I don’t think, we’ll be at 1.25 by the end of the year. And that the sense is that, if there is churn and financial leverage, we’ll have an increase in fee income that supports our ROE.”

The table below illustrates the impact on ROEs at differing levels of leverage (debt-to-equity) with higher and lower assets yields:

“As we said in the past, in periods where we see a decrease in our financial leverage, we would expect elevated levels of other fees from repayment activity to support our ROEs. We believe our revised financial policy will allow us to drive incremental ROEs for our shareholders as we reached the higher end of our leverage target.”

“We’ve added Slide 16 to our presentation material this quarter to isolate the impact of balance sheet leverage on the earnings power of our business. The table at the top of the page shows our unit economics based on annualized results for the first quarter. Below that, the sensitivity table illustrates that for each asset level yield, holding constant operating expense ratio and increasing financial leverage corresponds to an increase in ROE. We know that this concept is relatively intuitive. So the sensitivity table is really meant to help people calibrate the magnitude of leverage on ROE for our business. Looking ahead to Q2, based on the increase in our leverage from an average of 0.66 times in Q1 to our estimate of 0.83 times today, we would expect to experience approximately 70 basis points of annual ROE expansion even if we have seen the same low level of activity-related fees and asset yields as Q1.”

The following are the investment-grade ratings from Fitch, S&P and Kroll under the new target leverage range of 0.90x-1.25x debt-to-equity.

TSLX Risk Profile Update

TSLX continues to selectively growing its portfolio using prudent amounts of leverage, onboarding higher-than-average credit quality first-lien investments at higher-than-market yields and providing better-than-average dividend coverage and returns to shareholders. As discussed earlier, TSLX has excellent underwriting standards that protect shareholders during worst-case scenarios including voting control, call protection prepayment fees and amendment fees backed by first-lien collateral of the assets.

“Given our direct origination strategy, 99% of our portfolio by fair value was sourced through non-intermediated channels. At quarter end, we maintained effective voting control on 83% of our debt investments and averaged 2.1 financial covenants per debt investment consistent with historical trends. And we continue to have meaningful call protection on our debt portfolio of 103.4 as a percentage of fair value as a way to generate additional economic should our portfolio get repaid in the near term.”

“Our portfolio’s diversification profile benefit from this quarter’s funding activity, quarter-over-quarter, the number of portfolio companies increased from 48 to 56, our average investment size decreased slightly from $38 million to $37 million and our top 10 borrower concentration decreased from 37.8% to 34% of the portfolio at fair value. We continue to be late cycle minded with our exposure to non-energy cyclical industries at an all-time low of 3% of the portfolio at fair value. As a reminder, this figure excludes our retail asset based loan investments, which are supported by liquid collateral values and are not underwritten based on enterprise value, which tends to fluctuate.”

As of June 30, 2019, 100% of the portfolio was meeting all payment and covenant requirements. First-lien debt remains around 97% of the portfolio and management has previously given guidance that the portfolio mix will change over the coming quarters with “junior capital” exposure growing to 5% to 7%.

During Q2 2019, TSLX’s net asset value (“NAV”) per share increased by $0.34 or 2.1% (from $16.34 to $16.68) due to overearning the dividends by $0.07 per share after excluding excise tax, unrealized gains on its interest rate swaps of $0.09 per share and $0.19 per share of changes in portfolio valuations including Validity, Inc. discussed earlier and Ferrellgas Partners, L.P. (FGP) together accounting for around $0.17 per share of unrealized gains:

There were some additional markdowns in the three ‘watch list’ investments Mississippi Resources, Vertellus Specialties, and IRGSE Holding Corp. but mostly related to the equity positions as shown in the following table. However, its first-lien position in Mississippi Resources was marked down to 92% of cost and needs to be watched:

“The difference between this quarter’s net investment income and net income was primarily driven by net unrealized gains specific to individual portfolio companies and net unrealized mark to market gains related to our interest rate swaps given the change in the shape of the forward LIBOR curve.”

It is important for investors to understand that one of TSLX’s strategies for higher IRRs is investing in distressed retail asset-based lending (“ABL”) as “traditional brick and mortar retail gives way to the rise of e-commerce”. Historically, borrowers have paid amendment fees to avoid even higher prepayment fees if they decided to refinance. Also, the amendments included an additional “borrowing base” providing increased downside protection on the investment. This strategy continues to drive higher fee income including prepayment and amendments fees. See the end of this report for previous examples.

“Retail ABL continues to be one of our various themes given the ongoing secular trends in our platform’s differentiated capabilities and relationships in this area. As the direct lending asset classes become increasingly competitive, we have continually developed and evolved our investment themes in order to generate a robust pipeline of strong risk-adjusted return opportunities.”

“This quarter’s portfolio activity highlights the distinct competitive advantage that our platform offers from a sourcing and scale perspective. Let me take a moment to provide a few examples. We were active on our retail ABL team during the quarter with new investments in Barneys, Maurices and Sable. Together, these three names comprise $200 million of originations, $85 million of which were allocated to affiliated funds or third parties. As we’ve said on our previous earnings calls, we continue to like being a solution provider in this space, given the ongoing secular trends from brick and mortar retailers and our platforms’ human capital expertise. Inclusive of this quarter’s repayment of the Payless DIP loan, we’ve generated an average gross unlevered IRR of 22% across our fully realized retail ABL investments.”

