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BDC News Wrap-Up: January 8 & 9 2018

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Here’s what we learned from preparing the BDC News Of The Day for Monday and Tuesday January 8-9, 2018.   For all the details, links, etc.  go to the Daily News Table

Issuing New Unsecured Notes : Ares Capital (ARCC)

Repeat debt issuer ARCC has gone to the well again, raising $600mn of institutionally placed Unsecured Notes, with a maturity of 2025 and a coupon of just 4.25%. That’s not the lowest pricing ARCC has ever achieved for an unsecured facility, but is longer and less expensive than what its peers have been able to raise debt capital of this kind. Moreover, because the debt is placed with institutions, ARCC can redeem the obligation at any time, subject to a “make-whole” provision. The new debt is BBB rated, which is the sweet spot for many investors. Moreover, with this new addition to the capital structure, ARCC continues to have a nicely diversified set of debt liabilities, both secured and unsecured. Here’s a screen shot from the latest 10-Q:

Here’s the irony. This debt raise is likely to shave down ARCC’s earnings in the IQ 2018. Despite borrowing long term at an inexpensive rate, this debt is still more expensive than the two secured Revolving facilities which the BDC utilizes to finance itself. Even before a recent modest reduction in the margin being charged by its lenders, ARCC’s all-in cost on the $1bn Revolving Funding Facility was 3.61%. Another similar facility – the $2bn plus Revolving Credit Facility cost just 3.08%. At 4.25%, plus all the expenses associated with a new issue and the indirect cost associated with paying down its secured debt with the proceeds (as undrawn commitment fees increase of 0.375% on the balance repaid), the BDC’s debt costs will actually rise in the IQ of 2018 as a result of this transaction.

Use Of Funds

However, we can’t help noting ARCC is not making entirely clear where the $600mn of new capital is first going to go. Maybe the monies won’t go to pay-off the outstanding secured Revolver outstandings, which only aggregate $845mn, or 12% of the BDC’s capital. If paid off, there would be roughly only $150mn in Revolver debt outstanding and essentially all of ARCC’s borrowings would be in the form on one kind of unsecured debt or another. Amusingly, that’s a financing strategy not dissimilar to that of Prospect Capital (PSEC) whose Revolver is getting dusty from under-use. From a credit standpoint – if that’s the way ARCC is going to go – that’s a very safe balance sheet structure if we should get a financial crisis or recession. With no banks – and their pesky covenants and borrowing bases to contend with – ARCC would be sitting pretty. However, we doubt that the BDC is overly worried about such a scenario right now.

There are a couple of other ways the BDC could go. The $600mn could have been raised in anticipation of paying off its $750mn 2018 Notes, coming due in November. January is a little early but maybe the investment bankers convinced ARCC that this was the best available window, before any increase in longer term rates might kick in. Also, two Convertible Note issues are at or closing in on their maturity dates. The 2018 Convertible has $270mn outstanding and is due on the 15th of this month.A similar facility expires in early 2019 with a value of $300mn.

Then there’s the possibility ARCC will finally pay off the expensive 2047 Notes, assumed in the Allied Capital transaction in 2019. The $230mn in 2047 Notes are priced at 6.875%. Although redeemable at any time for several years the 2047 Notes – which are publicly traded under the ticker AFC – ARCC has steadfastly chosen not to pay the debt off. With profit pressure high at ARCC – with recurring earnings still below the dividend rate 9 months and a generous fee waiver after acquiring American Capital – the time may be nigh to pay off AFC.

The BDC Reporter won’t pretend to be able to divine what the liability management folk at ARCC are going to do. To their delight – and our confusion – ARCC has a wide range of ways to refinance the $1.3mn plus in debt coming outstanding in the next two years. Our best bet is that after a brief pay-down of the Revolver, the monies will go to pay off the 2018 Convertible Notes and the 2047 Notes, with another debt raise later in the year taking care of the $750mn of November 2018 Notes. What we are more certain of is that – for a time – ARCC’s overall borrowing costs -when figuring in the expense related to this new offering – will increase before they go down. As usual, ARCC is playing the long game.

Investment Disclosure: We have no position in ARCC or in AFC. 

Booking Big Fees: Solar Capital (SLRC)

The Daily News Table shows that SLRC announced booking a new $40mn venture-debt deal with a company called Alimera Sciences. That was already noteworthy because of the size of the deal ($40mn is on the higher side for an individual transaction) and because SLRC refinanced out another BDC – Hercules Technology (HTGC). That’s just more evidence of the competitive world in which BDCs have to operate. However, we’ve now learned from an SEC filing the kind of fees SLRC will be getting for its munificence to Alimera. Instead of taking/being offered any equity in the high flying company SLRC and Alimera have agreed on a generous bevy of fees. Here’s what the 8-K filing revealed:

