Fifth Street Finance: Amends Preliminary Prospectus
On January 13, 2017 Fifth Street Finance (FSC) amended for the second time its N-2 Registration Statement.
If the Registration Statement (i.e. prospectus) becomes “effective”, FSC would be in a position to raise new debt or equity capital.
The BDC Reporter does not know if FSC is just updating its paperwork or has a specific capital raising action in mind.
EARLY MORNING READING
We reviewed the document to determine if there was any new information not already made available in prior filings.
An initial review found nothing much new of a material nature.
The N-2 mentions the recent change in management at the BDC, and updated the 2017 changes to the Board and executive suite previously communicated:
“Effective January 2, 2017, Todd G. Owens stepped down from his roles as Chief Executive Officer and a member of our Board of Directors, and Ivelin M. Dimitrov stepped down from his roles as President, Chief Investment Officer and a member of our Board of Directors”.
There’s no news about the SEC investigation which is hanging over the Company, but nor is there any notice that anything has been resolved.
Most everything else is already contained in prior filings through September 30, 2016.
BACK TO THE WELL ?
The BDC Reporter cannot help asking itself what FSC is up to, if anything…
An equity raise would normally seem unlikely with FSC’s stock trading way below its latest NAV, as reported in tiny type on page 1:
“On January 12, 2017 and September 30, 2016, the last reported sale price of our common stock on the NASDAQ Global Select Market was $5.56 and $5.81 per share, respectively. Our Board of Directors is required to determine the net asset value per share of our common stock on a quarterly basis. Our net asset value per share of our common stock as of September 30, 2016 was $7.97”.
That’s a 30% discount of price from NAV.
However, as the Prospectus shows, the discount has been 45%, but FSC’s price has rallied with the BDC sector.
(Since hitting its lowest low on February 23, 2016, FSC’s stock price has rallied 22%, just below what the sector achieved in the same time period, as per this chart from Yahoo Finance).
On the other hand, the Company IS highly leveraged, and only avoids breaking the BDC requirement that debt to equity must be less than 1 to 1 thanks to the exclusion of its SBIC debt from the calculation.
“Real” Debt To Equity is 1.01 by our count, slightly less if you include cash in the numbers.
A year ago, FSC’s leverage was less close to the brink at 0.89 of equity.
However, huge Realized Losses, an increase in Unrealized Losses and a modicum of stock buy-backs thrown in has reduced capital by $211mn, or 16% of the September 30, 2015 number.
Is it possible that with Mr Tannenbaum’s increasingly tight grip on FSC’s stock (15% of the total) and with a new CEO in place with high hopes and ambitions, the BDC may bite the bullet and undertake a below NAV equity offering ?
Or a Rights Offering, which is a variation on the same theme ?
The BDC Reporter is just asking the question and has no special insight or prediction to make.
THEN THERE’S ALWAYS DEBT
FSC could also be planning on raising new Unsecured Notes, either to replace existing debt or incrementally, to fix a greater portion of debt liabilities in anticipation of greater income from higher interest rates on the loan portfolio.
RETURNING TO A FAVORITE THEME OF OURS
However, the BDC Reporter needs to point out-as we did recently for PennantPark Floating Rate (PFLT)-that the increase in short term rates is going to have to be substantial to effect much improvement in earnings per share.
In the prospectus, FSC calculates that a 1% increase in rates (presumably to LIBOR, which loans and Revolver borrowings are pegged) will only add $4mn to Net Investment Income.
That’s a 3.7% increase, on a pro-forma basis.
Even the most aggressive Fed members do not foresee a full 1% rate increase in less than a year and the markets appear to be expecting 0.5% in two raises in 2017.
Admittedly, LIBOR has risen since the September 2016 starting point in FSC’s calculation but only by 0.15% (from 0.85% to 1.0% currently).
Even if we get three 0.25% rate rises (which the BDC Reporter considers unlikely and unconscionable), FSC (and all the other BDCs counting on this move), the full but modest benefit will not be felt till calendar 2018.
(Then there’s the whole issue of spread compression in which borrowers claw back some of their higher cost by demanding better terms from asset hungry lenders).
BEWARE WHAT YOU WISH FOR II
Yes, if short term rates increase by 300 basis points or more the earnings needle for FSC and many other closed-end funds will materially move.
Unfortunately, the BDC Reporter-always the skeptic-believes that will not happen because the impact on the credit worthiness of leveraged borrowers will greatly outweigh any earnings benefit.
BACK TO THE SUBJECT AT HAND
Unfortunately for FSC’s shareholders there do not seem to be many attractive capital raising opportunities.
Raising new equity will obviously be highly dilutive, and probably result in yet another cut in the distribution.
Raising new debt to grow the balance sheet will add very little to Net Investment Income once interest, Management and Incentive Fees and incremental operating expenses are paid.
Raising new debt to pay off more expensive existing debt will result in higher operating expenses in the short run (all those investment bankers to pay) and a modest interest savings over time.
Waiting for higher LIBOR rates to push up income while fixing as many debt facilities as possible may be like waiting for Godot and won’t provide much succor in the next few quarters as loan floors continue to mitigate revenue gains.
KEEPING THE PAPERWORK TIDY ?
Maybe FSC will do nothing, and the prepping of this prospectus is just creditable caution.
ON THE CALENDAR
We will find out in the next few weeks, and report back.