Email us with questions or comments: nmarshi.bdcreporter@gmail.com           α

Capitala Finance: IVQ 2017 Results Preview

BDCs:
Premium Free

Here come the fireworks !

If last week the BDCs reporting quarterly results were a relatively high performing bunch that’s not universally the case this week.

In fact, several troubled funds – dealing with major credit and earnings issues – will be providing their updates.

See the BDC Earnings Table above for the BDCs and the schedule.

Here is what to look out for where one of those troubled names – Capitala Finance –  is concerned: 


CAPITALA FINANCE (CPTA) – REPORTING TUESDAY FEBRUARY 27, 2018 AFTER THE CLOSE – $0.27 E

Actual Vs Expected

Just over a year ago, CPTA was earning $0.47 per share of Net Investment Income. Last quarter – thanks to a flurry of bad debts – the number dropped to $0.28.

This quarter the analysts are expecting $0.27.

Much To Do

We noted in an earlier in-depth review of both the portfolio and earnings power published in January 2018, that CPTA will be under pressure for several quarters to come.

First, there is the settling out of the 5 non-performing loans on its 34 company portfolio  – by our way of counting –  and the status of several under-performing companies, which could yet take a bite out of earnings.

The non performing names are Immersive Media, On-Site Fuel Services, American Exteriors, Cedar Electronics and Print Direction.

Here is what we wrote in our earlier article about the non-performing credits in summary. We’ve not updated our research since this was written January 3 2018:

The publicly available information suggests 4 of the 5 non-performers (including Immersive Media) might be complete write-offs and generate no further income. The only exception might be On-Site Fuel Services, whose debt might get repaid and might – eventually – return to performing status. On these assumptions, CPTA might still write off – over time- ($15.2mn) of book value, which would bring NAV Per Share from $14.31 down to $13.36. Eventually the $11mn (at cost) of On-Site Fuel Services debt could generate 10%+ in income or $1.1mn annually. That amounts to about $0.07 per share in incremental Net Investment Income Per Share, a possible 6% increase.

One Notch Lower

So much for the non-performers. Just as important to CPTA’s future prospects are under-performing  names which are still on accrual that we’ve identified.

At September 30, 2017, that consisted of 6 companies : 3 where we anticipate full recovery is less likely than an eventual loss and 3 where we’re more optimistic.

From Most Worrying Down

Keep an eye out for the status of Velum Global Credit Management. There are questions surrounding a $11.8mn loan outstanding.

Velum is a financial firm that acquires non performing loans. In Brazil. Which should be reason enough to be on anyone’s Watch List.

The borrower’s debt – which was marked very modestly down by CPTA, which is the only BDC lender – matured in December 2017 and bears a juicy 15%,  all in PIK. (Two more red flags).

All CPTA would say back in November 2017 when asked about Velum is that negotiations were underway about extending the facility.

Other details were vague.

We’ve found nothing else in the public record.

Bad news on Velum could cause earnings to be lower than anticipated. Most likely, though, is that the debt gets extended.

Two More

The other two borrowers on our heightened risk list (we call our Worry Names) are Kelle’s Transport Services and Bluestem Brands.

Kelle’s, restructured just last quarter and which involved a Realized Loss to CPTA, has recently changed its name and attracted new capital, according to a January 2018 news report.

That’s probably good news for CPTA, which owns both debt (at very, very low rates) and equity in the refrigerated transport company.

We don’t know if the new majority owner – who specializes in transport businesses – will have repaid or rejigged the company’s debt. More info – presumably – will follow on the Conference Call.

We don’t expect to hear much new about Bluestem Brands (retailer).

The multi-brand retailer  seems to be hanging in there thanks to a turnaround and re-positioning strategy.

Main Street (MAIN) is also a lender – in the same Senior Loan position as CPTA – and has already reported.

MAIN maintained a (28%) discount on the debt in the IVQ 2017, essentially unchanged from the IIIQ 2017.

[CPTA only discounted its Bluestem debt position by 4% in the third quarter, for what that’s worth].

All this data mined from Advantage Data’s terrific database, which gets updated within hours of BDCs reporting.

There’s a good deal of public information available we’ve been keeping up with. Our summary of Bluestem’s performance: doing better but still very highly leveraged and not out of the woods.

Then There Were Three

Moving to the three borrowers that we’re a little less worried about (we rate these a 3 on our 5 point scale).

Worth looking out for in the IVQ 2017 portfolio valuation will be American Clinical Solutions, LLC.

Last quarter CPTA wrote the 2020 10.5% First Lien Loan to this lab test company, with a cost of $9.5mn, down by (16.5%).

Curiously, non-traded BDC Cion Investments – which has a position in the same facility – wrote down its position only (2%).

