Financial Services/Real Estate: Commercial Finance

Transcription

1 Financial Services/Real Estate: Commercial Finance Important disclosures can be found on pages 6-10 of this report. July 13, 2016 Christopher Nolan, CFA Matthew Brotman Industry Update Rising BDC Share Price Valuations Increase Prospect of Renewed Round of Equity Raises This Fall Summary and Recommendation Out of the 50 publicly traded BDCs, shares of 12 are currently trading above their respective NAV/ share, versus nine two months ago. There are an additional eight BDCs trading above 90% but below 1.0x NAV/share (versus six two months ago). Driving BDC share price multiples higher, in our view, are tighter high-yield bond spreads resulting from a combination of rising oil prices and good overall asset quality in the financial services sector. Assuming no negative 2Q16 earnings surprises and that BDC deal pipelines remain active, we think those BDCs with regulatory debt leverage ratios at or above 0.70x (or above the debt leverage level of their previous equity raise), as well as share price valuations above 1.0x NAV/share, could potentially look to raise additional equity in 2H16. BDCs that appear to fit this profile may include: FS Investment Corp. (FSIC), Golub Capital (GBDC), New Mountain Finance Corp. (NMFC), Monroe Capital Corp. (MRCC), Solar Senior Capital (SUNS), and Triangle Capital (TCAP). Key Points Higher BDC share price valuations increase prospect of new round of equity capital raising. According to data from SNL, BDC share prices have increased 5.6% year to date (versus 5.3% for the S&P 500 index). We note that over the last month, BDC price/nav multiples have risen to 0.94x on average (versus 0.92x on June 13, 2016) and are now at 90% of their two-year high and in line with their one-year high. We note 12 BDCs currently trade at a premium to their NAV/share (versus nine two months ago), and of these, six have regulatory debt leverage ratios approaching the levels when they last raised equity capital. We note there are an additional eight BDCs at 90% 100% of their NAV/share (versus six two months ago). BDC valuations correlated with oil prices and reverse-correlated with high-yield bond spreads. In our view, driving BDC price/nav multiples higher are higher oil prices, which in turn have contributed to tighter high-yield bond spreads. In the past, we have noted that BDC price/nav multiples inversely correlated to high-yield bond spreads. Thus, we believe stable to rising oil commodity prices are a key determinant for incremental BDC valuation multiple expansion. WTI is currently $44.77/bbl (versus $48.89/bbl on June 13, 2016). We note that in a report published July 6, FBR energy analyst Chad Mabry raised his 2016 oil price target by 9% to $44.98/bbl, which was 6% above consensus at that time. BDCs most likely to raise equity capital have high price/nav and leverage ratios. We think BDCs most likely to raise equity capital in the coming months are those trading at their respective NAV/share or higher and have regulatory debt/equity ratios approaching levels where they last raised equity. On this basis, BDCs that appear to fit this profile the best may include TCAP, GBDC, MRCC, FSIC, NMFC, and SUNS. Declining yield curve could be positive for BDC valuations. We currently do not see a decline in 10-year treasury yields having a dramatic effect on BDC operations. Lower rates could help BDC share price multiples as investors go searching for yield. We note that on average, BDCs offer a dividend yield of 9.5%, and tighter high-yield bond spreads are likely to incrementally support investor confidence on asset quality for the BDC sector. We do not see lower longterm rates affecting BDC spreads since BDCs invest primarily in companies that often do not qualify for bank loans; thus, yields often reflect a less liquid lending market. Prospect of a third SBA license could deter some BDCs from raising equity in the near term. We note that given higher BDC family of funds limits, certain BDCs that are applying for a third SBA license may forego raising equity in the near term, particularly if their stock routinely trades at a premium to NAV. We believe this is the case for MAIN and possibly for GBDC and TCAP as well FBR & Co.

