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Expense Ratios Are Influenced By The Liability Numbers

Sep. 30, 2016 9:50 AM ET1 Comment
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There are multiple metrics that have strong influences on valuations - (1) Dividend coverage ratios; (2) PWAYs (portfolio weighted average yields); (3) NAV trends and (4) NII/TII (net investment income to total investment income) ratios (the higher the ratio - the better). There are BDCs with good dividend coverage and bad NII/TII ratios. The same is true with the other metrics. As a result, when the data is parsed by one metric - there is always going to be noise caused by the other metrics. Despite that obstacle, when you have a strong influence, you will see it in the data.

The data that shows that expense ratios (or NII/TII ratios) matter:

The Correlation Between NII/TII Ratios and Price/NAV Ratios and weeding out FULL, KCAP, OHAI, SAR, MFIN and TICC
The following had LTM NII/TII Ratios over 60%: ACSF, BKCC, GSBD, MAIN and SUNS. Their mean price to NAV (when price equals NAV, the ratio equals 100%) is 110.03%. Their mean P/E is 10.80.
The following had LTM NII/TII Ratios between 53% and 60%: ABDC, CMFN, GARS, NMFC, PFLT, TCAP, TCPC, TCRD, TPVG and TSLX. Their mean price to NAV ratio is 97.28%. Their mean P/E is 9.23.
The following had LTM NII/TII Ratios between 50% and 53%: AINV, FSIC, GLAD, HTGC, MRCC, PNNT and SLRC. Their mean price to NAV ratio is 101.86%. Their mean P/E is 9.49.
The following had LTM NII/TII Ratios between 46% and 50%: ARCC, FDUS, FSFR, GBDC, HCAP, HRZN, OFS, PSEC and WHF. Their mean price to NAV ratio is 93.41%. Their mean P/E is 9.83.
The following had LTM NII/TII Ratios under 46%: CPTA, FSC, GAIN, MCC and SCM. Their mean price to NAV ratio is 80.98%. Their mean P/E is 8.52.

The work I have done on the "liability story" metrics shines some needed light on the importance of the "interest expense to TII ratio". Those BDCs with the better interest expense to TII ratios strongly tend to have better NII/TII ratios. The data above provide evidence that the NII/TII is important - therefore the interest expense to TII ratio is important. The data:

