Alcentra Capital Corporation was formed as a Maryland corporation on June 6, 2013 as an externally managed, non-diversified closed-end management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940. Alcentra is managed by Alcentra NY, LLC (the “Adviser”), a registered investment adviser. In addition, for U.S. federal income tax purposes, Alcentra elected to be treated as a regulated investment company commencing with its tax year ending December 31, 2014. The Company was formed for the purpose of acquiring certain assets held by BNY Mellon-Alcentra Mezzanine III, L.P. (the “Partnership”). The Partnership is a Delaware limited partnership, which commenced operations on May 14, 2010. BNY Mellon-Alcentra Mezzanine III (GP), L.P. (the “General Partner”), a Delaware limited liability company, is the General Partner of the Partnership. BNY Mellon-Alcentra Mezzanine Partners (the “Manager”), a division of Alcentra NY and an affiliate of the General Partner, manages the investment activities of the Partnership. Alcentra NY is wholly-owned by BNY Alcentra Group Holdings, Inc. (“Alcentra Group”), which is wholly-owned by The Bank of New York Mellon Corporation.
On May 8, 2014, the Company acquired all of the assets of the Partnership other than its investment in the shares of common stock and warrants to purchase common stock of GTT Communications (the “Fund III Acquired Assets”) for $64.4 million in cash and $91.5 million in shares of Alcentra’s common stock. Concurrent with Alcentra’s acquisition of the Fund III Acquired Assets from the Partnership, Alcentra also purchased for $29 million in cash certain debt investments (the “Warehouse Portfolio”) from Alcentra Group. The Warehouse Portfolio debt investments were originated by the investment professionals of the Adviser and purchased by Alcentra Group using funds under a warehouse credit facility provided by The Bank of New York Mellon Corporation in anticipation of the initial public offering of Alcentra’s shares of common stock. Except for the $1,500 seed capital, the Company had no assets or operations prior to the acquisition of the investment portfolios of the Partnership and as a result, the Partnership is considered a predecessor entity of the Company.
On May 14, 2014, Alcentra completed its initial public offering (the “Offering”), at a price of $15.00 per share. Through its initial public offering the Company sold 6,666,666 shares for gross proceeds of approximately $100 million. Alcentra used $94.2 million of the proceeds from the Offering to fund the purchase of the Warehouse Portfolio, and the cash portion of the consideration paid to Fund III. On June 6, 2014, Alcentra sold 750,000 shares through the underwriters’ exercise of the over-allotment option for gross proceeds of $11,250,000.
On May 17, 2017 Alcentra priced an underwritten primary offering of 808,161 shares of its common stock and a concurrent underwritten secondary offering of 1,691,839 shares of its common stock on behalf of Alcentra NY, LLC and “another selling stockholder” at a public offering price of $13.68 per share. In connection with the proposed offering, the Company granted the underwriters an option to purchase up to an additional 375,000 shares of the Company’s common stock.
TARGET MARKET (S)
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 structure 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 argues, 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.
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.
On April 27, 2017 Alcentra Capital Corporation’s Paul Hatfield was named as Chairman Emeritus of the Company and Paul Echausse appointed as Chairman of the Company’s Board of Directors. In addition to his role as Chairman, Mr. Echausse will continue to serve on the U.S. Direct Lending Investment Committee of the Company’s investment adviser, Alcentra NY, LLC. Also, in conjunction with David Scopelliti’s promotion as Chief Investment Officer of U.S. Direct Lending at the Company’s investment adviser, Mr. Scopelliti has been promoted, effective as of June 30, 2017, to President and Chief Executive Officer of the Company, succeeding Mr. Echausse in those roles. Additionally, effective as of April 21, 2017, Mr. Scopelliti has been elected to join Messrs. Hatfield and Echausse on the Company’s Board of Directors.Other management changes include the promotion of Ellida McMillan to Chief Financial Officer and Chief Operating Officer of the Company and Branko Krmpotic, who co-founded the U.S. middle market strategy with Mr. Echausse in 1998, as the Executive Vice President of the Company.
