Medallion Financial: A 6.3% Yield With Leverage To Higher Interest Rates [View article]
You can't look at Medallion Financial and only discuss the taxi business, even if it's the ticker symbol. For better or worse, TAXI also owns a bank, which is highly regulated, and makes consumer and small business loans. We don't invest in the stock partly for that reason, as the Company's dividend is subject to being cut off by regulators seeking to preserve capital when recessions come along, and forbidding distributions from the bank to it's parent and so to shareholders. Of course, that has not been much of a problem for several years now and TAXI has done very well from a dividend and stock appreciation point of view. All that performance is not due to the medallion business alone which management has been seeking to syndicate away and diversify from.
American Capital: A Unique BDC With No Dividend And A Large Buyback Program [View article]
Thank you for the first rate summary of American Capital and it's myriad components. There are numerous bolt-ons one could add. Here are a couple: 1. The stock may be down because of the performance of the mREIT (appreciate the chart) but also may be related to weaker than expected earnings in the first quarter. Part of the problem was that the fourth quarter had a couple of unusually high items, and the first quarter saw a new troubled loan hitting the books after a general improvement in credit quality previously.
2. The Company is under-leveraged. With debt to equity of 0.1 to 1.0 (doing this from memory) ACAS is having a hard time putting free capital to work four years into the expansion. That's good for stock buybacks firepower, but bad for earnings. Funny to hold out under-leveraged as a problem, but it is.
Like you, I was a witness to the disastrous over-leveraging of BDC balance sheets in the run-up to the Great Recession. The culprits were 1. the requirements that loans (even those held in portfolio for the long term) had to be marked to market quarterly, 2. the assumption by management that loan values would not drop materially even in hard times because they had been so stable for so long. Then 2008 came along and loans dropped 35% or more in value, which triggered the BDC requirement that if asset values don't cover total debt by at least 200% companies cannot pay dividends, and similar covenants in loan agreements. It didn't help that several lenders jumped out of the market just as this was happening, and demanded to be repaid when defaults occurred.
However, the good news from a medium term look back is that despite the dramatic swings in asset values, very serious non-performing portfolios in some cases, many un-cooperative lenders and an atmosphere of impending doom far greater than in prior recessions no BDC actually failed. (Yes I know Patriot Capital and Allied Capital were bought up at serious discounts and American Capital and Saratoga Investment have never returned to dividend paying status, but still...).
Moreover, I think most of the BDCs in business at the time and many that have come to market since (who must have learned much watching from the sidelines) have learned from the school of hard knocks that 2008-2009 became and have promised themselves never again to be in that position. Much of the liability management in the past 4 years in the BDC space has been to layer debt obligations over much longer periods, reduce reliance on bank Revolvers, eliminate covenants and keep asset coverage levels high. (New Mountain Finance, for example, has an agreement with it's bank lender that portfolio loans not be marked to market but only reflect actual credit performance). Moreover, with much of the capital raised coming from the SBIC, and most BDCs getting waivers for that debt counting against the 200% asset coverage, BDCs liquidity risk is far,far lower than it was in 2008.
My main concern about the next Recession (long may it be deferred) is that BDCs have taken on more risk than we fully realize during these years of low LIBOR rates to maintain the higher yields that are necessary for their business model. When the economy slows we may find that some of the gimmicks that BDCs have used to keep dividends stable will backfire on them (I'm thinking of investing heavily in CLO equity tranches, taking on too many "first loss" loan positions where they agree to absorbing most of the credit loss in return for higher fees, and by investing in sectors and companies outside of their historic areas of competence). I'm even worried that the recent predilection for the "unitranche loan", where the lender provides both senior and subordinated portions of a financing may tie up more capital in under-performing borrowers than BDCs anticipated, hurting both current earnings and long term recovery. I imagine we will see very different credit underwriting results across the industry.
Despite all that gloom-mongering, I still think the BDC model is very flexible and even after the next Recession the industry will continue to grow and prosper, because of the limitation on leverage, the diversification rules and the very real professionalism and sophistication of virtually all the BDC management teams out there.
I assume your question was to the last paragraph of my comment, so here goes:
First, sorry not to be clear. My only excuse is that I was writing that at my favorite hamburger bar on my IPad. Aaaah,technology...
