Business Development Company (or BDC) portfolio weighted average yields have fallen in 2013. "Portfolio yields" are the yields BDCs make on their investments. This is not the yield on the stocks that BDCs pay you. What follows is a spreadsheet showing loans by type from Q4-12; portfolio weighted average yields for three different quarters; end of quarter share counts; 2012 and 2013 EPS accruals and projections; and the change in leverage since the beginning of the year.
Most - but not all - BDCs have had falling weighted average yields on their portfolio company investments in 2013. The fall was not consistent across the sector. Why? Here are my findings on this inconsistent event: The larger the portfolio growth, the greater the fall in yields.
Portfolio Assets, Share Count Change and Yield Sensitivity
In the spreadsheet below, the share counts are in millions of shares. The leverage calculation divides debt per share by NAV per share. The portfolio weighted average yield stats are from company earning releases.
|Loans by Type||Port Weighted Av Yield||2013 Change||End of Quarter Share Count||EPS Change||Leverage|
Here is the data from parsing the data on falling yields into different metric attributes for the BDC:
- Q4-12 yields under 10%: KED, PFLT, SUNS, TAXI and TICC. Their change was -0.40 bps or -4.55%.
- Q4-12 yields over 10 but under 11.5%: ARCC, GBDC and NMFC. Their change was -1.07 bps or -9.33%.
- Q4-12 yields over 11.5 but under 12.99%: AINV, BKCC, FSC, FULL, GAIN, GLAD, MCGC and SAR. Their change was -0.36 bps or -2.93%.
- Q4-12 yields over 13%: ACAS, FDUS, HRZN, HTGC, MCC, PSEC, PNNT, SLRC, TCAP and TCRD. Their change was -1.10 bps or -7.56%.
- First lien loans under 20%: ACAS, FDUS, GAIN, GLAD, KED and TCAP. Their change was -0.85 bps or -5.75%.
- First lien loans over 20 and under 45%: AINV, ARCC, BKCC, GBDC, KCAP, NGPC, PNNT, SLRC and TCRD. Their change was -1.01 bps or -7.87%.
- First lien loans over 45 and under 70%: MCC, NMFC, PSEC, SAR, TAXI and TICC. Their change was -0.40 bps or -3.14%.
- First lien loans over 70%: FULL, HRZN, HTGC, MAIN, MCGC, PFLT and SUNS. Their change was -0.17 bps or -2.01%
- Share growth under 1%: ACAS, BKCC, FULL, GAIN, GLAD, HRZN, KED, MCGC, NGPC, PNNT, SAR and TAXI. Their change was -0.47 bps or -3.21%.
- Share growth over 1 but under 10%: ARCC, MAIN, NMFC and TCAP. Their change was -0.50 bps or -4.16%.
- Share growth over 10 but under 20%: AINV, FDUS, HTGC and SLRC. Their change was -0.88 bps or -6.33%.
- Share growth over 20%: FSC, GBDC, KCAP, MCC, PSEC, PFLT, SUNS, TCRD and TICC . Their change was -0.83 bps or -7.24%.
It made sense to me that with the Fed purchases of longer-term securities issued by the U.S. government and longer-term securities issued or guaranteed by government-sponsored agencies such as Fannie Mae or Freddie Mac, this quantitative easing would have a stronger influence on the better assets - and a weaker influence on the lesser assets. Parsing the data by yield and by percentage ownership of senior secured loans should have shown that effect if this thesis was right. But the data indicates that the thesis was wrong. The only division by attribute test that indicated a correlation between the attribute and falling yields was the test on share count growth.
I would have liked to test the relationship of falling yields to other attributes. But once again, the failure of transparency of several BDCs kept this from happening. I did not gather the best data to capture changes towards improved portfolio quality or safety due to so many BDCs failing to disclose portfolio company debt to EBITDA and interest coverage ratios. I do gather the data on weighted average yields in the hope that this metric would partially capture safety changes. I attempt to gather stats on portfolio turnover - but BDCs are inconsistent with those stats. A few fail to report it. Few report this metric by quarter - but for multiple quarter periods that fail of overlap. Some BDCs report the weighted average yields on originations - but that reporting is also inconsistent. I also did not gather the changes in the percentage of the portfolios that were in non-income producing assets. Those problems in data gathering result in problems when it comes to finding multiple verifiable causes of the falling yields.
