FSK Quick Update: Dividend Falling Back To Previous Levels

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

  • FSK target prices/buying points
  • FSK risk profile, potential credit issues, and overall rankings
  • FSK dividend coverage projections (base, best, worst-case scenarios)


FSK Summary

  • I have updated the projections for FSK to take into account the recently issued unsecured notes, changes to portfolio credit quality, and guidance from management on the recent call.
  • FSK will announce its Q4 dividend during the second week of November and investors should expect $0.60 which could have an impact on the stock price.
  • This is supported by the Leverage Analysis projecting earnings of $0.561/share using a $15 billion portfolio with a stable yield and not including temporary fee waivers contributing $0.05/share.
  • FSK has experienced over $1 billion in realized losses which does not include in the realized losses from FSKR. This is more than almost every other BDC, especially when measured on a per-share basis as shown below.
  • The total amount of investments considered non-accrual, related, or on the ‘watch lists’ accounts for almost $1.3 billion or 8.5% of the portfolio’s fair value. See details below.

This report discusses FS KKR Capital (FSK) which is considered a higher risk BDC for the reasons discussed in this report including historical NAV declines and realized losses driven by higher cyclical exposure that accounts for around 25% of the total portfolio. The company has many of the same sector exposures in its SCJV which is almost 10% of the portfolio. Also, management has removed the ‘total return’ hurdle or ‘look back’ provision that was previously protecting shareholders from additional capital losses.

As discussed later, the total amount of investments considered non-accrual or related as well as on the ‘watch list’ account for almost $1.3 billion or 8.5% of the portfolio fair value. This is close to the amount of investments that the company has identified with its ‘Investment Rating’ 3 and 4 which are considered “underperforming investments” with “some loss of interest or dividend possible” and/or “concerns about the recoverability of principal or interest”. These investments have a total cost basis of almost $1.9 billion or 13% of the total portfolio and could result in additional realized losses over the coming quarters. Also, if additional watch list investments are added to non-accruals status this would likely drive additional declines in NAV per share, earnings, and dividend coverage.

FSK announces dividends when it reports financial results which are typically around the second week of November and there will likely be investors disappointed with the lower dividend payment and could impact its stock price. Please see the full discussion below.

 


Comparison of Realized Gains/Losses & Changes in NAV

Gains or losses are said to be “realized” when an investment is actually sold or exited as compared to “unrealized” gains and losses due to an increase or decrease in the value of an investment that has not yet been sold. When a BDC incurs realized losses there is generally no way to reverse these losses but can potentially be offset by positive performance from other investments and/or over-earning the dividend.

Since 2014, FSK has experienced over $1 billion in realized losses which does not include in the realized losses from FSKR. This is more than almost every other BDC even when measured on a per-share basis as shown below. These losses were due to lower portfolio credit quality and the primary driver of NAV per share declines and two dividend cuts. It should be noted that FSK still has a meaningful portion of its portfolio in cyclical sectors and/or companies that are more likely to be impacted by supply chain issues as well as rising input costs especially labor. Many of these investments have been discussed in previous reports and some are discussed later



Operating Cost as a Percentage of Available Income

The last line in the projected financials (included in the Deep Dive Projection reports for each BDC) shows “Operating Cost as a Percentage of Available Income” which measures operating, management, and incentive fees compared to available income. BDCs with lower operating expenses can pay higher amounts to shareholders without investing in riskier assets.

  • “Available Income” is total income less interest expense from borrowings and is the amount of income that is available to pay operating expenses and shareholder distributions.

Many BDCs have been temporarily waiving fees or have fee agreements that take into account previous capital losses. The following table shows the average adjusted operating cost ratios for each BDC over the last four quarters without the benefit of temporary fee waivers (including SUNS) with examples for GBDC and PSEC.


BDC Leverage Versus Portfolio Mix

The following table shows each BDC ranked by its debt-to-equity ratio net of cash along with its portfolio mix. The “Other” column includes everything that is NOT first or second-lien secured debt. I do not cover most of the higher-risk BDCs for many reasons but mostly because these are not typically buy-and-hold investments. BDCs with higher quality portfolios can support higher leverage. Many of the BDCs with lower leverage also have lower dividend coverage over the last four quarters including SUNS, GAIN, GBDC, MAIN, and ORCC. I am expecting improved dividend coverage for many BDCs as leverage increases as well as higher amounts of first-lien positions (to support higher leverage).

PTMN, FSK, FCRD, PSEC, and OXSQ have higher risk portfolios that require lower leverage and are separated from the others. These companies typically have higher amounts of cyclical exposure and/or non-secured debt, joint ventures, senior loan programs, CLOs, or equity positions that all carry much higher external leverage. Typically these assets do not qualify for lower cost BDC credit lines and revolvers which is why many of these BDCs have higher cost unsecured notes as well as using less leverage to maintain credit ratings.

 


FSK Dividend Coverage Update

On August 9, 2021, FSK declared a quarterly dividend of $0.65 for Q3 2021 which is an increase from the previous $0.60 due to higher-than-expected earnings for Q2 2021. As mentioned in the previous report, management has adopted a ‘variable dividend policy’ based on ANV per share and expected earnings:

“Consistent with our variable dividend policy of seeking to provide shareholders with an annualized 9% dividend yield on our NAV over time, we are committed to paying out additional levels of NII during quarters where our portfolio generates additional income. As a result, during the third quarter our dividend will be $0.65.”

However, as discussed in this report and by management on the recent call, investors should expect $0.60 of quarterly dividends for the following quarters;

“From a forward-looking dividend perspective, our third quarter dividend will be $0.65 per share, with the increase in this quarter’s dividend being tied directly to the additional net investment income we generated during the second quarter. All else being equal, given that we expect our third quarter adjusted NII to approximate $0.61 per share, we believe it is reasonable for investors to expect that should we achieve our adjusted NII guidance for the third quarter, that our fourth quarter dividend would be $0.60 per share; however, I should note that dividends are subject to the discretion of our board and applicable legal requirements, and this forward guidance, while intended to be helpful to investors, should not be interpreted as a formal dividend announcement.”

“Looking forward to the third quarter, while we expect our one-time fee and dividend income to return to a normalized level, we expect our adjusted NII to be $0.61 per share. Our recurring interest income on a GAAP basis is expected to approximate $275 million. We expect recurring dividend income associated with our joint venture to approximate $44 million. We expect other fee and dividend income to approximate $33 million during the third quarter.”

This is supported by the Leverage Analysis shown earlier projecting quarterly earnings of $0.561 per share using a portfolio of around $15 billion with a stable yield and not including the $15 million of temporary fee waivers which are around $0.05 per share.

FSK announces dividends when it reports financial results which is typically around the second week of November and there will likely be investors disappointed with the lower dividend payment and could impact its stock price.

Historically, FSK has covered its dividend only due to no incentive fees paid driven by the ‘total return’ hurdle from previous realized/unrealized losses. However, the ‘total return’ hurdle or ‘look back’ provision was removed as a part of the merger agreement.

FS/KKR has agreed to waive $90 million of incentive fees spread evenly over the first six quarters following the closing. This waiver equates to $15 million per quarter. It is important to note that the company would have paid almost $90 million in incentive fees over the previous five quarters without the look-back provision which is almost $18 million per quarter. However, that is based on 20.0% income incentive fees compared to 17.5% but also only for FSK. The merger will double the size of the company with similar holdings and credit issues implying that the $15 million per quarter could be insufficient if there are continued/additional credit issues. FSKR’s NAV per share has declined by almost 30% over the last three years.


On October 4, 2021, FSK priced an offering of $750 million of 3.125% (YTM of 3.176%) unsecured notes due 2028 and $500 million of 1.650% (YTM of 1.703%) unsecured notes due 2024 that will likely be partially used to repay some of its higher rate borrowings and are taken into account with the updated projections. Management has guided for increased leverage driving portfolio growth over the coming quarters and is also taken into account:

“We’re at the end of this quarter roughly 0.9 times net. Our stated goals or targets there remain the same, really a range of 1.0 times to 1.25 times with probably a sweet spot around 1.1 times. We’ve got some room to grow there. We think that was one clear benefit of the merger. I think that can translate into additional deployment growth, additional income growth. I think we feel good about that, and then going back to the prior question, I think we feel quite good about the liability side of our balance sheet, how that all sort of stacks up. We do feel good about the macroeconomic environment, but I think we also want to be ready to play if there’s volatile times, and where we stand at our current leverage definitely allows us to do that. But you should expect us trending up to the one time-plus target over the coming quarters.”




There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, realized losses, fee structures including ‘total return hurdles’ taking into account capital losses, changes to portfolio yields, borrowing rates, the amount of non-recurring and non-cash income including payment-in-kind (“PIK”). Most BDCs have around 2% to 8% PIK income and I start to pay close attention once it is over ~5% of interest income. Higher amounts of PIK is typically a sign that portfolio companies are not able to pay interest expense in cash and could imply potential credit issues over the coming quarters.

The amount of PIK interest income declined but still accounts for almost 14.0% of total interest income compared to 15.6% during Q1 2021. There is a chance that FSK could be downgraded to ‘Level 3’ or ‘Level 4’ dividend coverage over the coming quarters if there is another round of credit issues driving additional realized losses and higher PIK similar to previous quarters and responsible for dividend reductions.