From previous call: “What really matters is, how we think the inventory will liquidate as it compares to what – where we are lending against it. Retail goes as well as the consumer. That is not the – that’s not what’s happening here, right. Consumer is in good health. There is a business model issue and a structural issue with retail, but more so given the fixed cost base and given the discerning mediation of both kind of fast brands and plus Amazon and omni-channel business models. And so, it’s really the liquidation value of inventory and the liquidation value of the inventory has held up great. So, we continue to hope for a decent amount of structural change. So we can provide capital and provide – be a solution provider into that space. And quite frankly, the liquidation values continue to hold up very, very, very well.

Similar to investing in distressed retail assets, the company is focused on increasing returns through investing opportunistically in oil/energy but only first-lien “with attractive downside protective features in the form of significant hedged collateral value at current price levels”. Management has mentioned that energy exposure would not exceed 10% of the portfolio and only first-lien using appropriate hedges. TSLX made “opportunistic” investments in Verdad Resources in Q2 2019, MD America Energy during Q4 2018, Ferrellgas Partners during Q2 2018 and Northern Oil & Gas in Q4 2017 that was previously repaid.

“Another transaction this quarter that highlights our platform’s capabilities is the $225 million term loan facility that we sold at an agent for the Verdad Resources, an upstream E&P company with primary operations in the DJ Basin. This opportunity was sourced with our energy team and coincided with our opportunistic approach of providing first lien reserve based loans to upstream companies situated low on their cost curves at current price levels. Our platform sector expertise and ability to act in size allows us to structure a customized one-stop solution for the company and its sponsor at pricing in terms that provide a strong risk return profile on our investment. Inclusive of the $42.2 million par value loan that we funded for Verdad, our portfolio’s total energy exposure of the quarter remained low at 3.8% of portfolio at fair value.”


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

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

To be a successful BDC investor:

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

Capital Southwest (CSWC) Upcoming Deemed/Special Dividends

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

This update discusses Capital Southwest (CSWC) and its Baby Bond that trades publicly on the NASDAQ under the symbol “CSWCL” that are included in the BDC Google Sheets. CSWC is an internally managed BDC with a $533 million portfolio with mostly first-lien debt positions and equity investments providing realized gains especially in its lower middle market investments similar to Main Street Capital (MAIN). CSWC is among a handful of BDCs that I have purchased in 2019 as I am waiting for a general market pullback.

CSWC has increased its regular quarterly dividend each quarter since 2015 and equity participation is partially responsible for supporting continued quarterly supplemental dividends of $0.10 per share. The current dividend yield is around 9.2% (MAIN is currently 6.7%) which takes into account the recently announced $0.40 quarterly regular dividend and quarterly supplemental dividends of $0.10.

Media Recovery, Inc. & Upcoming Deemed/Special Dividends:

There is a good chance that there will be a ‘deemed’ and/or special dividend related selling its final legacy equity position in Media Recovery, Inc. (“MRI”) driving around $48 million or $2.75 per share of realized gains that is expected to close later this year:

“Our last remaining legacy equity investment, Media Recovery, which does business under the banner SpotSee represents 10% of the portfolio and other equity co-investments as of the end of the quarter represented 6%. As we have mentioned on prior calls, Media Recovery is currently undergoing a sale process. The process is going well, and our expectation continues to be that this company will sell during the 2019 calendar year.”

“Media Recovery, Inc., dba SpotSee Holdings, through its subsidiary, ShockWatch, provides solutions that currently enable over 3,000 customers and some 200 partners in 62 countries to detect mishandling that causes product damage and spoilage during transport and storage. The ShockWatch product portfolio includes impact, tilt, temperature, vibration, and humidity detection systems and is widely used in the energy, transportation, aerospace, defense, food, pharmaceutical, medical device, consumer goods and manufacturing sectors. At June 30, 2019, the value of Media Recovery, Inc. represented 9.6% of our total assets.”

Management was asked about the use of proceeds related to the sale of MRI and mentioned that they will first “replenish the UTI bucket” which means that the quarterly supplemental dividends of $0.10 will be supported for the long-term. However, there will definitely be excess gains that will likely be partially retained as a ‘deemed distribution’ and partially paid as a special dividend above and beyond the quarterly supplemental dividends:

Q. “Do you have any updates on the decision once the sales process [of MRI] is complete? Or is that something you guys are still thinking about in terms of retaining versus paying out a special dividend?”

A. “The board is going to make that determination, and we’ll make that determination once it sells. So the answer is, no. We will replenish the UTI bucket, first and foremost, the gain will, obviously, most likely very likely be much in excess of that. So the remainder of the gain, we will we have options. We can either retain it and do a deemed distribution to the shareholders, pay a 20% tax or we can distribute it in a special dividend or a third option do a combination of both. And so the Board, like I said, will ultimately decide that once the sale is complete, and we’ll announce it.”

It should be noted that the recent increase in portfolio yield and dividend income during the recent quarter was partially due to MRI:

“The overall yield went up based on the dividend, one from MRI produced a larger dividend this quarter based on it having additional free cash flows.”

There is a good chance that the stock could back related to the announcement of 100% deemed dividend similar to GAIN as discussed in the previous GAIN Deep Dive report:

“On May 13, 2019, GAIN declared a deemed distribution of long-term capital gains of $50.0 million or $1.52 per share. Shareholders, including myself, were likely disappointed as the “deemed distribution” is not paid in cash to shareholders and is a way for the company to retain the capital with the exception of the taxes paid. It should be noted that if this dividend was paid in cash it would be classified as long-term capital gains to shareholders (20% tax rate).”

