TCG BDC: Strong Buy With 12% Yield With 30%+ Return Potential – Seeking Alpha



CGBD Article Follow-Up

In December/January, I purchased additional shares of multiple “oversold” higher-quality business development companies (“BDCs”) with risk-averse balance sheets prepared for a potential economic slowdown, including TCG BDC Inc. (CGBD) as discussed in “I Just Bought More TCG BDC, Which Is About To Rally With A Safe 13% Yield“.

The previous article included the following CGBD chart and mentioned:

CGBD has declined more than the average BDC, and I purchased shares yesterday at $12.34 for the reasons discussed in this article.



Source: Yahoo Finance

In December 2018, the BDC sector was oversold (along with other higher-yielding assets) due to wider yield spreads as discussed in previous articles. BDC pricing is closely correlated to yield spreads including other non-investment grade debt and ‘BofA Merrill Lynch US Corporate B Index’ (Corp B). I typically make multiple purchases when Corp B effective yields rise. As shown in the chart below, Corp B yields have been falling back to previous levels driving higher BDC pricing this year:



Source: FRED

Additionally, CGBD’s stock price has been under technical pressure due to the semiannual release of pre-IPO shares (June and December) as discussed at the end of this article.

As of the writing of this article, CGBD’s stock was trading at $14.93 and 21% higher than my most recent purchase, easily outperforming most BDCs and S&P 500:



Source: Yahoo Finance

CGBD Risk Profile Update

CGBD has a higher credit quality portfolio for many reasons including almost 90% of the portfolio in first-lien assets (including Credit Fund) highly diversified by sector, access to an experienced credit quality platform and low non-accruals. Credit quality remains strong with low non-accruals at $14.3 million fair value or around 0.7% of total investments.





Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

During Q4 2018, SolAero Technologies Corp. ($14.3 million FV, $23.8 million at cost) was written down by another $2.1 million and remains on non-accrual status. During Q3 2018, its non-accrual loan to Product Quest Manufacturing, LLC was completely written down due to “operational and liquidity challenges”. On the 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. Its Credit Fund portfolio investment in DBI Holding was on non-accrual as well.



Sources: SEC filings and www.bdcbuzz.com



Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

During Q4 2018, net asset value (“NAV”) per share declined by $0.57 per share or 3.2% due to net realized and unrealized depreciation of $0.49 per share “primarily driven by an increase in market yields” and special dividend of $0.20 per share partially offset by accretive share repurchases and over-earning the regular dividend. See the following discussions.



Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

Management thoroughly discussed the recent decline in NAV and is expecting at least a partial recovery “based on the recent yields”.

Despite a benign quarter from a credit standpoint, net asset value per share declined by $0.57 quarter-over-quarter from $17.66 per share to $17.09. Two factors contributed to the change. First was the $0.20 special dividend, which was paid in the fourth quarter and second was the unrealized loss on investments largely due to widening market yields. Overall, our marks as they relate to pure credit performance were flat to the prior quarter, but the extreme volatility I referenced earlier led to mark-to-market movement across the portfolio. Both Erica and Tom will elaborate on a specific market movements and how these movements are captured in our valuation methodology, will also touch on the recovery that’s been observed thus far in the first quarter.

Further given market yields have rebounded since 12/31, we currently expect a portion of the market-driven unrealized loss to reverse in the first quarter. If you look at the yields we track based on the recent yields, we estimate roughly one-third of the mark-to-market negative impact in the fourth quarter would be reversed, if we were to close the first quarter today.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

CGBD Dividend Coverage Update

For the quarter ended December 31, 2018, CGBD beat my best case projections mostly due prepayment-related income, higher-than-expected portfolio yield and income from its Credit Fund covering its dividend by 128%.

Total investment income for Q4 was $56 million, up $5 million versus the third quarter. The increase was driven by strength across the board. Higher interest income from net growth in the portfolio and an increase in LIBOR, an increase in OID acceleration on repaid positions, higher one-time fees and solid income growth at our JV.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript



Sources: SEC filings and www.bdcbuzz.com

Similar to previous quarters, there have been continued increases in recurring sources of income implying the potential for additional special dividends.