There is a good chance that management will be repurchasing shares during Q3 and Q4 2021:

“We also expect our previously announced $100 million board-approved stock buyback and program to begin during the third quarter. I think we’ve historically done these under a 10b5-1 plan. I think the expectation is we will continue to do that. I think going almost essentially exactly to your last point, we’ve probably thought about that more in the environment than if the stock was trading materially down, you want to try to be buying more if it was trading closer to book. We think that is starting to get into the numbers about it potentially being less attractive. We thought it was important as part of this merger to put another plan together, but I Think you should have the expectation it will be done under a 10b5-1.”

Management continues to reduce the amount of non-income producing equity investments from 9.3% to 6.8% partially related to the recent merger with FSKR.

For Q2 2021, FS KKR Capital (FSK) easily beat its best-case projections due to much higher-than-expected dividend income from Sound United, as well as a higher amount of fee and other income some of which is non-recurring:

“During the quarter, we materially out-earned our quarterly dividend due to strong originations as well as positive portfolio company performance, which included a significant one-time portfolio company dividend payment. The largest components of our fee and dividend income included $22 million of dividend income from our joint venture during the quarter. Other dividends from various portfolio companies totaled approximately $32 million during the quarter, of which $20 million was from our investment in Sound United. Finally, fee income totaled $23 million during the quarter, representing an increase of $12 million quarter-over-quarter with the change directly tied to our origination and repayment activity during the quarter.”

Also, it should be noted that the merger with FS KKR Capital II (FSKR) was near the end of the quarter which means that there is not a full quarter of income and expenses but also the amount of outstanding shares is now over 285 million compared to the weighted average of only 150 million used for calculating NII of $0.74 during Q2 2021.


FSK Quick Risk Profile Update

My primary concern is the higher amount of cyclical exposure including retail, capital goods, real estate, energy, and commodities that account for around 25% of the total portfolio. It also has many of the same exposures in its SCJV which is almost 10% of the portfolio. There is a good chance that many of FSK’s equity positions in these sectors have been benefiting from the recent recovery that could reverse at some point.

Also, many of the companies in FSK’s portfolio are more likely to be impacted by supply chain issues as well as “inflationary pressures” and rising input costs especially labor. On the August 2021 earnings call management views these issues as “transitory” and “supply chain disruptions to be resolved over the ensuing quarters”:

“The Fed’s comments in July regarding their belief of the transitory nature of many of the inflationary pressures currently affecting certain industries dovetails with our own views, as we expect many issues caused by COVID-related supply chain disruptions to be resolved over the ensuing quarters.”

During Q2 2021, FSK placed its first-lien loan from ATX Networks on non-accrual status but will likely be back on accrual during Q3 2021 and is taken into account with the updated projections. It should be noted that this investment was marked 8% over cost as of June 30, 2021, as shown in the following table.

“During the second quarter, we placed one investment on non-accrual, ATX Networks. ATX design radio frequency, optical and other video networking equipment used primarily by cable operators. The company’s earnings have been negatively impacted by lower cable company capex spend. We owned $80 million of the $227 million first lien term loan marked at 64% of cost as of June 30, down from 69% of cost as of March 31. The company, a group of first lien lenders holding more than two-thirds of the first lien term loan, and other parties in the capital structure have made significant progress on a resolution of ATX’s breach of its Q1 financial covenant, and we expect the transaction resolving such breach to close in the third quarter. The anticipated impact of this potential transaction has been factored into the Q2 mark.”

Total non-accruals currently account for around 4.7% of the portfolio at cost and 3.1% of the portfolio fair value but do not take into account the additional investments FSK has with these companies that account for another 1.9% of the portfolio at cost and 1.1% of the fair value. Also, there are quite a few investments that remain on its ‘watch list’ including Sequential Brands Group which filed for bankruptcy on August 31, 2021.

“The Company determined that, as a result of the significant debt on its corporate balance sheet, it was no longer able to operate its portfolio of brands. Accordingly, in conjunction with the filing, the Company will pursue the sale of all or substantially all of its assets under Section 363 of the U.S. Bankruptcy Code. In connection with this in-court process, Sequential will be obtaining $150 million in debtor-in-possession (“DIP”) financing from its existing Term B Lenders. The Company expects this new financing, together with cash generated from ongoing operations, to provide ample liquidity to support its operations during the sale process.”

As shown in the following tables, the total amount of investments considered non-accrual or related as well as on the ‘watch list’ account for almost $1.3 billion or 8.5% of the portfolio fair value. This is close to the amount of investments that the company has identified with its ‘Investment Rating’ 3 and 4 which are considered “underperforming investments” with “some loss of interest or dividend possible” and/or “concerns about the recoverability of principal or interest”. It should be noted that these investments have a total cost basis of almost $1.9 billion or 13% of the total portfolio and could result in additional realized losses over the coming quarters. Also, if additional watch list investments are added to non-accruals status this would likely drive additional declines in NAV per share, earnings, and dividend coverage.




The following “Timeframe of Recovery of Credit Metrics to 2019 Levels” from S & P Global Ratings on February 17, 2021, shows their view of the recovery prospects for each sector. BDCs such as FSK and AINV have much higher concentrations of sectors that will likely take longer to recover which is taken into account with their risk ranks and pricing.

 


Full BDC Reports

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

GAIN Quick Update: Another Dividend Increase

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

  • GAIN target prices/buying points
  • GAIN risk profile, potential credit issues, and overall rankings
  • GAIN dividend coverage projections (base, best, worst-case scenarios)


GAIN Summary

  • GAIN currently has among the lowest leverage in the sector (net debt-to-equity 0.58) but management is growing the portfolio including the recent infrastructure-related acquisition of Utah Pacific Bridge & Steel.
  • GAIN has the best NAV growth record of 28.7% (last 5 years) and there is a very good chance of another dividend increase for the reasons discussed in this report.
  • GAIN is not expected to cover its Q3 monthly dividends with NII due to being underleveraged but management is actively growing the portfolio with plenty of realized gains for additional coverage.

BDC Leverage Versus Portfolio Mix

The following table shows each BDC ranked by its debt-to-equity ratio net of cash along with its portfolio mix. The “Other” column includes everything that is NOT first or second-lien secured debt. GAIN, CSWC, MAIN, and FDUS prefer to have a higher portion of their portfolio invested in equity positions providing them with realized gains and dividend income to support supplemental dividends.

BDCs with higher quality portfolios can support higher leverage and companies with lower leverage typically have lower dividend coverage (last four quarters) including GAIN, SUNS, GBDC, MAIN, and ORCC. I am expecting improved dividend coverage for many BDCs as leverage increases as well as higher amounts of first-lien positions (to support higher leverage).

  • GAIN’s management has guided for portfolio growth given its extremely low leverage with a current debt-to-equity of 0.64 (0.58 net of cash) which is currently among the lowest in the BDC sector.

 


GAIN Realized Gains & Dividend Coverage Update

GAIN is considered a ‘Level 1’ dividend coverage BDC implying that there is a very good chance that the company will increase its dividends paid to shareholders due to plenty of capacity to grow the portfolio, lower non-accruals and NAV increases, additional dividend income from equity investments, maintaining a higher portfolio yield, and continued realized gains all of which are discussed in this update. Previously, GAIN had around $11.3 million or $0.34 per share of undistributed income “available for distribution at any one point”:

From previous call: “That is available for distribution at any one point. And we ended last year with a good amount of – the last fiscal year with a good amount of spillover as well. So that obviously started the year off with some cushion. As you know, this amount is already reduced by the book accrual of the GAAP capital gains-based incentive fee, and is not contractually due. We really manage our earnings on an annual basis. So we try to match the annual income to the annual dividend and that’s how we operate.”

As predicted earlier this month in “GAIN Deep Dive Projections: Upcoming Dividend Announcement”, GAIN announced a supplemental dividend of $0.09 per share for Q4 2021 which was higher than my conservative estimate of $0.03 per share. More importantly, the company increased its monthly dividend by 7% (from $0.070 to $0.75).

“GAIN announced that its Board declared the following monthly cash distributions to common stockholders, increasing monthly distributions from $0.07 to $0.075 per share, or approximately 7%. The Company also announced its plan to report earnings for its second fiscal quarter ended September 30, 2021. The Company will also pay a supplemental distribution of $0.09 per share to holders of its common stock in December 2021. The board of directors will continue to evaluate the amount and timing of any additional, semi-annual or incremental, supplemental distributions in future periods.

There is a good chance that GAIN will report closer to its ‘best case’ projections including increased portfolio growth and leverage (driving the increased regular dividend) as well as rotation out of equity positions with realized gains driving the larger supplemental dividend. As mentioned in the report, I was waiting for the company to report results before upgrading to ‘Level 1’ and ‘Tier 1’ but given the recent announcement (and my faith in management to do the right thing) I have already upgraded GAIN in the BDC Google Sheets.


Over the last three years, GAIN has increased its dividend three times and while paying supplemental dividends and growing its NAV per share by 9.4%. Also, GAIN has relatively low amounts of leverage with the potential for improved coverage through portfolio growth and rotating out of equity investments.

“The good news is that we are seeing more activity, meaning more companies that are looking to be sold that we have an opportunity to look at. It’s really more a question of how rapidly we can add to our assets and continue to increase the income and thereby obviously slightly increase our monthly dividend payoutSo that’s really our target, our goal. But it’s what we do every day.”


Most dividend coverage measures for BDCs use net investment income (“NII”) which is basically a measure of earnings. However, some BDCs achieve incremental returns with equity investments that are sold for realized gains often used to pay supplemental/special dividends. These BDCs include GAIN, FDUS, CSWC, TSLX, PNNT, TPVG, HTGC, and MAIN.

