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Triangle Capital: First Thoughts About The Two Step Sale

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NEWS

The BDC Reporter was in the midst of writing about S&P’s drastic decision to place its outlook to “negative” on multiple public BDCs while simultaneously affirming their “issuer credit ratings” when we saw the press release about the resolution of Triangle Capital’s (TCAP) “strategic alternatives” exploration. See attached.


ANALYSIS

Apparently, the troubled BDC is selling its default ridden and high risk investment portfolio to a third party: an affiliate of Benefit Street Partners for $981.2mn in cash.

At the same time, the BDC is ceasing to be internally managed and will add Barings, LLC (or an affiliate) as its Investment Advisor.

For that privilege – and the right to charge fees on the near $1.0bn of assets now in cash form – Barings will pay the BDC’s shareholders $85.0mn or $1.78 per share.

That Barings payment will be distributed to TCAP’s shareholders – if they approve this Texas two step of a deal.


VIEWS

This is a very intriguing deal because – at a stroke – TCAP divests itself of all its credit baggage, but also all its income generation.

No wonder that Barings has already announced that immediately following the closing, TCAP will stop paying any distribution.

The new Investment Advisor will presumably get to work re-investing the proceeds received from Benefit Street, and will be investing $100mn in the recast BDC.

Between its payment to TCAP’s shareholders, direct investment and pre-determined stock buyback monies, Barings is committing up to $235mn.

On the other hand, the new External Manager – if we assume average fees of 3% between Management and Incentive payments and a $1.0bn asset portfolio that could increase to $2.0bn under the new BDC rules- could earn $60mn a year in compensation and a very theoretical half a billion or more over the next decade.

Setting aside the direct equity investment at the outset and the shares to be bought in the open market, which will have value in their own right given that the underlying assets are cash, Barings should recover all their $85mn investment for the management contract in a year and a half.

That’s a canny move by TCAP’s new Investment Advisor.

To Be Determined

Of course, there are many items that need to resolved for shareholders and investors to get a full picture.

What will be the actual fee structure ?

What will be the investment strategy ?

How much leverage will TCAP use and what type ?

Will TCAP re-apply for an SBIC license ? (We’re assuming its SBA licenses will terminate with this deal).

What will the new Advisor’s dividend approach be ?

Etc.

Unopiniated

We won’t seek to weigh in on whether this is a Good Deal or a Bad Deal for TCAP shareholders.

Certainly there will be numerous opinions out there.

However, we’ll wait till the whole package in this unusual deal is known.

Look Back 

Instead, we’d like to take a moment to take in the remarkable arc that TCAP has gone through.

The BDC was one of only 4 out of 21 that was active during the Great Recession AND managed to avoid any reduction in its distribution.

For years during the subsequent expansion TCAP achieved the difficult feat of investing in riskier credits while keeping losses low and operating expenses lower.

As a result, TCAP was an investor favorite for several years as the BDC achieved double digit returns on book equity.

TCAP’s stock price – like Main Street Capital’s (MAIN) then and now – usually traded at a huuuge premium to book value.

The regular dividend was supplemented by a semi-regular Special Distribution, drawn from multiple Realized Gains.

Unfortunately, by 2014 the first signs started to appear that lenders can’t have their cake and eat it too.

More and more troubled loans started to appear.

What seemed at first like a normal run of bad luck (which happens in credit) metastsized into chronic bad debts.

A new CEO – plucked from the ranks – promised a new “safer” approach to leveraged lending and a “trust us, we’re getting there” message to investors.

However, TCAP did not get there.

The last time we looked hard at the portfolio we were shocked by how broadly credit problems had spread.

More importantly in terms of shareholder relations this happened quickly and after improvements were expected following the booking of many Realized Losses.

Lucky ?

Thanks to a still buoyant leveraged debt market which has allowed TCAP to jettison its portfolio at only a modest discount to par and the value to an asset manager of all that permanent capital and those juicy, recurring fees, the ultimate price for TCAP will be better than we might have expected, and greater than “deserved”.

On the other hand, let’s not forget this was a stock that not so long ago traded at $30 a share.

 

Pushing the credit envelope by management – who will receive handsome severance payments and will be able to cash in their stock holdings – will cause investors who bought into the track record and promise of the BDC back in 2013 to lose about two-thirds of their stake.

Even if you bought into TCAP a year ago the price was just shy of $20.0 a share, suggesting a 30%-40% loss in price terms since.

Educational

There are lessons here for long term BDC investors:

First, just because a BDC is “internally managed” that’s no guarantee of success. If TCAP is not enough proof think of MCG Capital (swallowed up by PennantPark Floating Rate); Allied Capital (bought up by Ares Capital) and KCAP Financial (still hanging in there but having lost  four fifths of its value).

Second, eternal vigilance is necessary about BDC portfolios, especially those in the more junior tranches of borrowers capital structures. When these essentially unsecured loans go bad complete or near complete loss of capital is likely. By no means are we saying that all higher risk taking lenders are doomed to follow TCAP to the BDC graveyard. We believe there are several players whose credit underwriting and business model make for very good investments. Nonetheless, nobody is immune to bad debts and junior lenders lose more and faster.

Third, take management’s reassurances and updates with a grain of salt. Yes, BDC managers have a fiduciary duty to be forthright about credit problems. However, they also have a duty to try and keep market confidence high, both in the stock and in the lending capacity of the firm.Then there’s human nature, and the need to believe in a brighter future. Because of this, BDC shareholders cannot rely exclusively on management’s credit assessments but must seek independent perspectives. From our own digging into BDC portfolios loan-by-loan we know it’s hard, the information available is patchy and drawing hard conclusions sometimes difficult. Nonetheless – and again from our own experience with TCAP (of which we used to be a big fan) – some of the credit weaknesses were showing up well in advance of the stock price collapse.

More reason to subscribe to the BDC Reporter and more reason for the BDC Reporter to spend more tedious hours looking under rocks.

In any case, we’ll be updating this Breaking News in the days ahead.

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