2 Equity Raising Window May be Opening for Some BDCs Our research indicates that there are currently six BDCs that could potentially look to raise equity capital. Given rising BDC price/nav multiples, there are currently 12 publicly traded BDCs (out of 50 total) whose shares are trading at or above their respective NAV/share. Of those, data indicates that six may be good candidates for raising equity via a follow-on offering given their regulatory debt leverage ratios are above 0.70x and/or their regulatory debt leverage ratio is above the level at which they last raised equity. These six are: FS Investment Corp. (FSIC), Golub Capital (GBDC), New Mountain Finance Corp. (NMFC), Monroe Capital Corp. (MRCC), Solar Senior Capital (SUNS), and Triangle Capital (TCAP). We note that TCP Capital (TCPC) recently priced a $35 million registered direct common share offering at a premium to its 1Q16 NAV/share. We exclude MAIN from this list of BDCs likely to raise equity in near term. This is because MAIN shares routinely trade at a premium to NAV/share, and in June, management commented that it is not likely to raise equity for at least a year or two. This is in part due to management s expectations for MAIN to be awarded a third SBA license in 3Q16, which will effectively increase the company s borrowing capacity. Awarding of third SBA licenses could affect equity raise decision for some BDCs. MAIN, GBDC, and TCAP are each currently in negotiations with the SBA for a third SBA license. We note the awarding of this could delay a management s decision to raise equity (as in the case of MAIN), but that also depends on how much of a BDC s future deal flow is eligible to be SBA funded. BDC deal pipeline will be a gating factor if additional equity raises occur in 2016, in our view. We think investment demand for new deals will be an important gating factor in management s decision to raise additional equity. If management comments during 2Q16 earnings calls indicate a robust pipeline, this could auger in favor of increased pace of equity offerings in 2H16 by those BDCs that can do so accretively to their NAV/share. BDCs Trading at or Above NAV/Share Ranked on Current Debt/Equity Ratio Price/ Latest Follow-On Equity Offering Prior Quarter Leverage Current Targeting Company Name Ticker NAV Date Type Size Quarter D/E D/E More SBIC FS Investment Corporation FSIC 1.05x 5/15/2012 Best Efforts 240M shares 1Q x 0.82x N/A Golub Capital BDC, Inc. GBDC 1.16x 4/10/2015 Follow-On $69.7M 1Q x 0.74x Yes New Mountain Finance Corporation NMFC 1.04x 9/22/2015 Follow-On $81.3M 2Q x 0.72x Yes Monroe Capital Corporation MRCC 1.05x 4/15/2015 Follow-On $41.8M 1Q x 0.71x Yes TPG Specialty Lending, Inc. TSLX 1.13x 3/3/2016 Follow-On $82.1M 4Q x 0.70x N/A TCP Capital Corp. TCPC 1.06x 11/20/2014 Follow-On $100.6M 3Q x 0.69x Yes Solar Senior Capital Ltd. SUNS 1.00x 1/14/2013 Follow-On $37.7M 4Q x 0.67x N/A Goldman Sachs BDC, Inc. GSBD 1.07x No Equity Raises Since March 2015 IPO N/A N/A 0.63x N/A Hercules Capital, Inc. HTGC 1.28x 3/24/2015 Follow-On $103.5M 4Q x 0.58x No Triangle Capital Corporation TCAP 1.32x 8/12/2014 Follow-On $132.8M 2Q x 0.58x Yes Main Street Capital Corporation MAIN 1.54x 3/9/2015 Follow-On $128.1M 4Q x 0.53x Yes Fidus Investment Corporation FDUS 1.02x 5/27/2016 Follow-On $43.9M 1Q x 0.04x No Priced as of 7/11/2016 Source: SNL Financial, Company Reports and FBR Research Industry price/nav valuations multiples inversely correlated with rising high-yield bond spreads. In our view, the key systemic factor affecting BDC share prices remains high-yield corporate bond spreads. We note that since 2013, BDC industry price/nav multiples have generally moved inversely with changes in the BofA Merrill Lynch U.S. High Yield Master II Option-Adjusted Spread (BofA High Yield). The BofA High Yield is an aggregation of yield spreads relative to treasuries of all corporate bonds rated BB or lower by the major credit rating agencies. Page 2