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

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

To be a successful BDC investor:

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

Solar Senior Capital (SUNS) Is A Sell At These Prices

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

On September 27, 2019, I sold my position in SUNS at an average price of $17.67 for the reasons mentioned in the updated SUNS Deep Dive report including likely NAV per share decline of 1.7% related to American Teleconferencing Services, increased reliance on fee waivers, current pricing well above its short-term target price and RSI of over 70 as shown in the BDC Google Sheets.



SUNS Risk Profile Update

During Q2 2019, SUNS’s net asset value (“NAV”) per share decreased slightly by $0.06 to $16.34 per share due to net unrealized losses including additional markdowns of its investment in American Teleconferencing Services and mostly writing off its only non-accrual investment Trident USA Health Services. SUNS had net realized gains of $0.1 million primarily related to the exit from its investment in Mavenir Systems, Inc.

Trident USA Health Services (cost of $7.0 million, fair value of $0.1 million) was previously added to non-accrual status and mostly written off during the recent quarter. Trident now accounts for 0.0% of portfolio fair value and is the only portfolio company with an “Internal Investment Rating 4” implying that the investment is “performing well below expectations and is no anticipated to be repaid in full.”

From previous call: “Trident is a health care provider in the mobile diagnostics business. To your point, it is a small position for us but we treat every position as if it’s our only position. And so we have been working this one. We’ve been an investor for a few years early on. We actually were a second lien lender a number of years ago. And in the health care sector, they’re not facing anything that is systematic to either the economy or the health care sector, they just have had some headwinds in terms of what’s going on at home health and some of the competitive dynamics there as well as some billing and collection issues, which we have seen from time to time in some of these health care rollouts. So it is very specific to Trident. And is not in any way an indication of what’s going on either in our portfolio, the economy or the health care sector broadly.”

The following is from the recent earnings press release and my primary concerns are the “Internal Investment Rating 3” which are investments “performing below expectations, may be out of compliance with debt covenants”:

“Our internal risk assessment maintained an approximately two rating when measured at fair market value based on our one to four risk rating scale with one representing the least amount of risk. And at June 30, our watch list represented approximately 4% of our portfolio.”

The following table shows my watch list investments which are likely the same “Internal Investment Rating 3” investments included in the previous table.

There is a good chance that American Teleconferencing Services (“ATS”) is still overvalued as other BDCs have the same investment valued at an average of 62% of cost compared to SUNS at 96% of cost. I am expecting additional unrealized losses in Q3 2019 related to this investment which will likely result in a 1.7% decline in NAV per share unless there are positive developments with this investment. However, it should also be pointed out that CSWCMAIN and PFLT have conservative valuation practices as mentioned in their respective reports.

As discussed in the recently updated CWSC Deep Dive report, ATS operates as a subsidiary of Premiere Global Services (“PGi”), offering conference call and group communication services. On January 28, 2019, Moody’s downgraded PGi’s debt to Caa2:

Moody’s: “The downgrade of the CFR reflects Moody’s view that PGi’s EBITDA will deteriorate significantly over the next 12 months. Given PGi’s challenges, Moody’s believes that the company’s ability to meet covenants beyond 2Q 2019 is highly uncertain and the capital structure is unsustainable. The risk of default and debt impairment is high given the continuing erosion in revenues and EBITDA. PGi has proposed amendments to its existing credit agreements to waive the total leverage covenant for 2Q 2019 and a potential going concern qualification requirement in its 2018 financial statements. The company also expects to complete the sale of certain non-core assets in the near term, which management believes, along with the equity support, will provide the company adequate liquidity through 2019 to execute on its plans to commercially offer a new UCaaS offering. The continuing support from financial sponsors’ is credit positive. However, Moody’s believes that the proposed amendment and equity infusion will only improve PGi’s liquidity on a short-term basis.”

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

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

To be a successful BDC investor:

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

ORCC Distributions & Risk Profile Update: September 2019

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

Owl Rock Capital Corporation (ORCC) is now the second-largest publicly traded BDC (much larger than MAIN, PSEC, GBDC, NMFC, and AINV) with investments in 90 portfolio companies valued at $7.2 billion that are mostly first-lien secured debt positions. On July 22, 2019, ORCC closed its initial public offering (“IPO”), issuing 10 million shares of its common stock at a public offering price of $15.30 per share. Net of underwriting fees and offering costs, the company received total cash proceeds of $141.3 million. ORCC is one of the few BDCs rated by all of the major credit agencies. The common stock began trading on the NYSE under the symbol “ORCC” on July 18, 2019.

Upcoming ORCC Distributions

On May 28, 2019, the Board declared a distribution of $0.31 per share, for shareholders of record on September 30, 2019, payable on or before November 15, 2019. The Board also declared the following special distributions and newly offered shares WILL be entitled to receive these distributions (as well as the $0.31):

It should be noted that the special dividends are likely temporary and only due to the five quarters of waived management and incentive fees discussed later.

Assuming that the regular quarterly dividend remains at $0.31 per share would imply that new investors will receive a total of:

  • $0.33 per share for Q3 2019
  • $0.35 per share for Q4 2019
  • $0.39 per share quarterly in 2020

ORCC Risk Profile Update

As of June 30, 2019, based on fair value, the portfolio consisted of 81% first lien senior secured debt investments, 17% second lien senior secured debt investments, 1% investment funds and vehicles, and 1% in unsecured debt investments and equity investments.

There were no investments on non-accrual status with only minor markdowns in select investments including Feradyne Outdoors, Give and Go Prepared Foods and Accela, Inc. that need to be watched. However, these investments account for less than 3% of the total portfolio:



Credit quality remains strong with no previous non-accruals and only 5.7% with “Investments Rating 3” which is a borrower “performing below expectations and indicates that the loan’s risk has increased somewhat since origination or acquisition”:


The portfolio has oil, energy and gas exposure of around 4.6%.



