INTRODUCTION

Even the occasional BDC observer will know that BlackRock TCP Capital (TCPC) has been underperforming of late, both in terms of fundamentals and price performance. In regards to the former, the mid-sized BDC with a big name external manager saw its net asset value per share (NAVPS) fall (8.4%) in the IIQ 2024 – the worst performance of all the BDCs we cover in the BDC NAV Change Table. Nor was this a one-time hit. Since the end of 2021, TCPC’s NAVPS has fallen (29%). Net realized losses this quarter came to ($36mn) but have amounted to ($163mn) in aggregate from 2019-June 2024. That’s equal to one-third of all the Net Investment Income generated by the BDC in this period.

Downward

Price-wise, since hitting a peak of $15.05 a share in June 2021, TCPC has been in constant decline for the past 3 years, as the chart below demonstrates. Intra-day on August 13, 2024, TCPC was at (yet another) 52-week low $8.59 a share.

In fact, except for a few months during the Covid crisis, TCPC is at an all-time low in its 12 year history. Furthermore, according to Seeking Alpha data, the BDC is the third worst price performer amongst the 42 BDCs we cover in 2024 YTD; the second worst over 1 year and 5th from the bottom over 3 years. In the past week, TCPC leads the pack of price underperformers – (13%) down and counting.

$64,000 Question

So what has happened at TCPC to cause such poor performance and such monumental losses in what has been a relatively auspicious time to be a BDC lender? One’s tempted to point back to 2018 when BlackRock acquired Tennenbaum Capital Partners and – by extension – the external management of the BDC. By that point, the BDC had been launched and managed by Tennenbaum for six years and had produced solid results. At the time of the take-over, the BDC’s NAVPS was $14.61, its Net Investment Income Per Share annualizing at $1.64 and the annual payout for 2018 came to $1.40. On the day the acquisition was completed, TCPC traded at a price of $14.84, a modest premium to its NAVPS.

Timing Is Everything

To be fair, though, BlackRock left Tennenbaum’s strategy and management team in place after the acquisition. Even the name of the BDC consisted of a compound of both managers and the ticker remained – as today – TCPC. Maybe Tennenbaum sold at just the right time. Our BDC NAV Change Table shows that TCPC’s NAVPS peaked in the IQ 2018 – just before the merger. One year after the acquisition, the NAVPS had dropped to $13.64 – a (7%) drop and fell to $11.76 in the IQ 2020 at the very bottom of the Covid crisis.

Head Fake

In the next 7 quarters, though TCPC had a resurgence, booking higher NAVPS every quarter but one and reaching $14.36 at the end of 2021 22% over the Covid low as assets that had been written down rebounded in value. In 2021, NIIPS came to $1.26 and the year’s dividend payouts to $1.20, The stock price – already in decline – closed at $13.51 – implying a historic price to earnings multiple of 10.7x.

Changes At The Top

As we’ve already noted, performance in the ensuing two and a half years has greatly deteriorated and the merger into BlackRock’s other public BDC – BKCC- did not arrest the downturn. By the way, around this time the co-founder of Tennenbaum and the Chairman/CEO of the BDC – Howard Levkovitz – bowed out. He was replaced by Raj Vig, who was the “President and Managing Partner”. Other managerial changes have occurred in recent years in the CFO, COO and Investor Relations roles.

Root Of The Matter

Clearly, TCPC’s post-2021 travails have everything to do with weak credit underwriting. As mentioned, the BDC has been booking many realized losses quarter over quarter. As this table shows – drawn from TCPC’s Investor Presentation – in each of the last 5 quarters, the BDC has booked a loss. Moreover – and more important – these are large losses – twice exceeding the NII in the period.

In fact, over the last 10 quarters, TCPC has booked a loss 9 times. Its only quarter’s gain was a very modest one.

Accelerating

Unfortunately, in the most recent quarter the credit situation got even worse. The metric that most investors probably noted is that the number of non-performing companies in the 158 company portfolio DOUBLED, from 5 to 10. 6 new non-accruals were added and the only one that was removed was Thras.io, which resulted in a large realized loss following a restructuring. Total losses – both realized and unrealized – were the highest we’ve seen at ($87mn).

Current Picture

Our sister publication – the BDC Credit Reporter – has taken the last two days to review TCPC’s portfolio. Unfortunately, management does not offer a quarterly investment rating snapshot of its portfolio as do many of its peers, so we have to rely on our own analysis. We identified 16 companies that are under-performing to varying degrees, with an aggregate cost of $381mn, or 18% of the portfolio at cost. By our count, the fair market value (FMV) of those investments came to $220mn, or 11% of TCPC’s portfolio.

Not Pretty

Management does publish non-accrual data and we heard from them that the cost of all non-accruals amounted to 10.5% of the portfolio at cost and 4.9% at FMV. This is high by BDC standards and suggests recoveries are likely to be below 50%. Of the 10 non-accruals – as we mentioned – 6 arrived in the IIQ 2024 and 2 others in the IQ 2024.

Everywhere They Turn

TCPC has managed to embroil itself in many troubled situations much in the news of late including the failure of Pluralsight (soon to be lender owned after a huge loss by Vista Equity); Magenta Buyer (McAfee) which is the subject of much disputation between lenders and the owner even as we write this; Khoros (aka Lithium) and several more. Lesser known trouble spots like INH Buyer” and Seller X Gmbh appeared almost out of the blue this quarter after being valued close to par till very recently and compounding the BDC’s loss of book value, income and investor confidence.