Is CPTA being overly conservative to be able to boost NAV in this or a future period or is Cion being too optimistic ? Or something else altogether ?

We’ve not been able to winkle out any recent public info.

U.S. Well Services – also in CPTA’s portfolio in both debt and equity (and another recent restructured credit) should be OK.

Several BDCs with both debt and equity positions have already reported debt valuations at par and equity carried at a premium, unchanged from IIIQ 2017.

Then there’s Sierra Hamilton, where CPTA’s $16.2mn in debt was converted into $7mn in equity last year, or 14% of the company.

We expect to see an increase in the valuation there, but still no income.

Most anything involved with oil & gas – even service companies – is getting the benefit of the doubt where valuation (and capital) is concerned these days.

The BDC Reporter – unlike some BDCs – does not forget that this is still a highly cyclical business and dodging a bullet does not mean you’re out of danger.

All energy related borrowers remain on our Watch List regardless of valuation levels.

Nonetheless, investors with short term outlooks should be cheered.

Strategic Change

The biggest threat to CPTA’s earnings this quarter – and for the rest of 2018 and even beyond – is of its own making.

With the second round of bad debts that CPTA endured last quarter and which caused its dividend to be reduced twice within a year, the Investment Advisor has said “No Mas”.

According to last quarter’s Conference Call CPTA is going to transition its portfolio to lower risk loans in the future.

Less risk = less investment income.

That  process – if the Investment Advisor follows through with its intentions –  will lower Net Investment Income from the levels of last quarter, but over time.

Here is what we wrote in January 2018 on the subject:

Another phenomenon underway which should cause CPTA’s income to drop is the decision by the Investment Advisor (not unreasonably given the multiple dividend cuts and credit losses) to seek refuge in lower risk but lower yielding credits. This is not a process that happens overnight but the CEO of the BDC did indicate that “we will probably lose 150 to 250 basis points on yield”. Using a midpoint of 200bps that suggests the portfolio yield could drop from 12.9% to 10.9% over the next three years or so. If we assume about $350mn in performing debt outstanding on CPTA’s balance sheet that could drop Investment Income by $7.0mn, all of which would also come out of Net Investment Income as well. That’s equivalent to 40% of the BDC’s current running rate, or $0.44 a share. Or in other words that could cut Net Investment Income Per Share from $1.12 to $0.68.

Shareholders will be interested to see what sort of new loans the BDC has booked and at what yield in the quarter.

However, even with the frothy environment for leveraged loans this is a process that will take several quarters to complete. We estimate above a three year horizon.

Reinforcements

That’s not the end of the story where CPTA’s earnings are involved.

On the positive side, the BDC is actively looking to sell off its performing and out performing equity stakes and converting the proceeds into Realized Gains and then into yielding loans.

That might help reduce the ($38mn) of net Realized Losses on the books and boost income.

Interesting will be to both evaluate what has been sold and what potential remains.

We know – as CPTA told us in a press release – Brunswick Bowling Products was sold in January 2018 and a $2.5mn Realized Gain booked on the equity, and $6.2mn received.

Otherwise, we count over $80mn in various non income producing equity and Preferred stakes in portfolio companies that CPTA could monetize.

However that’s also a process which will take years to play out, and much can happen in the interim to the companies involved and the value of those stakes.


CONCLUSION

This is an important earnings release for CPTA – after announcing those massive losses last quarter and critical to regaining some level of investor confidence.

After all, the stock trades at a (50%) discount to book.

Unless something negative has happened at Velum, or credit troubles have developed in credits we’re not aware of, earnings are likely to be close to the analysts estimate.

Whether that happens or not, the Bigger Question is how the combination of credit issues and strategic repositioning will affect recurring income from debt investments over time.

With many moving parts even the best analyst model cannot adequately project CPTA’s earnings trajectory in the year or two ahead.

With the stock at $7.16 – near its All Time Low – and at a multiple of IVQ 2017’s estimated earnings annualized of just 6.6x, investors seem to be assuming the ultimate resting place for the BDC’s recurring earnings per share are between $0.70-$0.75.

That’s roughly 30% lower than the $027 IVQ 2017 estimate annualized.

Uncertainty is what creates price volatility and CPTA has plenty of that to offer both on Tuesday when its results are published and for several quarters to come.

Already a Member? Log In

Register for the BDC Reporter

The BDC Reporter has been writing about the changing Business Development Company landscape for a decade. We’ve become the leading publication on the BDC industry, with several thousand readers every month. We offer a broad range of free articles like this one, brought to you by an industry veteran and professional investor with 30 years of leveraged finance experience. All you have to do is register, so we can learn a little more about you and your interests. Registration will take only a few seconds.

Sign Up