Alcentra Capital Corporationwebsite
ABDC’s business strategy is to provide first lien senior, second lien senior, subordinated and equity capital to lower middle market companies, here defined as having Earnings Before Interest, Tax & Depreciation (EBITDA) between $5mn-$25mn. The BDC is comfortable lending at all levels of the capital with debt investments spread proportionately across the tranches. Equity investments typically account for less than 10% of the portfolio and occur in one of two portfolio companies, and tend to be for minority stakes. The goal is to generate a high yield from income producing investments in the low teens, an above average proportion of which is in Pay-In-Kind form, typically repaid only at maturity. The External Manager focuses principally on transactions where capital is needed for “growth initiatives”, which ABDC argue tend to be less leveraged than average in order to allow for company expansion, and to reap potential capital gains from the equity stakes. One of the results of this approach is that the External Manager gravitates to sectors which are experiencing above average growth, and which the Alcentra Group has analysts who possess specialized expertise, to identify suitable candidates.
ABDC funds itself with an admixture of a Senior Secured Revolver , to which all the portfolio assets are pledged and unsecured Inter Notes. Roughly speaking, the maturity of the debt facilities match the average life of the portfolio investments and are rolled forward within a year or two of expiry. Given the higher risk, illiquid nature of ABDC’s portfolio assets, the BDC tends to fund itself predominantly with the Inter Notes, and access unfunded availability to meet liquidity requirements, rather than cash. Roughly speaking, the cost of the Revolver is about half that of the Inter Notes. ABDC has applied for an SBIC license, and may eventually be able to borrow 2x any equity in the form of low cost, interest only debentures issued by the Small Business Administration, but in a separate subsidiary whose assets would not be available as collateral to either the Revolver lender or the Inter Notes holders.
ABDC’s leverage strategy has been conservative by BDC standards. Typically total debt outstanding has funded only one-third of portfolio assets. As a result, Debt To Equity has been close to 0.5 to 1.0, and asset coverage of debt has exceeded 300%, versus the maximum 1 to 1 and 200% required by BDC rules. As mentioned above, the modest leverage policy has the effect of keeping available liquidity – accessed through the Senior Secured Revolver – high at most times.
ABDC is externally managed by a subsidiary of BNY-Mellon owned Alcentra Capital. The Advisor is paid a Management Fee equal to 1.75% of gross assets (less cash). Two standard Incentive Fees are charged: an Income Incentive Fee which is equal to 20% of Net Investment Income and payable if a 2% quarterly hurdle rate return on book equity is achieved. More generously than most ABDC does not charge the fee on non-cash income (viz. PIK) until received in cash. In addition, the Advisor receives 20% of Realized Gains every year, subject to adjustment for prior gain fees paid, as well as Realized and Unrealized losses accumulated. In its short history, the Advisor has been relatively generous in waiving fees due under the incentive agreements to ensure shareholders receive a targeted return, typically 9%. However, any waivers are fully voluntary and more recently the Advisor has not forgone any contracted compensation.
PORTFOLIO CREDIT SNAPSHOT
IIIQ 2016 REVIEW: One step forward, two steps back… Alcentra Capital sold off two Watch List companies after September 2016 quarter end, bringing down a relatively long list of Watch List names that had been at ten, down to eight. However, the Company- which had no Non-Performing companies (Category 5) in its portfolio at mid-year also saw one already under-performing Company unable to service its loan obligations in the IIIQ , and another company, that had been performing fine just three months before, get written off as recently as mid-October. (That brought the Watch List numbers back to 9, or one-third of the entire portfolio).
One notch down in Category 4, Alcentra has a mid-sized investment in an oil services company which the BDC Credit Reporter worries that full recovery is unlikely on, and non-accrual and/or a Realized Loss are the most likely outcomes. That leaves Alcentra with a motley group of 6 other under-performing companies in Category 3. There were no additions or subtractions to the companies involved in the latest period. These businesses could yet turn the corner but the credit trend for half of them is down, and none are yet seen to be improving. In a Worst Case- as shown in a recent review of the BDC’s credit portfolio-the potential losses of income from Watch List companies- most of which (8 of 9) involve debt obligations- could be substantial. On the other hand, the bulk of Watch List dollars and companies remain in the higher rated, less-likely-to-go-wrong, Category 3.
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