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Alcentra Capital: IIQ 2017 Review

BDCs:
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We’ve had an opportunity to review Alcentra Capital’s (ABDC) IIQ 2017 earnings release and its Investor Presentation, but not its Conference Call or 10-Q. Our first impression, though, is that the BDC’s performance turned out more or less as we warned it might in May 2017 and again in July.  Despite the fact that the BDC was hitting new stock price heights in the spring and was able to raise capital at book value, the BDC Credit Reporter’s closer look at the portfolio suggested caution was in order. We noted several problem credits in the relatively small portfolio. Typically where there is smoke in BDC credit matters, a fire is likely to pop up shortly thereafter.

Judging from the second quarter results that’s just what happened. The BDC wrote down its portfolio value by a net ($10mn), bringing Net Asset Value Per Share from $13.43 to $12.73 in just a quarter. That was quite a drop, and caused no incentive fee to be earned.  

The principal investment to get into trouble was My Alarm Center, which involved a recapitalization led by Oaktree Capital funds (if Oaktree is your new sponsor, you’re probably involved in a distressed investment) which resulted in a $8.4mn write down. Getting less press and the subject of a future post are several other names. The BDC likes to say 9 names were written up in value but 8 were written down, which My Alarm Center was only the most notable of this quarter.

Although earnings remained above the $0.34 quarterly distribution that’s largely a function of the Incentive Fee not being charged and thanks to much counting on Pay In Kind income on a range of restructured and non-performing investments. We’ll have the exact numbers in our coming in-depth assessment. However, the market, both before and after the release, appears to have come to the same conclusion as we have: that the distribution may be challenged down the road. As a result, the stock price has come off by a fifth since its highest point earlier in the year, and is now trading well below even ABDC’s lower book value.

OUR INVESTMENT STRATEGY

Common Stock

We have been out of ABDC’s common stock for a while, even though we’re relatively optimistic about its long term prospects as a higher risk BDC. It’s hard to justify a multi year investment in our long term Income Strategy when we foresee a potential dividend cut and a lower entry point. So we’ve been watching from the sidelines and will continue a little longer as the market appears to still be adjusting to the BDC’s prospects. At the right price ABDC could yet a “good little earner” as the expression goes over the next several years.  Just by waiting, rather than jumping into the stock in May we’ve said ourselves a 20% drawdown. Sometimes not doing anything is the best investment strategy.

Nor has ABDC been a candidate for our Special Situations strategy. Nothing much is happening that is out of the ordinary for a BDC. In this strategy we prefer situations where there are big uncertainties that might cause a price dislocation we can take advantage of. Here we have a run of the mill likely dividend reduction that should be expected in a BDC which makes loans at yields above 11%.  Most of the troubled investments are there for anyone to see, and the market is reacting accordingly. We’d need to see a sudden panic amongst investors before we’d buy for a short term bounce.

Baby Bonds

ABDC does not have publicly traded Baby Bonds, but does have Inter Notes in circulation which we purchased close to the time of their original issuance. The credit quality of these instruments remains good, and we could sell them out of our Baby Bond focus Fund if we wished to. However, we are holding on and have been searching -through our crack brokers at MS Howells- for additional notes, but with no success.

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