Monday, January 31, 2011

BDC Weekly Roundup 1/31/2011

The BDCR Index reclaimed last week's losses and rose by an amount of 3.88% from a level of 314.07 on 1/21/2011 to 326.74 for the week ending 1/28/2011. The major winners were TINY (+11.53%) and FSC (+10.81%) and the major losers were GAIN (-5.61%) and GLAD (-0.26%).


Some notable news items:
FSC - Upgraded by Stifel Nicolaus, issues 10million shares today
MCGC - Renews $150m secured credit facility -$150M+Secured+Warehouse+Cradit+Facility+Renewal/6235033.html
PSEC - Makes another large investment -
TINY - Portfolio company BioVex to be acquired -

Wednesday, January 26, 2011

A Look at Dividend Coverage

The Dividend Coverage Ratio is a way to measure how "safe" a dividend is for a firm. For a BDC with a required minimum payout (to avoid taxes), this ratio becomes a little more meaningful. As you can see below, some BDCs will pay out more in dividends than they earned in their current quarter's Net Investment Income.

There are many formulas out there, but this site will use these formulas:

DCR  = Net Investment Income / Current Quarterly Dividend.

DC = Net Investment Income - Current Quarterly Dividend

I am using Net Investment Income because a BDC is required to have at least 70% of their holdings in qualified securities / cash. These investments are the life-blood of a BDC and while many firms generate fee income from structuring deals, these are more volatile. One other note, if a firm pays out dividends on a Monthly basis, I am adding together the past three months of dividends to get the amount. The second formula is useful because it shows you how much room a firm has to pay out its dividend

In the below chart, I have pulled the NII from the BDCR Index and compared that value with their current dividend payouts. In cases where NII is negative, the DCR will also be negative, this allows us to sort the results.


Discussion of Table

As you can see, a large number of the firms are operating at the razor's edge when it comes to their payout ratio. While this is nice for fixed income investors, it may mean that a company is actually paying out their dividends at the expense of the firm. If a company cannot cover the dividend with investment income, it needs to generate the proceeds from another source(s).

  • The first source would be from capital gains on the sales of a firm's assets. This dividend is good for a tax-paying investor in the short-term as it will be classified as a return of capital and taxed (in the US) at the long-term capital gains tax-rate (15% for most people, for the IRS view, please click this link). Return of capital dividends do require you to adjust your cost basis for your position though and that may not be desired from a book-keeping standpoint. For a BDC, this type of dividend payment may be bad as the firm has presumably sold off an income generating asset to meet a payout requirement. 
  • A second source would be from the company tapping their Revolving Credit Facility (Revolver) to get the cash to payout to their investors. Again this may be a bad sign for the firm as they are increasing their interest expense and leverage without any offsetting gain.
  • The final source is when a firm actually goes "Ponzi" and will begin issuing new shares to pay-off old shares. This does not happen on a large scale for long; most firms will cut their dividend or violate a lender covenant if they are in this situation. But, a good example would be AINV for 2008, you can see that their asset values and net investment income were tumbling, but the firm maintained its dividend and partially funded this dividend with proceeds from selling shares. AINV was not the only BDC to do this, but they are an easy target as they are still one of the largest.
A firm that has a DCR over 1 or a DC > 0 is a firm that is currently covering its dividend with its investment proceeds and that may be a sign of a responsible management team. There are some firms that are close to their ideal payout (KCAP for example) that may be correcting their balance sheets, but you should take a look at their dividend and NII history to come to your own conclusions. The best firms in terms of dividend coverage are KFN (which is not a BDC) and MVC. The worst are the firms that have already cancelled their dividend.

Monday, January 24, 2011

BDC Weekly Roundup 1/24/2011

The BDCR Index fell a fair amount by -3.16% from a level of 324.01 on 1/17/2011 to 314.07 for the week ending 1/17/2011. The major winners were SAR (+6.63%) and KFN (+2.54%) and the major losers were NGPC (-8.08%) and CODI (-6.37%).