Stock Repurchase Plan, Use of Leverage & Capital Structure

On July 7, 2019, the Board approved its 10b5-1 Repurchase Plan, to acquire up to $150 million in stock at prices below NAV per share starting August 19, 2019, ending on February 19, 2021 or “as the approved $150 million repurchase amount has been fully utilized.”

“The Company agent will repurchase shares of common stock on the Company’s behalf when the market price per share is below the most recently reported net asset value per share. This corresponds to a market price of $15.27 based on June 30, 2019 NAV per share of $15.28.”

“We intend to put the Company 10b5-1 Plan in place because we believe that, in the current market conditions, if our common stock is trading below our then-current net asset value per share, it is in the best interest of our shareholders for us to reinvest in our portfolio. The Company 10b5-1 Plan is intended to allow us to repurchase our common stock at times when we otherwise might be prevented from doing so under insider trading laws. Under the Company 10b5-1 Plan, the agent will increase the volume of purchases made as the price of our common stock declines, subject to volume restrictions.”

As of June 30, 2019, ORCC had a debt-to-equity ratio of around 0.24 with plenty of growth capital including the recent IPO proceeds of over $141 million, almost $230 million of unrestricted cash and $1.8 billion available under its credit facilities. Neither the Board nor the shareholders are being asked to approve a reduced asset coverage ratio which means a maximum debt-to-equity ratio of 1.00. Also, before incurring any such additional leverage, the company would have to renegotiate or receive a waiver from the contractual leverage limitations under the existing credit facilities and notes.


ORCC Management Fees

On February 27, 2019, the Adviser agreed at all times prior to the fifteen-month anniversary of an Exchange Listing (which includes the IPO), to waive any portion of the Management Fee that is in excess of 0.75% of the Company’s gross assets, excluding cash and cash equivalents but including assets purchased with borrowed amounts at the end of the two most recently completed calendar quarters, calculated in accordance with the Investment Advisory Agreement.

On February 27, 2019, the Adviser agreed at all times prior to the fifteen-month anniversary of an Exchange Listing (which includes the IPO), to waive the Incentive Fee (including, for the avoidance of doubt, the Capital Gains Incentive Fee).

The management fee is 1.5% and excludes cash and after the offering, the advisor is entitled to pre-incentive fees NII of 17.5% with a hurdle rate of 6% annually as well as 17.5% of cumulative realized capital gains:

“The second component of the incentive fee, the capital gains incentive fee, payable at the end of each calendar year in arrears, equals 17.5% of cumulative realized capital gains from the date on which the Exchange Listing becomes effective (the “Listing Date”) to the end of each calendar year, less cumulative realized capital losses and unrealized capital depreciation from the Listing Date to the end of each calendar year, less the aggregate amount of any previously paid capital gains incentive fee for prior periods.”

ORCC Pre-IPO Share Lock-Ups

There is the possibility for technical pressure on the stock price as pre-IPO shares start to become available in 2020. However, this was discussed on the recent earnings call and many of these shares are held by longer-term institutional investors. Management mentioned that they communicate with their larger shareholders frequently and expect that they will continue to support the stock.

Upon completion of this offering, we will have 383,193,244 shares of common stock outstanding (or 384,618,244 shares of common stock if the underwriters’ exercise their option to purchase additional shares of our common stock). The shares of common stock sold in the offering will be freely tradable without restriction or limitation under the Securities Act.

Any shares purchased in this offering or currently owned by our affiliates, as defined in the Securities Act, will be subject to the public information, manner of sale and volume limitations of Rule 144 under the Securities Act. The remaining shares of our common stock that will be outstanding upon the completion of this offering will be “restricted securities” under the meaning of Rule 144 promulgated under the Securities Act and may only be sold if such sale is registered under the Securities Act or exempt from registration, including the exemption under Rule 144. See “Shares Eligible for Future Sale.”

Following our IPO, without the prior written consent of our Board:

for 180 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber any shares of common stock held by such shareholder prior to the date of the IPO;

for 270 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber two-thirds of the shares of common stock held by such shareholder prior to the date of the IPO; and

for 365 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber one-third of the shares of common stock held by such shareholder prior to the IPO.

This means that, as a result of these transfer restrictions, without the consent of our Board, a shareholder who owned 99 shares of common stock on the date of the IPO could not sell any of such shares for 180 days following the IPO; 181 days following the IPO, such shareholder could only sell up to 33 of such shares; 271 days following the IPO, such shareholder could only sell up to 66 of such shares and 366 days following the IPO, such shareholder could sell all of such shares.

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

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

To be a successful BDC investor:

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

Sold AFC Baby Bond Today For The Following Reasons

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

Recent Baby Bond Trade

Today, I sold my AFC Baby Bond Notes at $26.92 for the reasons discussed in this update and will use as an example for upcoming discussions.

BDC Baby Bond Sheets

The following information is included in the “Bond Info” tab from BDC Google Sheets:

  • BDC Baby Bonds trade “dirty” which means that there is a certain amount of accrued interest in the market price.
  • You need to own the Baby Bond one trading day before the ex-dividend date to be eligible for the full quarter of interest.
  • 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 refers to the number of days of interest needed to breakeven given the current market price.

