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Alcentra Capital: Key Issue Preview

BDCs:
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With IQ 2018 earnings season round the corner, the BDC Reporter is highlighting for as many BDCs as possible the key issue investors should be looking out for when earnings are reported and Conference Calls held.


Great Expectations

You might expect that after booking large credit losses in recent quarters which forced a dividend reduction, credit would be the key issue at Alcentra Capital (ABDC).

That’s right, but not in the way one might have supposed, as we’ll show.

We’ve spent more time on ABDC’s  portfolio  than most others and identify 9 Watch List names out of 29 companies on the books

At first glance, that’s a high number and may partly explain why the stock trades at a (45%) discount to book.

Surprise !

However , here is the ironic Good News.

5 of the Watch List are non performing or non income producing already, and have been essentially written off with the exception of Conisus,LLC.

That restructured credit (mostly into Preferred) is worth $6.7mn.

In our Realistic Case, we expect a full write-off or $0.50 per share, but no impact on income.

We Worry

Then there are two Worry List credits (those more likely to move to non performing than return to normal).

One was IGT, which has since been repaid in January 2018 (at par, no less)  and XPress Global, which may be rebounding (just opening a new location in Florida). 

Also On The List

Then there are two borrowers we’re less IMMEDIATELY worried about.

The most problematic is Black Diamond Rentals. There are 3 facilities. Two are already in default.

A $2.2mn senior loan is still performing but might join the other two on non accrual.

In total, ABDC has $11.2mn in FMV still outstanding.

If this all went belly up that another $0.84 per share but income impact minimal ($0.30mn).

With oil prices jumping and business activity increasing, though, Black Diamond Rentals appears to have the wind at its back.

Then there’s the restructured position in My Alarm Center.

Non income producing says the 10-K but still $4.2mn at risk. No reason to believe anything is going wrong – or right – at this security company roll-up.

Credit Risk Summary

So the credit risk at ABDC in the short term appears to be relatively modest.

Of course, we only have sketchy information at the best of times and there could be new names popping out of the 20 loans still in the Performing column.

Worth noting is that, by the BDC Reporter’s standards,  half the performing companies have one or more loans with unusually high rates (12% or higher) and/or a high proportion of Pay-In-Kind income.

Those type of loans – as common sense would dictate – are more likely to default than even the average leveraged loan.

As a result, credit profile risk at ABDC remains elevated.

Lower Gear

The more pressing threat to ABDC’s earnings is  likely to come from the necessary shift into lower yielding assets caused by all those recent and potential losses.

As of the fourth quarter of 2017 ABDC was booking $1.12 of annualized Net Investment Income Per Share thanks to a portfolio yield of 11.3%.

Management has already indicated it’s intention to materially de-risk the portfolio and swap out some of those high risk-high return loans for “safer”, single digit yield loans.

That Net Investment Income Per Share could drop a great deal if the portfolio yield drops by just 1% to 10.3%.

We calculate – very roughly – close to a $0.20 drop to $0.92.

That would probably cause another dividend cut and that’s before assuming any further income lost to the above credit uncertainties.

However, the drop in portfolio yield is likely to take several quarters to play out.

CONCLUSION

The chances of ABDC holding onto its $0.72 dividend for another year are 50/50.

We have a Dividend Outlook of AT RISK.

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