BDC News Of The Day: May 8, 2017
The BDC Reporter awoke at the crack of dawn to a…power outage. This lasted till early evening Los Angeles time and has set back our Quixotic attempt not only to keep up with the breaking news in BDC-land, but report all the highlights and provide some commentary besides. Nonetheless, we’ve made great progress on the Monday May 8th press releases, filings and presentations, which encompass a wide variety of names, including Gladstone Investment (GAIN); Hercules Capital (HTGC), BlackRock Investment (BKCC), KCAP Financial (KCAP), New Mountain Finance (NMFC), Solar Capital (SLRC), Solar Senior Capital (SUNS), Fidus Investment (FDUS), Main Street Capital (MAIN), Horizon Technology Finance (HRZN) and Capital Southwest (CSWC). And we’ll be adding a few stragglers in a second edition…
Gladstone Investment (GAIN) made the not unexpected or unanticipated decision to parlay its recent sky high stock price (after years in the dumps) into a common stock offering. (Details to follow). The BDC Reporter cannot help noting that GAIN’s stock has not been at this level in nearly a decade. Investors lost confidence in the Gladstone Companies run BDC ability to successfully implement its debt and equity strategy in lower middle market companies back at the time of the Great Recession. Where a number of other BDCs (we’re offering up Main Street Capital and Triangle Capital’s long term price journey here as illustration) came roaring back into investors confidence once worries about the collapse of our entire financial system were out of the way, GAIN remained a question mark. At its 2014 peak, GAIN was at the same level as the same apex in 2011. In fact, the BDC only “broke out” over its 2011 high in August of last year, before recently reaching its new highs, boosted by a recent – but tiny – increase in its distribution. It’s a remarkable arc. The BDC Reporter is not yet convinced that GAIN will be able to sustain its performance (after all these are the Days Of Summer for lenders and investors in the lower middle market). When the credit cycle heads south, there are a large number of companies on GAIN’s books that we have a question mark about. A lot. However, investors obviously no longer have such doubts, judging by the stock price. That’s partly due to a series of Realized Gains at GAIN that have offset losses and the canny distribution policy deployed by David Gladstone throughout the fallow years. What’s hard to evaluate is how much GAIN’s 40% increase in price since its Great Recession low, and 20% since 2016, is due to the all-pervasive market optimism.
Capital Southwest (CSWC) announced a new loan to Wastewater Specialties.
Suddenly controversial Hercules Capital (HTGC) drew a Hold rating from Wunderlich Securities from Hold, according to Benzinga. For those BDC investors just back from the proverbial desert island, HTGC is in the news because its CEO is seeking shareholder approval to switch from being an internally managed BDC to an externally managed one. For the BDC Reporter’s two recent articles on this subject, click here and here. Everybody interested in HTGC -whether an existing shareholder or a new investor drawn by an (18%) drop in the stock price since the bold announcement by the BDC’s current and maybe future CEO – will have to decide for themselves if this is much ado about nothing (“Buy, buy, buy”) or at the very least a potential downward change in the technology BDC’s earnings. The BDC Reporter’s own words of wisdom are this: “A Pandora’s Box has been opened here by Mr Henriquez- the CEO of HTGC. Despite the supine nature of the BDC’s Board (which has waved the issue on to shareholders to decide) how this will play out is far from clear. This could yet go off in a number of directions. We wouldn’t “bet against the house”, or in other words we’ve seen the insiders at most BDCs get their way when push came to shoving. Nonetheless, there is no clear cut path forward and much could yet happen. Hard to believe that this cauldron of controversy might not affect HTGC’s business in the short run, but manager and shareholders are playing for big stakes so we expect a period of maximum distraction. If the CEO “wins” shareholders may lose, yet if the CEO “loses” shareholders don’t necessarily win. As Pandora found out, once you open that box pretty much anything can happen. We will be reporting, but we’re far from having a view as to what will happen next and how this might play out. Anybody who puts their money down at this stage, or just remains invested, is just guessing.