“Consistent with our policy, our Board will continue to evaluate any supplemental distributions which we can make and may make from capital gains. When we started the semiannual dividends distributions, which are a function of realized capital gains as we’ve stressed, we’ve been able to maintain it pretty effectively. We made the one in June as we move forward during the year in part as a function of liquidity ourselves being that we’re doing new deals also.”


In June 2021, GAIN sold its investment in Head Country, Inc. and received cash proceeds of $16.7 million, including the repayment of its debt investment of $9.1 million at par which resulted in a success fee income of $2.0 million and a realized gain of $3.6 million or $0.11 per share that can be used to support additional supplemental dividends.

“With the sale of Head Country and from inception in 2005, Gladstone Investment has exited over 20 of its management supported buy-outs, generating significant net realized gains on these investments. Investments like Head Country prove out our focus on buying high quality businesses, backing outstanding management teams and our ability to be patient through longer hold periods.”


As shown in the following table, GAIN has significant unrealized gains in many of its preferred stock positions that will likely continue to drive additional realized gains over the coming quarters to support larger supplemental dividends in 2022. If GAIN exited these investments at their current fair value it would result in almost $95 million or $2.85 of realized gains. However, there are other investments valued below cost (please see the Risk Profile section) and management is taking a careful approach to exiting these investments:

“When and if they believe the time is right to exit for a variety of reasons, we will take that seriously. As we have pointed out we have had exits, as we go forward we will certainly be faced with opportunities for exits. And we’ll do that on a very careful basis, because, frankly, again, we exit a really good company and then we just have to figure out how we’re going to get a new opportunity to so to speak to replace it, right. Because, as you know, we keep focus very much on the income that we generate, because we want to keep growing our dividend our distributions to shareholders. So the debt pieces are really important. So again, yes, we will certainly entertain opportunities to exit if it really makes sense. And we might see some of that over the next six to nine months. But we’re not just going to rush out there and just do it just for the sake of doing it very frankly. We want to keep balance, and I think we’ve done a good job of that.”


During calendar Q4 2020, GAIN had $9.1 million or $0.27 per share of net realized gains which easily covers the upcoming monthly dividends of $0.07 per share.


The company will likely not fully cover its monthly dividends with net investment income for the quarter ended September 30, 2021, due to being underleveraged. Also, GAIN has lumpy dividend coverage partially due to its volatile dividend and other income and the company typically manages its dividend policy on an annual basis:

“Now just keep in mind that this other income we refer to can vary and probably will vary quarter-to-quarter. But we look at it and we try to manage this on an annualized basis. And we hopefully should be able to see some opportunity to continue generating this other income category during our calendar year 2021.”

The amount of preferred/common equity increased from 25.6% to 30.2% of the portfolio fair value due to additional markups and needs to be partiallymonetized and eventually reinvested into income-producing secured debt.


I am expecting additional portfolio growth through increased leverage over the coming quarters including an additional first-lien debt investment in Nocturne Villa Rentals in July 2021 and a $24.3 million investment in Utah Pacific Bridge & Steel through a combination of secured first-lien debt and preferred equity. Utah Pacific is a manufacturer of large steel components used in bridge replacement, rehabilitation, and construction.

“Subsequent to 6/30/21, we financed the add-on of another operating company to our recent bio platform investment, which is called Nocturne Villas, and we close on a new buyout investment, which is called Utah Pacific Bridge & Steel. This company actually provides large steel components in bridge replacement, rehabilitation and construction, so somewhat playing into the whole infrastructure developments that will occur in this country. Those are really good companies and evaluations that work for our model. So we’ll make a couple new acquisitions yet over the next year or so. But we’re not going to rush out and just go crazy because multiples are just really pretty, pretty bizarre to be perfectly honest with you on companies that we see.”

Q. “On Utah Pacific that really seems to fit your business model quite well, and now in an industry that is getting a lot of attention. Can you give us a sense of what sort of terms you paid on that in terms of leverage, and maybe the interest rate?”

A. “When we buy a business, roughly 30% of the dollars that we put out are going to be in the equity component, and the balance is going to be in the debt component. Generally, again, as we publish our yield on the debt component of our portfolio is generally in the solid 12% range. We generally try to stay in and companies we’re looking at, we need to stick within kind of the six to maybe seven, seven and a half times EBITDA, and so as long as we’re kind of in that range, it works well for our model. This particular companies has a very strong ownership, owned by an individual really built the business and that fortunately, we’ve been able to have them stay involved with us. So we got really strong management, good team going forward. And it’s kind of deal that other people might have overlooked very frankly, and that’s where we worked a little bit harder to find those kind of transactions. Yeah, we’re very excited about this one, given their position that they have in their market area.”

As leverage increases the company will likely earn around $0.22 per share each quarter covering 106% of the current dividend which is basically ‘math’ driven by an annual hurdle rate of 7% on equity before paying management incentive fees. It is important to note that the company could earn less than $0.22 per share but management will not be paid incentive fees as shown in the previous projections.

“The income-based incentive fee rewards the Adviser if our quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% [quarterly] of our net assets, adjusted appropriately for any share issuances or repurchases during the period (the “Hurdle Rate”). No incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the Hurdle Rate (7.0% annualized)”

During calendar Q2 2021, the company did not sell any additional common shares under its ATM program. Similar to all BDCs, GAIN continues to reduce its overall borrowing rates and is taken into account with the updated projections:

  • On August 11, 2021, GAIN priced its $117.0 million of 4.875% Notes due November 1, 2028, (GAINZ) and used the proceeds to fully redeem its 6.375% Series E Cumulative Term Preferred Stock due 2025 (GAINL).
  • On February 24, 2021, GAIN priced its $112.5 million of 5.00% Notes due May 1, 2026, (GAINN) and used the proceeds to fully redeem its 6.25% Series D Cumulative Term Preferred Stock due 2023 (GAINM).

For calendar Q2 2021, GAIN hit its best-case projections due to much higher-than-expected portfolio yield and growth driving interest income to its highest level at $16.0 million compared to $12.7 million the previous quarter. However, a large portion of the increase was from the payments of past-due interest from portfolio companies previously on non-accrual status which has been taken into account with the updated projections.

“Investment income increased quarter-over-quarter, as interest income was lifted by the collection of past due interest from those loans that were previously on nonaccrual, and other income benefits from the close up transactions and related other income in the current quarter.”

Q. “On reported yields in the quarter, they were really strong up nearly 200 basis points quarter-on-quarter. Was there any one-time items in that? And can you give us a sense for your outlook going forward there?”

A. “That was related to my earlier comment on the loans returning to nonaccrual. So as you often see in periods where loans come back on accrual, they’ve made some catch-up payments, and that’s what particularly lifted yield this quarter.”

Q. “Could you give us a sense of how much interest you recognized back past due interest you recognized on B&T and Horizon? And did you reverse anything for SPS?”

A. “We did not reverse anything for SPS, so that was solely within this quarter. And then the amount that was collected in past dues this period was roughly $2 million.”

Also, there was a $2.0 million decrease in dividend and success fee income, the timing of which can be variable. ‘Core NII’ takes into account incentive fees related to capital gains.

“We ended the first quarter fiscal year ‘22 with adjusted NII of $0.24 per share, which is continuing improving trend started over the last two quarters of fiscal year ‘21, where we reported adjusted NII per share at $0.20 and $0.24, respectively. So we’re very pleased again with this positive trend, hopefully continuing forward.”



GAIN Risk Profile Quick Update

As predicted/discussed in the previous report, there was a meaningful improvement in the portfolio credit quality including reduced non-accruals as Horizon Facilities Services and B+T Group Acquisition, Inc. were added back to accrual. However, SBS Industries Holdings was added to non-accrual status during the quarter but remains valued at 100% similar to Horizon Facilities Services from previous quarters with a full recovery. Management is expecting SBS to be added back to accrual status “pretty quickly” and was discussed on the recent call:

“While, we added one loan to nonaccrual this quarter, which we believe will be at a relatively short-term change. Over the last two quarters, we returned four portfolio companies to accrual status. So with all that said, as of 6/30, only two of our portfolio companies were nonaccrual status.”

“The one that did go on nonaccrual it’s in a position to pay. But again, because of just some constraints regarding senior bank, we just had to put it on nonaccrual, but it will probably come back on accrual pretty quickly. So generally, I feel pretty good about where we are with all of those, again, somewhat temporarily. But now we feel really good about going forward.”

Also, The Mountain Corporation remains on non-accrual status. The fair value of non-accruals decreased to $17.6 million accounting for 2.6% of the portfolio at fair value (previously 7.7%).

From previous call: “We are seeing two of our portfolio companies that were on non-accrual come back on accrual status this quarter and hope to continue that trend during the next fiscal year with at least two other companies. We believe we can expect further improvement going into this new fiscal year for us. One, generally, things that we have been, as you know, work on with our portfolio companies, whether that’s a change in management or improved management or that sort of thing, I’d say, it’s a combination, frankly. Generally, their business were improving, but they also were doing a good job managing the companies. And as we said in there, hopefully, there are a couple more. And if that all happens here by the end of this calendar year, we pretty much could be out of all our non-accruals with maybe exception of one company.”


GAIN’s NAV per share increased by another 10% (from $11.52 to $12.66) mostly due to markups during the quarter including many of its equity positions.

“Assets increased to $713 million from $644 million. This is in large part due to the continuing recovery of the values of our equity holdings, which do make up about 25% of our total portfolio at cost.”

