- This article uses my ‘optimal leverage’ analysis to assess dividend coverage for Fidus Investment.
- 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 more likely to increase or cut dividends in the future.
Over the next two 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 PennantPark Floating Rate Capital (NASDAQ:PFLT), Gladstone Capital (NASDAQ:GLAD), Golub Capital BDC (NASDAQ:GBDC), PennantPark Investment (NASDAQ:PNNT), Hercules Technology Growth Capital (NYSE:HTGC), FS Investment Corp (NYSE:FSIC), Ares Capital (NASDAQ:ARCC), TCP Capital (NASDAQ:TCPC), THL Credit (NASDAQ:TCRD), New Mountain Finance (NYSE:NMFC) and Medley Capital (NYSE:MCC) please see:
- Part 1: Ares Capital
- Part 2: Medley Capital
- Part 3: TCP Capital
- Part 4: THL Credit
- Part 5: New Mountain Finance
- Part 6: FS Investment Corp.
- Part 7: Hercules Technology Growth Capital
- Part 8: PennantPark Investment
- Part 9: Golub Capital BDC
- Part 10: Gladstone Capital
- Part 11: PennantPark Floating Rate Capital
Over the last two years, Fidus Investment (NASDAQ:FDUS) has had a declining portfolio yield from 15.5% to 14.4%, but still well above the average BDC at around 11.5%. The declining yield is due to a continued increase in safer senior debt as discussed on the most recent earnings call:
If you look back at a year ago, the yields have come [down] on the portfolio relative to where we were Q1 of 2013 and I think as we highlighted some of that has to do with the increase in the mix of senior secured loans as well as just kind of just ongoing market conditions.
FDUS has one of the most fiscally prudent capital structures among BDCs, with 100% of borrowing at fixed long-term rates and SBA debentures that are excluded from BDC debt-to-equity requirements.
Dividend and fee income has been fairly consistent from quarter to quarter at around 10% of total income, and I have used the average for projection purposes. The base management fee for FDUS is 1.75% of gross assets a year paid quarterly and excludes idle cash. Incentive fees are a standard 20% of pre-incentive fee income and gains, but for projection purposes, I use core NII that excludes both income and 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 portfolio yield of 14.4% 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, base management and income 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) and imply that the current dividend is sustainable if FDUS uses higher amounts of leverage. If its portfolio yield continues to decline, FDUS will most likely use its SBIC borrowing capacity to increase returns.
Side by Side Comparison:
The goal of using a side by side comparison is to show an 'apples to apples' view of each BDC with a stable portfolio yield, current cost structure and capital expenses with a portfolio that uses the same amount of leverage to increase return on equity investments. 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 the 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 FDUS to the other BDCs (so far in this series). As you can see, FDUS has a much higher than average 'operating cost as a percentage of available income' to match its lower portfolio yield. At this point, I believe TCP Capital, Hercules Technology Growth Capital and FS Investment Corporation have a much higher potential for dividend increases than the average BDC. I will continue to add more companies 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.