One of those potential causes of falling yields would be improvements in portfolio quality. I will show the stats from two BDCs that offer a higher level of earning release transparency. I do the challenging task of comparing trends in asset quality. The task is challenging because the stats are not consistent in telling the same story. That is the case in these two examples. It would be the same story if I offered two dozen examples. The data:
Comparing trends in asset quality is messy
As of 12-31-12, 96.4% of Fifth Street Finance's portfolio consisted of debt investments. Approximately 70.6% of the fair value of the portfolio was at floating rates. As of 9-30-13, 94.7% of Fifth Street's portfolio consisted of debt investments. Approximately 67.4% were at floating rates. The shift towards lower levels of debt should have hurt NII - and it did. The shift away from floating rate debt probably helped NII - but that shift was small. The big change was in share count. Fifth Street's total portfolio average leverage was 4.05x at the start of 2013 compared to 4.57x at the end of Q3-13 - indicating a significant fall in asset quality. Fifth Street does not disclose interest coverage ratio stats. Fifth Street had no investments on non-accrual in both time periods. Based on portfolio company leverage alone, I would say that Fifth Street had falling asset quality.
At the start of the year, Ares Capital had 75% of its portfolio in floating rate loans, 13% in fixed rate loans, and 12% in non-interest earning investments. As of 9-30-13, Ares had 82% of its portfolio in floating rate loans, 9% in fixed rate loans, and 9% in non-interest earning investments. The shift towards higher levels of income producing investments should have helped NII while the shift towards floating rate investments probably improved asset quality, lowered yields, and lowered NII. Ares' portfolio shifted towards higher ratios of interest rate coverage. That ratio changed from coverage of 2.4x to 2.6x - indicating improving asset quality. Ares' debt/EBITDA stats were 4.7x in Q3-13 compared to 4.6 at the start of the year - but such a small change could be rounding error noise. On the other hand, Ares' non-accrual investments were 1.1% of the portfolio at fair value at the end of Q3-13 compared to 0.6% at the start of the year. While all of the evidence fails to support the thesis, the preponderance of the evidence supports that thesis that Ares' portfolio quality improved.
Like I said, comparing trends in asset quality is messy. But if Ares had improving asset quality, it would help explain why its weighted average yield was falling more than average while its share count expansion was relatively small. It would have been informative to do the same kind of quality comparisons for GBDC, PSEC and SLRC. But all of them fail to disclose interest coverage ratios and debt/EBITDA metrics.
Comparing managements is easy
Three of the best BDCs over the last five years have been HTGC, MAIN and TCAP. All three are internally managed. All three have superior NII/TII ratios. All three have had superior dividend and NAV growth. As a result, the market has logically awarded them price/NAV ratios that stand out when compared to the rest of the sector. When a BDC sells at well over its price/NAV ratio, its NAV grows with each secondary offering. Over the short and mid terms, this tends to be a self-perpetuating virtuous cycle. All three have been fast growing BDCs. Their 2013 share count growth is well below trend.
There were 8 BDCs with more than 25% share count growth in 2014. All but one was externally managed. The sole internally managed BDC with high share count growth was the one with the shadiest of histories - KCAP.
2013 has proven to be a less than shareholder friendly time to raise the share count. Both internal and externally managed BDCs have mostly avoided that problem. But one grouping did a superior job of that avoidance. There is probably a lesson in that story.
This investor, who already has a preference for internally managed BDCs, found another reason for that preference. This investor, who already had problems with the poor metric transparency provided by many BDCs, found another reason to dislike that practice. While many investors are expressing concern about the Fed tapering that is coming, the 2012 decline in weighted average yields that is probably the result of that quantitative easing may be reversed with the upcoming tapering. And existing shareholders should - over the short term - favor the BDCs that are not doing secondary offerings. This is a time when BDCs that require extra capital should be doing it by raising debt, not equity.