 

 


Full BDC Reports

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

PFLT Quick Update: Improving Dividend Coverage

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

  • PFLT target prices/buying points
  • PFLT risk profile, potential credit issues, and overall rankings
  • PFLT dividend coverage projections (base, best, worst-case scenarios)


PFLT Summary

  • I have updated the projections for PFLT to take into account the $85 million of unsecured 2026 notes with a YTM of 3.875% which is an improvement from the previous issuance.
  • I am expecting continued improvement in dividend coverage due to portfolio growth using higher leverage, increased PSSL returns, and rotation out of equity positions into income-producing assets.
  • PFLT will likely not fully cover its dividend for the coming quarter but had around $0.22 per share of undistributed/spillover income that can be used for temporary dividend coverage issues.

PFLT Dividend Coverage Update

Leverage continues to decline and is now well below its targeted debt-to-equity ratio range of 1.40 to 1.50, currently at 1.07 net of cash giving the company plenty of capital for upcoming portfolio growth and improved earnings.

“We have ample liquidity and are prudently levered. Our GAAP debt to equity ratio was 1.1 times, while GAAP net debt to equity after subtracting cash was 1 times. The regulatory debt to equity ratio was 1.2 times and our regulatory net debt to equity ratio after subtracting cash was 1.1 times. With regard to leverage, we have been targeting a debt-to-equity range of up to 1.5 times.”

I am expecting continued improvement in dividend coverage mostly due to portfolio growth using higher leverage, increased returns from its PennantPark Senior Secured Loan Fund (“PSSL”), and rotation out of non-income producing equity positions:

“We are poised to significantly grow NII through a three pronged strategy, which includes number one, growing assets on balance sheet at PFLT, as we move towards our target leverage ratio of 1.50 times debt to equity from 1.10 times. Number two, growing our PSSL JV with Kemper to about $730 million of assets from approximately $500 million. And number three, rotating the equity value in the portfolio that has come from a strong equity co-investment program into cash paying debt instruments.”

On October 6, 2021, PFLT priced an additional $85 million of 4.25% unsecured notes due 2026 at a premium resulting in a yield-to-maturity of 3.875%. This is a lower rate than the $100 million notes issued in March 2021 at a discount resulting in a yield-to-maturity of 4.375% and has been taken into account with the updated projections. These notes further strengthen the overall balance sheet giving the company additional flexibility for long-term portfolio growth. Effective January 19, 2021, PFLT reduced the size of its credit facility from $520 million to $400 million in order to reduce the cost of the unused facility fees.

PFLT will likely not fully cover its dividend for the coming quarter but had around $0.22 per share of undistributed/spillover income that can be used for temporary dividend coverage issues. On October 4, 2021, PFLT reaffirmed its monthly distribution for October 2021:

The company is looking to improve returns from its PennantPark Senior Secured Loan Fund (“PSSL”) through previously refinancing the borrowing facilities and growing the portfolio using higher leverage. Total investments in its PSSL portfolio have increased from $393 million to almost $530 million over the last three quarters and the weighted average yield on investments increased from 6.8% to 7.2%. These increases are driving higher dividend income that increased to $2.3 million for the most recent quarter.

“With regard to the PSSL JV, with the CLO financing we completed earlier this year, as well as additional capital contributions from PFLT and Kemper, the JV will grow over time. The capital contributions from PFLT are targeted to generate a 10% to 12% return. During the June quarter, PFLT invested $20 million of capital and we intend to invest another 42 million over time in order to bring PFLT’s investment into PSSL to approximately $243 million.”


Similar to other BDCs, PFLT is expecting lower amounts of repayments over the coming quarters driving higher portfolio growth using leverage:

“We are well on our way to implementing the NII growth strategy. Since June 30th PFLT has had new originations of $102 million and PSSL has had new origination of $29 million. Although in the June quarter repayments exceeded new loans and in the September quarter so far, repayment activity has abated and new originations have accelerated. Our portfolio performance remains strong.”

“Quarter-to-date, repayments have been light and newer originations have been heavy. So last quarter, there were a lot of repayments. This quarter so far we’ve seen lighter repayment. We’re seeing a lot of new companies come in. Sometimes there’s the same more companies that get recycled and they go from one private equity firm to another, one private lender to another. This quarter, we’re seeing many more new companies come into the system.”

Also, PFLT will likely be rotating out of non-income-producing assets and reinvesting into higher-yielding assets over the coming quarters.

From previous call: “The combination of potential income growth from equity rotation, a larger and more efficiently financed PSSL, and a growing more optimized PFLT balance sheet should help grow the company’s net investment income relative to the dividend over time.”

There is a good chance that PFLT will be selling its equity positions in Cano Health, Inc. (CANO), Walker Edison Furniture, By Light Professional IT Services, and PT Networks. These investments account for $28.3 million or 2.7% of the portfolio and the proceeds will likely be reinvested into income-producing assets. As shown in the following table, these investments are marked well above cost and could result in $25.7 million or $0.66 per share of realized gains if sold at the current fair values potentially driving supplemental dividends in 2022. However, the company has offsetting realized losses from previous years and will likely be used to support temporary dividend coverage shortages.

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

“By Light is one that we talked about a lot, that’s about a $1 million market value there. We’ve got a company called Infosoft about $5.7 million of equity, GCOM of over 4 million of equity. PFLT is $7.6 million of equity. There’s still another $6.9 million of equity value in Walker Edison. So still some nice equity bites to be potentially exited and rotated over the coming year or two.”

From previous call: “We are pleased that we have significant equity investments in three of these companies, which can substantially move the needle in both NAV and over time net investment income. Cano, Walker Edison and By Light. All three of these companies are gaining financial momentum in this environment. And our NAV should be solidified and bolstered from these substantial equity investments as their momentum continues. Over time, we would expect to exit these positions and rotate those proceeds into debt instruments to increase income at PFLT. Walker Edison is leading e-commerce platform focused on selling furniture exclusively online through top e-commerce companies. As of March 31st, our equity position had a cost of $1.4 million and a fair market value of $12.1 million. Shortly after quarter end, the company executed a refinancing and dividend recap, which resulted in shareholders receiving approximately two times their costs, while maintaining the same ownership percentage in the company. This resulted in PFLT receiving a $2.8 million cash payment on its equity position. By Light is a leading software, hardware and engineering solutions company focused on national security challenges across modeling and simulation, cyber and global defense networks. Our position has a cost of $2.2 million and a fair market value of $11.8 million as of March 31st.”

For the three months ended June 30, 2021, PFLT slightly beat its base case projected net investment income (“NII”) of $0.261 due to higher-than-expected other income and maintained dividend income from its PennantPark Senior Secured Loan Fund (“PSSL”).

Art Penn, Chairman/CEO: “We are pleased with the strong performance of our portfolio this past quarter. Our PSSL joint venture saw significant growth. We believe that the growth of PSSL in conjunction with the Company’s growing, more optimized balance sheet and the rotation of equity positions into debt instruments, positions the Company well for increased income over time.”


PFLT Quick Risk Profile Update

For calendar Q2 2021, PFLT’s net asset value (“NAV”) per share increased by 0.8% but there was net realized losses of almost $13 million due to exiting its non-accrual investment in Country Fresh Holdings which has been discussed in many previous reports.

“The main driver of the realized loss was Country Fresh, which was a non-accrual which went through bankruptcy and is now not on the balance sheet anymore.”

“There were two capital events for Walker Edison in this past quarter. One was a dividend recap where two times we got back two times our money on the equity and then there was an investment by Blackstone where we got another two times our investment. So that was a nice cash realization on Walker Edison that came our direction on equity. Just looking at the quarter, I mean, that was the big one. It was about four point — that was a realized gain of about $4.3 million in the quarter. It was offset by Country Fresh. So the realization of the Country Fresh loss offset that, we had about a $1.4 million realized gain on DecoPac equity. And we had about $700,000 gain on WBB equity.”

American Teleconferencing Services was added to non-accrual status during the quarter. As of June 30, 2021, non-accrual accounted for 2.8% and 2.7% of the overall portfolio on a cost and fair value basis, respectively. If these investments were completely written off the impact to NAV per share would be around $0.72 or 5.6%.

“We did have a non-accrual — we had additional non-accrual American teleconferencing which is called Premier Global that was unrealized loss. We have only two non-accruals out of 105 different names in PFLT and PSSL. This represents only 2.8% of the portfolio of cost and 2.7% at market value.”

“As of June 30th average debt to EBITDA in the portfolio was 4.2 times and average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 3.3 times. This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry.”

“We have largely avoided some of the sectors that have been hurt the most by the pandemic such as retail, restaurants, health clubs, apparel, and airlines and PFLT also has no exposure to oil and gas. The portfolio is highly diversified with 100 companies in 42 different industries. Our credit quality since inception over 10 years ago has been excellent. Out of 381 companies in which we have invested since inception, we’ve experienced only 14 non-accruals.”


 

 


Full BDC Reports

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

ARCC Quick Update: Supplemental Dividend In 2021?

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

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


ARCC Dividend Update

As of March 31, 2021, ARCC had around $454 million or $1.04 per share of “undistributed taxable income” which is the amount of earnings in excess of what has been paid to shareholders. Similar to other BDCs such as TSLX, GAIN, and CSWC, there is a good chance that ARCC will need to pay a portion of this amount as a supplemental dividend in 2021 to satisfy the Regulated Investment Company (“RIC”) requirements set forth by the Internal Revenue Code (“IRC”) even when utilizing the spillback provision. For now, management is retaining this amount as a cushion to support “our goal of maintaining a steady dividend throughout market cycles”:

“I want to discuss our undistributed taxable income and our dividends. We currently estimate that our spillover income from 2020 into 2021 will be approximately $454 million or $1.04 per share. We believe having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend throughout market cycles and sets us apart from many other BDCs that do not have any spillover.”

