BDC Daily News: April 18, 2017
Here are the main news items and SEC filings from all the publicly traded BDCs that the BDC Reporter tracks for Tuesday April 18 2017 at 10:30 am EST. External links to articles or filings are in blue, internal links to BDC Reporter’s prior posts on the subject are in red. Where appropriate, we add comments. Only 3 items again today. We provide a follow-up on yesterday’s story about Hercules Capital (HTGC) and its troubled investment in solar panel installer Sungevity. Stellus Capital (SCM) announces both earnings date and latest distributions. We discuss what we’ll be looking for in the IQ results. Finally, we comment briefly about an insider “purchase” at Main Street Capital (MAIN), and raise the subject you should never lead with at a cocktail party: “So, how much money do you make ?”.
Hercules Capital (HTGC): Barron’s Blog.
Shortly after HTGC published the quarterly press release regarding its IQ 2017 loan originations, which we highlighted in yesterday’s BDC News Of The Day , Barron’s Blog – a periodic commentator on BDC issues – weighed in. As journalists will do, Barron’s asked investment banking firm Keefe Bruyette & Woods (KBW) for their take. Analyst Ryan Lynch said this:
“Overall, the origination activity was better than our expectations, but strong prepayments will limit net portfolio growth. Prepayments typically carry prepayment fees, which could give a boost to 1Q17 earnings. One negative is that a company in the portfolio — solar installer Sungevity — declared bankruptcy in the first quarter. Lynch estimates it is 3.1% of HTGC’s portfolio. He writes: While it is difficult to forecast the exact impact to HTGC’s investment, we expect Sungevity will be written down in 1Q17 given the low winning bid price. HTGC had $60 million (par) of debt investments in Sungevity with a $45 million fair value, but there is additional debt outstanding at Sungevity, although it is unclear how much debt and where it is located in the capital structure relative to HTGC’s senior secured loan. Lynch rates Hercules “Outperform” and has a $17 price target”.
The BDC Reporter has no view on the Outperform or on the $17 price target because we don’t understand how to use them, but both suggest KBW has its thumbs up for HTGC. We do agree that Sungevity will be written down in IQ 2017 because, in the interim, the troubled solar installer has announced that the bankruptcy court has approved the sale of the company for $50mn to Northern Pacific and….HTGC. The two groups will forgive debt in return for a controlling equity stake in Sungevity. Northern Pacific was the “stalking horse buyer ” for Sungevity in Chapter 11 from the outset. As so often happens in these situations where there already is a willing buyer with an existing loan interest in a busted company, Northern Pacific and HTGC ended up being the only potential buyers out of bankruptcy. A planned auction was canceled as a result.
We’d like to tell you we know the entire picture, but we don’t as yet. A press release says Sungevity had $146mn in debt, and $26mn in tax and unsecured trade debt. Given that HTGC had invested $68mn before Sungevity collapsed, it’s clear the BDC was a major creditor. However, we don’t know how the new capital structure will look like, but expect most of the debt to convert to equity; some amount of new capital to be injected to repay a nominal amount needed trade creditors and pay for costs, and second lien lenders to be wiped out. (Apparently MMA Energy Capital LLC,which stepped up with $10 million in second-lien loans in the fall of 2016, may lose its investment, says Dow Jones Newswire).
Don’t get too excited about that $50mn bid either. The amount includes a $20mn Debtor In Possession loan made last month after entering Chapter 11 – advanced by Northern Pacific and HTGC – to keep the business operating.
We expect a hefty initial write-down in how HTGC accounts for Sungevity’s value. After all, just three months ago when the company was negotiating a reverse merger, the stated value was $350mn. The latest price paid, netting out the DIP loan (much of which will go to transaction expenses because chapter 11 is a very expensive process) is only a tenth of the prior (admittedly never consummated valuation). We’re not encouraged either by the absence of any other bidders for Sungevity or other information we’ve read about the flawed business model which was being followed and led to this sad state of affairs. The only reason the BDC Reporter – or the BDC Credit Reporter which specializes in such things – does not want to stick its digital neck out and project HTGC’s likely dollar write-down in the IIQ of 2017 when the new portfolio values will be released is that BDCs have wide latitude in deciding how to book these restructured deals.
What is clear, though, is that HTGC will be losing an above average level of investment income in the short run. Before we even consider the DIP monies, HTGC had $60,000,000 in senior loans to Sungevity before the bankruptcy, priced at Prime + 370, with a 6.95% “Floor”. Yes, we did say a 6.95% Floor, but a few quarters earlier the Floor was 3.25%, suggesting an all -in cost closer to 7.0% being forgone. If all that gets converted to equity that’s $4.2mn of investment income that won’t be coming back.
Frankly, from the outside looking in, Sungevity may be a prime case of what the BDC Reporter has recently begun droning on about : lender portfolio companies becoming akin to cans kicked down the proverbial road. Like with Greece, though, the unfortunate aspect is that new monies often have to be advanced to give troubled companies a second chance at life. Here it’s likely that HTGC’s total exposure is now $10mn or more greater than the $68mn already reflected on the December 31, 2017 balance sheet at cost. The BDC Credit Reporter will continue to monitor the investment, but an eventual complete write-off is not impossible if this bold gambit by HTGC and Northern Pacific does not pay off. We’ve read relatively extensively about the competitive landscape in the solar installation industry and about Sungevity’s business model and attempts to differentiate itself. Moreover, there are hundreds of unfinished projects on the books with disgruntled homeowners to work through, but a greatly diminished work force after the lay-off of over 360 employees in recent weeks. Without being unnecessarily gloomy, we have to ask if Sungevity can -like Humpty Dumpty- be “put together again” ?