Some notable news items:
ARCC - Priced their convertible notes -$500M+Convertible+Senior+Notes+Offering/6225298.html
AINV - Typical of their sibling, Apollo and Ares are doing the same thing -
KED - Declares a 4th Q dividend of 30 cents/share -

Interesting article from a new linked site, BDC Reporter on Seeking Alpha -

Thursday, January 20, 2011

TPG Special Situations - New Guy on the Block

On January 14th, TPG Specialty Lending, Inc., the Special Situations division of Private Equity giant TPG Capital filed a 10-12G (Initial Form for General Registration of Securities, aka IPO overview) with the SEC. Judging by available tickers and what other companies have been doing, I assume they are going to go with "TPGM" (TPG Management, there already exists a TPG Capital, the parent) and for the sake of brevity I will refer to them as that for the rest of this post.

The company will use TSL Advisers (affiliate of TPG Capital) as the investment adviser and enter into an "Administration Agreement" with them. This means TPGM will essentially outsource all functions to them. TSL will provide the new firm with investment professionals, investment decisions, facilities and reporting functions. The new firm will operate very much like other externally managed BDC's such as Ares Capital (ARCC) and Apollo Investment (AINV).

People in Charge
The investment decisions will be led by Co-CIOs Alan Waxman and Joshua Easterly, both former Goldman Sachs employees. Mr. Waxman was the co-founder of the Goldman Sachs Specialty Lending Group (GSSLG) and Mr. Easterly is a former co-head of that group. The statement also stipulates that they have a team of over 20 dedicated professionals. The Board of Directors will be at the time of IPO only 5 people, where at least 3 people cannot be "interested persons" of the Company. The document states that the firm does not intend to ever have any direct employees.

This is where the filing gets interesting. An externally managed BDC is usually setup by the external manager as a way of increasing fee income. In a way, it is a publicly-traded CLO where the equity can be held by anyone. The manager collects a management fee + a performance fee. TPG Capital will collect a 1.5% management fee of the Company's average total gross assets of of the end of the quarter. Until the IPO, TPGC will not collect a fee and for the first two quarters the fee will be based on the quarter-end gross assets.
The performance fee will have two components. It is best to copy/paste directly from the filing on this one. "(i) Following an IPO, the first component of the Incentive Fee will equal 100% of the excess (if any) of pre-Incentive Fee net investment income over a 1.5% quarterly (6% annualized) hurdle rate, until the Adviser has received 17.5% of total net investment income for that quarter, and 17.5% of all remaining pre-Incentive Fee net investment income for that quarter. No Incentive Fee will be payable under this component for any quarter in which pre-Incentive Fee net investment income does not exceed the hurdle rate for that quarter. Prior to an IPO, the first component of the Incentive Fee payable by the Company will be subject to a reduced rate.
     “Pre-Incentive Fee net investment income” means dividends (whether or not reinvested), interest and fee income less operating expenses, calculated on an accrual basis.
     (ii) Following an IPO, the second component, payable at the end of each fiscal year in arrears, will equal a percentage, which we refer to as the “Weighted Percentage,” of the cumulative capital gains from the inception of the Company to the end of such fiscal year, minus the aggregate amount of any previously paid capital gain Incentive Fees for prior periods; but in no event will be less than zero. The Weighted Percentage will be calculated at the end of each fiscal year of the Company that occurs following an IPO and is intended to ensure that the portion of the Company’s capital gains that accrued following an IPO will be subject to an incentive fee rate of 17.5% and the portion of the Company’s capital gains that accrued prior to an IPO will be subject to a reduced rate. The Weighted Percentage will be calculated in the manner set forth in the Advisory Agreement, the form of which is filed as Exhibit 10.1 of this Registration Statement. Prior to an IPO, the second component of the Incentive Fee payable by the Company will be subject to a reduced rate.
“Cumulative capital gains” means, on any relevant date, cumulative realized capital gains, less the sum of (a) realized capital losses and (b) unrealized capital depreciation on investments, in each case as of such date. "
In normal person terms - this means they will collect 1.5/17.5 (kind of like a hedge fund 2/20 standard), with a quarterly high water mark of 1.5% on the NII + they get a kicker at the end of the year based on Capital Gains.
Portfolio Composition
Like most of the other BDC companies, TPGM will focus on senior secured loans, first and second lien, some unitranche loans (this post does a nice job of explaining), some mezzanine loans, structured equity and even straight equity/warrants.  Most of the equity instruments will be hand in hand with another more senior investment.

