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BDC Daily News Wrap-Up: Monday December 4 And Tuesday December 5

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Following the regular BDC Market Recap published on the weekend, the BDC Reporter published two features on December 4th: an in-depth review of New Mountain Finance‘s (NMFC) portfolio and income statement as part of our Dividend Outlook series. (More on the Dividend Outlook series in the days ahead). Although NMFC has been one of the most consistent dividend payers in the BDC space, when we looked under the hood of the most recent financial statements, there were a number of items that caused us concern about the BDC’s remarkable 23 quarters in a row of paying out a $0.34 dividend. We should add that Mr Market is evincing no concern, with the stock price essentially unchanged over the past 12 months, and the stock trading at a sub-10% yield (9.6%), which we take as sign of investor confidence of dividend sustainability. So we know our concerns are “contrarian” but that’s the self imposed mission of the BDC Reporter: to provide news, view and especially analysis that’s not appearing anywhere else. Investors can decide for themselves if our concerns are well founded or not. We’ve included many page references to the 10-Qs involved for readers who want to follow us through the weeds.

We also highlighted negative developments at a well known retailer (especially if you’ve been to a mall lately and buy women’s accessories) to which 4 BDCs have nearly $40mn in exposure. This has been a slow moving train wreck, as the first warning signs that Charming Charlie was cracking up came out two years ago, and the BDC Reporter – which keeps one eye on the BDCs themselves and another eye on their portfolio investments – has been waving its arms since the spring of 2016. Now the retailer – according to Reuters sources – might file for Chapter 11 at any moment in December or undertake a major capital restructuring. We bring you the various strands of information about Charming Charlie but also about the possible impact on two public BDCs we track: THL Credit (TCRD) and PennantPark Floating Rate (PFLT). The former is the lender at greatest risk, though both are in the secured Term Loan. Again, the BDC Reporter may not be the only publication mentioning Charming Charlie’s difficulties (we found multiple sources) but we are the only one with BDC investors in mind who discusses credit exposure and potential implications for earnings and the stock price.

OTHER NEWS

There were 6 other BDC news items on our Daily News Table (see the Tools section), which we added over the past two days. None were terribly important in and of themselves, but the BDC Reporter seeks to maintain continual coverage of the 46 public BDCs in our universe and places these items into a bigger context:

Both PFLT and PNNT announced unchanged distributions. However, the back stories at the two BDCs are different, as might be the outcome where their pay-outs are concerned in the year(s) ahead:

PFLT

PFLT announced its December 2017 pay-out, as expected. Notwithstanding the Charming Charlie risk above, PFLT has been performing well of late; expanding its balance sheet in a careful fashion (including expanding its Revolver, which was another news item)  and maintaining credit quality (just one non accrual on the books and 6 Watch List names overall according to our count). Readers who just skim the earnings report, though, should note that a good portion of the $0.32 in Net Investment Income Per Share achieved in the quarter ended September 30, 2017 and which buoyed the corresponding annual number to $1.10 a share was from a one-time event. That’s better than the $1.02 achieved in the prior fiscal year, but only because PFLT benefited from a legal settlement this year regarding a portfolio company acquired in the MCG Capital transaction. Plus, the BDC has been raising new capital at book value and issuing new shares at an above average pace when many other BDCs are stuck. However, that means PFLT has to find new sources of income if it’s dividend is to continue its three years unchanged run. No wonder management points out on the Conference Call that its squirreled away $0.45 of undistributed income to offset any shortfalls between recurring earnings and those outgoing distributions that might occur in the future. We’re convinced so far and have a Dividend Outlook for the next 12 months of UNCHANGED. So does Mr Market. The stock price, too,  is essentially unchanged over a 1 year period, as this chart shows. PFLT yields 8.1%, a good sign that shareholders are comfortable that the $1.12 a year pay-out is safe.

We are Long PFLT.

PNNT

The situation is slightly different at PNNT, even if the calendar fourth quarter distribution was unchanged. It’s been a year since PNNT had to bend the knee and break its multi-year $0.28 a quarter distribution streak by cutting its pay-out to $0.18. The latest earnings release suggested PNNT – run by the same Investment Advisor as PFLT – is making progress on its turnaround plans instituted after a disastrous foray into too much energy lending at the wrong time hit the results hard. Back at its post Great Recession height PNNT traded at $12.70. As recently as July 2014, the stock was at $11.90 – all while the distribution was at $1.12 a year. When everything went awry, the stock price dropped as low as $5.31 in December 2015.  That’s a nearly 60% price drop from Highest To Lowest. Equally as importantly – with the dividend cut that occurred in the IQ of 2017 (Mr Market had seen the writing on the wall 18 months before) – PNNT dropped out of that elite group of BDCs that could be counted on to maintain a stable distribution through thick and thin. That $0.28 pay-out had begun in the IVQ of 2011 and lasted 21 quarters. Is $0.18 a quarter sustainable for 2018 at the very least ? The BDC Reporter – unfortunately -is not completely sanguine and has an AT RISK rating, putting the odds – in our view – at 50/50. We’ve not done our quarterly “deep dive” update of the portfolio, but the metrics in the earnings release show some of the problem. Net Investment Income Per Share – due to lower income from many of those energy investments that have been chopped and changed in various ways- has brought Net Investment Income Per Share to $0.18 a quarter, just equal with the distribution. If you only look at cash income, the BDC is not even covering the pay-out already. Then there’s two cents a share of fee waiver benefit besides. More subtly, the very determination to not be in the position of having to cut its distribution again has caused the BDC’s business model – not unreasonably – to become more conservative and that’s eroding recurring earnings. As a result, PNNT is vulnerable to any new non-performing loans and its own revised strategic approach.