Yes, the SBIC funding is fixed but the rates change periodically with long term rates (I'm not certain exactly how the rate is computed but appears to be tied to the 10 year Treasury). As long term rates rise, the cost of borrowing from the SBIC will move up from their rock bottom recent levels when certain BDCs were able to borrow 10 year money at a tad over 3% (half the cost of using the private market). So BDCs may soon be fixing their SBIC debentures at rates of 4% or 5%. You would think they could just charge the ultimate borrowers more to reflect their increased cost of funds, but with the flood of SBIC and private capital out there I doubt that will be possible. So the spread that an SBIC oriented BDC will earn on their loans is likely to diminish in the months ahead IF long term rates go up and stay up. However, if the government increases the maximum debentures to $350mn as is being discussed, BDCs won't care so much. Anyway, it's still the cheapest long term capital around and has many other benefits.
Don't want to be a wet blanket here, and I appreciate the work that goes into these articles, but the data as provided here does not really illuminate the sensitivity to interest rate changes that BDCs face. The main problem is that you have not matched up the level of floating rate loan assets with floating rate borrowings. The key determinant is the net loan asset exposure to a rise in interest rates. The percentage of floating rate loan assets shown in the table is really irrelevant. If a BDC has 100% of its loans in floating rate form, with a value of $100, but has (in a hypothetical example) $100 of floating rate borrowings, the net result of an increase in rates (presumably LIBOR) will be nothing.
Problem number two are those complex floor agreements,both with borrowers and with the BDCs own lenders. Rates could rise modestly but some BDCs could see no increase in their own income from loans due to rates not reaching the floors, while their own borrowing costs might or might not increase depending on what their floor terms are with their Revolver lenders. Unfortunately one has to calculate each BDC individually to evaluate the interest rate opportunity.
The most important point I'd make is that no BDCs have any negative exposure to higher interest rates. Unlike Savings and Loans in the past who were making long term loans on fixed terms, but borrowing short term ,BDCs have either matched assets and liabilities or have a greater amount of floating rate assets than they have floating rate liabilities. In all cases BDCs should see income stay flat or increase from higher rates. The question is more who will benefit most.
I would end that if there are going to be any losers from higher long term rates, it will be the many BDCs which borrow from the SBIC at fixed rates. They will lose out not because they are not match funded (they are-i.e. they structure their loans with a fixed interest rate) , but because the cost of the SBIC loans will increase, and the BDCs will probably not be able to pass along all that increase in the rate they charge borrowers, both due to SBIC regulations and competitive pressures.
Why OFS Capital Was Downgraded By Oppenheimer [View instapost]
Hard to determine if OFS price has bottomed out. We bought more on the way down so that means the stock will drop further ! The issues that need to be resolved, including the full capture of the SBIC license, will take weeks or months to fully resolve so the price could be in limbo for awhile.
We read the 10-Q in some detail, and made a number of assumptions (the SBIC "drop-down" would be/would not be approved) and sought to calculate out the pro-forma earnings accordingly as all the capital available to OFS is deployed. The good news is that even if OFS is stymied, and can only invest $25mn as an investor in the SBIC, the Company will still be generating a decent profit (albeit at a lower level than anticipated by the level of the dividend) . Moreover, management will have the option to invest capital in higher yielding investments going forward, and/or raise "baby bonds" instead of SBIC debt. In such a fluid situation with so many alternatives available to OFS there's no point in trying to predict what management's exact steps might be. Still, with $142mn in GAAP equity, we'd be surprised if OFS could not earn an 8% NOI, or $11.4mn, or $1.18. That would suggest at today's price OFS could pay a dividend yielding 9.5%-10.0%. Of course, if everything goes as originally planned earnings could be substantially higher.
We like special situations with limited downside and a greater degree of upside, and that seems to apply in this situation.
Prospect Capital's Foray Into Real Estate [View instapost]
All prospective investments (no pun intended) haves pluses and negatives.( Even those companies which, on a relative basis, have less "issues" most likely will be over-priced). From our perspective, we want to be realistic about assessing each investment we make and the risks and upsides we are facing, rather than unreservedly "falling in love" with a stock.
You may be asking me the question as an existing investor in Prospect irked that I have said something critical of your stock but I don't see Seeking Alpha as a fan page for stocks but a place to provide a balanced view. Don't you think it's interesting that a BDC is building out a Real Estate Investment Trust from scratch ?
Goldman Sachs Jumps Into The Business Development Arena [View article]
Small pedantic correction: KKR does not have a BDC affiliate ( but Apollo Global Management does in Apollo Investment). You may be thinking of KKR Financial LLC (KFN) which has been around since 2004 and provides debt financing to buy-outs and pays a regular dividend. However KFN is not regulated as a BDC and can take on more leverage ( where a BDC is limited to debt to equity to 1:1) and can choose to retain earnings (where a BDC cannot).
