TCG BDC: 11.5% Yield And 17% Below Book

by: BDC Buzz

This article discusses a higher quality investment currently offering a safe 11.5% dividend yield that already has rallied almost 8% over the last three weeks and still underpriced.

As predicted in my previous public CGBD article, the company announced a special dividend of $0.08 per share for Q2 2019 and I'm expecting another one in Q4 2019.

The company is actively repurchasing shares as they are trading 17% below book value.

This article also discusses recommendation and what I'm doing.

TCG BDC (CGBD) is a business development company ("BDC") that's externally managed by Carlyle GMS Investment Management and part of the Carlyle Group, which is a global alternative asset manager with $216 billion of AUM across ~360 investment vehicles providing CGBD access to scale, relationships and expertise, which has advantages including incremental fee income and higher investment yields.

CGBD was formerly known as Carlyle GMS Finance, Inc. and closed its IPO on June 19, 2017, selling 9 million shares with four lockup periods each releasing 25% of an additional ~52 million pre-IPO shares. Obviously, this puts “enormous technical pressure on the stock” as discussed by management in previous reports. Release dates have occurred on December 11, 2017, June 9, 2018 and December 6, 2018. Following approval by the Board, the final Release Date was changed from June 4, 2019, to May 13, 2019. Clearly, there are still some pre-IPO investors looking for liquidity, and now that all shares are available some will continue to sell each time the stock rallies.

CGBD Share Repurchases

On November 5, 2018, the Board approved a $100 million stock repurchase program at prices below reported NAV per share through November 5, 2019, and in accordance with the guidelines specified in Rule 10b-18 of the Exchange Act. The company has repurchased around $58 million worth of shares representing approximately $0.14 in NAV accretion for shareholders.

As of today, we have $58 million remaining on our $100 million repurchase authorization implemented during the fourth quarter of 2018. We will continue to repurchase shares at or near our current valuation as we do not believe our current share price accurately reflects the strength of our investment platform. As you may recall from our discussion last quarter, our Board approved a $100 million stock repurchase program. On November 15th, the company began discretionary purchases and we've subsequently amended that plan to provide for the ability to purchase stock on a non-discretionary or programmatic basis under Rule 10b5-1. This was important strategically as there are significant periods of time typically around quarter and year-end when we're generally restricted from purchasing shares as valuations and financial results are finalized. Under the 10b5-1 program, we can purchase shares throughout these blackout periods, so long as these purchases are made within the price and volume guidelines set forth in the plan. Since inception, we purchased shares at prices we feel represent good value from a corporate finance standpoint.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Management has mentioned that they will continue to support the stock that's still trading at a 17% discount to its book value and I'm expecting additional accretive repurchases.

CGBD Management Update

I consider CGBD to have higher quality management for many reasons including previously waived management fees, conservative dividend policy driving continued/potentially additional special dividends and a shareholder friendly-fee structure of 1.50% base management fee (compared to 2.00%) and an incentive fee of 17.5% (compared to the standard 20.0%). However, the current fee agreement is not best-of-breed as it does not include a "total return hurdle" to take into account capital losses when calculating the income incentive fees.

On May 14, 2019, Michael A. Hart, the Chairman of the Board and the Chief Executive Officer, informed the Board that he had determined to resign from the Board and as the Chief Executive Officer of the Company, effective December 31, 2019, to pursue other interests. To facilitate an orderly transition, Mr. Hart will continue his current role as the Company’s Chairman and the Chief Executive Officer until Linda Pace takes over on January 1, 2020. Overall, I see this as a positive for the company.

Michael Hart: Let me spend a moment on the CEO transition we announced during the second quarter. As I mentioned, effective January 1 of next year, I'll be stepping down and Linda will become the new CEO of TCG BDC and until then I'll continue to operate in that capacity. Linda has an exceptional track record at Carlyle having led our broadly syndicated loan business for the past 10 years, a business today that manages over $25 billion in AUM. Linda has actually been with Carlyle for more than 20 years in different investment capacities and I've had the pleasure of working closely with Linda as she has been involved with our BDC since our inception, serving as an important member of our investment committee. She is an exceptional risk and investment manager and her skill and experience in global credit markets are a perfect addition to our direct lending team.