ARCC continues to reduce its overall borrowing rates as well as laddering its maturities. On June 3, 2021, ARCC priced $850 million of 2.875% notes due June 15, 2028, which is an extremely low fixed rate for an unsecured note due 2028 and is taken into account with the updated projections. Also taken into account are additional returns from its investment in Ivy Hill Asset Management as discussed by management on the recent call:

“We have continued to invest in Ivy Hill and with that obviously, we generate typically more funds under management, assets under management there that obviously increases the management fees of that company. As you know, we also invest securities in a lot of the funds and vehicles that they put together, which also just allows us to ramp up the investment income from Ivy Hill. So it is simply just an increased dividend this quarter that you should expect to see. As we invest more, obviously, we should be taking in more income from Ivy Hill. And obviously, a dividend increase just represents our continued belief that it is a very attractive investment vehicle and relationship with Ivy Hill, so just continuing upwards.”

For Q1 2021, ARCC reported another strong quarter slightly beating its best-case projections mostly due to much higher-than-expected dividend income and capital structuring service fees. Leverage (debt-to-equity) declined due to the recent accretive equity offering as well as no portfolio growth (slight decline). Its portfolio yield (at cost) decreased slightly from 8.0% to 7.9% due to new investments at lower yields.

ARCC is now near its lower targeted leverage with a debt-to-equity ratio of 1.01 (adjusted for $337 million in cash). Through April 22, 2021, the company has already funded $630 million of new investments partially offset by $432 million of exits.

“After considering our investment in capital activities during the quarter, we ended the first quarter with nearly $5.2 billion of total available liquidity and a debt-to-equity ratio net of available cash of $285 million of 1.02 times, down from 1.17 times at the end of the fourth quarter. While our leverage ratios will vary overtime, depending on activity levels, we will continue to work to operate within our stated target leverage range of 0.9 to 1.25 times.”


 

During Q1 2021, ARCC issued $1.0 billion of 2.150% unsecured notes due 2026 at a slight discount to par partially used to redeem $230 million of 6.875% unsecured notes which resulted in a realized loss on the extinguishment of debt of $43 million. In February 2021, ARCC completed a public equity offering of 14 million shares at $17.85 per share resulting in total proceeds, net of estimated offering expenses, of approximately $249.4 million. As of March 31, 2021, ARCC had $337 million in cash and cash equivalents and approximately $4.9 billion available for additional borrowings under its existing credit facilities.

“During the quarter, we extended our corporate revolving credit facility to a full five-years and upsized it by nearly $350 million, bringing the total facility size to $4 billion, which is the largest single credit facility for any BDC. In addition, we took advantage of the historically low rate environment and issued $1 billion of 2.15% unsecured notes maturing in July 2026, which was a record low coupon for us or any BDC, while also optimizing our liability structure by exercising our option to early redeem our 2047 notes at par. These $230 million of notes, which we assumed in our acquisition of Allied Capital over 10-years ago, represented the highest interest rate of any of our outstanding debt securities at 6 7/8%. We also returned to the equity markets for a secondary issuance for the first time since 2014, issuing 14 million shares of our common stock at a premium to our net asset value, bringing us net proceeds of approximately $250 million.”

Penni Roll, CFO: “With $5.2 billion of available liquidity and a predominately unsecured funding profile, we believe that our balance sheet remains one of our most significant competitive advantages and provides us with significant flexibility.”

 

Previously, ARCC’s Board reaffirmed its second quarter dividend of $0.40 per share payable on June 30, 2021:

 

As discussed in the Dividend Coverage Levels report, only BDCs that can cover dividends by at least 90% using the lower-yield Leverage Analysis with a debt-to-equity ratio of 0.80 will be considered for ‘Level 1’ dividend coverage.

 


Full BDC Reports

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

OCSL Quick Update: More Dividend Increases?

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

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


OCSL Distribution Update

Oaktree Specialty Lending (OCSL) remains a ‘Level 1’ dividend coverage BDC and as predicted in multiple previous projections, I was expecting dividend increases to $0.12 for calendar Q1 2021 and $0.13 for Q2 2021. On May 6, 2021, OCSL announced a $0.13 per share, up 8% from the prior quarter paid on June 30, 2021, to stockholders of record on June 15, 2021.

Armen Panossian, CEO and CIO: “The closing of the Merger on March 19 was, of course, another highlight of the quarter. We believe the combined company will provide significant value to our shareholders. As a result of our continued strong performance and potential to improve earnings following the merger, our Board of Directors announced a fourth consecutive quarterly dividend increase to $0.13 per share, up 37% from the level one year ago. OCSL generated solid earnings results in the second quarter. Net asset value per share grew by 4%, supported by continued price appreciation on our high-quality investment portfolio. Additionally, we capitalized on the current market environment by harvesting realized gains on some of our liquid debt securities and rotating out of lower yielding investments into higher yielding, proprietary ones.”

On March 19, 2021, OCSL announced the closing of the previously discussed merger with Oaktree Strategic Income (OCSI). In connection with the merger agreement, Oaktree has agreed to waive $750,000 of base management fees payable in each of the eight quarters following the closing and is taken into account with the previous projections. As shown in the ‘best case’ projections, there is the possibility of additional increases in its quarterly dividend partially due to the merger. In connection with the merger, former OCSI stockholders will receive 1.3371 shares of OCSL for each share of OCSI based on the final exchange ratio.

“I’d like to spend a few moments discussing the closing of the merger with OCSI, which occurred on March 19. As we have emphasized previously, we believe that this transaction has resulted in several benefits to OCSL, including a larger, more scaled BDC with $2.3 billion of assets, up from $1.7 billion in the prior quarter. And improvement in portfolio diversity, including the increase in first lien loans to 68% of the portfolio at fair value from 60%, increased trading liquidity. And we also expect the merger to be accretive to NII over both the near and long-term through cost savings and the two-year fee waiver. In addition, part of our rationale for the merger was improved access to more diverse, lower-cost funding sources.”

I am expecting continued improvement in earnings over the coming quarters through the use of higher leverage, continued rotation into higher yield investments, accretive impacts from the merger including fee waivers as well as higher returns from its Kemper and Glick joint ventures.

“The Kemper joint venture had $352 million of assets invested in senior secured loans to 57 companies, this compared to $341 million of total assets invested in 56 companies last quarter. Assets increased quarter-over-quarter, mainly due to the increase in the market value of its investments and net portfolio growth as purchases exceeded sales and repayments. As a result of the underlying portfolio depreciation, OCS sales investment and the JV were written up by $5 million or 4% from the prior quarter. Leverage at the JV was 1.3 times at quarter end, up slightly from 1.2 times in the December quarter. Given the strong balance sheet and earnings power at the Kemper JV, we anticipate that we will begin to receive quarterly dividends starting next quarter. Regarding the Glick joint venture, it had $137 million of assets at March 31. These consisted of senior secured loans to 36 companies. Leverage at the JV was 1.2 times at March 31. OCSL subordinated note in the Glick joint venture, totaling $55 million is current, and we expect to receive ongoing payments, consisting of coupon interest and principal repayments of $1.3 million per quarter on a run rate basis going forward.”

On May 11, 2021, OCSL announced that it had priced $350 million of 2.700% of unsecured notes due January 15, 2027, which has been taken into account with the updated projections. OCSL had growth capital available given its historically low leverage with a debt-to-equity ratio of 0.84 as of March 31, 2021. On May 4, 2021, the company amended its Syndicated Credit Facility increasing the size to $950 million used to repay borrowings under its higher cost Deutsche Bank Facility from OCSI:

“We amended our syndicated credit facility, increasing the size to $950 million from $800 million and extending maturity by 2 years to 2026. We also retired a higher cost credit facility that was acquired from OCSI. While there are still some more to be done, we believe these actions position us well to optimally fund investments and will help reduce our overall cost of debt capital. Overall, we are very pleased with the quarter.”


The following table excludes “interest income accretion related to merger accounting” to calculate net investment income similar to the company:

 

 


Full BDC Reports

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

TCPC Update: Reduced Borrowing Rates & Dividend Coverage Update

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

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


TCPC Dividend Coverage Update

 

For Q1 2021, TCPC slightly beat its base-case projections due to much higher-than-expected dividend income partially offset by lower portfolio yield and only $0.01 per share of prepayment-related driving lower interest income. Payment-in-kind (“PIK”) income continues to decline from 7.6% in Q2 2020 to 3.2% in Q1 2021 the lowest level of PIK income in three years.

“Investment income for the three months ended March 31, 2021 included $0.01 per share from prepayment premiums and related accelerated original issue discount and exit fee amortization, $0.03 per share from recurring original issue discount and exit fee amortization, $0.02 per share from interest income paid in kind, $0.06 per share of dividend income and $0.02 per share in other income. Notably, this was our lowest level of PIK income in more than 3 years. Origination, structuring, closing, commitment, and similar upfront fees received in connection with the outlay of capital are generally amortized into interest income over the life of the debt investment.”


Similar to most BDCs, TCPC continues to improve or at least maintain its net interest margin through reducing its borrowing rates including its SVCP Credit Facility reduced to L+1.75% announced on June 24, 2021, and $175 million of 2.850% notes due 2026 issued on February 9, 2021. Both Fitch and Moody’s reaffirmed the Company’s investment-grade rating with stable outlook during Q1 2021.