Once again, our NII comfortably covered our fourth quarter dividend of $0.37 per share, as it has in every reporting period since our IPO in June of 2017. As you may recall from last quarter, we had approximately $12.5 million in undistributed NII, which equated to $0.20 per share. This amount was paid to shareholders in the fourth quarter, bringing total dividends paid in 2018 to $1.68. This amount represents nearly a 10% trailing dividend yield on our year-end NAV.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

The company already has $0.13 per share of accumulated undistributed income available for a special dividend in 2019:

The cushion of undistributed earnings has once again grown to $7.9 million or nearly $0.13 per share, which will carry forward into the first quarter of 2019.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

There will likely be another larger special dividend paid in Q4 2019 as discussed by management on the recent call below. I am expecting the company to easily over earn the regular dividend by around $0.30 per share to be paid in 2019.

Q. Given the strong core earnings relative to the dividend. Could you talk about your dividend policy? At some point, well the core dividend be reevaluated or is the thought process that you’re just going to continue to pay a special payout either at year-end or potentially sometime in subsequent quarters to meet requirements?

A. Well as a basic policy matter we evaluate that all the time and certainly at each quarter-end. It has been our view that setting a consistent dividend at $0.37 the time of the IPO made good sense and it was a level that we had high level of confidence in. And it was the level that we felt had strong support when you’re looking at simply the core contribution of our portfolio. We don’t look to rely on a lot of one-time fees or OID. You look at a quarter like this and as Tom and others have explained, the increase over a base I’d really call $0.41 has been largely attributable to the early repayments. That’s not something we rely on. But we also recognize that over the course of the year, those things are going to occur and that gets back to another element of this business that can be lumpy. And so we try to do two things, we want our investors to understand that we have a high level of confidence in the $0.37, we have a belief that we will be able to earn over the year an amount in excess of that, we try to provide transparency as I did today on exactly where we are on a quarter-by-quarter basis on the excess and it would be our intention to pay that at a very high level at the end of the year. And so that’s the way we approach it. We want confidence in the $0.37. We want our investors to believe that we can earn that and we also want people as we’ve demonstrated in the last two year-end reporting periods that we have the capacity to grow in excess of that, and that will come in the form of a special dividend.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

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

Investments in the Credit Fund decreased slightly from $1.20 billion to $1.17 billion producing a 14.4% annualized yield. The Credit Fund’s new investment fundings were $123 million for the quarter with sales and repayments of $122 million.

The dividend yield on our equity in the JV, was a solid 14.4% for the fourth quarter, in line with our mid-teens target. In the first quarter of 2019, we do expect some contraction from that level given we’re currently running the JV at modestly lower leverage.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript







Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

Increased Leverage & Dividend Potential

The company has been increasing its use of leverage and will likely continue. 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. CGBD has received all approvals needed to use higher leverage with a target debt-to-equity of 1.0 to 1.4 and I have taken into account with the updated projections including no expected equity offerings.

Our debt to equity at the end of the fourth quarter was 0.9 to 1, essentially flat to prior quarters. As we discussed upon our adoption of the lower asset coverage requirement last year, we haven’t altered our investment strategy in any way. We’ll continue to invest, where we see best relative value and any increase in leverage will likely be through organic growth in our asset base when market opportunities present themselves. The higher level of repayments in the fourth quarter had a muting effect on our leverage ratio, which otherwise would have increased as a result of our strong originations. Our target leverage range is 1 to 1.4 times.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript



Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

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

We finished the fourth quarter with total debt outstanding of approximately $1 billion, generally in line with the prior quarter. As of 12/31, we had approximately $300 million of total unused commitments under our credit facilities, which should provide adequate dry powder for new investment opportunities in future quarters. Statutory leverage was unchanged versus prior quarter at 0.9 times, but we do see this leverage level increasing in the first quarter, based on the current pipeline of new deal activity.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript



Source: TCG BDC Inc 2018 Q4 – 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’.



Sources: SEC filings and www.bdcbuzz.com

Clearly, management will also be earning higher fees but there is the potential for a quarterly dividend increase from the current $0.37 to between $0.40 and $0.50 depending on the yield of the new assets. I would guess that if management decides to take on higher leverage, it would be obligated to pass along higher returns to shareholders.