As for the Goldman BDC, we don't expect much. Middle market lending is not the firm's expertise and the commitment so far, in terms of capital and asset size, has been very modest. This appears to be more of a toe in the water than a major move. We doubt Goldman will be a top ten player in the BDC space even a year out.
Prospect Capital: Is It Better Than American Capital? [View article]
I'll weigh in, but from memory: ACAS is still a BDC but has elected C Corp status.to take advantage of all it's losses. Nonetheless, I treat ACAS as an asset manager, rather than a BDC.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
No. All the BDC Notes (there are over 20 issues now !) are fixed rate. That's the benefit to the BDC: fixing their liability cost at historically low levels. The maturity of the Notes vary from 6 years to 30 years plus, but most are ten years and under. Most pay interest quarterly and a few month monthly (GLADP, GAINP and OXLCP are Yahoo tickers).
For an investor the longer term maturity adds interest rate risk to the normal credit risk calculation.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
Goldman is not a middle market player, nor a renowned lender, so the new BDC is a very interesting development and not necessarily going to end well. Agree with CorvetteKid that their huge earnings are unlikely to be much affected by the contribution from a BDC. Looking forward (if that's the right way term) to reading the Prospectus.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
To Guardian3981: Agree that prices for BDCs are high (which might account for profit taking today). Our own analysis sees a 7% further upside on the 36 companies we track.
However, don't count on IPOs making much of a difference as a competitive capital source. Very, very few of the private companies financed by BDCs ever go public (exception are the technology BDCs): too small and insufficient growth (remember BDCs like companies with consistent, predictable cash flows. The IPO markets want fast growth companies).
As for banks, there's no sign of increasing competition from them. The new Basel rules make direct leveraged lending (as opposed to underwriting and syndicating) unattractive from a capital adequacy standpoint. Competition is coming from finance companies (like CIT), CLOs (but only for bigger transactions), the junk bond market (but only at the very largest companies), and other BDCs. Still, a review of the fourth quarter 2012 BDC filings shows that most of the lower mid market and middle market BDCs were not seeing much in yield erosion on new loans. The situation is different for the larger BDCs which have to compete with junk bonds and CLOs.
I'd stick my neck out and say that BDCs in the years ahead, because of their deal networks, access to low priced public capital and blue chip sponsorship, will increasingly dominate the market for providing senior, subordinated and uni-tranche lending to smaller and mid-sized buyouts. Maybe that explains Goldman joining the party with their own BDC.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
To Guardian3981: Agree that prices for BDCs are high (which might account for profit taking today). Our own analysis sees a 7% further upside on the 36 companies we track.
However, don't count on IPOs making much of a difference as a competitive capital source. Very, very few of the private companies financed by BDCs ever go public (exception are the technology BDCs): too small and insufficient growth (remember BDCs like companies with consistent, predictable cash flows. The IPO markets want fast growth companies).
As for banks, there's no sign of increasing competition from them. The new Basel rules make direct leveraged lending (as opposed to underwriting and syndicating) unattractive from a capital adequacy standpoint. Competition is coming from finance companies (like CIT), CLOs (but only for bigger transactions), the junk bond market (but only at the very largest companies), and other BDCs. Still, a review of the fourth quarter 2012 BDC filings shows that most of the lower mid market and middle market BDCs were not seeing much in yield erosion on new loans. The situation is different for the larger BDCs which have to compete with junk bonds and CLOs.
I'd stick my neck out and say that BDCs in the years ahead, because of their deal networks, access to low priced public capital and blue chip sponsorship, will increasingly dominate the market for providing senior, subordinated and uni-tranche lending to smaller and mid-sized buyouts. Maybe that explains Goldman joining the party with their own BDC.
Medallion Financial: A 6.3% Yield With Leverage To Higher Interest Rates [View article]
What The Wave Of New Private Mezzanine Funds Means For The BDC Sector [View instapost]
American Capital: A Unique BDC With No Dividend And A Large Buyback Program [View article]
1. The stock may be down because of the performance of the mREIT (appreciate the chart) but also may be related to weaker than expected earnings in the first quarter. Part of the problem was that the fourth quarter had a couple of unusually high items, and the first quarter saw a new troubled loan hitting the books after a general improvement in credit quality previously.
2. The Company is under-leveraged. With debt to equity of 0.1 to 1.0 (doing this from memory) ACAS is having a hard time putting free capital to work four years into the expansion. That's good for stock buybacks firepower, but bad for earnings. Funny to hold out under-leveraged as a problem, but it is.