“We also took advantage of the favorable bond market during the quarter to lower our borrowing costs. We issued an additional $175 million of unsecured notes at an attractive rate of 2.85%, which was record pricing for sub index eligible BDC bond issuance. In February, both Moody’s and Fitch, also reaffirmed our investment-grade rating with stable outlook. We ended the quarter with total liquidity of $420 million. This included available leverage of $396 million, cash of $14 million and net pending settlements of $10 million. Unfunded loan commitments of 2 portfolio companies at quarter end equaled just 4% of total investments or $75 million, of which $29 million were revolver commitments. Combined, the weighted average interest rate on our outstanding liabilities decreased to 3.48%, down from 3.54% at the beginning of the quarter.”


 

I am expecting higher amounts of dividend income partially related to Edmentum, Inc. but not as much as there was in Q1 2021. Management discussed the recurring amount of dividend income on the recent call:

“Dividend income in the first quarter included $1.3 million or $0.02 per share of recurring dividend income on our equity investment in Edmentum. I would say I would note that, that is — we view it as recurring dividend income. We had about $0.5 million from Iracore this quarter. We also had about, I think, $800,000 from 36th Street and then some other income from Amtech dividend income this quarter, about $800 million from Amtech as well. I would say most of that should be recurring. 36th Street, as you know, has a preferred rate contractual, and then we have a participation in dividend income a majority split, which has actually been — we’re well into that each quarter, and it’s growing. So that is actually partly recurring and then the variable component actually takes us up quite a bit over the recurring amount, which we like. So the majority — I would say the majority of it is recurring, but then where it’s not, we’re actually seeing good, consistent variable income that has actually been growing as it ties to 36th Street.”

Previous reports correctly predicted the reduction of TCPC’s quarterly dividend from $0.36 to $0.30 which was at the top of my estimated range of $0.28 to $0.30. At the time, the company had spillover or undistributed taxable income (“UTI”) of around $0.78 per share. However, this is typically used for temporary dividend coverage issues. Please do not rely on UTI as an indicator of a ‘safe’ dividend.

The previously projected lower dividend coverage was mostly due to lower LIBOR and portfolio yield combined with management keeping lower leverage to retain its investment-grade rating.

The previous declines in interest rates (LIBOR) were mostly responsible for the decline in portfolio yield with “limited exposure to any further declines”.

“Since December 31, 2018, LIBOR has declined 261 basis points or by 94%, which has put pressure on our portfolio yield. However, our portfolio is largely protected from any further declines in interest rates as 84% of our floating rate loans are currently operating with LIBOR floors.”


As shown below, TCPC’s portfolio is highly diversified by borrower and sector with only 4 portfolio companies that contribute 3% or more to dividend coverage:

“As the chart on the left side of Slide 6 of the presentation illustrates, our recurring income is spread broadly across our portfolio and is not reliant on income from any 1 portfolio company. In fact, over half of our portfolio companies each contribute less than 1% to our recurring income. 94% of our debt investments are floating rate. Additionally, 86% of our debt investments are first lien.”


Historically, the company has consistently over-earned its dividend with undistributed taxable income. Management will likely retain the spillover income and use for reinvestment and growing NAV per share and quarterly NII rather than special dividends.

On the previous earnings call, management was asked about resetting the dividend higher (closer to the previous level) and mentioned the lumpy nature of fee, dividend, and prepayment-related income, “investors take comfort from dividend stability” and “great pride and comfort from knowing that we’ve got good dividend coverage”. I agree.

Q. “Knowing that you folks never like to do anything in a herky jerky way and having just trimmed your dividend from 36 to 30 last year for reasons that are understandable kind of in the middle of the lockdowns. And so I’m just kind of wondering, again, not for the next quarter, two or three. But just philosophically, what would you be looking forward to or is it a goal to get back to the prior distribution?”

A “I just want to remind you of something that we had said earlier about a decrease in LIBOR, which basically cost $0.09 a share. So yes, we did this during the lockdown. But we were also reacting to the very significant change in LIBOR, and the math is set out. And so when we made that decision, it was really primarily looking at LIBOR as opposed to events in the portfolio. We’re very proud of having earned our dividend every quarter. We think investors take comfort from dividend stability, knowing that it’s well-earned and appropriately covered. And that’s really been our focus. I think the other thing is, as you look at our earnings, we benefited from prepayment fees. And as we discussed earlier on the call, those are lumpy. We’ve had significant prepayment fees the last couple of quarters. We don’t always — we did into Q1 of last year. In fact, we had very few of them. And Q1 tends to be a seasonally slower quarter. Paul pointed out, we hadn’t received any in a material way yet this quarter. We take great pride and comfort from knowing that we’ve got good dividend coverage. But we also know that there’s a certain lumpiness to the extra earnings from additional fees, dividends and prepayments and the more unusual items.”


Full BDC Reports

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

TPVG Quick Update: Lumpy Earnings

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

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


TPVG Dividend Coverage Update

TPVG’s dividend coverage needs to be assessed on an annual basis due to the lumpy nature of earnings from successful portfolio companies prepaying loans. This results in certain periods of higher prepayment fees driving higher earnings often followed by lower earnings due to being underleveraged and not having a fully invested portfolio.

“I would like to remind everyone that while prepayments are a natural part of our venture lending model, it does come with a great deal of uncertainty. One of the other aspects of prepayment activity is that the origination vintage of alone that prepays really does matter. Given the nature of income acceleration when a loan prepays, the characteristics of income changes, the longer the loan remains outstanding, for example, should alone repay or prepay in its first year, we would generally recognize a comparatively higher level of income.”

This is what happened in Q1 2021 driving interest income well below previous levels due to lower amounts of prepayment-related income as well as the previous prepayments resulting in “lower weighted average principal outstanding on our income-bearing debt investment portfolio”

“Our earnings were impacted by the significant prepay activity we’ve experienced over the past several quarters on our overall portfolio size, despite strong new commitments, growing investment funding and stable core portfolio yield is in the past. We believe any shortfall is temporary and will be more than made up during the rest of the year as the fundamentals of our industry.”

Also, there were some timing issues with new investments near the end of the quarter which did not contribute a full quarter of income and likely some prepayments earlier in the quarter:

Q. “Was there a mismatch in terms of the timing of repays versus the timing of originations? Did, did repays come early in the quarter and were originations stacked towards the back of the quarter?”

A. “Yeah. So I think generally that is what happens, fundings tend to occur towards the end of the quarter and usually in the last month of a quarter in particular and prepays, I think we, we had announced on our year end results that we had already had some prepay. So that was definitely the case for Q1. And I would, I would argue that that’s, that’s pretty typical. We’re fundings tend to average short towards the latter half of, of a quarter in prepays can happen in the early part as well.”

However, since March 31, 2021, and through May 4, 2021, the company has already received $46 million of prepayments generating more than $2.0 million of accelerated income. There is a good chance that many of the prepayments for Q1 ended up in Q2 and the first quarter is typically the slowest for new investments.

“We remain in a strong position to generate NII or net investment income in excess of our distribution over the longterm. As we always have in fact, over the last four years and cumulatively, since our IPO, we have over earned our distribution. We’ve also paid three special distributions, including one that we just made last week. Additionally, other trend that we will benefit from is the acceleration of exit events”

As of March 31, 2021, the company’s unfunded commitments totaled $168.8 million and through May 4, 2021, had closed $52.0 million of additional debt commitments and funded $23.7 million in new investments. Leverage remains low due to previous early repayments driving a debt-to-equity ratio of 0.57 net of cash giving the company plenty of growth liquidity.

“We need to position ourselves to take advantage of the strong demand we are seeing from venture growth stage companies. We expect this to continue throughout 2021 and the first quarter we increased signed term sheets by 142% year over year. And our pipeline continues to be more than a billion. We expect to accelerate funding throughout 2021. And our poise drawn our ample liquidity, which we further enhanced in the first quarter through upsizing our credit facilities and also completing our second investment grade notes offering under very attractive terms.”

The Board reaffirmed its quarterly distribution of $0.36 per share for Q2 2021 and there is still estimated spillover income of $0.45 per share for temporary dividend coverage shortfalls as well as another Q4 2021 special dividend.

“As of June 16th to be paid on June 30th, we have significant spillover income totaling, approximately $14 million or $0.45 per share at the end of the quarter to support additional distributions in the future.”


As shown below, early prepayments are lumpy including a previous low in Q3 2019 driving lower portfolio yield and much lower dividend coverage as shown in the previous table.


On March 1, 2021, TPVG closed a private offering of $200 million 4.50% institutional unsecured notes due 2026, and used a portion of the proceeds to redeem its 5.75% Baby Bond (TPVY) lowering its overall borrowing rates:

“During the first quarter, we executed on our playbook to diversify our funding sources, lower our cost of capital, and strengthen our funding capabilities. Upsizing our credit facility and completing our second investment grade notes offering will enable us to meet the increasing demand from venture growth stage companies.”

From previous call: “we are refinancing our most expensive term debt to baby bonds with 22% cheaper notes. Concurrently, with the private notes offering this week, DBRS maintains its investment-grade rating [BBB] on TPVG given the strength and diversity of our portfolio and the reasonable level of leverage we maintain.”