Linda Pace, Head of Carlyle Loans and Structured Credit: I assumed kind of the new role of President. I've been a consistent member of the team, since the beginning, having been on the investment committee and we're taking the opportunity because of the importance of the BDC to the Carlyle's overall Global Credit platform, not just to put me into the President role, but really to add more people and more focus and more resources to the BDC platform. So we are – it's business as usual and we continue to work really hard. And I think the shareholders can feel confident that we have a ton of focus with a lot of senior and highly experienced professionals from Carlyle's credit platform focused on the BDC. The BDC remains an important flagship vehicle for Carlyle, which is why I'm excited to take on these new management responsibilities. Our BDC and direct lending more broadly is a business which is core to Carlyle’s global credit development and the business which has market leading capabilities.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

CGBD Risk Profile Update

CGBD has a lower risk portfolio due to 89% invested in first-lien assets (including its Middle Market Credit Fund discussed later) highly diversified by borrower and sector, access to an experienced credit quality platform and historically low non-accruals.

We consider our BDCs portfolio to be extremely well positioned fundamentally against this macroeconomic backdrop. We have 70% of our portfolio in true first lien instruments. A high degree of investment diversification and significant under weights to more cyclical industry exposures, all of which we believe will be long-term benefits to our shareholders. We’re acutely aware that we're investing in what could be late cycle and therefore we remain ultra selective. Carlyle's credit investment platform has over 100 investment professionals that have the expertise to evaluate opportunities across the capital stack, company sizes, sectors and market cycles all with the lens and relative value and fundamental credit investing.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

As mentioned in previous articles, management takes a conservative approach to valuing its portfolio which is another indicator of higher quality management:

When we held our initial earnings call as a public company back in August of 2017, I highlighted that based on our robust valuation policy, each quarter you may see changes in our valuations based on both underlying borrower performance as well as changes in market yields and that movement evaluations may not necessarily indicate any level of credit quality deterioration.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

During Q2 2019, net asset value (“NAV”) per share decreased by 1.4% or $0.28 per share due to net realized/unrealized losses of $0.29 per share partially from additional non-accruals (discussed later) and paying a special dividend of $0.08 per share, partially offset by accretive share repurchases adding $0.04 per share and over-earning the dividend. Management mentioned that the recent credit issues are “idiosyncratic credit issues, not indications of either thematic risk concentrations in our portfolio or broad economic weakness”:

The one controllable area which fell short of expectations in Q2 was the progression of our NAV, which was impacted by higher realized and unrealized losses than we would expect to see in normal course. We have dug into each situation and ascertained they represent idiosyncratic credit issues, not indications of either thematic risk concentrations in our portfolio or broad economic weakness. As you would expect, these loans are a significant focus for our team and we have committed the necessary resources to maximize shareholder value. For the most part, for the names that are on our watch list or on non-accrual, they're idiosyncratic situations. But one thing we can point to is that within the healthcare services space, where we're seeing companies do more aggressive types of roll-up transactions that those come with more challenges.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

As mentioned in the previous article, “my primary concern is two investments that were added to ‘Internal Risk Rating 4’. However, management discussed these investments on the recent call as “these are temporary performance issues” and “our goal remains full recovery”:

The weighted average internal risk rating remained 2.3. However, total watch list loans again increased this quarter with a net addition of three borrowers. With the overall theme is that in most cases we believe these are temporary performance issues. Sponsors have been supportive with additional capital. We've closed their negotiated credit enhancing amendments and our goal remains full recovery. During the quarter, we repurchased 1.1 million shares of stock for over $16 million, which was $0.04 per share accretive to NAV. Stabilizing and growing our NAV via our integrated platform approach will be the major focus area for me and the team over the next few years.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

During Q2 2019, non-accruals increased due to adding Dimensional Dental Management and Indra Holdings Corp. (Totes Isotoner) during the quarter resulting in NAV decline of almost $0.16 per share. Totes hired Houlihan Lokey, which specializes in restructurings and CGBD exited this investment during Q3 2019 which will result in additional realized losses and a slight decline in NAV due to exiting at “a bit lower” value:

The level of non-accruals increased this quarter from 0.8% to 2% based on fair value with the addition of two borrowers. We exited one of these positions (Totes) post quarter end at a level a bit lower than our 6/30 mark, driven by our developing view on the potential downside to our recovery in that investment. For the other non-accrual transactions these continue to be fluid and developing situations. Given the status of ongoing negotiations between the various parties we're limited in providing additional color, but we hope to have updates over the next couple of quarters.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

SolAero Technologies Corp. has been discussed in previous reports and was restructured during Q2 2019 driving most of the realized losses of almost $9.1 million or $0.15 per share:

The roughly $8 million realized loss this quarter has two primary components. First, a $9 million realized loss for our recapitalization of SolAero and that was primarily reversal of prior period unrealized losses. And second, a $2 million gain on an equity co-investment in imperial date.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Product Quest Manufacturing, LLC remains on non-accrual and was written down due to “operational and liquidity challenges” and its smaller first-lien loan was added to non-accrual in Q1 2019. On a previous call, management mentioned that all lenders (including CGBD) have provided an additional credit facility to support the working capital needs and will provide updates on future calls. Non-accruals account for around 2.0% of the portfolio fair value and $0.70 of NAV per share:

Some of the other investments that have been discussed in previous reports and/or that I am watching closely include Derm Growth Partners, PPT Management Holdings, Superior Health Linens, SPay, Inc.,, Hydrofarm, Hummel Station, and GRO Sub Holdco. Most of these investments were marked down during Q2 2019 with the exception PPT:

Indra Holdings Corp. (Totes Isotoner) was its only investment with an "Internal Risk Rating 6" and has been exited as discussed earlier.

Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

CGBD Dividend Coverage Update

As predicted in my previous public CGBD article, the company announced a special dividend of $0.08 per share for Q2 2019:

CGBD continues to over earn its dividend for the reasons discussed in previous articles including potential/continued ramp of its joint venture Middle Market Credit Fund, LLC (“Credit Fund”), increased overall portfolio yield and excellent dividend coverage. For the quarter ended June 30, 2019, CGBD covered its dividend by 125% reporting just below its best-case projections. Over the last four quarters, its average earnings have been almost $0.45 per share compared to its quarterly dividend of $0.37 per share.

We generated net investment income of $28 million or $0.46 per share, $0.01 higher than the $0.45 we produced in the first quarter. We declared a regular $0.37 dividend and as we previewed last quarter, we also declared a $0.08 special dividend for a total of $0.45 in dividends declared in the quarter. Our Company has consistently produced net investment income in excess of our quarterly dividend and we expect to continue this trend going forward.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Middle Market Credit Fund, LLC (“Credit Fund”):

Investments in the Credit Fund increased from $1.26 billion to $1.33 billion during Q2 2019 producing a 12.7% annualized yield. The Credit Fund’s new investment fundings were $121 million for the quarter with sales and repayments of $43 million.

Moving onto the JVs performance, the dividend yield on our equity in the JV was about 13% for the second quarter. As previewed on last quarter's call in late May, we closed our second CLO at the JV, which resulted in an overall reduction in the JVs cost of capital by about 20 basis points.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

The company has covered its dividend by an average of 118% over the last eight quarters due to continued increases in recurring sources of income implying the potential for an increase to regular quarterly dividend and was discussed on previous calls. The company still has $0.21 per share of undistributed income available for a special dividend that will likely be announced in Q4 2019:

We will consider additional future special dividends with some regularity as appropriate and as our core earnings allow. At the end of the second quarter, we had approximately $0.21 per share in spillover income to fund special dividends in future periods.

