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Fifth Street Senior Floating Rate Corp. Reports An Ugly Q1/16

|Includes: Oaktree Strategic Income Corporation (OCSI)

FSFR is the evidence I used to prove my testimony to some of the key questions investors have about BDCs.

1. What happens when BDCs sell new units below NAV? To put it politely, existing investors are harmed. (I am heavily tempted to put it impolitely in an effort to correctly express the degree of harm.)

2. Do BDCs exist to make investors rich - or to make management rich? Its the latter. Management grows their income by increasing 'assets under management'. It is a rare event when portfolio and share growth results in accretive growth to the existing share holder.

3. Is a light amount of due diligence sufficient to assess risk? FSFR is a larger than average BDC run by an experienced team and invests in lower risk senior secured loans - so it must be safe. Alexander Pope wrote 'A little knowledge is a dangerous thing' long before BDCs were created - and its still true.

4. For retired investors living on portfolio income - the amount of due diligence should not just be proportional to the percentage of investment that investment is or will become - but the amount of due diligence should be proportion to the percentage of portfolio income that investment will produce.

5. Your weighting in BDCs should be proportionate to your level of skill in assessing BDC risk and values. If you know nothing - then your correct allocation is 'nothing'.

FSFR Reports NII of $0.1963/share compared to forward Dividend of $0.225
What They Earned Fifth Street Senior Floating Rate Corp announced Q1-16 total investment income $11.555 million ($0.4478/share). There was $11.555 million of interest income, $0.023 million in PIK income, $0.875 million in dividend income and $0.741 million of fee income. Net investment income was $5.785 million ($0.1963/share). The net increase in assets resulting from operations was a loss of $0.660 million (- $0.0223/share). NAV was $11.18 compared to $11.36 at the end of Q4-15. FSFR IPOed on 7-12-13 at $14.12.
FSFR closed a public offering of 22,800,000 shares at $12.91/share for total gross proceeds of approximately $294.3 million during August of 2014. That event appears to have resulted in a drop in price from the high 13s from March till July of 2014 (when NAV was close to $15) to a price in the 10s (with NAV close to $12.50) starting in October till April 2015. Share price has continued to drop. There were significant spreads in the analyst TII projections (high for the fiscal year of $55.50 million - low of $45.91 million - consensus of $52.14 million - based on five projections) leading up to the earnings release. Actual fiscal year 2015 TII was $51.472 million.

What They Own At March 31, 2016, the FSFR portfolio consisted of investments in 62 companies. At fair value, 89.3% of the FSFR portfolio consisted of senior secured floating rate debt investments, and 10.5% of the portfolio consisted of investments in the subordinated notes and LLC equity interests of FSFR Glick JV LLC. The portfolio remained spread across a number of industries and their average portfolio company debt investment size at fair value was $9.2 million at March 31, 2016. The average portfolio company EBITDA was $58.9 million at March 31, 2016, with only 0.6% of the portfolio's fair value invested in the energy sector.
As of March 31, 2016, FSFR had modified the payment terms of their investments in four portfolio companies. Such modified terms may include increased PIK interest rates and reduced cash interest rates. As of March 31, 2016, there were two investments on which FSFR had stopped accruing cash and/or PIK interest or original issue discount income that represented 2.6% of their debt portfolio at fair value in the aggregate. One of the securities on non-accrual status, Ameritox Ltd., which represented 2.2% of the debt portfolio fair value, was restructured subsequent to quarter end.

The projections from Yahoo Finance:

Earnings History Jun 15 Sep 15 Dec 15 Mar 16
EPS Est 0.27 0.25 0.24 0.24
EPS Actual 0.22 0.25 0.24 0.20
Difference -0.05 0.00 0.00 -0.04

My historical context spreadsheets:

  Q1-16 Q4-15 Q3-15 Q2-15 Q1-15 Q4-14 Q3-14 Q2-14 Q1-14 Q4-13
Realized & Unrealized Gains -6.446 -20.308 -7,114.935 -4,198.072 -158.452 -4.948.796 274.131 -69.719 -86.752 -271.814
Realized & Unrealized Gains/share -0.2187 -0.6892 -0.2415 -0.1425 -0.0538 -0.1679 0.0295 -0.01462 -0.0130 -0.0408

  Q1-16 Q4-15 Q3-15 Q2-15 Q1-15 Q4-14 Q3-14 Q2-14 Q1-14 Q4-13
Interest income 11.555 12.146 11.702 10.624 9.627 7.887 3.3 2.979 2.568 1.305
Fee income 0.741 1.313 1.710 3.008 2.265 7.973 3.0 0.866 0.837 1.001
Total investment income 13.195 13.914 14.068 13.707 11.892 15.860 6.285 3.845 3.406 2.306
Net investment income 5.785 7.002 7.402 6.339 6.701 10.425 3.805 1.853 1.791 1.503
Investments @ fair value 0.575 0.604 0.624 0.628 0.584 0.596 0.300 0.192 0.180 0.135
Wt Av Share Count 29.467 29.467 29.467 29.467 29.467 29.467 17.075 6.667 6.667 6.667
TII/share my calculation $0.4478 $0.4722 $0.4774 $0.4652 $0.3267 $0.5382 $0.3681 $0.5767 $0.5109 $0.3459
NII/share my calculation $0.1963 $0.2376 $0.2512 $0.2151 $0.2274 $0.3538 $0.2228 $0.2779 $0.2686 $0.2254
NII/share FSFR calc. $0.20 $0.24 $0.25 $0.22 $0.23 $0.35 $0.22 $0.28 $0.27 $0.23
Distributions/share $0.225 $0.225 $0.225 $.30 $0.30 $0.30 $0.30 $0.27 $0.23 $0.21
NAV/share $11.18 $11.36 $12.11 $12.23 $12.46 $12.53 $12.65 $15.13 $15.13 $15.10
Wt Av Yield 8.4% 8.0% 8.1% 7.6% 7.4% 7.1% 7.2% 7.0% 6.7% 6.64%

And now the good news: At 5-06-16 with a price of $7.83, FSFR was priced for a yield of 11.49% compared to a portfolio weighted average yield of 8.4%. There was a heck of a lot of risk and bad news already priced into FSFR. I am reluctant to ever say something nice about FSFR - but . . . . the bad news of Q1-16 (which is substantial) is lower than the bad news existing in the current price or valuation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.