It should be noted that TPVG is one of the only BDCs currently with 100% unsecured borrowings giving the company much more flexibility over the coming quarters:


Full BDC Reports

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

NMFC Management Committed To Paying Dividends Through 2022

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

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


New Mountain Finance (NMFC) has a relatively higher dividend yield consistently covered, with a defensively positioned portfolio and management that exhibits higher quality indicators including responsiveness to personal requests for information, waived management fees, look-back feature for the capital gains portion of the incentive fee. However, NMFC does not have a ‘best-of-breed’ fee structure due to income incentive fees not taking into account realized or unrealized losses. Management has “committed to paying quarterly dividends of at least $0.30 over the next seven quarters” through fee waivers.

“New Mountain was built with defensive growth industries and risk control in mind long before COVID hit. The great bulk of NMFC’s loans are in areas that might best be described as repetitive, tech-enabled business services such as enterprise software. Our companies often have large installed client bases of repeat users who depend on their service day-in and day-out. These are the types of defensive growth industries that we think are the right ones at all times, and particularly attractive in difficult times.”


NMFC Dividend Coverage Update

On May 4, 2021, NMFC entered into a fee waiver agreement and the Investment Adviser agreed to reduce the base management fees not exceed 1.25% of gross assets through December 31, 2022. Also, management has “committed to paying quarterly dividends of at least $0.30 over the next seven quarters” through additional fee waivers:

“We are pleased to announce again a second quarter distribution of $0.30 per share payable on June 30, 2021 to holders of record as of June 16, 2021. With the continued support of our Investment Adviser, we are committed to paying quarterly dividends of at least $0.30 over the next seven quarters as we expect our positive performance will continue.”

“We’re implementing a dividend support program for at least the next two-years by pledging to charge no more than a 1.25% management fee on all assets. For the next two years, we also pledged to reduce our incentive fee, if needed to support the $0.30 dividend. We do not anticipate needing to use this pledge, but want shareholders to have greater confidence in the current dividend. While we believe our ability to earn our $0.30 quarterly dividend remains intact as we come out of the COVID crisis, given the twin headwinds of a very low base interest rates and what we believe is a temporarily increased non-interest earning equity portfolio, we want to assure our shareholders that the dividend and the earnings base that supports it are secure. To that end, we are implementing a program whereby for at least the next two calendar years, we will effectively guarantee to reduce our incentive fee if needed to make sure earnings support the $0.30 dividend. Further in order to simplify our fee structure instead of waiving fees on a portion of certain managed assets as we historically have done for at least the next two years, we will simply charge a 1.25% management fee on all assets. We believe these two important changes even further align management’s interest with those of our shareholders, an approach that has always informed our actions.”

Over the next seven quarters management is working to improve earnings through lowering its borrowing expenses and increasing returns including from its Senior Loan Programs and rotating the portfolio out of equity positions and non-income-producing assets:

“Equity portfolio with things like Edmentum, Benevis and UniTek and we actually believe there is tremendous potential in those names to create real economic value, but of course for every dollar that’s in a non-yielding piece of equity at non-cash and non-income yielding piece of equity that obviously is a dollar that’s not earning NII in the quarter. So, nothing has changed, and in fact, our outlook continues to brighten for those names, and from a timing perspective, it’s not the case that we think we’re going to own them any longer than we would have thought last quarter. It’s just the timing of those uncertain right like will you because it’s a lumpy will you exit one of those and convert that into cash, that’s redeployed in NII generative traditional debt securities we just don’t know. So, we want to just make sure that the new explicit NII per action program has enough runway to make sure we can recycle those proceeds.”

It should be noted that there will likely be less dividend income paid in Q2 2021 due to Edmentum Inc. and is taken into account with the updated projections:

Q. “Edmentum looks like they paid a dividend here in the first quarter and was curious if you expect that dividend to be stable on a going-forward basis or how should we think about just the level of that dividend coming in from Edmentum?”

A. “Yes, that’s really more a truing up of some elements from the fourth quarter transaction. So we do not expect Edmentum to be a regular payer of dividends. So it was more of a one-time post transaction settling than it was a policy of paying dividends, I think Edmentum is going to be more of a growth entity than a dividend payer.”

There is a good chance that management would extend the fee waivers if the company was not covering its dividend but management seems confident that would not be needed:

“So we’re not saying it’s two years for sure and then we said at least two years and that’s important. We feel pretty good about just naturally earning the $0.30, but we recognize there are some post COVID headwinds and we want to make sort of explicit what’s been frankly implicit, and we just don’t want anyone to be worrying about the $0.30 dividend and the sustainability and the coverage it through NII and I think in a listen two years as we’ve all seen in the world is a very long time and we’ll be readdressing if and as needed, but I think our hope and expectation is that two years from now the things that have hurt the dividend, the base rate going down and the larger equity portfolio. We’ll have made progress and there’ll be just much more fulsome coverage to give people that more traditional confidence in the dividend. And of course, if there is not, we are going to be, I think you’ve seen as we’ve always been very supportive. I would be shocked if we weren’t, we needed to extend it, we will likely extend it.”

As discussed in the previous report, management is working to improve its net interest margins by reducing borrowing expenses. In March and April 2021, the company extended and reduced the borrowing rates on its Deutsche Bank and Wells Fargo credit facilities. On February 5, 2021, NMFC announced the redemption of its 5.75% notes due 2023 (CUSIP 647551209; “NMFCL”) on March 8, 2021, using the proceeds from its recent private placement of $200 million of 3.875% notes due 2026. These notes were also used to redeem its 5.31% unsecured notes due May 2021. Moody’s and Kroll recently assigned/affirmed their investment-grade credit ratings:

“We have made material progress decreasing the cost and increasing the duration and flexibility of our liabilities. Specifically, we have extended our two main asset-backed secured credit facilities to $730 million Wells Fargo facility and the $280 million Deutsche Bank facility out to 2026. At the same time, we were able to lower applicable spreads on these two facilities by 40 basis points and 25 basis points respectively. On the unsecured side, we received an investment grade rating from Moody, which will allow us to access the institutional bond market, even more effectively than in the past, which should further reduce our cost of capital. We also received an upgraded outlook from Kroll Bond Rating Service.”


On May 5, 2021, NMFC and SkyKnight Alpha entered into an agreement to establish a joint venture, NMFC Senior Loan Program IV (“SLP IV”) transferring/contributing 100% of their membership interest in SLP I and SLP II to SLP IV. The purpose of the joint venture is to invest primarily in senior secured loans issued by portfolio companies within its “core industry verticals”. Also, the SLP IV entered into a $370 million revolving credit facility with Wells Fargo at a rate of LIBOR plus 1.60% per annum.

“Finally, we combined the SLP I and SLP II funds into a newly created SLP IV, the scale of which will allow for more simplified and efficient financing and execution going forward.”


On January 4, 2021, NMFC announced that its Board authorized an extension of its $50 million share repurchase program “to be implemented at the discretion of NMFC’s management team”. Unless further extended by NMFC’s board of directors, the Company expects the repurchase program to be in place until the earlier of December 31, 2021, or until $50 million worth of NMFC’s outstanding shares of common stock have been repurchased. To date, only $2.9 million worth of repurchases have been made.

For Q1 2021, NMFC reported between its base and best-case projections covering its dividend with slightly higher-than-expected dividend and other income during the quarter. Also, its portfolio yield remained stable and leverage (debt-to-equity) declined slightly.

 


Full BDC Reports

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

GBDC Quick Update: Reduced Borrowing Rates

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

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


This update discusses Golub Capital (GBDC) which is a BDC with ‘higher quality’ management, access to SBIC leverage, and its higher credit quality portfolio. GBDC has one of the most investor-friendly fee structures, with a base management fee that is calculated at an annual rate of 1.375% (compared to 1.50% to 2.00%, for many) of average adjusted gross assets, excluding cash and cash equivalents. GBDC’s fee structure includes a ‘total return hurdle’ which means that its incentive fee structure protects total returns to shareholders by taking into account capital losses when calculating the income portion of the fee. Incentive fees are paid after the hurdle rate is reached, requiring a minimum return on net assets of 8% annually. Once this hurdle is reached, the advisor is entitled to 100% of the income up to 10%. This ‘catch-up’ provision catches up the incentives to 20% of pre-incentive fee net investment income and then the advisor is paid 20% after the ‘catch-up’. However, GBDC is currently between the 8% and 10% hurdles so its incentive fees are much lower and basically ensures dividend coverage.


GBDC Recent Insider Purchases

  • The Chairman and CEO have purchased over $35 million of common shares over the last 10 months.


GBDC Dividend Coverage Update

I am expecting improved dividend coverage over the coming quarters for many reasons including portfolio growth through increased leverage, improved net interest margins, and recent/continued increases in its NAV per share.  For the three months ended March 31, 2021, GBDC hit its best-case projections with slightly increased portfolio yield (from 7.4% to 7.5%) and higher fee income partially offset lower portfolio growth (decline). Leverage (debt-to-equity) declined due to increased NAV per share and repayments/sales/exits exceeding new investments for the quarter. NAV per share increased by another 1.8% “primarily attributable to portfolio companies that generally continued to perform well. Strong performance across the portfolio was reflected in our internal performance ratings that have largely returned to pre-COVID levels.”

 

On February 24, 2021, GBDC closed an offering of $400 million of unsecured notes at 2.500% due in 2026. This is an excellent fixed rate for flexible unsecured borrowings and improves the overall strength of the balance sheet as well as lowering the overall borrowing rate.


As shown in the following chart, the net interest margin (green line) previously increased to 5.1% but declined slightly due to the higher weighted average cost of borrowings. Similar to all BDCs, management is working to reduce borrowing rates including the recently issued notes at 2.50% and lower-cost credit facilities. On February 11, 2021, GBDC entered into its $475 million JPM Credit Facility (one-month LIBOR plus 1.750% to 1.875%) and repaid its WF Credit Facility (one-month LIBOR plus 2.000%).

