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Triangle Capital: Credit Implosion

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With the beginning of earnings season, the BDC Reporter will be reviewing all the latest earnings releases and quarterly filings, and writing about as many as we can on these pages.  Rather than than seeking to cover everything we’ve learned about a reporting BDC, we will seek to summarize our key insights shortly after review.( If necessary, we’ll take a deeper look at a later date). Moreover, we will provide our Dividend Outlook for each BDC in turn, assessing the sustainability of their current distribution for the next 12 months. As usual, we’ll also share our own investment approach with our readers. Next up: Triangle Capital Corporation (TCAP):


Cave In

In one remarkable quarter, TCAP’s already challenged credit quality imploded. As we’ll show, the IIIQ 2017 results may have reverberations for the BDC, its managers and investors well beyond the 33% reduction in the distribution which was announced along with the results. The quarterly pay-out was cut from $0.45 to $0.30 a quarter. However, that development pales in comparison to the latest update on the credit performance of TCAP’s $1bn portfolio. The BDC Reporter has read the earnings release and looked through the 10-Q and the portfolio company list in some detail and the results are devastating. Here are some key numbers:

By The Numbers

  1. Out of 91 companies in portfolio, 11 were on cash non-accrual at September 30, 2017.
  2. That’s 6 more cash non-accruals than were on the books last month.
  3. Of the 6 new names, 2 had been on PIK non-accrual in June , but 4 others had been carried as performing.
  4. The total cost of cash non-accruing loans has increased from $68mn to $168mn: a $100mn increase in three months.
  5. The fair value of non-accruing portfolio loans (both cash and PIK) has increased to $51.2mn from $38mn.
  6. Unrealized Depreciation in the IIIQ 2017 amounted to ($66mn) and Realized Losses to ($9mn).

Context

To put that into context, TCAP has written down/off assets equal to nearly a tenth of its equity capital at par.

In this quarter alone TCAP wrote off or down 40% of total losses accumulated over a ten year history.

Beyond The Valley Of the Non Accruals

When the BDC Reporter reviewed each portfolio company in turn, we identified (including the non-accruals) 19 on our Watch List.

That means that roughly one in every five companies which  TCAP has lent to or invested in is under-performing, many of them seriously judging by the valuations on some of the still performing Watch List credits.

Dropping Bottom Line

In a quarter, book value – as measured by NAV per share – has dropped by 11%, and since the beginning of the year by 13%.

NAV is now $630mn or $13.20 a share  and could head lower.

If just the non-accruing loans get written down to zero, book value would drop another 8%, and NAV Per Share would reach $12.14.

The still performing Watch List credits have a value over $100mn. What amount of that group might be written down/off in the future is anybody’s guess.

The number could be from zero to $66mn or more judging from what we’ve seen in the losses booked beyond cost in the 11 non-accrual assets we discuss above.

So far, write-downs have accounted for 70% of original investment cost.

Euphemisms

No wonder management led off the press release with the word “challenging” and admitting to “meaningful unrealized depreciation”.

Even more telling, TCAP has raised the possibility of selling “certain investments”. That’s probably a non-starter judging by prior BDC experience, but you never know.

Find Me A Buyer

Even more intriguing and opaque is the announcement that TCAP is exploring “strategic alternatives”; looking to hire an investment banking adviser; interviewing several candidates and interested in discussing joining up with some other financial firm.

Here is the language:  TCAP is interested in exploring “the potential benefit of partnering with another organization to accelerate our corporate initiatives”.

How Bad Is It ?

The BDC Reporter has rarely witnessed such a fast credit meltdown outside of the Great Recession in all the years we’ve been following the BDC sector.

Moreover, these write-downs and new names added to the non-accrual list follow several years of TCAP already booking Realized Losses of ($32mn) through June 2017 already.

We would suggest that the chances of TCAP being able to regain shareholder trust as a stand alone company are very low.

Moreover, the entire business strategy on which the BDC was initially based – investing principally in mezzanine debt – has gone out the window as management desperately tries to re-invent itself as a senior secured, much lower yield, lender.

Illustrative is the deal that TCAP booked following the close of the quarter with Deva Holdings,Inc. Where TCAP is used to achieving pricing in the 10%-12% range, this loan was priced at LIBOR + 6.75%.

That’s roughly a third lower in terms of investment income generated.

Coming Up

Much more might be learned – and much more digital ink used – once TCAP holds its Conference Call on November 2nd at 9:00 a.m. EST.

Hopefully our readers will check their in-box early for this article -if they’re not already familiar with TCAP’s travails- and will participate in the conclave.

Management is likely to downplay the seriousness of the situation, as is their wont and their perceived fiduciary duty.

Breaking News

However, the BDC Reporter believes this is likely to be the Big Story of the third quarter and will raise questions more broadly about credit quality in the leveraged loan space.

We’ve not done a full evaluation yet but just looking down the list we know that several TCAP Watch List credits appear in the portfolio lists of multiple other BDCs.

Even if you’re not invested in TCAP, keeping up with What Happens Next is important to anyone with exposure to the sector.


INVESTMENT APPROACH

Common Stock

We had dropped TCAP -once a favorite – from our Long Term Income list many quarters ago due to its ever worsening credit record.

On the other hand, the uncertainty about the dividend cut – now resolved- and the doubts about whether TCAP might be able to “fix” its credit problems made the BDC a perfect candidate for our Special Situation Watch List. 

For our own account, we’ve been seeking to divine a “bottom” for the stock, and buy a short term position if TCAP became oversold.

We actually bought and sold TCAP recently as part of that high risk/ quick return approach. 

Unfortunately, we retained modest exposure in our Investment Fund.

Frankly, we’ve been shocked by the worsening of TCAP’s credit picture and we expect the market -notwithstanding the slide in the stock price – will feel the same too.

We’ll be taking our lumps and selling out ASAP.

From what we can tell the future of TCAP is likely to become unknowable for awhile if an investment bank is hired and a several month sales process initiated.

We will probably be once bitten and twice shy and stay away.

Fixed Income

TCAP has two Baby Bond issues outstanding: TCCA and TCCB.

We have positions in both issues.

Both Baby Bonds mature in 2022 but TCCA can be redeemed at any time, while TCCB passes that milestone only in March 2018.

The BDC’s troubles do not – as yet – cause us any concerns about ultimate repayment of either Baby Bond.

However, it’s impossible to handicap if management will seek to repay either Baby Bond in the months ahead, either by issuing new unsecured notes or just from investment repayment proceeds.

Less likely is that TCAP would draw heavily on its Revolver to pay off the Baby Bonds.

Generally speaking, troubled BDCs would much rather deal with passive unsecured Note holders than with worried bank lenders watching the ever higher bad credit body count in horror, and checking their covenants and documents.

Should existing Baby Bond holders panic and drop the price of either unsecured Note, we will probably buy more.

However, we doubt that will happen.

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