- This article uses my ‘optimal leverage’ analysis to assess dividend coverage for TCP Capital.
- The BDC industry is experiencing yield compression and 7 out of the 26 BDCs that I cover have recently cut dividends.
- I will use this series to project which BDCs are less likely to cut dividends in the future.
Over the next few weeks, I will be assessing dividend coverage for most of the 26 BDCs that I cover in an effort to uncover companies that have the potential to sustain or increase current dividends. I will also be using this information to update my latest "BDC Rankings: May 2014." For more details regarding this series and for the dividend coverage results for Ares Capital (NASDAQ:ARCC) and Medley Capital (NYSE:MCC) please see:
Over the last four quarters, TCPC has seen its portfolio yield decline slightly from 10.9% to 10.8% and is currently lower than the average BDC (closer to 11.7%). TCPC is a younger BDC that is in an earlier growth phase and has not reached its target debt-to-equity ratio of 0.75 (currently at 0.53). The company is shifting its borrowings to fixed rates and on April 2, 2014 TCPC announced that it received final approval from the SBA to operate as a Small Business Investment Company (SBIC). This will give the company access to attractive long-term financing with many advantages including increased amounts of leverage that is excluded from BDC leverage requirements.
During Q1, TCPC received onetime dividend income of $2 million and I have not projected any dividend income for the coming quarters. Most BDCs have a base management fee of 1.75% to 2.00% of total assets and TCPC has one of the lowest at 1.50% of assets less idle cash resulting in a lower than average cost structure for an externally managed BDC. Incentive fees are a standard 20% of pre-incentive fee income but with a hurdle rate of 8% return on equity annually. This is higher than some BDCs and helps to ensure that investors receive higher returns before incentives are paid. For projection purposes, I use core net investment income ("NII") that excludes incentive fees related to capital gains.
The following table shows the results for the most recent quarter along with projections at various levels of leverage and using a stable yield of 10.8% to determine the impacts on dividend coverage. Each of these scenarios assumes a full quarter of benefit from interest income but also a full quarter of interest expense, management and incentive fees.
These scenarios assume the highest level of efficiency and actual results could be lower because there will always be some turnover in the portfolio (that could drive higher fee income). Given the slight historical declines and already lower than average portfolio yield I would assume that TCPC is less likely to experience significant amounts of future declines in overall yield. This analysis implies that there is the potential for dividend growth especially if TCPC can effectively use higher amounts of leverage.
Side by Side Comparison:
For the side by side comparison, I will be using the amount of equity as of March 31, 2014 (or most recent) along with a debt-to-equity ratio of 0.80 and current portfolio yield to project income and expenses, tracking the following metrics:
- Dividend coverage (using a debt-to-equity 0.80)
- BDC expenses (as a % of available income)
'Available income' is total interest and fee income less interest expense from borrowings and is the amount of income that is available to pay management expenses and shareholder distributions. BDCs with lower expenses can pay higher amounts to shareholders without investing in riskier assets.
The following table compares the results for TCPC to ARCC and MCC. I will continue to add BDCs in the following articles. As you can see, TCPC and ARCC both have slightly lower cost structures than MCC and better dividend coverage. It is also important to point out that MCC has a higher portfolio yield that could decline more than other BDCs.
For more details including some of the potential variances to this methodology for assessing dividend coverage, please see "Part 1" of this series. Investors should only use this information as a starting point for due diligence. See the following for more information: