THL Credit: Doubts About Credit Outlook
This a revised version of A Word From The Editor post from March 14, 2017, repurposed as a brief comment on THL Credit’s (TCRD) latest 10-K, and an update on what has happened to the BDC’s stock price in recent days:
AFTER REVIEWING TCRD’s 10-K…
From the BDC Reporter’s perspective, THL Credit’s (TCRD) risk profile and outlook still leave much to be desired.
NOT A GOOD YEAR
The unfortunate mid-sized BDC has booked a number of Realized Losses in 2016, seen its NAV tumble and reduced its quarterly distribution from $0.34 to $0.27.
There have been a series of managerial and strategic changes; a complete withdrawal from CLO investing (last 2 positions sold in January) and a growing commitment to its (so far) successful JV.
NOT OVER YET
Nonetheless, the portfolio continues to have both non-accruing loans (albeit less than in the past) and plenty of under-performing investments.
Management has made the case that the prior strategy of investing partly in non-sponsored transactions (i.e. without a Private Equity owner to run to for more capital when things go awry) was the root of its problems and this is being solved by sticking with those non-sponsored deals that worked; restructuring those that did not and making the pledge to not take on any new deals without a sponsor present.
Our analysis is that TCRD’s credit problems are more pervasive. We still count 12 Watch List names in the portfolio, with a fair market value of $161mn (out of $669mn and with assets of $189mn).
2 are on Non Accrual, but 10 are performing, but not well enough.
Just to make clear that this is not just the BDC Reporter being overly-conservative (as we’ve been accused of), we note that TCRD’s own portfolio rating system has 36.1% of all its investments rated 3, 4, or 5-various ranges of under-performing initial expectations. In dollar terms that $242mn, quite a bit more than our Watch List number.
At the end of 2015 TCRD’s own ratings of Watch List assets was at $200mn, so that’s a 20% increase of deals to worry about in the past 12 months.
What’s more TCRD wrote off nearly ($40mn) in bad deals, suggesting that the “real” increase in trouble is closer to 40%.
DIVIDEND COVERAGE AT RISK
If that isn’t enough, TCRD may have a dividend sustainability issue going forward, despite cutting its distribution level last year.
Go to page 183 of the 10-K, and you’ll see Taxable Income dropped (39%) in 2016 to $29mn. That’s $0.88 a share of Taxable Income versus a revised distribution of $1.12.
Looking forward, TCRD has promised to reposition the portfolio into lower risk, lower yielding assets.
Well, the current (non Logan) average yield is 10.9%. Yet new deals are getting done at yields in the 9%-10% range.
We’ve run the numbers and if TCRD’s yield drops to 9.5% on its half a billion dollars of yield bearing assets, the loss of Net Investment Income Per Share is over $0.20 a year, because Investment Income will be reduced but management fees, interest expense and operating costs do not change as revenues drop.
At the end of the IVQ 2016 Net Investment Income Per Share was $0.28 (i.e. equal to the distribution), or $1.12 annualised.
Take $0.20 off that ($0.05 a quarter) and you see why we’re concerned. That’s before any potential further losses to income from those 10 Watch List names not already on non accrual.
As this chart shows, the market appears to share some of our doubts.
Since the March 9th earnings release, TCRD’s price is down over (8%).
By contrast, the UBS Exchange Traded Note with the ticker BDCS which we use as a measuring stick, is up in that same period.