BDC Risk Profiles: Part 6 - Interest Rate Sensitivity [View article]
Like you, I was a witness to the disastrous over-leveraging of BDC balance sheets in the run-up to the Great Recession. The culprits were 1. the requirements that loans (even those held in portfolio for the long term) had to be marked to market quarterly, 2. the assumption by management that loan values would not drop materially even in hard times because they had been so stable for so long. Then 2008 came along and loans dropped 35% or more in value, which triggered the BDC requirement that if asset values don't cover total debt by at least 200% companies cannot pay dividends, and similar covenants in loan agreements. It didn't help that several lenders jumped out of the market just as this was happening, and demanded to be repaid when defaults occurred.
However, the good news from a medium term look back is that despite the dramatic swings in asset values, very serious non-performing portfolios in some cases, many un-cooperative lenders and an atmosphere of impending doom far greater than in prior recessions no BDC actually failed. (Yes I know Patriot Capital and Allied Capital were bought up at serious discounts and American Capital and Saratoga Investment have never returned to dividend paying status, but still...).
Moreover, I think most of the BDCs in business at the time and many that have come to market since (who must have learned much watching from the sidelines) have learned from the school of hard knocks that 2008-2009 became and have promised themselves never again to be in that position. Much of the liability management in the past 4 years in the BDC space has been to layer debt obligations over much longer periods, reduce reliance on bank Revolvers, eliminate covenants and keep asset coverage levels high. (New Mountain Finance, for example, has an agreement with it's bank lender that portfolio loans not be marked to market but only reflect actual credit performance). Moreover, with much of the capital raised coming from the SBIC, and most BDCs getting waivers for that debt counting against the 200% asset coverage, BDCs liquidity risk is far,far lower than it was in 2008.
My main concern about the next Recession (long may it be deferred) is that BDCs have taken on more risk than we fully realize during these years of low LIBOR rates to maintain the higher yields that are necessary for their business model. When the economy slows we may find that some of the gimmicks that BDCs have used to keep dividends stable will backfire on them (I'm thinking of investing heavily in CLO equity tranches, taking on too many "first loss" loan positions where they agree to absorbing most of the credit loss in return for higher fees, and by investing in sectors and companies outside of their historic areas of competence). I'm even worried that the recent predilection for the "unitranche loan", where the lender provides both senior and subordinated portions of a financing may tie up more capital in under-performing borrowers than BDCs anticipated, hurting both current earnings and long term recovery. I imagine we will see very different credit underwriting results across the industry.
Despite all that gloom-mongering, I still think the BDC model is very flexible and even after the next Recession the industry will continue to grow and prosper, because of the limitation on leverage, the diversification rules and the very real professionalism and sophistication of virtually all the BDC management teams out there.
BDC Risk Profiles: Part 6 - Interest Rate Sensitivity [View article]
First, sorry not to be clear. My only excuse is that I was writing that at my favorite hamburger bar on my IPad. Aaaah,technology...
Yes, the SBIC funding is fixed but the rates change periodically with long term rates (I'm not certain exactly how the rate is computed but appears to be tied to the 10 year Treasury). As long term rates rise, the cost of borrowing from the SBIC will move up from their rock bottom recent levels when certain BDCs were able to borrow 10 year money at a tad over 3% (half the cost of using the private market). So BDCs may soon be fixing their SBIC debentures at rates of 4% or 5%. You would think they could just charge the ultimate borrowers more to reflect their increased cost of funds, but with the flood of SBIC and private capital out there I doubt that will be possible. So the spread that an SBIC oriented BDC will earn on their loans is likely to diminish in the months ahead IF long term rates go up and stay up. However, if the government increases the maximum debentures to $350mn as is being discussed, BDCs won't care so much. Anyway, it's still the cheapest long term capital around and has many other benefits.
Hope that is clearer.
BDC Risk Profiles: Part 6 - Interest Rate Sensitivity [View article]
Problem number two are those complex floor agreements,both with borrowers and with the BDCs own lenders. Rates could rise modestly but some BDCs could see no increase in their own income from loans due to rates not reaching the floors, while their own borrowing costs might or might not increase depending on what their floor terms are with their Revolver lenders. Unfortunately one has to calculate each BDC individually to evaluate the interest rate opportunity.
The most important point I'd make is that no BDCs have any negative exposure to higher interest rates. Unlike Savings and Loans in the past who were making long term loans on fixed terms, but borrowing short term ,BDCs have either matched assets and liabilities or have a greater amount of floating rate assets than they have floating rate liabilities. In all cases BDCs should see income stay flat or increase from higher rates. The question is more who will benefit most.