Some investors may take some solace from the reduction in the BDC’s management fee and incentive fee (a mini-trend in the BDC sector these days) but there’s less there than meets the eye. PNNT has been waiving 16% of its Management Fee (associated with those energy investments gone bad). We’ve not done the math, but those waivers will be going away when the new fee structure kicks in. Somehow we doubt that PNNT investors will benefit very much at the bottom line – or at all. (When we undertake a more in-depth review we’ll update readers). Here too the Investment Advisor has “undistributed income” to “cover” distribution shortfalls from previously earned monies, but both the absolute amount and the underlying economics of the business are different than at PFLT. Even Mr Market – who has seemed relatively comfortable that the current (if lower) distribution is “locked in” – has begun to have doubts. From a recent, pre-earnings release high on October 4 of $7.80, the price has dropped as low as $7.03 (intra-day) on December 5. That’s a 10% drop in 8 weeks. Volume of shares traded jumped up. PNNT is yielding 10.% – just around the dividing line the BDC Reporter has chosen to represent when the markets are getting doubts about distribution sustainability. Still, if PNNT – which desperately does not want to do so – should decrease its distribution by – say – 20% in the year ahead to get its economics right, investors should expect a further stock price drop. At a pro-forma $0.60 a year pay-out, PNNT is likely to trade between $4.8-$6.60, depending on the outlook at that time. That’s as much as a 33% drop over the current price and 40% off the highest level reached after the last dividend cut. Although the dividend reduction is only in the Maybe category, the BDC Reporter is staying away because the price punishment in these situations can be harsh, even if the stock has already moved down as investors do the math.

We have no position in PNNT. 

TICC

National Securities took TICC to the woodshed, publishing a report recommending a Sell. The analyst points to the recent increase in TICC’s stock price as an opportunity to get out before the negative fundamentals of the CLO and higher risk loan business model which the BDC has adopted catch up with them. As we’re talking about distributions, National Securities expects TICC to reduce its $0.20 a quarter pay-out shortly. We can’t say we disagree as the BDC Reporter’s Dividend Outlook has been set at DECREASE for several months. TICC reduced its distribution from $1.16 annually to $0.80 just a year ago. Even then, we’ve been skeptical that the current pay-out is sustainable. We won’t review all the reasons why here, but note that our far-from-infallible way of determining what the market believes by looking at the current yield suggests we – and National Securities – are not alone. Notwithstanding any price increases in the short term, TICC is yielding a juicy 12.9% yield…Over 12.0% is what we use as the dividing line between a distribution AT RISK and a DECREASE rating in the eyes of the market.  A cut to $0.48 a year – as Chris Testa at National Securities predicts – and with no change in sight to the current business model – could readily drop TICC”s stock price to $5.00 or lower from its current level. National Securities price target is $5.0, but the final resting place could be higher or lower by $0.50 or more. Still at $5.0, TICC would be ($1.18) or 20% lower than as of today. Worth the risk for a perennial dividend cutter which is increasing its risk profile of late ? We don’t think so, especially as so much of the BDC’s income derives from CLO equity tranches whose economics are as much a mystery to us despite years of unsuccessfully trying to get our arms around them as quantum physics and the appeal of pumpkin pie.

Nonetheless – and to be balanced- we should note that TICC received this week an A- rating from Egan Jones.  The credit rating group rated both the BDC itself and its 2024 Unsecured Note with the ticker TICCL, as we reported in the updated BDC Fixed Income Table. Of course, both a dividend cut and an A- credit rating are not mutually incompatible. If you were wondering what an A- rating from Egan Jone means here is a link to their scale, which ranges from AAA to D.

We have no position in TICC’s stock. We are Long TICCL.

IN OTHER NEWS:  CSWC

Check out the Daily News Table for details about a CSWC borrower who is making a major new acquisition which could result in one of the BDC’s well performing Second Lien Loans – paying just over 10.0% – getting refinanced.  CSWC has been involved with this borrower since March 2015 in a loan that was scheduled to run till 2022. Like so many other leveraged loans, the life of this financing looks like it might clock in under two years versus the seven initially anticipated.

We have no position in CSWC. 

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