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TICC Capital: Receives Exemptive Relief

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On June 15, 2017 TICC Capital (TICC) announced, in a press release, the receipt of “exemptive relief” from the Securities And Exchange Commission regarding co-investments with affiliates. Details and commentary follow:

FOLLOWING THE CROWD

Like most every other BDC out there with an external asset manager, TICC requested and was approved to co-invest with other funds managed by its Investment Advisor. Historically, the 1940 Act – concerned with concentration risk and conflicts of interest – has forbidden these co-investments unless a specific waiver has been received. Over the last few years most every asset manager which also “advises” a BDC has requested that waiver, and almost always been given the green light. This is said, as TICC’s press release did, to provide the BDC’s shareholders  “a broader range of investment opportunities”.

IMPORTANT

We can hear the few readers who will bother even opening this article already yawning and wondering what else to read. Nonetheless, this is an important subject, and worth tuning in to if you’re a long term investor in the sector and/or in TICC, which we’ll discuss specifically below after we review the issue at a 36,000 feet level:

CRITICAL

In fact, the “exemptive relief” is a key factor in many BDCs – and their asset managers – entire business strategies. Without being able to co-invest with sister funds  Golub Capital (which managed GBDC) and  FS Investments (which manage FSIC, but also FSIC II, FSIC III and FS Energy & Power) and Fifth Street Finance (FSC and FSFR and other funds), Medley Management (MCC and non-traded Sierra Income and private funds) would be up a creek without a paddle. These groups would not have the firepower to underwrite the larger transactions if not for the exemptive relief, and the BDCs involved would either lose out on the opportunity or be forced to take a much bigger stake than might otherwise be prudent to lock up the deal. Viz. the “broader range of opportunities”.

FOR GOOD

Some asset managers have used the exemptive relief and the availability of several investment pockets in which to slip in investment exposure to create a highly diversified portfolio for their BDC, keeping a sliver of much bigger amounts booked in each transaction. GBDC has done a very good job of using exemptive relief AND a vast origination network which is booking hundreds of deals a year to create what we like to call a “granular” investment portfolio, as we’ve discussed in the past.

FS Investments, and its investment advisor GSO Blackstone, have used the exemptive relief to band several of its public and non-traded BDCs together to control entire loan tranches and allow for a very strong negotiating position if and when there are disputes with the borrower or other stakeholders. That proved a boon in the last few years as FS Investment and GSO Blackstone sought to extricate themselves or restructure a host of busted energy investments, and are using their heft as we write this to restructure (along with Apollo Global – a long time master of this technique) Mood Media.

YING AND YANG. NOW TO YANG.

However, in the case of exemptive relief, there are downsides as well as benefits:

GOOSE AND GANDER

The main downside is the Inappropriate Investment risk.  An asset manager might be tempted to take down a larger investment with multiple funds, but the risk-return or investment profile of the transaction may not be what the shareholders of the BDC placed into a portion thought they were signing up for. The BDC may have been “sold” to its investors as being focused on opportunities in the lower middle market, but their share of the deal might be in a much larger borrower. Or, the credit risk involved might be within the parameters of one of the funds under the asset manager’s jurisdiction but would typically exceed the risk tolerance of the other, but would get booked and shared anyway. Or, the transaction might be very favorable for any number of reasons for the asset manager (enhancing their reputation or getting another fund launched or any number of hard to define in advance benefits) but not be “right” for the BDC that is involved. In all these cases you can imagine there is a real risk the investments are going to go ahead any way given the control afforded the asset manager in these situations.

FAIR ?

Another issue which exemptive relief does not cover is compensation fairness. Obviously there’s far less work involved in booking 10 transactions of $10mn each than one $100mn investment. Yet, all the asset manager’s funds – including the BDC – pay their normal Management Fee as if the transaction had been originated for them alone. The BDC Reporter has inveighed against this practice for years, but the number of transactions involved only increases and the quiet benefit to the asset managers too.  Yet several  BDCS in the past have agreed to receive lower Management Fees on syndicated loan transactions as opposed to self-originated deals.

We boldly ask why a BDC receiving a sliver of a much larger deal (and sometimes less than shareholders – if they were aware – might have desired in order to satisfy all the funds involved) should pay full freight ?  These exemptive reliefs are in-house loan syndications and BDC shareholders should receive some compensation cost relief from their Investment Advisor.

CLEAR EYED

We are well aware that BDC and other regulations require the Board to monitor and decide whether these transactions are appropriate for its public shareholders. However, we all have to be realistic and recognize that there is very little evidence that BDC Boards – like many Boards in every public company – do anything more than nod through most every “conflicted” transaction. If anything, BDC Boards are hand picked by the very Investment Advisor that they are supposed to regulate and have a very poor track record – as the BDC Reporter has been bleating about for years – in just Saying No.  BDC shareholders cannot expect much in the way of protection from Inappropriate Transactions from that source. Nor has there be any instance, to our knowledge,  of any Board seeking to negotiate better terms for its shareholders from the Investment Advisor for essentially using the BDC as a syndicate partner in a larger deal spread between multiple funds. (When we were younger and in the biz, we used to call these syndicate members the “stuffees”, which gives you a sense of the position the BDCs are  in this Brave New World where they are just one fund amongst several).

