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Early Highlights From IIQ 2018 BDC Earnings Season

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NEWS

First Round

Since the beginning of the second quarter 2018 earnings season and the close of the market on August 2, nine BDCs have reported results.

All the earnings press releases can be found in the Daily News Table, along with the BDC Reporter’s ad hoc commentary based on a partial review.

In each case we have read the earnings press release and some combination of any Investor Presentation, Conference Call transcript and quarterly filing.

Record Keeping

We have input the recurring earnings per share for the quarter and annualized for each reporting BDC into our database, alongside similar data from the first calendar quarter of 2018.

Moreover, we have compared these actual results against the BDC Reporter’s full year recurring earnings projection that we prepare for each of the BDCs in our coverage universe. See “2018 NIIPS E” column.

This allows us to compare actual results against our expectations.

Results below expectations gave a red background, above a green background and those within our expectations an orange background.

Based on the latest results – and from information gathered in our research – we project out for each BDC likely earnings for the next 12 months on a rolling basis.

This allows us to determine what earnings are likely to be against our earlier calendar year estimate and against the current recurring distribution.

See the table below:


ANALYSIS/VIEWS

We are roughly a quarter of the way through the earnings season at this point.

Here are the key takeaways from this initial review of a varied group of reporting BDCs:

First, there has not been any unexpectedly poor results published by any of the BDCs involved.

Typically in every reporting period one or more BDCs report results substantially below both market expectations and our own.

To date, there has been no catastrophe.

The Market Speaks

This is reflected in market prices in the past 24-48 hours, which we’ve analyzed for any signs of investor panic.

There has been none of the 10-30% price drops associated with BDCs posting unexpectedly poor results.

However, a few BDCs have seen some investors jump ship as results were not as strong as expected.

Oxford Square

As first discussed in an earlier article, Oxford Square (OXSQ) has now dropped by (5.7%) in three days from its opening price.

Investors may have expected more than the $0.17 Adjusted Net Investment Income Per Share achieved and worry about another quarter of earnings “not covering” the distribution.

That other CLO focused BDC

Likewise, but in only one business day after reporting its results after the close on August 1, KCAP Financial (KCAP) dropped over (5%).

KCAP had seemed to promise to observers an increasing earnings profile after several quarters of successful financial engineering.

Instead, recurring earnings were unchanged for another quarter as CLO income dropped off.

Not helping was a drop in the BDC’s book value from $4.85 to $4.72 per share.

Promises by management on the Conference Call that when loan activity picks up the result might be different do not appear to have succeeded.

KCAP trades in the bottom third of the last 52 weeks trading range, 9% off its 52 Week Low and 21% off its highest point and 33% below book value.

Now For Some Good News

However, most of the reporting BDCs had good news to impart, whether expected by investors or not.

Both by the BDC Reporter’s own expectations and in absolute terms, Horizon Technology (HRZN), TPG Specialty (TSLX) and Triple Point Venture (TPVG) reported good earnings results.

New High

The TPVG CEO called their IIQ 2018 results “fantastic” as Net Investment Income Per Share hit a record at $0.50.

Without committing themselves, the management seemed to suggest a dividend increase or a big Special Dividend (or both !) might be in the cards going forward.

Still, investors kept their cool and only increased the stock price by 0.7%.

The stock was already flying high and closed at 97% of the 52 Week High and at a 2% premium to book value.

On The Horizon

That other venture-debt lender – HRZN – buoyed by an unusually high portfolio yield and an increasing portfolio grew earnings over the prior period.

Still, HRZN is still playing catch up with its distribution. Earnings were 1 cent below the $0.30 paid out quarterly.

Without benefit of a review of the 10-Q, we project the bogey is likely to be met in the next 12 months, but in that uneven manner which venture debt investors are accustomed to.

(Earnings swing sharply from quarter to quarter based on unpredictable and unmanageable portfolio company repayments and M&A activity).

Since announcing results, HRZN is up 2.0% in 48 hours.

Elsewhere

Ares Capital (ARCC) – still the BDC sector leader in many ways – reported unchanged Core Earnings, but boasted both a big jump in book value and a small dividend increase.

The former was the fruit of the sale of an American Capital portfolio company at a great premium. 

The latter may have been actuated by the need to demonstrate – after 24 quarters of an unchanged distribution – that the BDC can increase its payout in advance of higher leverage.

At least one analyst on the Conference Call – and the BDC Reporter as well – seemed taken aback by the welcome decision.

Admittedly recurring earnings may be barely covering the new distribution level (and is goosed by the temporary fee waivers in place), but ARCC has a small mountain of undistributed gains to draw from.

Here too – as with TPVG – shareholders may be in line to receive both quarterly and Special Distributions in the months ahead.

Heard On The Street

ARCC’s stock price – though – went nowhere on the news of one of the biggest Realized Gains in the BDC’s history and a once-in-6 -years dividend increase.

Market participants appear to have gotten the word some time ago that something was afoot.

As a 1 month chart shows, ARCC’s stock price is up 4.8% in the last month versus 2.3% for the sector wide BDCS.

At $17.24, ARCC is trading just off its 52 Week High of $17.32 and not very far off its post-Great Recession top levels.