I would end that if there are going to be any losers from higher long term rates, it will be the many BDCs which borrow from the SBIC at fixed rates. They will lose out not because they are not match funded (they are-i.e. they structure their loans with a fixed interest rate) , but because the cost of the SBIC loans will increase, and the BDCs will probably not be able to pass along all that increase in the rate they charge borrowers, both due to SBIC regulations and competitive pressures.
Why OFS Capital Was Downgraded By Oppenheimer [View instapost]
We read the 10-Q in some detail, and made a number of assumptions (the SBIC "drop-down" would be/would not be approved) and sought to calculate out the pro-forma earnings accordingly as all the capital available to OFS is deployed. The good news is that even if OFS is stymied, and can only invest $25mn as an investor in the SBIC, the Company will still be generating a decent profit (albeit at a lower level than anticipated by the level of the dividend) . Moreover, management will have the option to invest capital in higher yielding investments going forward, and/or raise "baby bonds" instead of SBIC debt. In such a fluid situation with so many alternatives available to OFS there's no point in trying to predict what management's exact steps might be. Still, with $142mn in GAAP equity, we'd be surprised if OFS could not earn an 8% NOI, or $11.4mn, or $1.18. That would suggest at today's price OFS could pay a dividend yielding 9.5%-10.0%. Of course, if everything goes as originally planned earnings could be substantially higher.
We like special situations with limited downside and a greater degree of upside, and that seems to apply in this situation.
Prospect Capital's Foray Into Real Estate [View instapost]
You may be asking me the question as an existing investor in Prospect irked that I have said something critical of your stock but I don't see Seeking Alpha as a fan page for stocks but a place to provide a balanced view. Don't you think it's interesting that a BDC is building out a Real Estate Investment Trust from scratch ?
Fifth Street Finance Corp.'s Upcoming Q2 2013 Income Statement Estimation [View article]
Goldman Sachs Jumps Into The Business Development Arena [View article]
As for the Goldman BDC, we don't expect much. Middle market lending is not the firm's expertise and the commitment so far, in terms of capital and asset size, has been very modest. This appears to be more of a toe in the water than a major move. We doubt Goldman will be a top ten player in the BDC space even a year out.
Prospect Capital: Is It Better Than American Capital? [View article]
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
For an investor the longer term maturity adds interest rate risk to the normal credit risk calculation.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
However, don't count on IPOs making much of a difference as a competitive capital source. Very, very few of the private companies financed by BDCs ever go public (exception are the technology BDCs): too small and insufficient growth (remember BDCs like companies with consistent, predictable cash flows. The IPO markets want fast growth companies).
As for banks, there's no sign of increasing competition from them. The new Basel rules make direct leveraged lending (as opposed to underwriting and syndicating) unattractive from a capital adequacy standpoint. Competition is coming from finance companies (like CIT), CLOs (but only for bigger transactions), the junk bond market (but only at the very largest companies), and other BDCs. Still, a review of the fourth quarter 2012 BDC filings shows that most of the lower mid market and middle market BDCs were not seeing much in yield erosion on new loans. The situation is different for the larger BDCs which have to compete with junk bonds and CLOs.
I'd stick my neck out and say that BDCs in the years ahead, because of their deal networks, access to low priced public capital and blue chip sponsorship, will increasingly dominate the market for providing senior, subordinated and uni-tranche lending to smaller and mid-sized buyouts. Maybe that explains Goldman joining the party with their own BDC.
Fight The Fed: 5 BDCs Yielding Nearly 10% With Safety Limits [View article]
However, don't count on IPOs making much of a difference as a competitive capital source. Very, very few of the private companies financed by BDCs ever go public (exception are the technology BDCs): too small and insufficient growth (remember BDCs like companies with consistent, predictable cash flows. The IPO markets want fast growth companies).
As for banks, there's no sign of increasing competition from them. The new Basel rules make direct leveraged lending (as opposed to underwriting and syndicating) unattractive from a capital adequacy standpoint. Competition is coming from finance companies (like CIT), CLOs (but only for bigger transactions), the junk bond market (but only at the very largest companies), and other BDCs. Still, a review of the fourth quarter 2012 BDC filings shows that most of the lower mid market and middle market BDCs were not seeing much in yield erosion on new loans. The situation is different for the larger BDCs which have to compete with junk bonds and CLOs.
I'd stick my neck out and say that BDCs in the years ahead, because of their deal networks, access to low priced public capital and blue chip sponsorship, will increasingly dominate the market for providing senior, subordinated and uni-tranche lending to smaller and mid-sized buyouts. Maybe that explains Goldman joining the party with their own BDC.