The following sheet is from the “Baby Bond” sheet

As shown in the table below:

  • AFC goes ex-dividend soon and has $0.43 of accrued interest priced in.
  • AFC was callable on April 15, 2012.
  • AFC currently has Call Risk Capital Loss of $1.35
  • It would take 312 days of not being called before you would breakeven

Call Risk Capital Loss and Breakeven Days Calculations:

My Reasons For Selling AFC

I had some tax reasons for selling but it was mostly due to being overpriced with limited upside plus I wanted to lock in the following gains and will reinvest in something else.

Over the coming weeks, I will be spending more time discussing Baby Bonds that currently yield around 6% and much less volatile than stocks even during extreme scenarios experienced in December 2018 where I made multiple purchases of BDC stocks, bonds, and preferred shares. My personal portfolio includes various other bonds some of which are tax-related and likely not applicable to most but included in “Other” along BDC Baby Bonds shown below. Together these investments account for around 37% of my portfolio and this report will discuss all of my recent purchase and returns.

Subscribers of Premium Reports will receive real-time announcements of all upcoming purchases of BDC Baby Bonds and preferred shares but please be aware that these have lower returns and are not expected to outperform the S&P 500 or upcoming BDC stock purchases. However, these investments will easily outperform during volatility and/or downturn while continuing to provide a relatively safe and stable yield as they are senior to the common stocks. Also, I am constantly monitoring the balance sheets of BDCs which provide insight for bond risk measures including portfolio credit quality, changes to leverage, interest coverage ratios and redemption risk such as GAINM as discussed in the GAIN Deep Dive report.

To be a successful BDC investor:

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

ARCC Risk Profile Update: September 2019

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

ARCC Risk Profile Update

I consider ARCC to have one of the safer BDC risk-profiles with consistently lower non-accruals, historical net realized gains and net asset value (“NAV”) per share growth. During Q2 2019, NAV per share increased by 0.3% or $0.06 per share from $17.21 to $17.27 due to overearning the dividend(S) by $0.07 per share partially offset by net unrealized depreciation. Some of the largest markdowns were investments on my watch list including Indra Holdings Corp.Ivy Hill Asset Management (was previously marked up), Alcami CorporationCentric Brands, Urgent Cares of America Holdings, SiroMed Physician Services, and ADF Capital.

My primary concern is that only 3 of the 20 companies on my watch list that are not on non-accrual showed improvement (Panda Liberty, AEP Holdings, and Instituto de Banca y Comercio) during Q2 2019. ARCC’s second-lien position in Shock Doctor was refinanced and is now considered first-lien but the equity portion is still valued at 22% of cost as shown in the following table and needs to be watched.







Non-accruals remain low and decreased slightly due to the previously discussed markdowns of Indra Holdings Corp. and ADF Capital as well as Javlin Three. However, its $25 million second-lien loans to WASH Multifamily and Coinamatic were added to non-accrual status during Q2 2019 and are still marked around 98% of cost as shown below. If non-accruals were completely written off, it would impact NAV per share by around $0.12 or 0.7%:

My primary concern is additional unrealized losses from companies that have been previously marked down (including equity positions) and shown in the previous and following tables.

The following table summarizes the information from the previous tables and I will update each quarter as well as tracking the details for each company and provide updates to subscribers of Premium BDC Reports when available.

The information in the following table was provided by the company showing the grade of the investments in the portfolio at fair value but does not include detail by portfolio company:

It is important to note that ARCC has investments in around 345 companies so there will always be a certain amount of credit issues but historically non-accruals have remained low:

During the 2008/9 financial crisis, ARCC had non-accruals of around 2.5% and much lower than the average leveraged lender:

Its portfolio asset mix continues to shift from first-lien positions toward second-lien and its SDLP now with 41% first-lien (was 47% as of Q4 2018), 33% second-lien (was 29% as of Q4 2018), 7% of subordinated certificates of the SDLP (was 5% as of Q4 2018), 5% of senior subordinated loans, and 14% in other and preferred equity securities that should decline over the coming quarters due to portfolio rotation out of non-core assets.

However, It should be pointed out that ARCC’s second-lien investments are likely safer with better security than other BDCs as discussed by management:

Q. “Can you give us some color on your appetite for second lien? Obviously, it’s been — it increased over the last year a tiny bit as a percentage of portfolio not much. But obviously also your weighted-average EBITDA has been going up.”

A. “Yes, generally, we’ve said this to you in the past most of our large second lien deals are in companies that have been with the portfolio for a longer period of time. We tend to be in larger businesses that we think have better downside protection and they tend to be in industries that we think of as very defensive and not cyclical.”

“Credit quality continues to be very stable. Our portfolio continues to generate weighted average EBITDA growth of 4% over the past 12 months. We do not add any new portfolio of companies to non-accrual in the second quarter and our non-accruals remain stable at 2.3% of the total portfolio like amortized cost and 0.2% at fair value.”

“In these types of aggressive markets, we become even more selective. Our selectivity ratio this quarter was 2% which is about half of our historical average of approximately 4% and we refer to that in terms of the percentage of deals that we see — that we close rather versus those that we see. It has been trending lower over time and that’s reflective of our disciplined approach. We’re trying to stick to the playbook that we’ve had for a long time of having conservative structure with real covenants and loan documents that actually allow us to enforce in a position, where we need to. And I think it’s allowed us to achieve better recoveries and fewer losses than competitors.”

“We think that industry selection is key. And we think not being frankly in unsecured positions at this stage in the cycle are the two keys and to stay away from cyclical industries and frankly stay away from sub-debt for now. And we’ve been spending years as it continues to be late in the cycle trying to exit the companies from our portfolio that were not performing to plan. So we’re happy with where we are. We don’t see anything here in the near term that’s kind of change what today is an attractive place to invest where there’s a lot of income relative to the risk-free rate and good credit quality.”

