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Triangle Capital: Final Proxy Filed

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NEWS

On June 1, 2018 Triangle Capital (“TCAP”) filed the Proxy for a Special Shareholders meeting to be held on July 24, 2018.

See the attached Schedule 14-A.

The purpose the meeting is to approve the sale of the BDC’s portfolio and the change from an internally managed to an externally managed status.

The new Investment Advisor will be Barings, LLC.

For the background of the transaction, read the BDC Reporter’s articles published on April 4 and April 5, 2018.


ANALYSIS

There are 6  items which TCAP shareholders are being asked to vote on, most of which were previously known.

Shareholders are also being asked to vote on an “advisory, non binding” basis the $17.2mn in severance payments to the BDC’s existing managers.

Moreover, the shareholders are voting on whether to immediately adopt the new higher leverage limitation allowed under the Small Business Credit Availability Act. 

Three of the provisions (the sale of the BDC’s assets to Benefit Street Partners, the issuance of new shares to Barings, LLC and the new Advisory Agreement) are contingent upon each each other.

Although the portfolio sale was initially pegged at $981mn when the transaction was first announced, the Proxy reveals the expected proceeds will be $937mn.

The difference is due to a number of items including net purchases and repayments in the intervening period; net interest income and a “servicing fee” payable to Benefit Street Partners.

The reduction in purchase price is attributable to cash proceeds received by the Company for the repayment of Purchased Loans and redemption of Purchased Equity Interests since December 31, 2017, partially offset by the purchase price of new Purchased Loans and Purchased Equity Interests made during the quarter, and the increase in purchase price attributable to capitalized interest and accrued but unpaid interest and fees. The net reduction in purchase price, however, is offset by cash proceeds that are retained by the Company and therefore does not impact the net asset value of the Company.

Pay Offs

The $937mn (estimated) proceeds will be used to repay outstanding obligations.

As expected TCAP’s existing Revolver and Baby Bonds will be paid off, and any accrued interest.

This amounts to $325mn.

However, still unclear is whether the BDC’s SBIC debentures will be required to be repaid by the SBA.

(Typically, the SBA requires repayment in full of any outstanding debentures following a change of ownership).

This affects $252mn in SBIC debentures outstanding.

Another $26.3mn has been allocated to the afore mentioned severance payments and professional fees.

That will leave $380mn available for re-investment by the new Investment Advisor.

Bonus

In addition, Barings LLC will pay shareholders $85mn, or $1.78 a share each, as additional compensation.

The Proxy makes clear that this payment will be treated as ordinary income for tax purposes.

Skin In The Game

Furthermore, the new Investment Advisor has agreed to purchase $100mn of newly issued stock of the BDC following the consummation of the various transactions envisaged above.

In addition, Barings, LLC is committed to investing another $50mn in common stock in the soon-to-be renamed BDC over a two year period.

The BDC itself is reserving $50mn to purchase shares at below book value following the consummation of the transaction.

The completion of the Externalization Transaction will result in the Company converting from an internally managed BDC to an externally managed BDC that is managed by Barings. The Stockholder Payment, together with the consideration to be paid by Barings in connection with the Stock Issuance and the Open Market Purchases, results in a total financial commitment by Barings with respect to the Externalization Transaction of $235 million.

The Proxy calculates that Barings, LLC – assuming the deal goes through – will own a 19% stake in the BDC, which could rise to 24%. (See page 24 of the Proxy).

Fees

No changes have been made to the proposed incentive compensation for the new External Manager. Here is a useful summary:

Under the Advisory Agreement, the Company would pay Barings as compensation for the investment advisory and management services consisting of two components: (i) a base management fee (the “Base Management Fee”) and (ii) an incentive fee (the “Incentive Fee”). The Base Management Fee under the Advisory Agreement will be 1.0% of gross assets for the period commencing on the date of the Advisory Agreement through December 31, 2018; 1.125% of gross assets for the period commencing on January 1, 2019 through December 31, 2019; and 1.375% of gross assets for all periods thereafter. “Gross assets” includes any investments made with borrowings, but excludes any cash or cash equivalents.