“GBDC took advantage of attractive market conditions to continue to optimize its balance sheet. We executed a second unsecured bond issuance, building on the success of our inaugural offering last year. We also closed a new corporate revolver. These financings are consistent with the strategy you have heard us discuss before, low-cost, flexible financing with limited near-term maturities.”

“On February 11th, we closed on a $475 million revolving credit facility with JPMorgan which matures on February 11, 2026, and has an interest rate that ranges from one-month LIBOR +1.75% to one-month LIBOR + 1.875%. Second, On February 24th, we issued $400 million of unsecured notes, which bear a fixed interest rate of 2.5% and mature on August 24, 2026. With the completion of our second unsecured debt issuance, our percentage of unsecured debt as a percentage of total debt increased to 38.0% as of March 31st. And finally, on February 23rd, we decreased the borrowing capacity under our revolving credit facility with Morgan Stanley to $75 million. After the end of the quarter, we further amended this revolving credit facility to, among other things, extend the reinvestment period through April 12, 2024, extend the maturity date to April 12, 2026, and reduced the interest rate on borrowings to one-month LIBOR + 2.05% from one-month LIBOR + 2.45%.”


Full BDC Reports

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

FDUS Update: Baby Bonds “FDUSZ” and “FDUSG”

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

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


 

This update discusses Fidus Investments (FDUS) which has provided investors with higher returns supported by equity investments. FDUS has maintained NAV per share performance and realized gains relative to most BDCs with equity investments in over 87% of its portfolio companies which is primarily responsible for NAV growth and dividend income to support supplemental/special dividends paid over the last 8 years.

 


FDUS Dividend Coverage Update

On May 6, 2021, the company reaffirmed its regular quarterly dividend of $0.31 and another supplemental dividend of $0.08 for Q2 2021. As of March 31, 2021, the company had $0.98 per share of spillover income (or taxable income in excess of distributions) that can be used for additional supplemental dividends.

As predicted in previous reports, FDUS slightly increased its regular dividend in February 2021 and recently announced a dividend strategy that includes an easily sustainable regular dividend as well as a variable portion to pay out the excess earnings as needed (similar to TSLX, HTGC and CGBD) and was discussed on the call:

“The Board has devised a formula to calculate the supplemental dividend each quarter, under which 50% of the surplus and adjusted NII over the base dividend from the prior quarter is distributed to shareholders. For the second quarter, the surplus is $0.15 per share. Therefore, on May 03, 2021, the Board declared a base quarterly dividend of $0.31 per share, and a supplemental quarterly cash dividend of $0.08 per share.”

From previous call: “As a result of the steady improvement in the overall health of the portfolio since then, the Board has increased the base quarterly dividend by $0.01 to $0.31 per share and implemented a supplemental quarterly dividend for 2021 equal to 50% of the surplus in adjusted NII over the base dividend for the prior quarter. Being aggressive with dividend policy just doesn’t seem like the right thing to do. We feel this approach is a good solution for at least 2021 and provide significant upside to the base dividend as we had in the last two quarters, while also providing what I would say is a durable and flexible distribution model in these uncertain timesWill this be a permanent move? It could be. I think the base dividend is something we will always look at, but the approach is a good one. And I wouldn’t say we are the first to do this. But I do think it’s a good one, especially in this environment and we will consider kind of on a permanent basis as well as we move forward, but this is a 2021 move at this point.”


Also, previous reports correctly predicted the reduction in FDUS’s quarterly dividend from $0.39 to $0.30 per share announced in May 2020. FDUS has paid supplemental dividends over the last 8 years but usually in Q4 (last 5 years) and many of them are around $0.04 as shown below.


There is the potential for significant realized gains related to the exit of certain equity investments including Pfanstiehl, Inc.Pinnergy, Ltd., and Global Plasma Solutions which were among the largest markups in 2020. If these investments were sold at the fair value as of March 31, 2021, would imply potential realized gains of over $61 million or $2.51 per share which would likely drive a significant increase in supplemental dividends over the coming quarters. Also, these investments currently account for 9.1% of the portfolio fair value and could be reinvested into income-producing assets driving higher earnings and a potential increase in the regular dividend.


However, FDUS does not have a controlling interest in these companies, and management mentioned “there is no rush” to exit Pfanstiehl as the company has additional upside potential:

“We did rotate half of our investment and rotate out of it in Q1 of last year. Pfanstiehl is a manufacturer of high-purity sugars and active ingredients for injectable drugs and biologic drugs, mostly in the oncology arena, are focused on the oncology arena. They also do participate in the vaccine arena to a certain degree. I’d say the company is performing very well, and the outlook is also strong. So the positives are outweighing any potential negatives of COVID-19 at this point in time. So valuation reflects the performance of the company. And I would say, look, we’re – we like the outlook of the business. We are not in control of the company and that would require discussions with the company or sale of the business which neither of what are happening at this point, but I don’t think there is any rush.”

During Q1 2021, FDUS had net realized gains of $3.2 million or $0.13 per share due to exiting many of its equity investments including Software Technology, Rohrer, and FDS Avionics:

“We have equity investments and approximately 87.3% of our portfolio companies with weighted average fully diluted equity ownership of 5.3%. For the three months ended March 31, we recognized approximately $3.2 million of net realized gains from the sale of several equity investments including Software Technology a $1.4 million gain, FDS $0.9 million gain, and Rohrer $0.9 million gain.”


The updated projections take into account lower amounts of expected fee income (relative to the previous quarter) and continued repayments offset by new investments:

“When I look at Q2 from a fee perspective, my current expectation would be for fees to be lower. In Q1, we had about $3.1 million of fees approximately half of that was from prepayments. And so in Q2, I would expect our fees to really be driven more from origination activity and maybe to a minor extent, maybe a few amendment fees, but not the level of prepayment fees we saw in Q1. We expect Q2 to be relatively busy from origination perspective this quarter was I guess in April, we had $43 million in origination. We’re working hard on several opportunities right now. We do expect repayments to continue through the year, but at a slower pace than the recent past. Overall, we believe the portfolio is headed in the right direction and remains well structured in support of our capital preservation and income goals. Our strategy is working and we remain committed to our goal of growing net asset value over time through careful investment selection, and focus on preservation and on generating attractive risk adjusted returns.”

Also taken into account with the updated projections are the following subsequent events:

  • On April 1, 2021, we invested $11.0 million in first lien debt of Winona Foods, a leading provider of natural and processed cheese products, sauces, and plant-based alternatives.
  • On April 1, 2021, we invested $5.5 million in first lien debt and $1.0 million in common equity of Level Education Group, LLC (dba CE4Less), a leading provider of online continuing education for mental health and nursing professionals.
  • On April 5, 2021, we invested $25.5 million in first lien debt, common equity, and made a commitment up to $2.0 million of additional first lien debt of ISI PSG Holdings, LLC (dba Incentive Solutions, Inc.), a tech-enabled incentive rewards and digital marketing firm that facilitates and optimizes its clients’ indirect sales channel strategies.
  • On April 5, 2021, we exited our debt investment in The Kyjen Company (dba Outward Hound). We received payment in full of $15.0 million on our second lien debt, which includes a prepayment fee.
  • On April 14, 2021, we exited our debt investment in Medsurant Holdings. We received payment in full of $8.0 million on our second lien debt.
  • On April 29, 2021, we exited our debt investment in Virginia Tile Company. We received payment in full of $12.0 million on our second lien debt.

 


For Q1 2021, FDUS easily beat its best-case projections covering 147% of its quarterly regular dividend due to much higher-than-expected fee income resulting from an increase in prepayment and amendment fees, partially offset by a decrease in origination fees.

“I would say Q1 fee income was a little higher than normal. There were some events there that were large events, not small, that’s been obviously positive, and it’s a benefit of our model. But it’s not something that I would say is going to reoccur every quarter for sure.”

Edward Ross, Chairman and CEO: “For the first quarter, our portfolio generated strong adjusted NII, including a lift from fee income. NAV per share grew for the fourth consecutive quarter reflecting an ongoing trend of improving health of the portfolio overall since the pandemic began last year. As a result of continued high levels of M&A activity in the lower middle market, repayments were once again above historical averages and, as expected, outpaced originations.”


Baby Bonds “FDUSZ” and “FDUSG”

On December 16, 2020, FDUS priced a public offering of $125 million of 4.75% unsecured notes due January 31, 2026, and used the proceeds to redeem all of its outstanding 5.875% notes due 2023 (FDUSL) and “a portion” of its outstanding 6.000% notes due 2024 (FDUSZ) callable on February 15, 2021). On December 23, 2020, FDUS announced the redemption of $50 million of 6.000% notes due 2024 (FDUSZ) total of $69 million) Notes on February 16, 2021.

“In Q1, using the proceeds from our December bond offering, we fully redeemed our 5.875% $50 million notes due 2023 and partially redeemed $50 million of our 6% public notes due 2024. In addition, we paid down $19.2 million of SBA debentures and our second SBIC fund. We realized a one-time loss on extinguishment of debt in Q1 of approximately $2.2 million from the acceleration of unamortized deferred financing cost on the redeem bonds and SBA debentures.”

FDUSZ and FDUSG are considered ‘lower risk’ Baby Bonds due to the company having higher quality management and better-than-average historical credit performance as well as an adequate asset coverage ratio and interest expense coverage which are shown in the updated projections.

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

 


Full BDC Reports

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