Private Offering
Prior to the IPO, the company will have private offering with a number of investors that provided seed capital. The company will structure the private offering like a Private Equity fund where investors will make an initial capital commitment and drawdowns (capital calls) will take place. These initial shareholders will not be able to sell their stock until the restrictions are lifted. The release condition would be for TPGM to have an IPO that results in the Company having a common stock float of at least $75 million or for the fourth anniversary of the private closing to have passed. TPGM has also reserved the right to offer a board seat to a member of the initial private subscription group.

Stated Risks
This could easily be another post, but I will list the main bullet points here

  • We are a newly-formed company with no operating history
  • We will be dependent on upon management personnel of the Advisor for our future success
  • The Adviser and its management have no prior experience managing a BDC
  • Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital.
  • We may borrow money, which may magnify the potential for gain or loss and may increase the risk of investing in us.
  • We will operate in a highly competitive market for investment opportunities
  • Even in the event the value of your investment declines, the Management Fee and, in certain circumstances, the Incentive Fee will still be payable (No matter what, TPG will get paid)
  • We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code.
  • There is a risk that you may not receive dividends or that our dividends may not grow over time. 
  • You may be subject to filing requirements under the 1934 Act as a result of your investment in the Company.
  • You may be subject to the short-swing profits rules under the 1934 Act as a result of your investment in the Company.
  • Potential conflicts of interest could impact our investment returns.
  • Our Board may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
  • Changes in laws or regulations governing our operations may adversely affect our business.
  • The Adviser can resign on 60 days' notice. We may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations. 
  • To the extent that we do not realize income or choose not to retain after-tax realized capital gains, we will have a greater need for additional capital to fund our investments and operating expenses.

So there you have it. I encourage anyone who would like to know more about a BDC to read as many 10-12G filings as possible as this provides you with a great look into how the firm was organized (most of these filings have some copy/paste to them) and it provides a number of definitions in it.

Tuesday, January 18, 2011

BDC Weekly Roundup 1/17/2011

The BDCR Index rose by 1.65% from a level of 318.66 on 1/10/2010 to 324.01 for the week ending 1/17/2010. The major winners were TINY (+11.14%) and NGPC (+7.17%) and the major losers were MVC (-3.64%) and KFN (-2.9%).

Some notable news items:
ARCC - Increases capital committed to its SSLP fund
GAIN / GLAD - Elected Jack Reilly elected to Board and selects David Watson as CFO
TINY - Coverage initiated by Research 2.0
TTO - Wants to deregister as a BDC and own Real Assets (not just investment securities)

TPG Special Situations group intends to register as a BDC

Thursday, January 13, 2011

Net Investment Income Addendum

Someone pointed out to me that I failed to mention what the below line represents:

Interest income from cash and cash equivalent investments
This line item for most companies will include true Cash that is sitting in an account and assets that are readily convertible into cash. This second category is more fluid than Cash. For most firms, CE will be money market holdings, short-term government bonds (DEVELOPED countries), US Treasury Bills and Notes, highly liquid securities and commercial paper with Investment Grade Ratings. For example, MSFT commercial paper may be considered Cash Equivalent while Lehman CP would not. Some firms like to get more exotic in their cash equivalent definition by including duration (bonds), time to maturity, if the issuer of the debt (bond/loan) is a GSE and the list goes on and on.

Thank you for reading and welcome to all new readers!

Wednesday, January 12, 2011

Net Investment Income Overview

Net Investment Income (NII) is one of the most important factors when evaluating a BDC. NII as a definition is a measure of the income received from investment assets (bonds, stocks, funds, loans and other investments) minus equivalent investment expenses. For a BDC, this number measures how well their investments are performing. As a simple way of breaking this information down, I am pulling in the balance sheet from TCAP's Q3 earnings release to illustrate.