As part of the fees and expenses incurred in conjunction with the term loan discussed above, Alimera paid Solar Capital a $400,000 fee at closing. Alimera is obligated to pay a $1.8 million fee upon repayment of the term loan in full ($2.0 million if the interest only period has been extended to 36 months). Alimera may elect to prepay not less than $10.0 million of the outstanding principal balance of the term loan. Alimera must pay a prepayment premium upon any prepayment of the term loan before its maturity date, whether by mandatory or voluntary prepayment, acceleration or otherwise, equal to:
(a)    2.00% of the principal amount prepaid for a prepayment made on or after January 5, 2018 through and including January 5, 2019;
(b)    1.00% of the principal amount prepaid for a prepayment made after January 5, 2019 through and including January 5, 2020; and
(c)    0.50% of the principal amount prepaid for a prepayment made after January 5, 2020 and greater than 30 days before the maturity date.
Alimera is also obligated to pay additional fees under the Exit Fee Agreement (the “Exit Fee Agreement”) dated as of January 5, 2018 by and among Alimera, Solar as Agent, and the Lenders, a copy of which is filed with this Current Report on Form 8-K. The Exit Fee Agreement survives the termination of the Loan Agreement and has a term of 10 years. Alimera is obligated to pay up to, but no more than, $2.0 million in fees under the Exit Fee Agreement.
Specifically, Alimera is obligated to pay an exit fee of $2.0 million on a “change in control” (as defined in the Exit Fee Agreement). To the extent that Alimera has not already paid the $2.0 million fee, Alimera is also obligated to pay a fee of $1.0 million on achieving each of the following milestones:
(a)    first, if Alimera achieves revenues of $80.0 million or more from the sale of its Illuvien® product in the ordinary course of business to third party customers, measured on a trailing 12-month basis during the term of the agreement, tested at the end of each month; and
(b)    second, if Alimera achieves revenues of $100.0 million or more from the sale of its Illuvien product in the ordinary course of business to third party customers, measured in the same manner.
As noted above, the total fees payable under the Exit Fee Agreement may not exceed $2.0 million.
No warrants were issued in connection with the term loan.
There are many “ifs, ands and buts” but SLRC could extract several million dollars from Alimera over the years if all goes well. Nor is the current interest rate on the loan too shabby, currently at 9.2% and could rise to double digits if LIBOR rises further. Of course, much can happen to Alimera Sciences along the way. At this stage, though, this seems like a feather in the cap for SLRC – whose venture debt portfolio is much smaller than HTGC’s.
Investment Disclosure: We are Long SLRC. We may add to our position. 