Fidus Investment (FDUS) published a Company Presentation slideshow. Nothing new in the 28 pages involved that existing shareholders would not know from recent earnings releases, Conference Calls and filings. However, for a prospective new investor interested in a Lower Middle Market BDC lender and equity investor with a successful formula to date, this might be a useful education. We mention this because the stock price- which had been flying high – took one of its traditional dives around the time of the IQ 2017 earnings release. From a YTD high of $18.06, FDUS is now at $16.76, a (7.2%) drop. That hardly makes FDUS inexpensive as the price is both above NAV and well above the level at the beginning of the year, and still yields but 9.3%. Nonetheless, there’s no harm in doing one’s homework in advance, and if the price should drop some more…
Main Street Capital Corporation (MAIN) has also published a Company Presentation, but with more of a focus on IQ 2017 results. Again, nothing new here for existing investors but a good overview for those outside looking in. Unfortunately for (relative) bargain seekers out there, MAIN has not pulled back from the all-time high price reached recently more than (2.7%), and is still just (1%) off its Everest-like high. New investors will have to swallow hard and accept a lower current yield than pretty much anywhere else in BDC-land before investing. Might be worth one read through that presentation.
Once again, Solar Capital (SLRC) and Solar Senior Capital (SUNS) reminded their shareholders to vote their shares for the May 17 shareholders meeting. This was not the first time, as the BDC Reporter noted back on May 2nd. We do recommend shareholders find the time to vote, whether for or against, because all the costs of getting these votes corralled inure to them, so it’s just money out of their own pockets, even if the outcome of the balloting is a foregone conclusion. (Both BDCs are doing well, so shareholders are likely to say yes to most anything asked of them). Somehow we don’t think HTGC will have to issue so many reminders for shareholders to vote when the time comes in a few weeks.
BlackRock Capital Investment (BKCC) reported the result of 3 votes put to shareholders in recent weeks. Even though BKCC’s performance of late has been something less than impressive, shareholders doffed their collective caps and agreed to allow the BDC to issue shares below Net Asset Value if deemed necessary. (Of course, with the consent of the Board). Adjusting for BlackRock owned shares, the proposal went through by a greater than 3:1 margin. Deloitte Touche were approved as the independent accountant by a landslide receiving 61mn shares. (We assume the 2mn shares that said nay are held by other accounting firms). Only the election of BKCC’s two Directors to the “staggered” Board did not receive the traditional shareholder standing ovation, with about a third of votes being “withheld”, but probably because of indifference rather than hostility. The BDC Reporter doubts BKCC will play this capital raising card under the current market conditions, but we continue to note that – in our view- shareholders continue to be part of the problem where BDC governance is concerned, and we understand how managers/insiders must get the impression – as Mr Henriquez appears to have sussed out – that “who dares , wins”.
KCAP Financial (KCAP) -which is internally managed (which many investors make much of) – also reported results from its annual shareholders meeting. Suffice to say – even though the BDC’s performance has been abysmal and its dividend repeatedly cut- everything the Board and senior managers suggested was approved. Less telling than the 5mn non-binding votes against management’s compensation plan (versus 7mn in favor) were the 20mn non-votes.
A Horizon Technology Finance (HRZN) Director bought a material number of shares (7,000) at $11.274, bringing his total ownership to 8,500 shares. From a YTD standpoint that was hardly at a bargain basement price. HRZN has been as low as $10.03, and has not exceeded $11.72.
Candidly, the BDC Reporter is not terribly concerned with a BDC’s quarterly earnings. There are so many variables that go into one period’s numbers that drawing any solid conclusions from a Net Investment Per Share of X or Net Income of Y is impossible, and possibly misleading. We like to remind investors when we’re being wise, and showing our age, that BDC earnings per share peaked in 2008 ,just before crashing in the Great Recession. Looking back, we realized that the BDCs were charging a spate of change and amendment fees to increasingly desperate borrowers; and re-pricing existing loan arrangements upwards (in the exactly opposite direction of just a few months before). That made earnings look very good but was actually a deadly harbinger of the trouble to come. Many BDCs went from having portfolios valued at or above cost to deeply in the red within a couple of quarters, or less. That’s when the defaults began to occur and earnings and BDC net book values dropped out of bed. Between BDCs highest earnings and lowest earnings was a period of only one year…
What’s more, BDC economics are not like a factory. There is no steady, automated, stamping out of widgets. A new loan can be delayed by a couple of days; or a big fee from an early pre-payment can occur out of the blue; or a threshold can be reached on an Incentive Fee or missed by a few dollars and an entire quarter’s results can change. Suddenly a BDC which was said to be “covering” its dividend with Net Investment Income could suddenly be in a deficit. Or vice versa. This can cause something resembling panic by both investors and analysts. You’ll see the breathless headlines : “So and So BDC misses by such and such Earnings Per Share”. No wonder BDC managers do their utmost to manage expectations and earnings in every quarter, with varying degrees of success.