P.S. : According to Advantage Data’s records Apollo Investment (AINV), which is often in the wrong place at the wrong time from a credit standpoint these days, is the only other BDC with exposure to Sungevity. The BDC has invested $4.4mn at cost in the company’s Preferred. “Curiouser and curiouser” as Alice might say, AINV had valued the Preferred at par at year end 2016, while HTGC had fully written down its own share of the security. Maybe this is just a classification issue and AINV’s investment has some special status, or the valuation was made when Sungevity was still hoping for a reverse merger and a value ten times greater than today’s ?
Stellus Capital (SCM): Announced IQ 2017 Earnings Release Date.
SCM announced earnings would be released on Thursday May 4th, after the market close. The BDC has become an investor favorite in recent months, and raised equity in a secondary stock offering two weeks ago at $14.10 a share. Its current price is within cents of the secondary. The BDC also announced an unchanged monthly distribution of $0.1133 for the three months of the IIQ 2017.
The BDC Credit Reporter opined last quarter about the sustainability of SCM’s distribution in an article on January 18th. At the time we were sanguine that the SCM pay-out was “sustainable”. Even then, we predicted that an equity offering might soon be in the cards, and were proven right. We returned to the subject back on February 21, 2017, laying out the reasons why SCM was likely to successfully tap the equity markets. (We are rarely so prescient about these capital market moves, so please allow us this brief self-reference). Nonetheless, SCM has requested its shareholders approve the ability to issue additional stock at below Net Asset Value in the year ahead in its recent Proxy, which the BDC Reporter continues to believe is an unnecessary “blank cheque”, but one which is unlikely to be cashed given i) capital just raised; ii) BDC prices still high ; iii) fewer good value opportunities out there; iv) Investment Advisor’s history has been relatively disciplined about such things.
On May 4th, the BDC Reporter’s principal focus will be on the quality of the investment portfolio. Through the end of 2016 SCM’s credit performance had been above average, with the exception of the now ended saga of the Binder & Binder investment, bankruptcy and re-emergence. That was an unmitigated disaster with SCM writing off about ($13mn) last year, and is left with a $1mn “residual claim” for costs, as spelled out in the IVQ 2016 earnings press release. Of course, if you’re a lender – and all BDCs are – there are going to be occasional disasters. At year end 2016 – as we’ve said before – the rest of the portfolio seemed in pretty good shape except for a handful of names, and no apparent blow-ups on the way.
However, SCM’s risk profile is relatively high, with two-thirds of investments in unsecured debt or in equity, and an average debt yield of 11.0%. Non investment grade company lending is, by the very term, never safe but the “less risky” part of the spectrum is currently pricing loans at yields below 6.0% in some cases and certainly under 8.0%. As a result, borrowers willing to pay 11.0% are clearly riskier and-as Binder & Binder showed- capable of losing all a lender’s capital. Thus, vigilance is always warranted. Based on valuation trends, though, there are very few names popping up on even the top part of the BDC Credit Reporter’s Watch List. (Glori Energy has been restructured and Securus Technologies has been sold off, which we applaud). We have questions about Grupo Hima San Pablo and Hostway Corporation. In the past we’ve had a skeptical look at Skopos Financial, to which SCM has $20mn in advances, but that’s not even on our Watch List. We are left to worry that SCM has nearly half of all its assets in 4 industry segments, including Financials and Healthcare, both of which we’re monitoring more carefully than usual. Moreover, the Company does occasionally take bigger individual positions than we’d like to see. At year end 2016, there were 3 investments which each accounted for more around 10% or more of SCM’s equity capital at fair value.
Main Street Capital (MAIN): Issued Form 4: Statement Of Changes In Beneficial Ownership Of Securities.
Routine share purchases were recorded for an EVP at MAIN, for a very small number of shares : 1.788 and 23.468. The purchases were made under the internally managed BDC’s dividend re-investment plan and deferred compensation plan. What may be more notable is the balance of shares this executive has accumulated, presumably from the drip drip effect of these compensation related programs: 163,872 shares. That’s a market value of over $6mn. Shareholders will have to decide for themselves if these generous stock compensation programs at internally-managed BDCs, which barely show up on most investors radars compared to the Management and Incentive Fees charged very publicly by External BDC Managers- are a Good Thing or otherwise. Glass half full observers might say that the stock ownership -even if granted rather than purchased- aligns managers interests with shareholders. (That’s certainly what MAIN would say, and the other half dozen internally-managed BDCs). A glass half empty observer might worry about the dilution in their earnings from these compensation plans. The size of the pay-out pie does not change, but the number of slices gets increased.
We know long term shareholders in MAIN have done very well for themselves over the years, so we’re pretty sure what most of them would say if asked about this subject. The BDC Reporter -which prides itself on having a niggling observation to make about just everything – does not begrudge MAIN’s managers their stock compensation, nor even the independent Directors (but that is another issue worth looking at). We would only wish there was a more open debate and discussion about the subject, but that’s a difficult subject – in the same league as religion and politics – for shareholders and managers to discuss. Shame.