BDC News Of The Day: April 19, 2017
Here are the main news items and SEC filings from all the publicly traded BDCs that the BDC Reporter tracks for Wednesday April 19, 2017 at 11:30 a.m 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. Just two items today, so we’ve been able to discuss Fidus Investment’s (FDUS) possible debt or equity capital raise and Horizon Technology Finance’s (HRZN) upcoming earnings release -and the risk of a sudden drop in the stock price- in some detail.
Fidus Investment Corporation (FDUS): Filed Form N-2 Registration Statement
Lower middle market oriented FDUS filed a preliminary prospectus to raise up to $300mn in new capital, whether in common stock or in debt. As the document reminds readers right at the top, FDUS has been granted by its indulgent shareholders the right to issue new shares at a price below Net Asset Value. However, that controversial issue will remain academic as FDUS is trading well above its NAV of $15.76: more than $2 a share higher. In any case, the BDC may also be considering a Baby Bond offering or a Convertible (both popular forms of capital raising by BDCs in recent weeks). With an average yield of 13% on income producing investments, FDUS could make the case that medium term debt at 5%-7% is accretive to shareholders. We would suppose, though, that an additional SBIC license and an increase in SBA debentures at rates south of 4.0% over 10 years remains the favorite capital source for FDUS, which already had $225mn outstanding of the debt under two licenses with an aggregate borrowing capacity of $275mn, and is applying for a third license.
Complicating the subject is that the BDC’s first SBIC license is reaching a stage where debentures made 10 years ago will shortly be coming up to their repayment date -in bullet form – starting in 2018. The Investment Advisor is trying to get ahead of the issue by pre-paying a portion of the $36mn in debentures coming due in 2018. (Another $30mn comes up in 2019). Back in February FDUS repaid $25mn to the SBIC due in March 2018.
The BDC Reporter is guessing – based on comments made by the FDUS CEO on the latest Conference Call – that the BDC has a complex liquidity challenge where its SBIC debt capital is concerned. On the one hand, FDUS still has $51mn of debentures to draw from its second SBIC subsidiary. At the same time, $66mn has to be repaid between now and the end of 2019 as detailed above, which has already begun. The BDC cannot access the honey pot of a third SBIC license until the second license has been essentially fully used up, leaving uncertain the timing of $75mn theoretically accessible. The SBA is very busy managing dozens (hundreds ?) of SBIC licenses of various types, and has rules in place about when a new license can be applied for and has no obligation to say yes or to approve or disapprove anything to a pre-determined timetable. FDUS may not be granted a third license, or funds may not be tapped for eighteen months or more. Even then, the first license will continue in wind down mode for many years, requiring large amounts of capital to be repaid to the SBA/SBIC.
From what we can determine looking in from the outside is that FDUS needs to play defense against the possibility that its long term SBIC debt capital may, on a net basis, shrink in the years ahead, rather than increase to fund a growing portfolio that has been boosted by two equity raises in the last year alone. Of course, the BDC has access to a Revolver if funds are needed, but that’s not a good way to match assets and liabilities. Furthermore, the ING-led Revolver is only $50mn in total size and subject to a borrowing base calculation. It’s unclear from the filings how much FDUS could even draw under the Revolver (so many assets are pledged to the SBIC). Other drawbacks: the financing is not cheap (LIBOR + 3.5%). The all-in yield is around 4.5%. Add in undrawn line fees and the arranging costs and this debt, if drawn, might cost the BDC over 5% a year. Finally, the Revolver is currently due in 2018.
The Company could continue to raise equity capital – by issuing more common stock- to fund its debenture repayments and continue its growth, but that would shrink earnings and distributions per share if the arbitrage available from also borrowing debt capital on favorable terms goes away.