Keeping Busy: Hercules Technology (HTGC)
There’s no need to cry a river for HTGC. The BDC may have lost Alimera Sciences – willingly or not – but has been keeping busy elsewhere. The BDC Reporter alerted readers to that in our last update on January 8. Since then HTGC has published its quarterly press release detailing highlights from the prior quarter and the YTD’s investment activity. We’ve never been great fans of these marketing press releases posing as disclosures because the BDCs can pick and choose what to tell us and what not. We wrote an unappreciative article on the subject last time HTGC was discussing this subject, back in October of last year.
All our misgivings continue to apply but we have to admit this press release was choc-a-bloc with some juicy facts and figures. We learn early pay-offs came in at $124mn for the quarter and $505mn for the calendar year. We learn this was 25% higher in the last quarter than had been anticipated. (We’re not aware that HTGC discloses its pay-off expectations up front, so we’ll have to take their word). The BDC Reporter likes to see a high level of prepayments at venture debt lenders. As we’ve been educated by the management over the years, prepayments often result in higher fee levels and the capture of exit fees. (The Alimera Sciences arrangements are illustrative). Just as importantly early repayment also suggests borrowers who are on plan or ahead, which speaks well – taken in aggregate – to the health of the sector.
We also learn that new investment activity has been fast and furious – albeit helped by buying a portfolio from Ares Capital intra-year. The headline number is $882mn in new commitments in 2017. We all know by now that commitments do not equal loan outstandings in the venture debt game – which has a number of thresholds which have to be met to access all promised monies. Some of those targets could be years out, and so could the financing. Nonetheless- at a 36,000 foot level – an impressive number.
Even more intriguing to the BDC Reporter is the detail provided about the new borrowers and the size of the commitments made. Thankfully HTGC continues to take a diversified approach to portfolio construction, generally avoiding taking very big individual bets.
What’s most exciting to many investors are the HTGC portfolio companies that were acquired or went public – or might do so shortly. These investments often achieve equity gains, unrealized or otherwise. The list is not very long this year, but there were three IPOs in the IVQ 2017. Interested investors will note that Forescout Technologies came to market and HTGC’s Preferred positions are now worth $5.8mn. That’s a nice jump from $3.3mn fair value at September 30, 2017, according to the crack data aggregators at Advantage Data.  
None of this tells us what IVQ 2017 results will look like or what’s happening to credit quality, but it’s useful color. Anecdotally – from this press release and other bits and pieces of news we pick up – HTGC seems to be on a roll. However – where the BDC Reporter is concerned at least – there is still the shadow of the CEO’s frustrations at running an internally managed BDC rather than having the opportunity to make a small fortune as the owner of an external manager. Doubts about the CEO’s commitment to the BDC – and its current format – once raised are hard to dispel.
Investment Disclosure: We have no position in HTGC.
Launching A New Non-Traded BDC: CM Finance (CMFN)
CMFN is about to have a sibling. The Investment Advisor (CM Investment Partners LLC) to the BDC is launching a non-traded fund to be called CM Credit Opportunities BDC I, Inc. So what ? you might say. Some investors might be pleased to hear that the public BDC will soon be joined by a private BDC with a similar strategy and investment profile. In fact, as the Prospectus shows, the Investment Advisor is already asking the SEC for its easily approved “exemptive relief”  that allows the Investment Advisor to originate transactions and divvy them up between funds under their control.  The BDC Reporter – grumpy as always – is less enthusiastic given that CMFN’s performance since going public relatively recently has been less than stellar.  We spelled out many of our concerns about CMFN in a long article on November 11, 2017. A couple of weeks later, we followed up with concerns about the BDC’s capital structure and liquidity. Most recently of all, we wrote an article after CMFN received  – on the third attempt – shareholder approval to sell stock below NAV, even though the current price is (32%) below book.
To the BDC Reporter – and we recognize that we might be in a minority on this subject – launching a new BDC represents a major distraction from the focus necessary on CMFN, whose dividend has already been reduced by 29% in just over 3 years in the public market and whose stock price has slumped by nearly 50%, as this lifetime chart shows from 2014 till today:
Who Goes First ?
Then there’s the issue of conflicts of interest. The principals – thanks to regulations – themselves describe the risk – as it pertains to the prospective shareholders of the new fund – of wearing many hats. Here is a useful extract from the new fund’s Prospectus:
There are significant potential conflicts of interest that could negatively affect our investment returns.
There may be times when the Adviser or the members of the Investment Team have interests that differ from those of our stockholders, giving rise to conflicts of interest. The members of the Investment Team serve, or may serve, as officers, directors, members, or principals of entities that operate in the same or a related line of business as we do, such as Stifel, or investment funds, accounts, or investment vehicles managed by the Adviser. Similarly, the Adviser or the members of the Investment Team may have other clients with similar, different or competing investment objectives, such as CM Finance Inc, a publicly-traded BDC. In serving in these multiple capacities, they may have obligations to other clients or investors in those entities, including CM Finance Inc, the fulfillment of which may not be in the best interests of us or our stockholders. In addition, the Adviser and some of its affiliates, including our officers and our interested directors, are not prohibited from raising money for, or managing, another investment entity that makes the same types of investments as those we target.
The members of the Investment Team also include four (4) investment professionals that also serve as employees of Stifel, Nicolaus & Company, Incorporated. Although these members of the Investment Team spend substantially all of their time in the Adviser’s office providing services to the Adviser, they may also continue to engage in investment advisory activities for Stifel, Nicolaus & Company, Incorporated and its affiliates and Mr. Nitka, Stifel’s designee to the Adviser’s Investment Committee, also serves as a managing director and head of the Credit Investments Group at Stifel, Nicolaus & Company, Incorporated. This could result in a conflict of interest and may distract them from their responsibilities to us. As a result, although the Adviser, the Investment Team and Mr. Nitka are subject to a written conflicts of interest policy, the time and resources the Investment Team and Mr. Nitka could devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.

As the second paragraph of that Risk Disclosure mentions, CMFN shareholders are already dealing with a management team with other duties and responsibilities. Moreover, the Investment Advisor’s bench is not very deep, as the Prospectus for the non-traded fund reminds us: The Adviser’s investment team is led by its Co-Chief Investment Officers, Michael Mauer, our Chief Executive Officer and Chairman of our Board and Christopher Jansen, our President. Messrs. Mauer and Jansen are supported by four (4) additional investment professionals, who, together with Messrs. Mauer and Jansen, we refer to as the “Investment Team.” The members of the Investment Team have over 100 combined years of experience structuring customized debt solutions for middle-market companies…”

The Few.

By our math that’s 6 professionals managing two funds,  four of which are still carrying their Stifel cards to meetings. As we’ve said at other times, if the focus of the (small) team is going to be divided between multiple funds, the least the Investment Advisor can do is reduce its fee requirements given the dilution of effort. By the way, the non-traded BDC enjoys a much more generous fee arrangement than the public BDC. The management fee at CMFN is 1.75% on assets versus 1.25% for the new fund – although both have similar strategies and may divvy up loans made. The new fund investors don’t even pay ANY Incentive Fee until a Liquidity Event is achieved.

If either set of shareholders at CMFN or at the new fund expect the Board to stand up for their interests they may be disappointed. There are multiple conflicts of interest with two major groups – Stifel and Cyrus Funds – owning stakes in the BDCs and in the Adviser and having appointees on the Board. CMFN and its sister fund  – like many BDCs- has been established as a Maryland Corporation, a jurisdiction which is very “insider friendly”, to coin a term. We understand the drive of Investment Advisors to grow and make more money for themselves and their partners. Shareholders, though, have to ask themselves if a BDC which has already failed to perform is well served by having its senior management team’s limited bandwidth shared with another fund, and with no means of redress or mitigation from the Board.

Disclosure: We have position in CMFN.

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