PORTFOLIO CREDIT SNAPSHOT
IQ 2017: ABDC has 31 portfolio companies, 7 of which are on our Watch List. Right at the bottom, with a Corporate Credit Rating of 5 is Show Media, which has been on the Watch List since the IQ of 2016 and non-accrual since the IVQ 2016. $7.7mn of First Lien debt and common equity has been written down to $1.1mn by the end of the first quarter. Of course, the loss of income is already impacting ABDC and we expect a complete write-off, given the trends.
More disturbing for ABDC are the 3 companies in Category 4, our Worry List, where we anticipate that the likelihood of an eventual loss is greater than that of full recovery. Oil services company Black Diamond Rentals has been a borrower since the IIQ of 2014, with a $13.9mn First Lien Loan due 2018. However, the Company went on our Watch List at the CCR 3 level from the IQ 2016 when the debt was written down (23%), or ($3.1mn). In the next quarter the debt was restructured into a Senior Note and a Subordinated Note, and the rating changed to the CCR 4 or Worry List. The $5.9mn of the former was valued at par but the Sub Note was valued at 50% of cost of $8mn. Since then both tranches have been written down further but an additional advance by ABDC made in the IQ 2017 of $1.3mn is carried at par. Yet another advance was made in April 2017. The Subordinated Debt carries a bargain basement 4% rate, which is already eating into the income ABDC used to generate pre-restructuring of 12.0% on $12.9mn. The rest is at 12% cash pay and 2% PIK.. Both interest rates suggest Black Diamond Rentals ia special situation. In the IQ of 2017, the original two tranches continue to be written down further. We get the impression ABDC is funding the Company on the hopes of a turnaround. The Company generates $2.2mn in annual investment income even now.
Xpress Global Systems is a logistics company, which ABDC has been a lender and investor in since IVQ 2015, with $5.5mn invested. By the IQ 2016, the equity investment in the Company was sharply written down so we added Xpress to our Watch List. That was confirmed the next quarter when the Second Lien debt too was written down by a third, and is nearly (40%) discounted as of the IQ 2017. The Company generates $0.9mn of annual investment income.
Last but not least is My Alarm Center LLC, which just went on the Worry List straight from Performing in the IQ 2017. This is a large syndicated loan which several BDCs are invested in. Total exposure at IVQ 2016 from BDCs was $164mn. ABDC carried its Second Lien loan of $12.6mn at par in the IVQ of 2016. A quarter later the amount involved has increased and the value written down (24%). The equity stake ABDC owned in the business has gone from a premium to nil value. The security company has been growing by debt financed acquisitions and must have hit a speed bump. Even in April, ABDC advanced additional funds, but did admit on its Conference Call that the Company was on its Watch List. At an interest rate of LIBOR + 11.0%, My Alarm Center, LLC generates $1.6mn of annual income. The second lien status is worrying if the Company is facing financial troubles.
At the Watch List level there are another 3 companies: Conisus, LLC, Southern Technical Institute and FST Technical Services. We won’t get into the details of each, but in aggregate these 3 companies are valued at over $45mn, equal to 25% of the latest equity. Income-wise too these companies are major contributors.
In toto, there is around $70mn of ABDC’s $180mn of IQ 2017 in net assets up in the air, or nearly 40%. Just the possible investment income loss from the 3 CCR 4 credits could result in a loss of 15% or more of current Net Investment Income. While we have a Long Term rating of C for ABDC -which means we expect average annual NAV erosion of 2%-4%- the amounts of income and capital at risk are on the high side. Of course, these are only possible losses and the BDC maintains several options, including the ability to convert debt to equity or continue to deficit fund if necessary. We are not changing our long term rating, but can’t help noting the nominal risk is on the high side.
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.
5-17-2017: Updated History section with latest stock offering.
5-17-2017: Updated Management section.