The Incentive Fee payable under the Advisory Agreement will consist of two parts: (1) a portion based on the Company’s pre-incentive fee net investment income (the “Income-Based Fee”) and (2) a portion based on the net capital gains received on the Company’s portfolio of securities on a cumulative basis for each calendar year, net of all realized capital losses and all unrealized capital depreciation for that same calendar year (the “CapitalGains Fee”). The Income-Based Fee will be 20% of the Company’s pre-incentive fee net investment income during the immediately preceding quarter with a 2% per quarter (8% annualized) hurdle rate. However, beginning for each quarter ending on or after January 1, 2020, the Income-Based Fee will also be subject to a three-year look-back as further described in this proxy statement under the section captioned “Proposal 3 – Approval of the Advisory Agreement.” The Capital Gains Fee will be 20%, which will be determined and payable in arrears as of the end of each calendar year (or upon termination of the Advisory Agreement), commencing with the calendar year ending on December 31, 2018.

In A Hurry

The Board of TCAP has already approved the increase in leverage allowed under the Small Business Credit Availability Act on April 3, 2018.

As part of the Special Meeting, the shareholders are being asked to agree to the change, which would make the new rule immediately effective, as opposed to waiting till April 2019.

New Identity

The new name will be “Barings BDC, Inc.” and the new ticker will be “BBDC“.

A closing will occur three days after an affirmative vote is received.

Thinking The Unthinkable

Should shareholders not approve the transactions envisaged, TCAP will remain internally managed and the Board will consider other alternatives.


VIEWS

More Or Less As Expected

There is not a great deal of new information in the Proxy except what we’ve highlighted above.

Nor is there much of a chance that TCAP shareholders will vote against the proposals, given that the alternative would be a maintenance of the status quo.

That’s because the managers of TCAP have completely lost investor confidence, and clearly have both feet out the door.

Good Price

Moreover, the purchase price to be paid by Benefit Street Partners remains a very good deal for TCAP, unlikely to be matched elsewhere.

The Above Notwithstanding…

Nonetheless, the BDC Reporter has a few observations to make that existing or prospective shareholders might want to take into account.

First, the Management Fee which Barings,LCC proposes to charge starts out fair (1.0% of assets) but quickly reverts to something less attractive.

In less than 18 months – shortly after the BDC gets fully invested in its new strategic direction – the Management Fee increases by a third.

Comparing And Contrasting

By comparison, Goldman Sachs BDC (GSBD)  has recently set the new bar for the industry with a permanent Management Fee of 1.00%.

Of course, GSBD’s kind offer comes with the proviso that shareholders approve the new leverage rules.

TCAP shareholders are also being asked – essentially under duress when no other options are available – to approve the same doubling of maximum leverage allowable, but at a substantially higher management fee.

Dollar And Cents Consequences

This is no academic issue, but will affect both the new BDC’s risk profile (as BBDC will now be much more leveraged than in the past) and shareholder returns.

We estimate that incremental net recurring earnings on assets purchased with debt will drop to 1.5% from 1.8%, or 20%,  as the Management Fee increases from 2020.

That’s before we consider a provision for credit losses – a subject that BDC managers, analysts and some investors tend to forget about when considering returns.

A Plus

On the positive side, Barings, LLC has agreed to a “look-back” feature, which might reduce the Incentive Fee down the road.

However, that does even begin to kick in till January 2020, causing a full  Incentive Fee to be paid even if the value of the Barings,LLC assembled portfolio drops in the next 18 months.

Another Plus

As before we remain impressed with the amount of stock that the new Investment Advisor is purchasing in BBDC.

Compare that investment to what Oaktree Capital (OAK)  has not done when taking control of Oaktree Specialty Lending (OSCL) and Oaktree Strategic Income (OCSI).

Why The Hurry ?

We would have preferred if the new External Manager – like so many of its peers – had held off adopting the new leverage limit until a more exhaustive study of the pros and cons had been effected.

Requiring shareholders to say yes to much, much higher leverage with an untested Investment Advisor which has never run a BDC before and whose strategic approach exists only on paper,  feels unduly pushy.

After all, whatever Barings, LLC’s track record in the debt arena, we are very late into the current economic cycle, and purchase prices and leverage multiples are at or close to all time highs; lender protections are at record lows and we face an uncertain future where interest rates are concerned.

An automatic shift to higher leverage mode may not be in shareholders long term interest at this stage.

Conclusion

With all that said, the overall package being offered TCAP’s shareholders – even when adjusting for the high severance costs – is far better than the status quo ante.

Moreover, when comparing with other recent change in advisory control transactions, the offer being made to the BDC’s shareholders in the Barings,LLC/Benefit Street deal is materially superior to what Oaktree, Oak Hill and even Ares Capital have offered up.

We expect shareholders to provide a resounding Yes Please, and the change of ownership,format and strategy to kick in from August 2018.

That’s just round the corner.

We should be listening to the BBDC Conference Call within a few weeks.

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