We've been worried about the sustainability of TICC Capital's (NASDAQ:TICC) 15 cents a quarter dividend for several months. The company is a Business Development Company (BDC) which mostly focuses on middle market technology lending, and whose most notable feature is having no debt and no bank line, a result of drastic de-leveraging at the very beginning of the Great Recession. Of course, during the intervening time the Company has announced a new distribution of 15 cents, earned 1 cent more in Net Investment Income in the fourth quarter of 2009 than in the prior period, and seen its stock price jump up to nearly $7, just 16% off NAV. So we thought the issuance of the 10-K would be a good time to revisit our analysis of the Company. Please read on, but in brief: we came away with a warmer feeling about TICC's 2010 prospects, but continue to question the ability of TICC to maintain earnings per share above $0.60 a year should more credit problems develop.
Let's start by pointing out that the Company does not have a stellar credit underwriting record. In each of the last 3 years the Company has recognized major Realized Losses (notwithstanding a few Realized Gains) which have totaled $32mn. That's 10% of initial capital. Plus, another $61mn in assets still on the books have been written down, which means that TICC's assets at FMV are being carried at 77% of cost, and that's despite the Company recirculating a substantial portion of its assets in the past year. We used to be a major proponent of the Company back in the go-go days but we lost our religion when the Company announced several bad debts back in 2007-2008. Of course all companies have problem credits. The issue with TICC is that, from an investor's point of view, many of its loans went from performing to valueless very quickly. On paper the Company was principally a senior secured lender but when troubles occurred at portfolio companies, the underlying assets often had no or little value.
TICC was taking risks more akin to an equity investor than a lender and was not being recompensed appropriately. NAV dropped by more than 50%, its lenders bailed, the Company scrambled (very effectively) to de-leverage and the dividend was repeatedly cut from a high point of 36 cents a share in the first quarter of 2008 to 15 cents today.
With all that said, management has done a creditable job in the post-meltdown period. Rather than running after onerous bank borrowing, the Company has remained un-leveraged, and focused on deploying the cash generated from a healthy turnover of assets into better quality, high paying yield assets (97% of the portfolio). Last quarter was the first one in the past eight quarters where Total Investment Income and Net Investment Income were above the preceding period. NAV is up from a year ago although the value of the assets at cost actually dropped in 2009 versus 2008, thanks to Unrealized Appreciation boosting the Fair Market Value of the loans on TICC's books. Moreover, TICC has a relatively modest cost structure. The independent manager does receive 2% of assets managed but the "Incentive Fee" is earned only after the investors receive a hurdle return. In 2009, the Incentive was quite modest and may be again in 2010. Overall, total operating expenses amount to 2.7% of assets at cost and 34% of Investment Income.
Where we were worried in the past is about where TICC goes from here. The Company does not have much room for asset expansion. Yes, there is $24mn of cash on the balance sheet, equal to 12% of investment assets at FMV. However, with no line of credit, management has made it clear on conference calls that only a minority of those funds are available for long term investing. TICC will probably keep $10mn-$15mn in cash at all times to be ready to face any unforeseen adversities, pay dividends and management fees and such. We don't hold out much hope for drastic reversals of fortunes from its non-accruing loans, which could otherwise be a source of increased revenue. By our count there are 3 major "problem loans" with a cost basis of around $60mn. Looking at the FMV trends on those loans in the last 2 years, there's no reason to optimistic. At the end of 2008 the aggregate FMV of those 3 loans was $16.7mn. By the end of 2009, the aggregate value had dropped to $9.9mn. Not a good sign, especially as the portfolio in general was going up in value.
The best hope in the short run is for TICC to turn its loan book over and increase its loan spreads. If you ignore the non-accruing loans, TICC's loan portfolio yields an OK 11.7% and could go higher. The Company (much to the confusion of some analysts on the latest Conference Call) has chosen to devote some of its resources to investing in the higher risk portions of existing CLOs selling at a discount. These investments may earn TICC north of 20% but the Company is unlikely to invest more than $15mn in this sector, with $7mn already booked during the IVQ of 2009. The Company is not impressed by the spreads available in the syndicated loan market, which is getting overheated (already!). That leaves direct middle market lending, which may or may not be a good idea. We're assuming that TICC will be able to grow its average yield throughout the year even if LIBOR rates remain at their current anemic level. Yanking the average yield on the $200mn of existing yield assets by 1% would earn TICC a projected 7 cents a year net-net. (We were not very excited to hear management is considering spending some of its capital on equity investments rather than 100% on yield investments. We understand the attraction, especially after TICC harvested $6mn on an equity investment this year, but this kind of income is lumpy for those of us who prefer steady dividend income.)
Longer term TICC stands to gain if LIBOR rates start to appreciably increase. With 90% of its yield assets in floating instruments, and with no corresponding borrowing to pay for, TICC should benefit substantially from the long awaited higher interest rate period which most pundits are predicting for 2011 and thereafter. As the 10-K points out, a 1% increase in rates means $1.8mn in higher investment income, virtually all of which goes to the Net Investment Income line. That's 6 cents a share a year, after accounting for higher Incentive Fees. A few cents here and there can make a difference for a Company whose annualized Net Investment Income (using the fourth quarter data) is just 52 cents a year. Should all go well, we estimate Net Investment Income could run $0.59 in 2010. Two analysts have a consensus of $0.61. That would be just enough to cover the $0.60 dividend. Down the road (i.e. when rates rise), TICC could see even higher Net Investment Income Per Share. The analysts say $0.62 for 2011. Our calculations, assuming a 200 basis points increase in LIBOR, has the number even higher.
So what's the problem? As always, it comes back to credit quality. Maybe we've entered a magic period like the one that existed in 2003-2006 when a rising tide lifted all boats and bad debts were virtually nil. Nonetheless, with a portfolio still replete with loans made in the go-go days, and facing up to the fact that TICC lends into a high risk sector, it's hard to imagine that some more loans will not go on non-accrual. Company by company credit information is not available so we just have to guess from whatever slivers of fact are available in the public filings. Currently we're concerned about TICC's investment in Box Services. The loan is still current but TICC has written down the senior loan from $12mn at cost to $4.1mn at FMV. (A year ago the FMV was $10.5mn.) Should that loan stop paying, that's ($1.1mn) in lower income or 4 cents a share per year.
If instead of being too specific we just assume that 10% of the performing yield assets which TICC owns go bad, that would imply $20mn of loans currently paying interest would cease to do so. Quantifying that, there could still be 7 or 8 cents reduction in Net Investment Income coming from these additional bad debts to take into consideration. That lower income would offset some or all of the higher yields from portfolio reinvestment. The bottom line is that TICC's earnings per share - barring anything drastic happening - should trade in a relatively narrow range a few cents above or below the current dividend rate. At today's stock price and using the $0.52 a year in Net Investment Income Per Share the Company is currently earning, TICC seems expensive at a multiple of over 13x. The yield is only 8.6%. However, if you believe the 2010 estimate advanced by the analysts of $0.61, TICC is a little less expensive at 11.4x.
Go one step further and believe that yields can be increased and new bad debts completely side stepped, our calculation pegs a pro-forma TICC earnings per share of $0.73 and a multiple under 10x. We've been burned before so we may be more cautious than most investors where TICC is concerned. However, the good news is that the absence of a lender to contend with limits some of the downside risk here.
Disclosure: Long TICC