Interest Expense to TII compared to NII/TII Ratios

Company Int Exp TII Int Exp/TII Ratio NII/TII Ratio
Alcentra Capital Corporation (ABDC) 1.335 10.640 12.55% 55.44%
American Capital Senior Floating (ACSF) 0.640 4.272 14.98% 69.48%
Apollo Investment Corporation (AINV) 16.793 76.469 21.96% 47.16%
Ares Capital Corporation (ARCC) 45.334 245.262 18.48% 42.92%
BlackRock Capital Investment (BKCC) 4.154 33.429 12.43% 64.64%
CM Finance Inc (CMFN) 1.377 7.815 17.62% 53.78%
Capitala Finance Corp. (CPTA) 5.029 16.991 29.60% 43.74%
Fidus Investment Corporation (FDUS) 2.654 13.832 19.19% 35.73%
Fifth Street Finance Corp. (FSC) 13.149 64.026 20.54% 45.45%
Fifth Street Senior Floating Rate (FSFR) 2.437 13.114 18.58% 47.01%
Franklin Square Investment Corp (FSIC) 18.064 110.211 16.39% 51.58%
Full Circle Capital Corporation (FULL) 0.740 3.700 20.00% 48.60%
Gladstone Investment Corporation (GAIN) 0.971 14.393 6.75% 45.80%
Garrison Capital Inc. (GARS) 2.078 11.137 18.66% 51.63%
Golub Capital BDC, Inc. (GBDC) 2.186 32.106 6.81% 49.49%
Gladstone Capital Corporation (GLAD) 1.677 9.844 17.04% 49.85%
Goldman Sachs BDC (GSBD) 3.246 29.321 11.07% 62.07%
Harvest Capital Credit (HCAP) 0.963 4.729 20.36% 43.75%
Horizon Technology Finance Corp (HRZN) 1.521 9.092 16.73% 49.62%
Hercules Capital (HTGC) 8.850 43.538 20.33% 53.64%
KCAP Financial,Inc. (KCAP) 2.265 9.579 23.65% 53.32%
Main Street Capital Corporation (MAIN) 8.255 42.902 19.24% 64.45%
Medley Capital Corporation (MCC) 7.680 27.440 27.99% 38.55%
Monroe Capital Corporation (MRCC) 1.773 11.118 15.95% 51.80%
New Mountain Finance Corporation (NMFC) 6.771 41.490 16.32% 52.62%
OFS Capital Corporation (OFS) 1.308 7.683 17.02% 45.00%
Oak Hill Advisors (OHAI) 0.975 4.373 22.30% 41.97%
Prospect Capital Corporation (PSEC) 41.838 193.038 21.67% 47.32%
PennantPark Floating Rate Capital (PFLT) 1.276 10.803 11.81% 63.23%
PennantPark Investment Corp (PNNT) 7.005 35.540 19.71% 50.07%
Saratoga Investment Corp. (SAR) 2.368 7.908 29.94% 32.11%
Stellus Capital Investment (SCM) 2.015 9.375 21.49% 40.99%
Solar Capital Ltd. (SLRC) 5.543 41.369 13.40% 47.21%
Solar Senior Capital Ltd. (SUNS) 0.913 6.681 13.67% 60.85%
Medallion Financial Corp. (MFIN) 3.368 15.676 21.49% 60.06%
Triangle Capital Corp (TCAP) 6.764 28.422 23.80% 57.48%
TCP Capital Corp. (TCPC) 5.834 35.595 16.39% 52.00%
THL Credit, Inc. (TCRD) 3.873 20.480 18.91% 56.95%
TICC Capital Corp. (TICC) 1.903 17.047 11.16% 39.88%
TriplePoint Venture Growth (TPVG) 1.903 9.405 20.23% 52.72%
TPG Specialty Lending (TSLX) 5.630 46.034 12.23% 55.40%
WhiteHorse Finance (WHF) 1.951 13.050 14.95% 49.24%
Averages for full group 17.94% 50.59%
Averages for interest expense under 18% 13.76% 53.45%
Averages for interest expense over 18% 21.73% 47.98%

I still have work to do one this. I suspect that PWAY has an influence on these metrics. Low PWAY stocks tend to borrow at lower rates and have lower leverage. Leverage should also have an influence on its own - and I do not have that metric in my javascript. The Annualized Interest expense to Debt ratio should have an influence - and I do not have that newly created data in my javascript.

And - there are weird outliers out there that mess with the data. For example. Solar Capital or SLRC has been a good BDC lately. Dividend coverage is great. The LTM NAV trend is much better than average. Price appreciation has been strong (probably too strong given the yield). Its leverage is going up and its 'percentage' interest expense (or annualized interest expense to debt ratio) is going down. All things being equal, I would have thought that rising leverage would add to both the interest expense and the interest expense percentage. But SLRC is adding lower cost debt - and good things are happening. SRLC started with a low debt ratio.

Stellus Capital Investment Corporation or SCM is adding leverage and bad things are happening. SCM almost has dividend coverage and it LTM NAV is slightly better than sector average. SCM is also doing better than sector average on price appreciation. But . . the SCM debt/NAV ratio is getting ugly (120%). The NII/TII ratio is getting uglier (41%) as the interest expense to TII ratio rises. SCM has added debt and the annualized interest expense to debt ratio appears to be slightly rising. SCM started with an average debt ratio.

NMFC and GSBD have added debt at the end of this quarter. NMFC started with an average debt ratio while GSBD started with a slightly below average debt ratio. GSBD added $100 million of 4.5% debt. NMFC added $35 million of 5% debt. There are differences - but are they differences that matter? I have some expectation that as I keep on tracking these metrics, I will one day have an answer.

GSBD started with an annualized interest expense to debt ratio of 2.77% while NMFC started with a ratio of 3.83%. GSBD should have the larger increase in expenses. THAT should be the thing that matters most. But, NMFC is shifting more towards second lien debt from first lien debt. If 18 months down the line the non-accruals are up for NMFC - that THAT will be the thing that matters most.

The more due diligence I do (to some degree) the more confused and complicated things get. That is the bad news. At the same time, the more due diligence I do, the more I realize investing is playing a game of falling dominoes. Given attributes lead to expected outcomes. You need to start with good attributes to arrive at good outcomes. The more due diligence I do, the clearer the picture becomes as to which attributes are "good".

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