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BDC News Coming Up: Three Stories To Watch

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The BDC Reporter spends much of its time tracking every material development at all 46 publicly-traded Business Development Companies (“BDCs”) in our BDC News Of The Day feature. Typically, we’re covering two or more stories per day of interest to investors, and which are important enough to move the BDCs stock price in the short or medium term. In this article, though, we’re going to look forward and project out what might be some of the bigger news item coming down the pike in the month ahead, and which both the BDC Reporter and investors should be looking out for:

FIFTH STREET ASSET MANAGEMENT/FIFTH STREET FINANCE/FIFTH STREET SENIOR FLOATING

Since the Wall Street Journal reported on June 29, 2017 that Fifth Street Asset Management (FSAM) was in advanced stages of negotiation to sell out to Oaktree Capital (“OAK”), investors in the asset manager have been waiting for confirmation. So have shareholders in Fifth Street (FSC) and Fifth Street Senior Floating (FSFR), the two public BDCs which FSAM serves as the Investment Advisor of,  and who will presumably be much affected by a change in management. In fact, the stock prices of all 3 entities jumped on the news. Investors in FSC and FSFR foresaw that Oaktree might be a much better Investment Advisor than FSAM and the uncertainty that has swirled around for months – and which has brought the stock prices sharply down prior to the WSJ news – would be removed. FSAM on June 30 confirmed negotiations were underway with a third party, but gave no further details and did not mention Oaktree – or any potential buyer- by name. Since then there has been no news on FSAM and Oaktree. The only development – and a material one – was the sale by FSAM of its CLO management subsidiary, and its CLO investment therein to Newstar Financial (NEWS).

However, investors will be eagerly awaiting confirmation that the Oaktree transaction will be proceeding.  Chances are if the news is that the acquisition is going ahead, we may see an immediate double digit increase in the stock price of FSAM. On June 29, on the first report, FSAM increased to $5.21 but the price has since fallen back to $4.55 as the absence of any update has made investors jumpy. Just going back to $5.21 would be a 14% increase.  Likewise FSC jumped to $5.01, but has slipped back to $4.79. A return to a fiver would be a 4% increase. Only FSFR is marching to its own drummer. The stock price did jump initially: to $8.01 from $7.47, but has remained undeterred by the absence of any update about its Investment Advisor’s fate.

However, investors will need to do more than just be informed that Oaktree has finally consummated the deal. Another coming news factor that will be a major determinant to the price at FSC and FSFR will be whatever the eventual press release and filing says about the terms of the proposed Investment Advisory agreement between the two BDCs and their self chosen new manager. Will Oaktree just be stepping into FSAM’s shoes and match its current terms, or will better or worse compensation pricing be in the offing ? Moreover, the proposed timing of the take-over – if there is one – will also be important.  Both BDCs have been in limbo for months. If another several months are likely to pass before Oaktree gets to step in and save the day (which is the perspective of many existing shareholders), there is a risk credit quality and earnings quality will deteriorate further, which will reflect in the market price. There are other variables besides in the news that might be coming, including if anything is said about merging the two BDCs (which will cause all the analysts to reach for their calculators) and whether the new Investment Advisor will be changing strategies and what that might look like.

A left field possibility that might change all the best laid plans of FSAM and Oaktree is if some other would-be Investment Advisor offers up their services to the currently completely ignored shareholders of FSC and FSFR instead of Oaktree. The mammoth public asset manager is not known as a low cost provider and another firm may offer shareholders a much more generous set of terms than the clubby deal presumably being agreed between a desperate FSAM and its suitor, known for driving a hard bargain. TICC Management sought to undertake a similar hand off of its investment advisory contract to Benefit Street Partners, only to draw competing offers from two different other mega-managers. That ended badly for the two wanna-be Investment Advisors, but it was a close run thing. Maybe some other firm is preparing a competing offer to whatever Oaktree might be about to reveal. In any case – and providing that slight tinge of uncertainty even if nobody steps up to counter Oaktree – shareholders will almost certainly be asked to bless whatever deal is agreed between FSAM and Oaktree.

The other news that might come out in the days ahead that would up end the stock price and valuations of all 3 Fifth Street organizations is no news at all. Or, in other words, if the acquisition falls through. “Impossible”, “unlikely” we’ve heard the pundits say, but the fact is nobody outside the protagonists and their advisors knows for sure, and ten days have passed since the transaction was first leaked.  If the deal falls apart and Oaktree walks, or is walked away from, investors will have to mark all 3 entities down accordingly and ascertain what the next likely step by FSAM might be. That won’t be an easy task whatever is said in a press release, and with so many moving parts, investors could head in a variety of potential directions, most of which (excepting maybe fund liquidation) would be negative.

So from the next few hours (for all we know a press release is being crafted as we write this) to the next few weeks, every news development about the Oaktree transaction (including there being no development) will be moving 3 public companies share prices (and we’re not even counting OAK). The BDC Reporter – and our readers interested in the subject – will need to parse every press release and filing very carefully. This is likely to be a “developing news story” as the nightly TV news says, and will need to be monitored closely just to have some sense of what the likely final economics will be for all three Fifth Street companies.