Which leads the BDC Reporter to believe FDUS will be issuing either Unsecured Notes or a Convertible Note under the Registration Statement. That would provide the net new debt capital needed for the years ahead. We’re guessing proceeds would be used to prepay the 2018 and 2019 SBIC debentures due, which would not hurt the BDC’s P&L too much as the interest rate on those tranches are still on the high side. That would give FDUS the breathing room necessary to gain clarity about a third SBIC license, and see how the financing landscape might develop under the new Administration.
Of course, we could be wrong and FDUS could raise new equity again, which adds to Net Asset Value Per Share. Or the BDC could do nothing. We shall see before long.
Horizon Technology Finance (HRZN): Announced IQ 2017 Earnings Release.
The technology-oriented BDC announced earnings would be released before the close on May 2, 2017.
The BDC Reporter points out that existing shareholders in HRZN may want to stay well tuned to the reported performance in May. Unfortunately, the BDC has not yet made a convincing case since coming public that it’s business model can generate an appropriate return on equity for shareholders. There have been management challenges; a failure to receive an SBIC license and the low cost, dependable terms that go along (see FDUS above); a high cost of debt capital and – most of all – a series of credit set-backs. Recently the distribution was cut-again. Since joining the ranks of public BDCs in 2010, the pay-0ut has been cut by one-third from its height in 2012 when the quarterly distribution was $0.45. Today, HRZN pays a monthly dividend of a dime a share.
Moreover, the market has shown a propensity to punish the share price when disappointed. As this two year chart shows, HRZN has sharply dropped on 3 occasions in the past 24 months when shareholders threw up their hands and headed for the exits. In the most recent episode, HRZN’s stock price dropped by 28% after the BDC reported IIIQ 2016 earnings, and a big drop in Net Asset Value and several non-performing loans. A less dramatic drop occurred after the IVQ 2016 results, but there was no major drop in NAV or in the performance to rile investors. Of course, in the current bull market, HRZN’s stock price has moved up in the weeks since the last earnings release to $11.66, barely below its latest NAV of $12.09 and paying a yield a hair over 10.0%. As the chart also shows, HRZN is trading at roughly the same price as two years ago despite a (13%) drop in the distribution and a (16%) drop in NAV.
Unfortunately -as we reported on April 13 – HRZN has given us no clues as to its credit quality in its recent IQ 2017 portfolio update. By reading the press release and doing some simple math we’ve worked out that total portfolio assets have dropped on a net basis as repayments have outstripped new advances. That might boost earnings in the quarter as several companies will be paying prepayment fees and HRZN will be able to accelerate so-called End Of Term fees. The latter are a specialty of venture-lenders (and something the BDC Reporter is not enamored of. Instead of charging Pay-In-Kind on its loans, technology lenders often assess borrowers a fee to be repaid at the time of the repayment of the advance. The part we don’t like is that this fee -which may not be collected if something happens to the borrower along the way -is counted into income through the nominal life of the loan, even though there’s no cash associated with the income until the final day of reckoning. This boosts the BDC’s reported Investment Income, Investment Advisor fees and shareholder Taxable Income, but with non-cash items). Anyway, when loans gets repaid early any as yet unrecognized End Of Term fees will get recognized in the period, boosting earnings. So we may see an improvement in Investment Income in the IQ 2017 (plus a $1mn Realized Gain from a warrant sale).
What investors don’t know as yet is whether there has been any further deterioration amongst HRZN’s 44 different borrowers, 10 of which are on the Company’s own Watch List, including several on non-accrual. Together these Watch List names have a value equal to 10% of the BDC’s equity, and are major contributors to earnings and the distribution. The market-given the price movement- appears to be optimistic that HRZN’s credit problems are in the rear view mirror. We have no opinion on that score (this is a very difficult portfolio to evaluate for the BDC Credit Reporter) but we’d point out that investors have not been infallible in this regard judging from the two year chart that we showed you above. The BDC Reporter would posit that whatever is happening to the loans in the portfolio will prove to be much more important for HRZN and its shareholders than how IQ 2017 earnings turn out.