3 BDC Price/NAV $/bbl BofA High Yield Spread BDC Price to NAV 2016 FBR & Co. Inverse Correlation of High Yield Bond Spreads and BDC Price/NAV Multiples x 1.15x 1.10x 1.05x 1.00x 0.95x 0.90x 0.85x 0.80x 0.75x 0.70x BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread BDC Price to NAV Source: FBR Research and St. Louis Federal Reserve Industry price/nav valuations positively correlated with rising oil prices. We note that BofA High Yield spreads have decreased markedly since February 2016, corresponding with a recovery in commodity oil prices. Thus, we think the decrease in high-yield spreads likely reflects improved investor sentiment for economic stability for borrowers tied to the energy sector. Energy 6% of BDC investments. We estimate that on average at 1Q16, energy accounted for 6% of BDC investment portfolios at cost (and 4% at fair value) and that energy investments are being marked at 69% of cost. Positive Correlation of Oil Prices and BDC Price/NAV Multiples 1.15x 1.10x 1.05x 1.00x $120 $100 $ x 0.90x 0.85x 0.80x 0.75x 0.70x $60 $40 $20 $- BDC Price to NAV WTI Crude Oil ($/bbl) Source: FactSet and FBR Research Page 3

4 BDCS Ranked by Price/NAV Valuation Multiples 7/11/2016 NAV/ Price/ 2-Year Price/NAV Regulatory Company Ticker Rating Price Share NAV High Low D/E Main Street Capital Corporation MAIN OP $32.65 $ x 1.60x 1.21x 0.53x Triangle Capital Corporation TCAP NR $19.84 $ x 1.77x 1.01x 0.58x Hercules Capital, Inc. HTGC OP $12.55 $ x 1.60x 0.97x 0.58x Golub Capital BDC, Inc. GBDC NR $18.45 $ x 1.17x 0.96x 0.74x TPG Specialty Lending, Inc. TSLX NR $17.13 $ x 1.35x 0.97x 0.70x Goldman Sachs BDC, Inc. GSBD NR $19.98 $ x 1.29x 0.90x 0.63x TCP Capital Corp. TCPC OP $15.50 $ x 1.16x 0.82x 0.69x Monroe Capital Corporation MRCC OP $15.22 $ x 1.10x 0.76x 0.71x FS Investment Corporation FSIC NR $9.26 $ x 1.07x 0.80x 0.82x New Mountain Finance Corporation NMFC NR $13.35 $ x 1.09x 0.81x 0.72x Fidus Investment Corporation FDUS NR $15.51 $ x 1.30x 0.79x 0.04x Solar Senior Capital Ltd. SUNS NR $16.78 $ x 1.00x 0.76x 0.67x Gladstone Capital Corporation GLAD NR $7.79 $ x 1.16x 0.54x 0.64x THL Credit, Inc. TCRD NR $11.66 $ x 1.07x 0.67x 0.82x Horizon Technology Finance Corporation HRZN NR $12.83 $ x 1.01x 0.65x 0.69x Harvest Capital Credit Corporation HCAP NR $13.09 $ x 1.03x 0.70x 0.73x TICC Capital Corp. TICC NR $5.54 $ x 1.01x 0.57x 1.15x PennantPark Floating Rate Capital Ltd. PFLT NR $12.68 $ x 1.01x 0.72x 0.35x OFS Capital Corporation OFS NR $13.49 $ x 0.93x 0.69x 0.00x Solar Capital Ltd. SLRC NR $19.23 $ x 0.94x 0.70x 0.50x American Capital Senior Floating, Ltd. ACSF NR $10.45 $ x 0.94x 0.60x 0.84x Capitala Finance Corp. CPTA MP $14.38 $ x 1.02x 0.56x 0.71x WhiteHorse Finance, Inc. WHF NR $11.54 $ x 0.95x 0.63x 0.77x Alcentra Capital Corporation ABDC NR $12.36 $ x 0.96x 0.60x 0.45x Ares Capital Corporation ARCC NR $14.06 $ x 1.06x 0.75x 0.76x BlackRock Capital Investment Corporation BKCC NR $7.99 $ x 1.00x 0.78x 0.64x Prospect Capital Corporation PSEC OP $7.99 $ x 1.04x 0.54x 0.79x