MIXED

So the BDC Reporter has mixed feelings about the SEC’s constant waivers of one of the key protections of the 1940 Act.  As is often the case the asset managers – with the SEC’s approval – have ripped open a material change in one of the key regulations protecting shareholders ( look also at how BDCs evade leverage and asset diversification rules). However, whether that change will be positive or negative for a particular BDC and its shareholders will vary, depending on the actions of the asset manager/ Investment Advisor involved. Some BDC asset managers may (or already have) use the exemptive relief to go that bridge too far. Others will be circumspect. All, though, will keep 100% of the financial benefits for themselves.

HARD TO TRY AT HOME OR EVEN IN THE OFFICE

Shareholders who want to determine if an asset management organization is pushing the envelope or not with Inappropriate Investments will find it very difficult to assess. Much of the information needed is not available. You may know GBDC has invested $10mn in  XYZ Company, but do you know the size of the entire deal ?  When Ares Capital (ARCC) invests in long term power generation investments that happens to be  an area of specialization of Ares Management is that within the ambit of the BDC or just a useful pocket ?  When FSIC gets banded together with its sister funds for yet another energy deal because the group owns FS Energy & Power is that the appropriate use of shareholder capital or just helpful to the asset manager seeking to control a block of debt ?  When PennantPark Investment and Pennant Park Floating “happen” to invest in the same company, even if their credit profiles are about as far apart as you can imagine, is that because there was some area of overlap, or was that just for the convenience of the Investment Advisor ? Ditto at a host of loans at FSC and FSFR ?

WORTH DOING

We don’t know the answers and the research will be difficult but the BDC Credit Reporter – a future subscription service of the BDC Reporter- is going to try.  Thanks to our relationship with Advantage Data we can quickly review which public and private BDCs have a shared interest in portfolio companies and use the public record to gather additional data. Look for the occasional “deep-dive” into this web of relationships.  Shareholders of the BDCs involved may not have the protection of the 1940 Act, nor the unqualified oversight of their Board Of Directors but the BDC Reporter may – at least – be able to provide some independent analysis of what is happening behind the scenes, and allow you to decide – BDC by BDC – whether the SEC’s exemptive relief is a Good Thing or something else.

BACK TO TICC

In this case, TICC will have the opportunity to invest with its sister public vehicle which invests solely in Collateralised Loan Obligations, Oxford Lane Capital (OXLC) and its private fund Oxford Bridge.  Here is the text of their press release issued on the same day as TICC’s.

Oxford Lane Capital Corp. (NASDAQ: OXLC) (NASDAQ: OXLCO) (NASDAQ: OXLCN) (“OXLC” or the “Company”) announced today that on June 14, 2017, the Securities and Exchange Commission issued an order permitting OXLC and certain of its affiliates, including TICC Capital Corp. (NASDAQ: TICC) and Oxford Bridge, LLC, (collectively, the “Companies”) to complete negotiated co-investment transactions in portfolio companies, subject to certain conditions (the “Order”). Subject to satisfaction of certain conditions to the Order, the Companies are now permitted, together with any future business development companies, registered closed-end funds and certain private funds, each of whose investment adviser is OXLC’s investment adviser or an investment adviser controlling, controlled by, or under common control with OXLC’s investment adviser, to co-invest in negotiated investment opportunities where doing so would otherwise be prohibited under the Investment Company Act of 1940, as amended, providing OXLC’s shareholders with access to a broader array of investment opportunities.

About Oxford Lane Capital Corp.

Oxford Lane Capital Corp. is a publicly-traded registered closed-end management investment company. It currently seeks to achieve its investment objective of maximizing total return by investing in securitization vehicles which, in turn, primarily invest in senior secured loans made to companies whose debt is unrated or is rated below investment grade.

BIGGER CLO BITES

The upshot for TICC shareholders is probably more joint and bigger purchases of CLO equity and debt investments by the group in both the secondary and primary market. (Given the CLO focus we don’t expect any joint investments in the higher yield loans which comprise the bulk of the BDC’s portfolio in dollar terms, if not in income).  TICC’s managers will probably argue that the potential control of a CLO’s equity by having several of its funds band together will make a difference as to when the vehicle gets called, or not. Prospect Capital (PSEC), which has its own group buying underway in CLOs  – has argued for years that it’s majority control of junior CLO tranches provides a distinct benefit and justifies a higher valuation than would otherwise be the case. Watch this space to see if the TICC asset manager makes a similar argument. What other plans the Investment Advisor to TICC  may have  – including potentially issuing its own CLOs – are not known, but may change with the exemptive relief.

MORE OF THE SAME

Investors who are both in TICC and OXLC will have to keep track of how similar the two portfolios might become over time, which might matter to investors seeking diversification.   We would guess there will be much overlap between TICC’s considerable CLO holdings and that of OXLC, which we’ll also seek to monitor. The universe of potential investments is relatively small so OXLC and TICC – at least where CLOs are concerned – might increasingly – like owners and their pets – begin to look alike.

SUMMARY

  • TICC and its sister entities have received “exemptive relief” from the SEC to band together to invest, probably only in CLOs.
  • This is part of a bigger trend amongst asset managers which control BDCs to seek the waiver of a key 1940 shareholder protection in order to allow a broader range of investing opportunities.
  • In fact, there are benefits to BDC shareholders from exemptive relief but there are also risks, and no improvement in the compensation costs despite the economy of scale benefits inuring to the asset managers.
  • The BDC Reporter will seek to analyze and discuss specific risks and opportunities relating to exemptive relief  in the future by having the BDC Credit Reporter delve into portfolio details.
  • TICC may benefit from group control of CLO equity tranches but also may see its portfolio increasingly mirror those of its sister funds.
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