Delving

We tried to discern some patterns in TCPC’s most troubled investments that might help us evaluate what’s happening. The manager does appear to consider itself an expert in funding e-commerce platforms and booked multiple borrowers in this category with disappointing results. Besides Thrasio, we got the default of SellerX and credit weakness at another German company Razor Group. TCPC argues that this will eventually all turn out alright as the industry re-sizes itself but as of now there’s an inordinate amount of the proverbial “blood in the streets”.

A Perennial Weak Spot

We also notice that many second lien loans figure in the most difficult credit situations. Unfortunately for TCPC and its shareholders junior debt is always at higher risk of default. This is only the more so when higher interest rates have made many leveraged balance sheets untenable. Typically the lenders involved get wiped out or receive a pittance in equity. It’s no wonder TCPC management has been talking recently of “moving up the balance sheet” on new loans and avoiding more second lien exposure. That’s good – even if income will suffer – but is akin to closing the barn door after your prize horse has vacated the premises.

Not So Granular

Like many BDCs, TCPC has sought to build a highly diversified portfolio. According to its latest conference call average company exposure is only $12.5mn. Unfortunately, the BDC allows itself to occasionally take on individual company exposure much greater than that. Of the 16 underperforming companies we identified, 12 had a cost balance above the portfolio average. In the case of Razor Group – for example – the outstandings are 5x greater than the average. If TCPC had kept its exposure to those 12 companies at $12.5mn, the total cost of its troubled investments would be (60%) lower. In credit, diversification can be a wonderful thing.

Looking Forward

TCPC’s management do not concede that they have a credit problem – besides a shift away from second lien loans – and are not proposing to change anything going forward. This quarter’s red ink is blamed – essentially – on bad luck, as expressed by the CEO in the most recent conference call:

During the second quarter, our NAV declined 8.4%, and we added 6 portfolio companies to non-accrual status, taking non-accruals from approximately 1.7% to 4.9% of fair value. While this increase is clearly notable and disappointing, it’s important to point out that for the most part the change is due to a set of factors at each individual company level that are wholly unrelated but coincidentally converge this quarter to drive the non-accrual levels. More importantly, these changes do not change our view of the overall strong health of our portfolio.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEOTCPC – IIQ 2024 Conference Call

Analysis

Given what we’ve noted about TCPC’s commitment to funding e-commerce aggregators, we wouldn’t say the factors involved are “wholly unrelated”. One could also argue that the BDC has a predilection for “software” related companies – once thought to be impervious to the business cycle. Typically, anything “software” has tended to be highly leveraged and – thus – susceptible to being unable to service its debt when interest rates shot up.

Resilient

The good news is that most of the troubled companies seem to have balance sheet challenges rather than flawed business models. Once restructured – typically with the lenders becoming owners as is likely to be the case with most of TCPC’s delinquent borrowers – these businesses might thrive. Down the road, TCPC may book realized equity gains on Thrasio; Pluralsight; SellerX; Khoros etc. However, in the short run, income is likely to be greatly reduced for years to come and TCPC will have to continually decide whether to support these businesses with more funds to ensure their success.

Are We There Yet?

Looking down the list of TCPC’s currently under-performing companies, most seem to have taken the bulk of their valuation knocks and loss of income. Or, in other words, most of the damage is done. The BDC Credit Reporter estimates that further losses amongst the largest, most troubled companies could reach just short of ($60mn). That amounts to about ($0.70) a share and would bring TCPC’s NAVPS from $10.20 currently to $9.50 – a (7%) further drop. That’s also (33%) lower than the BDC’s NAVPS at the end of 2021.

Less

Just as importantly, we’ve been only able to identify 3 companies that are modestly under-performing which could wreak further damage in the future – or 2% of all portfolio companies. With that said, companies that are currently solidly in the performing category could begin to deteriorate, enlarging our list of underperformers. Our analysis in the public record can only go so far and we may yet be surprised.

CONCLUSION

Bluntly Speaking

We do believe TCPC is “credit challenged”, and both the metrics and the market support our view. Compared to its peers and longer-term sector metrics, we consider the BDC to be performing BELOW NORMAL, which means that much of what is earned in recurring income is going out of the back in the form of capital losses. Unfortunately, there is no guarantee – given no change in credit behavior – that this will not continue in the future.

Foreseeable

However – in the short term – we may see losses plateau or increase much more slowly. We would expect that restructurings underway should reduce the total number of non-accruals announced in the IIIQ and IVQ 2024 , but not without substantial realized losses and more tenable further write-downs from the IIQ 2024 value levels. There’s also a fighting chance that losses booked in the last two and a half years will be offset – to some degree – by realized gains from equity acquired. Realistically that won’t happen till 2025 or later.

Finally

Could TCPC turn out to be a credit disaster for its shareholders over the long term? There have been several others over the years – BDCs whose NAVPS was in constant decline and eventually caused their asset manager to pull the plug in some way. (Losses like the ones we’ve experienced surely must represent a reputational embarrassment for BlackRock or is the firm so huge – and TCPC so relatively small – to be invisible? ). We’re not sure at time of writing, based on the data. Although we suspect the worst is over for awhile, there’s no guarantee that two or three years out TCPC’s NAVPS could not be in the middle single digits. These declines are very hard to stop once they get going as has been the case for two and a half years. It is too early to say a turning point has been reached, but we expect some investors will take that bet given how low the stock price has gone.