To DRIP or Not to DRIP (Seeking Alpha Article)

I just posted a Seeking Alpha article over here that outlines BDCs and whether or not reinvesting your dividends is worthwhile.

The companies to be examined for this article will be American Capital (ACAS), Apollo Investments (AINV), Ares Capital Corp (ARCC), Blackrock Kelso Capital Corp (BKCC), Kohlberg Capital (KCAP), Main Street Capital Corporation (MAIN), PennantPark (PNNT), Prospect Capital (PSEC), Solar Capital (SLRC) and Triangle Capital Corp (TCAP).

A look at High Dividend Stocks (BDC / Finance) and Ranking Them

(This article will also be cross-posted on Seeking Alpha, if you read the article there and have come back here, welcome to BDCR! If not, thank you for still reading. Due to some extensive work over these past few weeks, I now have some great historical data on the BDCR companies. This post is the first of hopefully many deep dives into the companies.)


It is quite common for a major financial website to post a link of "dividend darlings". A dividend darling list typically involves a group of companies that have a strong history of paying increasing dividends over their lifespan. If you look on Forbes, Investopedia or Seeking Alpha you will see lists containing some chosen companies.
This article will include a "dividend darling" list that is exclusively focused on BDCR-followed companies. Not only will the current dividend high-rollers be highlighted, but I will rank the companies based on history and dividend coverage. All of the information gathered is available on the SEC website and/or your favorite financial website (Yahoo, Google, DailyFinance, etc). I want to reward companies that have been around for awhile and ding those that are not paying and covering their dividends. This means that a company like American Capital (ACAS), which was once the top of the heap in terms of dividend payers, will now be more towards the bottom of the list.
Below is the criteria:

1. Is the company currently paying a dividend? I am penalizing a company that does not pay a regular dividend. I know owning ACAS over the past year with a 94% return would have been a far better total return, but I am looking at BDCs strictly on a yield-basis and not a total return basis for this article. 10 pts
2. Does the company have a strong dividend history? For example, Prospect Capital Corporation (PSEC) likes to publicize its history of dividend increases and consecutive dividends. One thing it fails to mention is that in May of 2010, the company slashed its dividend by 10 cents per quarter, skipped most of its June dividend and changed over to a monthly payout (which overall I believe was a good thing). This list will penalize a company for doing that. 3-6 pts (3 pts for never missing a dividend, 3 pts for never cutting a dividend)
3. Is the dividend currently covered by net investment income? I covered this in a previous post in which I explained why I believe it matters. Below you can see the updated chart. Again, the same situation applies where I multiplied a monthly dividend payer by 3 to turn it into a quarterly dividend. 3 pts
4. How long has the company been paying dividends? I believe companies that have successfully navigated the 2007-2009 period should receive an extra credit above those companies which may have IPO'd over the past two years. 1-2 years is 1 pt; 2-5 years is 2 pts; 5+ years is 3 pts

Given this format, the max score a company could receive is 22 (5+ years of consistent dividends covered by NII) and the minimum score is 1 (company is still in business). For the BDC-R companies, the range of scores was 21 as a max and 3 as a min.
click to enlarge image
Results

Discussion of Results
As you can see, most of the companies are in the higher range of the numbers. This is partially due to the sample selection (I do not track some of the newer BDCs at the moment) and the favorable market conditions for BDC companies.
The main negative on the scoreboard was dividend cuts. Only 5 of the companies listed here have not cut their dividend. Of those 5, PennantPark Investment Corporation (PNNT - first dividend June 2007) and Compass Diversified Holdings (CODI - July 2006) have been around for awhile. Solar Capital Ltd. (SLRC - March 2010) and Horizon Technology Finance (HRZN - December 2010) are new to the world.
The other major reason for taking away points is the fact that most of the companies listed do not cover their dividend with net investment income. This means that they are either not covering their dividend or are cannibalizing their portfolio to meet payout requirements. One such company is MVC Capital (MVC). It realized losses on portfolio companies at 23 cents per share so it could meet its dividend payment of 12 cents per share. By continuing this payout, it reduced its book NAV from 17.71 to 17.38 during the six month period ending April 30th 2011.
Only 7 out of the 26 companies are "safely" covering their dividend as of their last reporting dates, which safely means their NII is greater than or equal to their current dividend. These companies are PNNT, HTGC, Kohlberg Capital (KCAP), KKR Financial Holdings (KFN), Triangle Capital (TCAP), GLAD and MCG Capital Corporation (MCGC).
The Clear Winner
PNNT (PennantPark Investment Corp) comes out ahead of the pack with a solid dividend history and good earnings numbers. It scored a 21 out of a possible 22 and the only detraction was due to the firm's lack of longevity (only paying dividends since June 2007).
The first runner up is Hercules Technology Growth Capital. There has been a fair amount of good press on HTGC this year and it appears that the company has done a good job of backing up what people are saying about it Nicholas Marshi, one of the top posters on BDC companies on Seeking Alpha, did an extensive write-up on the company in March of this year.
Surprises
Former-troubled BDC KCAP (Kohlberg Capital) is also sitting high on the list. The company was hit with a shareholder lawsuit in 2010, a changing of auditors (it switched from Deloitte to Grant Thornton) and restatement of earnings (again check the SEC website for the filings). For example, the restated as of June 30th 2009 earnings adjusted total assets down by $25m, which slashed the NAV from 11.09 to 9.73 and gave more fuel to the arguments it had with its lender BMO. It appears that the company may have weathered the storm and could be worth a deeper look into its financial statements and conference call logs.
Disappointments
At the bottom of the list is EQS. While not a BDC, EQS was a strong dividend-paying stock for 8 years and at this point it is too early to tell if the new management will be able to revitalize the company. SAR (remember GNV Investment?) is also sitting at the bottom as it has yet to show any signs of breaking out of GNV's slump.