Source: CGBD Q2 2019 Results - Earnings Call Transcript

Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

CGBD Increased Leverage and Dividend Potential

The company has been increasing its use of leverage that will likely continue. Previously, CGBD received shareholder approval to reduce its asset coverage requirement to 150% effective June 7, 2018, and the Board approved a 0.50% reduction in the 1.50% annual base management fee on assets financed using leverage in excess of 1.0x debt to equity. As of June 30, 2019, CGBD had cash and cash equivalents of $62 million and $207 million available for additional borrowings under its revolving credit facilities. Management guided for active portfolio growth in Q3 2019 due to “a steady originations pipeline combined with more modest repayments expected this quarter” and is taken into account with the updated projections:

During the quarter, we increased commitments under our revolving credit facility by another $80 million. So we had about $340 million of total unused commitments under our credit facility. Statutory leverage was 1.07, generally in line with prior quarter giving you the growth in the portfolio. However, we do see this level increasing more meaningfully by the end of the third quarter due to a steady originations pipeline combined with more modest repayments expected this quarter. And given them more favorable rate environments for issuers, we anticipate exploring additional financing transactions in the near term to increase our operational flexibility we'll be looking at all areas of the market including the private and public capital markets.

Source: CGBD Q2 2019 Results - Earnings Call Transcript


Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

CGBD has a lower cost of borrowings including its previously reset 2015 CLO Notes and the credit facilities at around LIBOR + 200/225.

Regarding our liabilities, we continue to benefit from the association with one of the premier CLO platforms in the world. This quarter, we priced our fourth middle-market CLO further diversifying our sources of financing and reducing our overall cost of debt. We continue to be one of the few BDCs that has an investment portfolio anchored in first-lien senior secured loans with the scale and diversification necessary to support the issuance of CLOs. This not only provides our BDC and our shareholders with lower cost of debt relative to our peers but perhaps more importantly, it provides us with non-mark-to-market term financing which we feel is highly valuable in markets with increased volatility.

Source: CGBD Q2 2019 Results - Earnings Call Transcript


Source: TCG BDC, Inc. 2019 Q2 - Results - Earnings Call Slides

The following table shows the updated Leverage Analysis using the recently reported results including the higher portfolio yield. However, I have taken into account the following:

  • Management guidance of debt-to-equity "in the area of 1.2 to 1.4 to 1, which we believe to be a prudent level, given the overall risk in our portfolio today."
  • Reduced base management fee to 1.00% on assets financed with debt-to-equity over 1.0
  • Higher borrowing rates due to the company diversifying its borrowing sources to take on higher leverage.
  • Potentially lower portfolio yield of 9.0% due to investing in safer assets at lower yields.
  • Correspondingly higher income from its Credit Fund (similar to previous quarters as shown in the table above).
  • Slightly higher "Other G&A."


Summary and Recommendations

As mentioned in "Building A Retirement Portfolio With BDCs Currently Yielding 10.6%," interest rates will likely remain low and investors will continue to need equity investments (stocks) to generate an adequate portfolio yield. BDCs pay higher-than-average yields with the average BDC currently yielding over 10%. Safer BDCs are closer to 9% annual yield but patient investors can get higher yields by taking advantage of volatility (and underpriced BDCs).


Over the last three weeks, the stock price has rallied almost 8% but it's still likely underpriced and considered a "Buy" for conservative investors. As shown below, CGBD is underpriced compared to its peer group (using NAV per share performance) and currently offering a dividend yield of 11.5% after taking into account special dividends of at least $0.16 per share in 2019.

Also, as shown in the Leverage Analysis, there's the potential for a quarterly dividend increase from the current $0.37 to between $0.40 and $0.50 depending on the yield from new investments. This also was discussed on the previous earnings call:

...given the consistency of our NII performance, we'll be considering an increase to our stated quarterly dividend as well.

Source: CGBD Q1 2019 Results - Earnings Call Transcript

I believe that there will be an improvement in NAV per share over the next few quarters due to improved credit quality and conservatively valued assets. However, I have not purchased additional shares recently as this is already a meaningful position in my portfolio and I will wait for the current credit issues to be mostly resolved. BDCs invest in smaller private companies with limited public information available so there can be surprises which is why I suggest having at least 5 to 10 positions (I currently have 16).

Disclosure: I am/we are long CGBD. 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.