This might account sometimes for the wide variability in the “quality” of the earnings. Many loans are made to companies which BDCs control and can set whatever interest rate they like -usually in non cash Pay-In-Kind form. Or earnings can swing because the value of the BDC’s debt are marked at fair market value. Just when income from loans might drop, that same BDC can book an unrealized drop in the value of its own borrowings, which is effectively income. Or, a number of new financing arrangements can be booked and with them a portion of the fees that might or might not be received seven years out when the debt is to be repaid. Or the discount rate used in valuing a CLO or a regular loan can be tweaked between one period and another which can change the impact on the quarter’s bottom line. Like icebergs, we only see a portion of what’s going on above the surface. There is so much that happens below – and which does not get memorialized in the filings. This is how the sausage is made, which the BDC Reporter accepts is the way of the world in public companies, but we do not take the results too seriously.
Instead, we regard the quarterly earnings reporting as more of an opportunity to confirm whether our view of the long term direction of a BDC continues to be valid. We look less at hard numbers, and more at “softer” issues like strategic direction; personnel changes; distribution policies and sometimes just the tone expressed on Conference Calls. Plus, we like to review changes in portfolio company values (part of a long and tedious quarterly exercise each BDC approaches differently) to get early warning signals of what’s happening to the private borrowers on the books about which publicly available information is scarce. Just looking at the trend in the valuation of an investment – regardless of the specific numbers – can speak volumes.
Rarely does one quarter’s results cause a drastic re-assessment in our BDC underwriting. In a long term business where loans are made with seven year maturities and which even the fast turning portfolios last at least three years, what happens over the course of 3 months rarely causes a U-turn, either positive or negative. This has become even more the case since we’ve begun-under the aegis of the BDC Credit Reporter- to investigate each BDC’s portfolio name-by-name and seek to learn in real time what’s happening to the under-performers, rather than wait around for the quarterly update. Of course, there are exceptions to every rule.
Most recently we were surprised by the proposed change from internal to external management at HTGC, as we’ve covered above. The arrival and sudden departure of Patrick Dalton as Fifth Street Finance and Fifth Street Senior Floating Rate did cause a re-think, but even then only a modest one. Most BDCs are on a long glide path which barely alters from quarter to quarter, and even from year to year.
Nonetheless, we know that quarterly earnings are important to many investors, as well as the analyst community which uses the opportunity to make amendments to its BDC recommendations. So we’ve reviewed the latest batch of earnings press releases (and where humanly possible read the quarterly filings) just in case there was anything unexpected to report:
New Mountain Finance (NMFC): Reported IQ 2017 Earnings.
NMFC recorded Investment Income, Net Investment Income, NAV Per Share and its distribution just as we would have expected.
Longer term NMFC has out-performed our expectations in regards to credit performance. NMFC is not unaware of its low credit loss history, as discussed in the latest earnings report:
The Company has had only seven portfolio companies, representing approximately $112 million of the cost of all investments made since inception in October 2008, or approximately 2.4% of $4.6 billion, go on non-accrual.
However, the press release suggests (before the BDC Credit Reporter takes its own independent view) there is a risk of a reversion to the mean going on, with the troubles at Sierra Hamilton and potentially beyond:
During the first quarter of 2017, the Company placed its entire first lien notes position in Sierra Hamilton LLC / Sierra Hamilton Finance, Inc. (“Sierra”) on non-accrual status due to its ongoing restructuring. As of March 31, 2017, the Company’s investment in Sierra placed on non-accrual status represented an aggregate cost basis of $27.2 million and an aggregate fair value of $16.5 million.
As of March 31, 2017, one portfolio company had an investment rating of “3” [performing below expectations], with a total cost basis of approximately $36.7 million and a fair value of approximately $26.9 million.
As of March 31, 2017, three portfolio companies (including Sierra referenced above) had an investment rating of “4” [performing below expectations and some kind of loss anticipated]. As of March 31, 2017, the Company’s investments in these portfolio companies had an aggregate cost basis of approximately $58.5 million and an aggregate fair value of approximately $20.5 million.
Given NMFC’s fully leveraged status most of the time, and the tight relationship between distribution and Net Investment Income Per Share (identical) even one or two losses could result in lower NAV and a lower distribution, as we have been anticipating at some point. Nothing dramatic is likely to happen and NMFC might dodge the bullet awhile longer, but the BDC Reporter still anticipates a step down.
We will update the Daily News with the earnings of Capitala Finance (CPTA), PennantPark Investment (PNNT) and TICC Capital (TICC) in a later edition. We can say in advance that none of the 3 BDCs deviated materially from what we would have expected.