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Fee Reductions Coming At Two Major BDCs ?

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NEWS

National Securities’ Chris Testa is kind enough to send the BDC Reporter the firm’s timely BDC stock updates.

We’re always curious by what other analysts of the BDC Sector are observing and we compare and contrast our annual earnings projections against theirs.

Given that we are at the tail-end of earnings season, we’ve been receiving a bevy of reports.

We noted that Mr Testa – who has regular access to the senior managers at the BDCs – is projecting that two firms may be preparing to permanently reduce their compensation arrangements.

First

In a May 15, 2018 note regarding FS Investment (FSIC), National Securities projects the management fee will be reduced by 50 bps to 1.00% on assets from the IQ 2019.

In addition, Mr Testa also projects the dividend of FSIC will be increased, helped by the savings from the fee reduction.

Finally, Mr Testa projects “adjusted Net Investment Income Per Share” for the huge BDC will be on an upward trend this year and next:

We are revising our 2018 adjusted NII/share estimate to $0.84 from $0.88 and our 2019 adjusted NII/share estimate to $0.95 from $0.89.

Second

In another stock report, Mr Testa also projects Ares Capital (ARCC) MIGHT be another BDC prepared to reduce its fees.

Here’s an extract from the May 15, 2018 conclusion:

  • We think that given the size of Ares, consistency of returns, and shareholder friendly actions carried out by the company to this point that it is also possible that they lower management fees, although we do not model that into our assumptions.

  • Reduced fees would also portend to management getting votes to expedite when the increased leverage is available as we think cutting fees concomitant with increasing leverage so that more of the benefits flow through to shareholders would induce shareholders to vote yes.  Being the largest public BDC currently, Ares also has significant institutional shareholder ownership relative to the sector who would more readily understand these benefits, in our opinion.


ANALYSIS

Only one public BDC so far has pro-actively offered its shareholders a permanent fee reduction.

That is Goldman Sachs BDC (GSBD)  which proposed reducing its Management Fee from 1.5% to 1.0%, IF shareholders approve the new higher leverage rule allowed by the Small Business Credit Availability Act.

Here is the May 3, 2018 press release by GSBD on the subject.

(However, there have been multiple fee reductions unrelated to the new leverage rules at other BDCs including Alcentra Capital (ABDC) and Solar Capital (SLRC), not to mention a continuing stream of waivers and temporary concessions big and small by BDC managers seeking to keep the peace with shareholders. We keep a list and it’s a long one).


VIEWS

Followers

If Mr Testa is correct, and if two more BDCs join the fee reduction movement, others could follow.

After all, FSIC is managed by the same Investment Advisor that controls Corporate Capital (CCT), which happens to have just reported its results.

Other candidates for fee concessions would include Apollo Investment (AINV), whose Management Fee is a highly expensive 2.0% of assets.

Less likely – but not impossible – would be a fee drop from Oaktree Specialty Lending (OCSL). However, the Investment Advisor has a huge payment to Fifth Street Asset Management for gaining the right to manage the BDC to consider.

Other candidates might be long term under-performer BlackRock Investment (BKCC) and its soon-to-be sister BDC TCP Capital (TCPC).

BlackRock Inc. might want to relaunch itself into the BDC space – once the TCPC acquisition is approved – with a goodwill gesture.

We could go on but these are just speculations.

Knock On Effect

However, if there is a broad reduction in Management Fees in the BDC space – brought on by the opportunity for managers to benefit from bigger balance sheets thanks to the new Act – expect a short term boost to sector stock prices.

Whatever will happen down the road (and we’re not optimistic) the short term result from this potential munificence by BDC managers would be higher earnings.

Increased Pay-Outs

Moreover – as Mr Testa suggests in the case of FSIC and for a host of reasons outside of compensation levels – this might allow several BDCs to (modestly) increase their dividend levels.

At the moment, the BDC Reporter’s Dividend Outlook is for only 6 BDCs to raise their current distribution between now and IQ 2019.

That number might double – or more – as BDC managers seek to gain support from shareholders for the potential huge increase in their balance sheets thanks to higher leverage levels.

Context

As readers of the BDC Reporter’s Market Recap know, the sector has been in “rally mode” since early May, and trending upwards since March 2018.

We even felt compelled to write a mid-week article on the subject back on May 10, 2018.

Wood On The Fire

If we start to get actual announcements of management fee reductions this could serve as an accelerant for the rally.

At the close on May 14 the price of the UBS Exchange Traded Note with the ticker BDCS, which we use to measure sector-wide trends, was at $20.11.

We’ll use that price as a starting point to determine in the weeks ahead if market enthusiasm for BDC stocks increases from here on.

More To Come

Expect an update from the BDC Reporter either as major BDCs actually cut their fees, or if time passes and they do not.

This is likely, with a number of shareholder votes coming up on the new leverage rules, to play out sooner rather than later.

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