Full Disclosure: We are Long FSFR and FSC’s Baby Bond (FSCE)

MEDALLION FINANCIAL

The stock price of the once leading taxi financier Medallion Financial (MFIN) is also at risk of being swung one way or another by what happens in a Conference Room in NYC in the 5 weeks ahead when that news gets reported.   Last Friday July 7, 2017 MFIN filed an 8-K announcing that its multi-week renegotiation of its Credit Agreement with its lenders, led by DZ Bank, was still unresolved. All the parties agreed to extend the Revolver for a further period: to July 15, 2017. Obviously – as anyone who’s followed the implosion in taxi medallion values caused by competition from Uber, Lyft and other players – MFIN is tackling a great number of troubled loans to the individuals and companies who bought and financed taxi medallions in NYC, Chicago and Boston. The drop in medallion collateral value and the percentage of borrowers already in severe trouble is as great as any that have been seen in any industry segment since the Recession. In Manhattan, medallion values have dropped by as much as 80%. Worse, there are no buyers given the uncertainties involved and a slew of financially stressed borrowers facing Chapter 7 or Chapter 11.

At the same time, none of the parties involved benefit from taking any drastic action. Which is probably why MFIN’s management has been slow to strong arm distressed medallion borrowers, and DZ Bank and MFIN’s own bank regulators (which is stuffed with medallion-secured loans) have not lowered the hammer either. Someone has to help the taxi medallion financing industry dig itself out from under, which has kept MFIN’s own debt agreements being called, by the BDC Reporter’s estimate. (Put yourself in DZ Bank’s shoes. Should the German lender foreclose on the long list of medallion loans which secure their advance to MFIN and seek to directly force repayment from potentially many dozen underlying borrowers, many of them immigrants with limited means, spread over 3 cities ? Ditto where the SBIC is concerned – which is also renegotiating with MFIN as well as the Utah bank regulators looking over the books of Medallion Bank). So far it’s been a case of Stay Calm And Carry On, but will that continue ?

The key unanswered business question is whether the whole revaluation process for taxi medallions  has reached a nadir and the parties involved can adjust to the new economics created by the Rise Of Uber. MFIN has been arguing of late that the bottom has been reached and a certain clarity is emerging about what medallions are worth and how to “work out” the problems of lenders and borrowers alike. The BDC Reporter has been continuing to read on the sad subject – which has blighted the lives of many medallion owners – and we are not so sure. Nonetheless, the creditors of MFIN itself have been holding off taking any harsh action even as their various debt facilities are in severe trouble.

Whether MFIN’s lenders and regulators will continue to “extend and pretend” is not known. However, one item for investors to keep an eye out for is how the DZ Bank renegotiation mentioned above plays out before the July 15 deadline agreed upon.  If DZ Bank or other lenders to MFIN lose their patience and composure the news will be reported in the filings and could  cause a further drop in the stock price, which is already very low. News of a satisfactory renegotiation of the Revolver might result in greater optimism that MFIN can yet survive this threat to its existence. The market – as reflected in MFIN’s stock price – is far from optimistic. MFIN traded at $2.25 at the July 7 close, off its lowest low but below a recent optimistic spike of $3.33.

Full Disclosure: We are Long MFIN.

TCG BDC

The newest public BDC is Carlyle Group’s TCG BDC (ticker: CGBD), which the BDC Reporter has written about extensively. CGBD came to market just a few weeks ago. On July 7, 2017, CGBD announced the release of its quarterly financials for the quarter ending June 30, 2017. That’s scheduled for August 9, along with many other public BDCs.  What CGBD reports in its press release and in its first 10-Q as a public entity could move the needle in either direction. That’s partly because CGBD – as any new player – is not well known or understood by many investors, even if it has the Carlyle stamp.

However – and as we reported – investors do not have a very clear idea – notwithstanding the IPO Prospectus – what the balance sheet and income statement of CGBD looks like. Unlike most other BDC IPOs, Carlyle got very busy in the weeks before the offering. CGBD merged with another Carlyle BDC in June; acquired a large number of investment assets in the markets; faced a battery of repayments; changed its effective Management Fee and Incentive Fee (and put those changes up to an as-yet unresolved shareholder vote) and rejigged its financing. The BDC Reporter can guess, but does not know the size of the new BDC’s investment portfolio; or its current portfolio yield (Carlyle was in the process of boosting that number in the last few weeks) or what the recurring earnings are likely to be. The distribution level going forward has already been reduced but unclear is what the dividend payment policy will be in the future.

None of this is very dramatic but the markets will not be able to make a realistic assessment of CGBD’s prospects until those blanks are filled in. That’s why the August 9th earnings release will be of greater than average importance and may result in an immediate change in the stock price or a longer term cogitation by the markets. Investors would be well advised to read carefully the 10-Q and the transcript of the coming Conference Call to get an accurate irea of what CGBD is all about at this stage.

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