TriplePoint Venture Growth BDC Corp. TPVG NR $11.10 $ x 1.09x 0.62x 0.32x Capital Southwest Corporation CSWC NR $14.23 $ x 1.09x 0.29x 0.00x CM Finance Inc CMFN NR $9.74 $ x 1.00x 0.57x 0.85x Stellus Capital Investment Corporation SCM NR $10.62 $ x 1.02x 0.58x 0.81x PennantPark Investment Corporation PNNT OP $7.11 $ x 1.05x 0.50x 0.71x Gladstone Investment Corporation GAIN NR $7.33 $ x 0.93x 0.73x 0.79x American Capital, Ltd. ACAS NR $15.90 $ x 0.82x 0.59x 0.20x Saratoga Investment Corp. SAR NR $17.22 $ x 0.79x 0.60x 0.46x Garrison Capital Inc. GARS NR $10.51 $ x 1.00x 0.70x 0.96x Apollo Investment Corporation AINV NR $5.52 $ x 1.01x 0.57x 0.81x Full Circle Capital Corporation FULL NR $2.67 $ x 1.11x 0.52x 0.41x Medley Capital Corporation MCC MP $7.24 $ x 1.05x 0.54x 0.68x Fifth Street Senior Floating Rate Corp. FSFR NR $8.23 $ x 0.93x 0.56x 0.89x KCAP Financial, Inc. KCAP NR $3.93 $ x 1.12x 0.42x 0.89x Rand Capital Corporation RAND NR $3.60 $ x 0.94x 0.64x 0.00x Medallion Financial Corp. MFIN NR $7.76 $ x 1.16x 0.54x 1.22x Fifth Street Finance Corp. FSC NR $5.38 $ x 1.02x 0.54x 0.77x Equus Total Return, Inc. EQS NR $1.75 $ x 0.80x 0.49x 0.40x Harris & Harris Group, Inc. TINY NR $1.52 $ x 0.96x 0.56x 0.06x Crossroads Capital, Inc. XRDC NR $2.11 $ x 0.81x 0.35x 0.00x GSV Capital Corp. GSVC NR $5.37 $ x 0.79x 0.33x 0.28x OHA Investment Corporation OHAI NR $2.34 $ x 0.81x 0.39x 1.04x Firsthand Technology Value Fund, Inc. SVVC NR $7.39 $ x 0.92x 0.28x 0.00x BDC's highlighted in green currently trade at a premium to their NAV/share BDC's highlighted in orange currently trade at a Price/NAV valuation between 0.9x and 1.0x Source: SNL Financial, Company Reports and FBR Research Page 4

5 Industry Risks Macroeconomic risks. BDCs are sensitive to the overall credit environment. A sudden change in market conditions or market liquidity can negatively affect BDCs. Liquidity risk. BDCs are primarily invested in the debt of below-investment grade companies. These investments can be illiquid, and valuing them often relies on estimates. Dilution risk. Shares of most BDCs currently trade at a discount to NAV/share. If these companies were to raise equity at current valuations, it would likely dilute existing shareholders. Regulatory risk. Changes in the regulatory environment could adversely affect the industry. Margin risk. Rising debt costs or declining investment yields could reduce margins for the BDCs and reduce earnings, potentially affecting dividend payouts. Alignment risk. BDC external management companies receive an incentive fee on gross assets (typically less cash), while shareholders receive distributions from net assets. Management could be incentivized to make riskier investments, use leverage more aggressively, or reorganize capital gains in ways that are not ideal for shareholders. Dividend risk. BDCs on average only narrowly covered their dividends in Failure to cover the dividends could lead to a reduction in dividends paid. Page 5

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