Investment income:
Loan interest, fee and dividend income:
Non—Control / Non—Affiliate investments
Affiliate investments
Control investments
Total loan interest, fee and dividend income
Payment—in—kind interest income:
Non—Control / Non—Affiliate investments
Affiliate investments
Control investments
Total payment—in—kind interest income
Interest income from cash and cash equivalent investments
Total investment income
Interest expense
Amortization of deferred financing fees
General and administrative expenses
Total expenses
Net investment income

Basic line by line breakdown:
Non-Control / Non-Affiliate Investments - These represent the bread and butter investments of a BDC - extending capital (most of the time in the form of term loans) to firms to collect interest. You would expect the majority of a firm's NII to come from this line.

Affiliate Investments - This means that TCAP has some type of influence or relation to these companies. Such situations could be: a person in TCAP sits on the board of the company (or if an officer), holds either directly or indirectly 5% or more of the outstanding voting securities or if the affiliated company is an investment company, TCAP has seeded the company.

Control Investments - Will let the 1940 take it from here - "Control" means the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of an official position with such company. From what I have seen, a BDC likes to avoid controlling a firm as that is not the specialty of the BDC. Also, it tends to take considerable personnel power to both manage another company as well as your entire portfolio.

Payment in Kind Interest Income - Quick sub-note on this.

Interest Expense - This is the expense that the company pays on the leverage it issues (loans/bonds) to make investments. A BDC will take out a Loan (most likely a Revolver) because they make money off of the spread. If a BDC pays interest at LIBOR+200 and can lend that money out at LIBOR+500, it is doing OK. This is the same principal on how a traditional bank makes money. Take in deposits and pay a certain rate and lend money out at a higher rate. Remember, a BDC must be in compliance with a max 1:2 Leverage to Assets ratio (200% test).

Amortization of deferred financing fees - These are the costs incurred with issuing debt such as commissions paid to investment banks, auditors, lawyers, etc. These fees are amortized because of accounting reasons which you can easily lookup online.

General and administrative expenses - The incredible catch all which includes costs of doing business. For example, if a business professional is evaluating a potential portfolio company, they can expense (within limits) travel costs and acquisition costs.

What does this all mean?
Well, from looking at those lines, we see that TCAP has a positive NII and if you divide that by the number of outstanding shares, you get to a NII of 0.46 per share. This is important because that means TCAP is currently covering their dividend of 41 cents (now 42 cents) with their NII. This is important when you look at a BDC. There are a number of BDCs that currently have a dividend shortfall (future post). If a BDC is not covering their dividend with NII, then you have a problem with a BDC selling assets to make payments or even going Ponzi by paying out dividends from equity and leverage raises.

Monday, January 10, 2011

BDC Weekly Roundup 1/10/2011

The BDCR Index rose by 1.24% from a level of 314.72 on 1/3/2010 to 318.66 for the week ending 1/7/2010. The major winners were HRZN (+7.6%) and MVC (+3.5%) and the major losers were FSC (-1.55%) and KCAP (-1.48%).

Some notable news items:

ACAS - Cramer said to stay away from ACAS,|headline|quote|text|&par=yahoo
FSC - Had a record quarter of closings
GAIN - Glad sold off Chase Doors,
MAIN - Made two new investments totalling $11.4m and expanded their credit facility
TCAP - Made a $9m investment in SRC

Wednesday, January 5, 2011

BDC Weekly Roundup 1/3

In a new direction for this site, I will be publishing more weekly statistics and charts. As I collect more data these charts will become more advanced and contain better information (total return as opposed to just price changes, etc).
For now, here is the weekly chart of BDCs. As we can see, the BDCR Index (my own personal one) rose by 1.4% from a level of 310.15 on 12/17/2010 (I took the 24th off) to 314.72 in the week ending 12/31/2010. The major winners were EQS (+7.48%) and TTO (+6.8%) and the major losers were TINY (-7.13%) and HRZN (-4.01% although HRZN went ex-div for 22 cents).