Family Plan

Both the Gladstone BDCs – for different reasons – reported good results.

Gladstone Investment (GAIN) saw a big jump in its book value aided by a portfolio company sale at a profit.

Recurring earnings went nowhere.

At Gladstone Capital (GLAD), recurring earnings “jumped” a cent a share.

However, that’s better than it seems given that the manager did not have to subsidize the shareholders with a voluntary fee waiver as before.

GLAD and GAIN were also able to boast of getting one of their shared non accrual companies back to performing status.

Admittedly this was achieved by taking control of the borrower and sharply reducing the interest burden, but that may work.

Time will tell.

Worst For Last

From a performance standpoint, the least impressive BDC to report was BlackRock Capital (BKCC).

Admittedly earnings per share at $0.16 was only unchanged, but still off the $0.18 dividend.

Still, that’s after a huge fee waiver by the External Manager and despite much buying back of stock.

Credit Trouble

More disturbing for the future is that a major portfolio company called Oxford Mining (also known as Westmoreland Resource Partners) has gotten into trouble.

(Who would have guessed that coal mining might be a dangerous sector to lend to ? In this case BKCC is the only BDC lender with exposure).

BKCC has lent $26.4mn to Oxford in a First Lien loan whose risk was probably evident based on the rate being charged.

The loan is priced at L + 850bps AND a 3.0% PIK.

The PIK is already on non accrual and if the cash portion follows suit close to $3.0mn of Investment Income could be lost, temporarily or permanently.

That could knock 6%-7% off BKCC’s Net Investment Income all by itself. 

Not Alone

We have a couple of other BKCC borrowers ability we’re worrying about but Oxford is the key concern.

Observations

Management itself seems to have lost its nerve where lending is concerned  – or maybe its External Manager’s support – and is mostly funnelling capital into Gordon Brothers or its Joint Venture.

The former is a finance company involved in asset based lending and the other a vehicle in which to invest in liquid, lower risk loans.

That’s fine as a stop gap measure and keeps the lights on.

(For example, Gordon Brothers advances yield 13.0%).

However can BKCC justify its existence as a doorway to investing in other debt vehicles ?

Like A Salmon, We Return To This Notion

The BDC Reporter continues to wonder what’s next for BKCC, especially as BlackRock just completed the purchase of Tennenbaum Capital  Partners, LLC (see the Daily News) and the management team running TCPC.

The CEO of BKCC continues to be titled “Interim” and no word was spoken – and no analyst asked – what the future might hold.

As frequent readers will know, the BDC Reporter – wearing its psychic hat – continues to believe that BlackRock will fold its two public BDCs into one another with TCPC the surviving entity.

However, for that to happen more readily we imagine BlackRock will look to “stabilize”  BKCC’s portfolio and its NAV.

This quarter, the setbacks at Oxford and at KAGY Holding – whose Preferred was written down by $10.6mn in one quarter were partly offset by higher valuation at U.S. Well Services.

That has partly disguised what could have been an even bigger loss in book value.

Patient Or Foolish Money ?

The above notwithstanding, BKCC investors have kept their calm in the face of this less than stellar performance.

That’s partly due to the fact that BKCC already trades at a (20%) discount to book and yields nearly 12.0%.

However, we can’t help believing that other shareholders – like us – are holding on the assumption that BlackRock, Inc. will “do something” to protect its shareholders.

Like a book value merge into TCPC…

After all, since BlackRock took full control of BKCC with much hoopla back in 2015 the stock price has dropped (30%) as this chart shows.

We shall see…

Final Note

The BDC Reporter will be very busy for the next couple of weeks reading and reporting on the seemingly endless flow of earnings results.

(That’s why the BDC Reporter is the biggest fan out there for BDC consolidation…)

So far, and without digging too deep into the data, most everything is going as one would expect.

Snowflakes

As always – though – there are many differences between the players.

Each has to be taken in turn to be properly understood and not as a group, even those of similar size and/or business strategy.

Litmus Test

We can already see with different BDCs adopting different postures towards the leverage allowed under the Small Business Credit Availability Act that there are going to be ever wider differences in performance over time.

Just with the 9 BDCs that have reported so far we’ve heard from some who are intending to take full advantage of the higher leverage and push up towards 2:1 eventually.

Others are aiming at a mid point between the current and new levels.

Then there are some who promise only to reach up to not much more than one to one debt to equity.

Unanimous

Note, though, that ALL the BDCs in our table above – as we suspected from the start – have signed up for the lower asset coverage and higher leverage allowed by the Act.

Moreover, nobody is talking about de-emphasizing their SBIC subsidiaries or Joint Ventures or third party managed finance companies.

On the contrary. Please see what ARCC, TSLX and HRZN have to say on this subject on their Conference Calls.

The Long March

So continues the inexorable and apparently inevitable “leveraging up” of the BDC model.

We hope the promise of higher earnings and distributions will be worth the growing credit risks associated with adding anywhere (we make a calculation for each name) between 20%-80% more assets to BDC portfolios, all financed with borrowed money.

The BDC Reporter will continue to look at that phenomenon even as we report on these fleeting changes in earnings and outlook.

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