BDC Weekly Roundup 4/1/2011

The BDCR Index enjoyed a healthy gain this past week by an amount of 2.11% from a level of 318.75 on 3/25/2011 to 325.762 for the week ending 4/1/2011. Note, the index is still below the high set on February 22nd 2011 of 337.57. The major winners were ACAS (+8.12%) and TCAP (+5.54%) and the major losers were GAIN (-3.06%) and NGPC (-2.97%).

Chart:

News items from this past week. Looks like the first week of May will be a busy earnings season:

ARCC - Earnings release scheduled for 5/3.

FSC - Locks in a 4.03% borrowing rate for 10 years - http://finance.yahoo.com/news/Fifth-Street-Finance-Corp-pz-1409467551.html?x=0&.v=1

KCAP - Seeks to win shareholder approval to issue shares below NAV (common in 2009), but Nicholas Marshi disagrees - http://seekingalpha.com/article/261391-dubious-feelings-about-kohlberg-s-equity-raising-plan

KED - Increases dividend from 30 cents to 31 cents per share - http://finance.yahoo.com/news/Kayne-Anderson-Energy-bw-736572173.html?x=0&.v=1

KFN - Investopedia looking at yield vs. P/E - http://stocks.investopedia.com/stock-analysis/2011/Single-Digit-PE-Stocks-With-Juicy-Dividends-CH-KFN-HCII-KED0328.aspx

PNNT - Earnings release scheduled for 5/4.

PSEC - Popular with Wall Street insiders - http://www.fool.com/investing/general/2011/03/28/wall-streets-buy-list.aspx

SLRC - Earnings release scheduled for 5/2.

BDC Weekly Roundup 3/11/2011

(Was out last week) The BDCR Index took a tumble fell this past week by an amount of -3.76% from a level of 335.45 on 3/4/2011 to 323.26 for the week ending 3/11/2011. The major winners were TTO (+8.44%) and HRZN (+0.75%) and the major losers were BKCC (-20%) and TINY (-11.71%).

Chart:



Notable News Items:
BKCC - Misses earnings, reports Q4 EPS of 03 cents, expected 11 cents. Link to the CC - http://phx.corporate-ir.net/phoenix.zhtml?p=irol-eventDetails&c=209952&eventID=3753698
CODI - Raises dividend from 34 cents to 36 cents. Reports Q4 EPS of 48 cents, meeting consensus.
KCAP - Posts positive surprise EPS of 24 cents versus expected 17 cents. Link to the CC - http://ir.kohlbergcap.com/eventdetail.cfm?eventid=93480
Also releases/prices convertible notes - http://finance.yahoo.com/news/Kohlberg-Capital-Corporation-pz-3295497930.html?x=0&.v=1
MCGC - Selling portfolio company Superior Industries for $42.3mm http://finance.yahoo.com/news/MCG-Capital-Announces-Sale-of-bw-3869544465.html?x=0&.v=1
NGPC - Misses earnings, reports 15 cents per share versus estimate of 17 cents. http://finance.yahoo.com/news/NGP-Capital-Resources-Company-pz-3932944371.html?x=0&.v=1
FSC - Closed $182mm in new investments YTD - http://finance.yahoo.com/news/Fifth-Street-Finance-Corp-pz-1930631458.html?x=0&.v=1
MAIN - Raises dividend 4% (from .125 to .13)
MVC - Reports 1Q losses of 26 cents, misses the 3 cents estimate. Link to 1Q presentation - http://www.mvccapital.com/eventdetail.cfm?eventid=41339
TICC - Met earnings estimates - CC details - http://www1.snl.com/irweblinkx/corporateprofile.aspx?IID=4089666

Motley Fool link on BKCC/MVC - http://www.fool.com/investing/general/2011/03/09/blackrock-kelso-capital-shares-plunged-what-you-ne.aspx

BDC Weekly Roundup 2/7/2011

The BDCR Index rose again last week by an amount of 1.11% from a level of 326.74 on 1/28/2011 to 330.41 for the week ending 2/4/2011. The major winners were EQS (+11.38%) and KCAP (+9.62%) and the major losers were GLAD (-3.60%) and FSC (-0.11%).

Chart:

Some notable news items:

ACAS - Sells triVin for $11m gain

AINV - Earnings call transcript - http://seekingalpha.com/article/251005-apollo-investment-ceo-discusses-q3-2011-results-earnings-call-transcript

EQS - Sells three equity investments for $10m to a Fund

FSC - Closes share offerings, declares monthly dividends of 10.66 cps.

KCAP - Paid off its debt - http://seekingalpha.com/article/250089-kohlberg-capital-pays-off-its-debt-what-s-next

PNNT - Increases quarterly dividend to 27 cents http://www.sys-con.com/node/1700862

A Look at Dividend Coverage

Overview
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.


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.