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

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

To be a successful BDC investor:

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

BDC Baby Bonds/Preferreds Update: Upcoming Coverage And Balancing Your Portfolio

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

Over the coming weeks, I will be spending more time discussing Baby Bonds that currently yield around 6% and much less volatile than stocks even during extreme scenarios experienced in December 2018 where I made multiple purchases of BDC stocks, bonds, and preferred shares. My personal portfolio includes various other bonds some of which are tax-related and likely not applicable to most but included in “Other” along BDC Baby Bonds shown below. Together these investments account for around 37% of my portfolio and this report will discuss all of my recent purchase and returns.

Subscribers of Premium Reports will receive real-time announcements of all upcoming purchases of BDC Baby Bonds and preferred shares but please be aware that these have lower returns and are not expected to outperform the S&P 500 or upcoming BDC stock purchases. However, these investments will easily outperform during volatility and/or downturn while continuing to provide a relatively safe and stable yield as they are senior to the common stocks. Also, I am constantly monitoring the balance sheets of BDCs which provide insight for bond risk measures including portfolio credit quality, changes to leverage, interest coverage ratios and redemption risk such as GAINM as discussed in the GAIN Deep Dive report.

Bond pricing is closely correlated to expected investment yields including other non-investment grade debt and ‘BofA Merrill Lynch US Corporate B Index’ (Corp B) that previously increased to 8.45% on December 26, 2018.

As discussed in previous updates, these yields have been declining in 2019 and are currently around 5.89%. This is meaningful for many reasons but mostly due to indicating higher (or lower) yields expected by investors for non-investment grade debt.

 

Baby Bonds Basics:

  • BDC Baby Bonds trade “dirty” which means that there is a certain amount of accrued interest in the market price. I have included the amount of accrued interest that updates daily.
  • The ‘effective yield’ is based on the current price less accrued interest.
  • Investors should use limit orders when purchasing exchange-traded debt such as Baby Bonds.
  • You need to own the Baby Bond one trading day before the ex-dividend date to be eligible for the full quarter of interest.
  • It is important to take into account which BDCs are “callable” and the potential for capital losses during the worst-case scenario.
  • I do not actively cover some of the BDCs with baby bonds, especially if they are thinly traded.

I will discuss various details related to investing in Baby Bonds and preferred shares over the coming weeks including redemption risks and the timing of purchases as well as my upcoming purchases and limit orders. One of the metrics used to analyze the safety of a debt position is “Interest Expense Coverage” ratio which measures the ability to pay current borrowing expenses. From Investopdia:

“The interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. The ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by the company’s interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

“The ratio measures how many times over a company could pay its outstanding debts using its earnings. This can be thought of as a margin of safety for the company’s creditors should the company run into financial difficulty down the road. The ability to service its debt obligations is a key factor in determining a company’s solvency and is an important statistic for shareholders and prospective investors.”

I have included the “Interest Expense Coverage” ratio in the Leverage Analysis and financial projections for GLAD and GAIN using net investment income before interest expense divided by interest and debt expenses for each quarter. GLAD has a historical ratio between 3.2 and 3.8 and projected to be between 3.1 and 3.4 in the coming quarters. It should be noted that this is higher than GAIN historically between 2.0 and 3.3 and projected to be between 2.4 and 3.0 in the coming quarters.

Over the coming weeks, I will include this ratio for all BDCs that have Baby Bonds so that subscriber can compare.

BDC Baby Bonds and Preferred Stocks are currently averaging 6.07% yield as shown in the following table including some that are considered investment grade. Please read “Baby Bonds For BDCs: Price Stability” for previous discussions and information about these investments.

The following is from the BDC Google Sheets and is what I use to make purchases when increasing allocations:

 

How much of your portfolio should be in stocks and bonds?

Your portfolio allocations depend on a few factors including your age. Historically, investment advisors used the “100 minus your age” axiom to estimate the stock portion of your portfolio.

  • For example, if you’re 50, 50% of your portfolio should be in stocks.

That has been updated to 110/120 due to the change in life expectancy and lower interest rates for risk-free and safer investments. Today, 10-year treasury-bill yields just over 2% annually compared to 10% in the early 1980s. Please see Bloomberg article “U.S. Is Heading to a Future of Zero Interest Rates Forever“.

The previous table uses 120 as I believe interest rates will remain low given the changes to various policies from central banks and investors will continue to have equity investments for an adequate yield from their portfolios.

The following chart uses a different approach that seems more aggressive and is discussed in “Is your retirement portfolio too heavily invested in equities?” from MarketWatch.

General Bond Funds

There are plenty of choices when it comes to bonds including government bonds such as treasuries, municipal bonds, or corporate bonds. Within each of those categories, there is a wide variety of maturities to select from, ranging from a matter of days to 30 years or more. And there is a full range of credit ratings, depending on the strength of the bond’s issuer.

To make it easy, many investors use a bond-based mutual fund or ETF that fits their needs. The primary reasons for allocating a portion of your portfolio to bonds are to offset the stock volatility and a reliable income stream as compared to capital gains or beating the market.

There are plenty of higher yield bond funds that typically invest in non-investment grade assets such as HYG and JNK that were discussed in a previous article “Search For Yield: Bond Funds Vs. BDCs Paying 10%+“. Currently, HYG and JNK are yielding 5.2% and 5.6%, respectively.

