FS Investment: BDC Dividend Coverage Part 6

| About: FS Investment (FSIC)


This article uses my "optimal leverage" analysis to assess dividend coverage for FS Investment Corp.

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), TCP Capital (NASDAQ:TCPC), THL Credit (NASDAQ:TCRD), New Mountain Finance (NYSE:NMFC) and Medley Capital (NYSE:MCC) please see:

Franklin Square recently rang the opening bell at the NYSE for the listing of its flagship fund, FS Investment Corp. (NYSE:FSIC). Since January 2009 FSIC has been operating as BDC and now has a $4.1 billion portfolio of mostly safer senior secured debt. I have included FSIC in my suggested 'Total Return' and 'Value' portfolios.

Over the last five quarters, FSIC has been able to maintain its portfolio yield between 10.2% and 10.4% and is currently lower than the average BDC (closer to 11.5%). Its direct lending channel leverages its sub-advisor GSO/Blackstone's global sourcing and origination platform to directly originate investment opportunities for above-market risk-adjusted returns.

The following chart shows the debt-to-equity ratios over the last 11 quarters.

Recently FSIC has announced a reduction in the base management fee paid to the Investment Advisor from 2.00% to 1.75% of average gross assets. This is an investor friendly move and will reduce its management expenses as a percentage of available income (see following table). Incentive fees are a standard 20% of pre-incentive fee income and gains, but for projection purposes I use core net investment income ("NII") that excludes both income and incentive fees related to capital gains.

On June 4, 2014 the company announced "Pursuant to the Tender Offer, FSIC has accepted for purchase 23,255,813 shares of Common Stock at a purchase price of $10.75 per share, for an aggregate cost of approximately $250,000,000, excluding fees and expenses relating to the Tender Offer. The 23,255,813 shares of Common Stock accepted for purchase in the Tender Offer represent approximately 8.9% of FSIC's issued and outstanding shares of Common Stock as of May 28, 2014. Upon settlement of the Tender Offer, FSIC will have approximately 239,026,360 shares of Common Stock outstanding."

This tender offer will impact the amount of growth capital available and reduce the amount of shares. I have assumed that a portion of the $250 million is paid using debt and cash which was almost $300 million at the end of the last quarter. 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 10.2% 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). This analysis implies that the current dividend is sustainable and that there is the potential for growth in the coming quarters.

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 from the previous table for FSIC to TCRD, TCPC, ARCC, NMFC, MCC and Hercules Technology Growth Capital (NASDAQ:HTGC). At this point I believe HTGC, FSIC and TCPC have a much higher potential for dividend increases than the average BDC. I will continue to add more BDCs in the following articles.

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:

Disclosure: I am long FSIC, HTGC, MAIN, TCPC, ARCC, NMFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.