To be a successful BDC investor:

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

PFLT Earnings & Risk Profile Update: Resolving Credit Issues

 

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

Recent PFLT Insider Purchases

As shown below, Art Penn (Chairman and CEO) was actively purchasing shares last month at prices between $11.55 and $11.73:

 

PFLT Risk Profile Update

I consider the recent portfolio credit issues to be idiosyncratic (as compared to systematic) implying that they are not indicative of general underwriting issues within the portfolio. These investments have been discussed in many of the previous reports as management was clearly marking their values. PFLT has not experienced non-accruals over the last two years and “it’s unfortunate that they all happened in this one quarter”:

From previous call: “Look, we haven’t had a non-accrual and over two years, it looks lumpy here and we’re certainly disappointed, but non-accruals are part of this business. It’s unfortunate that they all happened in this one quarter. But we normally, they’d be smoothed out overtime and we had, as you said, we already had already marked them down by and large. So, this should not have been a big surprise to people to know for them were exhibiting weakness in the past.”

“Our credit quality since inception eight years ago has been excellent. Out of 357 companies in which we have invested since inception, we’ve experienced only nine non-accruals. Since inception, PFLT has made investments totaling about $3 billion at an average yield of 8.1%. This compares with an annualized loss ratio, including both realized and unrealized losses of only about 8 basis points annually.”

PFLT remains a component in the suggested ‘Risk Averse’ portfolio due to its portfolio of mostly higher quality, first-lien senior secured investments at floating rates.

“The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense continue to be healthy 2.8 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.8 times, another indication of prudent risk. In our core market of companies with 15 million to 50 million of EBITDA, our capital is generally important to the borrowers and sponsors. We are still seeing attractive risk reward, and we are receiving covenants, which help protect our capital.”

During calendar Q2 2019, its net asset value (“NAV”) per share declined by $0.17 or 1.3% (from $13.24 to $13.07) due to the previously discussed investments shown in the following table. Country Fresh Holdings is still not considered a ‘non-accrual’ but was restructured during the quarter resulting in realized losses of $7.2 million. PFLT now has $2.3 million of first-lien, $5.2 million of second-lien and $10.5 million of non-income producing common equity fair valued at $8.6 million. The other meaningful realized loss came from exiting its non-accrual investment in New Trident HoldCorp resulting in another $7.0 million of realized loss for the quarter.

“New Trident was certainly a big driver. The other ones were [Hollander], which remains a problem, that was one of the non-accruals; and Country Fresh, which got restructured into our quarter. Those were the negative drivers. We do have some very nice co-invest like By Light, DecoPac, Cano Health and Walker Edison, which have been performing well, which, you know, the theme here of course is we are going to make mistakes from time to time; we are going to have non-accruals; and these equity co-invest investments are meant to have some upside that could, you know, in part or in full, you know, fill some of those gaps. So, New Trident certainly was a negative outcome for sure.”

 

Hollander Sleep Products, Quick Weight Loss Centers, and LifeCare Holdings remain on non-accrual status and were marked down again during the recent quarter but still account for $10.1 million in fair value or 0.9% of the portfolio. If the current non-accruals were completely written off, the impact to NAV per share would be around $0.26 or 2.0% (previously $0.38 or 2.8%). However, management mentioned that there were only two companies on non-accrual as of the earnings call on August 8, 2019:

“Credit quality has improved since last quarter. Today, we only have two non-accruals on the books, representing only 1.4% of the portfolio at cost, and 0.5% end market. As of June 30, we had three non-accruals, which represented about 2.3% of our overall portfolio cost and 0.8% at market. We are pleased with the progress we are making on this front.”

That would imply that Quick Weight Loss Centers was likely restructured or exited during calendar Q3 2019. American Teleconferencing Services was marked down again but is still considered to be performing asset that could be restructured and/or added to non-accrual status over the coming quarters.

As discussed in the previous report,Hollander and LifeCare filed for bankruptcy in May 2019 and are both working to reduce costs to improve overall profitability and/or selling assets. Hollander cited “across-the-board increase in costs, including new tariffs, rising material, labor and shipping costs and the costs of integrating a competitor it acquired last year had left it in a severe liquidity squeeze”. In June 2019, Hollander announced that it could be closing its plant in Thompson, Georgia. In addition, Hollander has been spending money to integrate Pacific Coast Feather Co., which it acquired in 2017.

On September 4, 2019, a New York bankruptcy judge approved the $102 million sale of Hollander to private equity firm Centre Lane Partners. In the motion asking for approval of the new plan, Hollander said negotiations since the filing produced a global creditor settlement that was approved by the court on August 15, 2019. Under the terms of the settlement, Hollander and the plan sponsors will put up $1.25 million to be paid to the company’s unsecured creditors, it said. While the settlement negotiations were happening, the company said it was also soliciting bids for its assets. Ten initial expressions of interest were narrowed down to the one acceptable bid from Bedding Acquisition, it said.

A revised plan with a “toggle” feature to allow switching to an asset sale was put to a vote by the impaired creditors and received approval from the holders of all of the company’s $173.9 million in term loan debt and the holders of more than 95% of its $38.5 million in unsecured debt, it said. Hollander noted that additional changes to the plan include that the providers of the company’s $90 million in debtor-in-possession funding have agreed to accept less than full repayment and to cede repayment priority to Hollander’s prepetition term loan creditors, as well as the establishment of a $1 million wind-down reserve fund.

CEO Marc Pfefferle said “Upon emergence [from bankruptcy], we will have a stronger balance sheet and the financial flexibility needed to compete in today’s dynamic business environment now and over the long-term.”

Montreign Operating Co. is owned by Empire Resorts (NYNY) and operates a resort casino in Monticello, New York that previously received $130 million of additional equity capital from its sponsor as discussed in the previous report. On August 19, 2019, NYNY announced that it was being acquired by Kien Huat Realty and Genting Malaysia Berhad. Kien Huat has agreed to provide incremental credit support to Empire Resorts, “which will enable the company to meet its debt obligations as we continue to execute on our business strategy”.

Ryan Eller, President and CEO of Empire Resorts, said, “With the resources and support of Kien Huat and Genting Malaysia, Empire Resorts will be better positioned financially and operationally, which will help us advance our mission of delivering a winning combination of luxury facilities, quality entertainment and exceptional customer service. This transaction is a win-win for all our stakeholders, including our stockholders, customers, employees, creditors and the communities in which we operate.”

The transaction is expected to close in the fourth quarter of 2019 and I am expecting PFLT’s investment in Montreign to be marked back up to 100% over the coming quarters which would positively impact NAV per share by around $0.13 or 1.0%. Management discussed Montreign on the recent call:

Q. “I believe on the last call you mentioned activity from the sponsor up at Montreign, the casino in the Catskills, and with the announcement over the last few days about the sponsor possibly taking out the minority shareholders, I’m wondering how does that all flows through to your holding in it and the value you assign to that holding?”

A. “Montreign is – the equity there is controlled by an entrepreneur, and KT Lim, is well-known in the gaming sector. He controls Genting, which is a large gaming company. Montreign is owned in a public company called the New York-New York, NYNY is the ticker. KT Lim has made an announcement that he wants to take NYNY private. He already owns 80% plus of it. At the enterprise value that he’s proposed to take the company private; it values the equity around $300 million. That $300 million of equity of course is junior to $500 million of debt. We own a piece of the Montreign debt, which, today is marked in the mid-80s or so. We still think this is par. Obviously, if the entrepreneur behind it is valuing the equity of $300 million beneath the debt, we think the debt is par, the entrepreneur is indicating that he thinks the debt is par, you know, we’ll see. We think we have a fairly full position right now in PFLT, so we’re not going to add any more debt, but for all those of you in the market who want to buy what we think is very attractive piece of paper, that is broker dealer quoted in the mid-80s, Montreign first lien debt is and we think it’s going to end up being a par piece of paper.”

The portfolio remains predominantly invested in first-lien debt at around 76% portfolio and the PSSL has grown from 9% to 16% (previously 18%) over the last four quarters. It is important to note that its PSSL is 100% invested in first-lien debt.

“Although PFLT was not in existence back then, PennantPark as an organization was, and at that time was focused primarily on investing in subordinated and mezzanine debt. Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million, again primarily in subordinated debt. During the recession, the weighted average EBITDA of those underlying portfolio companies, declined by 7.2% at the trough of the recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%. As a result, the IRR of those underlying investments was 8% even though they were done prior to the financial crisis and recession. We are proud of this downside case track record on primarily subordinated debt.”

From previous call: “We underwrite as if it is the peak of the credit cycle. We do our downside cases in our investment memos assuming a recession hits next year. On average, the equity cushions from the financial sponsors are 40%, 50%. So, we’re underwriting as if we’re at the peak of the credit cycle.”

“We can be extremely selective about what we ultimately invest in. We are only investing in about 2% of the deals that we have shown. We remain primarily focused on long term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.”

PFLT Dividend Coverage Update

PFLT continues to increase leverage, growing its portfolio and overall yield through ramping of its PennantPark Senior Secured Loan Fund (“PSSL”).

Art Penn, Chairman and CEO. “Due to our activity level and the maturation of PSSL, we are pleased that our current run rate net investment income covers our dividend. Our earnings stream should have a nice tailwind based on gradual increase in our debt to equity ratio, while still maintaining a prudent debt profile. As of September 30, our spillover was $0.31 per share.”

On August 26, 2019, PFLT announced that it had priced its $301.4 million debt securitization in the form of a collateralized loan obligation (“CLO”) which is a lower-cost alternative to its credit facility as well as longer-term and more flexible. The company will retain all of the Class D Notes and Subordinated Notes through a consolidated subsidiary.

“You know CLO financing, you know, has a nice long term and longer than our credit facility. So, we’re actively assessing that option, and as we, you know, think about gradually and prudently increasing leverage of that, that could be a key element of doing that really doing CLO financing, contributing assets to that, and then fraying up the revolver to finance future growth.”

On April 5, 2018, the Board approved the application of the modified asset coverage requirements reduced from 200% to 150%, effective as of April 5, 2019. Management is targeting a debt-to-equity ratio of 1.40 to 1.70 that will “take several quarters”:

“Over time, we are targeting a debt to equity ratio 1.4 to 1.7 times. We will not reach this target overnight. We will continue to carefully invest and it may take us several quarters to reach the new target. Given the seniority of our assets, in the near-term we’re actively considering utilizing CLO financing to help achieve the target.”

For the quarter ended June 30, 2019, PFLT reported just above base case projections with much higher-than-expected portfolio growth partially offset by continued lower portfolio yield. During the quarter, the company invested $183 million of in 14 existing portfolio companies with a weighted average yield of 9.3% with sales and repayments of $67 million. As expected, the company continues to increase leverage with a debt-to-equity of 1.09 utilizing its Board approved reduced asset coverage ratio, effective as of April 5, 2019. It should be pointed out that the company had $36.5 million of ‘payables for investments purchased’ that is not included in the current borrowing.

 

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

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

To be a successful BDC investor:

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