CGBD Share Repurchases

As predicted in the previous article, the company has started to repurchase shares including 338,408 during Q4 2018 at $14.36 per share (19% discount to previous NAV). 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 stock is still trading at 13% discount to NAV and there will likely be additional accretive repurchases including another 556,473 so far in Q1 2019.

They’ve been accretive to both our NAV and our dividend yield, but we also view the program as another visible commitment to our shareholder alignment and the confidence we have in the value of our portfolio. Through February 22nd of this year, we have repurchased nearly 900,000 shares at an average price of $14.46, totaling $12.9 million of aggregate repurchases. This activity has increased our NAV by $0.04. Some of the factors that could influence the ongoing use of the plan include the stock price, the current investment opportunity set and our leverage levels. However, we expect to continue to use the program so long as shares are available at levels that we feel underprice the fundamental value of the stock.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

CGBD Summary & Recommendations

CGBD is currently underpriced compared to its peer group which are BDCs with higher quality management and portfolios, excellent dividend coverage and current dividend yields between 9% and 10%.

Some of the potential reasons for being underpriced include the recent NAV decline that is partially due to the Q4 2018 special dividend and higher quality management conservatively valuing the portfolio as well as semiannual releases of pre-IPO shares “that puts enormous technical pressure on the stock”.

CGBD has higher quality management that takes a conservative approach to valuing its portfolio each quarter:

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. This was indeed the case this quarter, based on the volatility in the market that Erica highlighted.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

Also, 98% of the losses in 2018 were unrealized and management is expecting at least a partial recovery “based on the recent yields”:

Our total aggregate realized and unrealized net loss, excluding the JV was about $23 million for the quarter. The largest contributor to this loss was the increase in market yields across both the large cap and middle markets as well as reversal of prior appreciation on exited positions. In fact, if you remove the impact of market yields in the exits on the BDC portfolio, total net realized, unrealized was roughly flat for the quarter.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript



Source: SEC Filing

CGBD was formerly known as Carlyle GMS Finance, Inc. and closed its IPO on June 19, 2017, selling 9 million shares at $18.50. As discussed below, the company releases pre-IPO shares semiannually which has been putting technical pressure on the stock:

As part of the IPO, process there is the release of the pre-IPO shares. So that’s happening on a semi-annual basis, it occurred in December of ’17. June of ’18 and at that time we were sort of on the edge of the third release. As you probably also remember that puts enormous technical pressure on the stock. It had previously and history has shown that it did again here, but that’s also complemented or contributed with the overall sell-off in the BDC space as well as the overall general sell-off in the broader market. So we think about that also in the context of the fact that we have prolonged periods around quarter-end and in this instance, I’ll give you the exact dates. Our blackout windows run from December 10th and they run through March 1st of this year. So thinking about putting a program in place that’s non-discretionary, which we did because what we did want to do is to provide consistent support throughout that period, but didn’t want to be buying stock when the market was entirely selling the industry. And so that’s a fine line that we put between supporting the stock, making good investments in terms of the stock that we buyback. But at the same time not wasting the money in a downdraft that has no real defined bottom. And we saw that really play out in spades, where our stock went from $15.60 at the beginning of — at the end of December to closing the year around $12.40. We’ve seen a nice recovery there back to the year the $15 range and that’s in — I would like to think it’s in some event or some resolve of the buyback plan supporting that, and also the general recovery in the market. So we’ll continue to actively buy at these levels and provide that support, but it’s going to be balanced by appreciating that we want this plan to be in place over the long term so that we can provide the kind of support that we want to overall for the shareholders.

Source: TCG BDC Inc CEO Michael Hart on Q4 2018 Results – Earnings Call Transcript

Assuming that CGBD keeps its quarterly dividend at $0.37 per share and pays a $0.30 per share special dividend in Q4 2019 to investors that are expecting a healthy 10% yield would imply a conservative price of $17.80 compared to the current $14.93. This means that investors at current prices will likely receive $1.78 in dividends over the next 12 months (12% yield on cost) plus potential price appreciation of around $3.00 for total return potential of ~31%.



Source: TCG BDC Inc 2018 Q4 – Results – Earnings Call Slides

The following table ranks each BDC by historical change in NAV per share and includes special dividends for GAIN, MAIN, FDUS, TSLX, ARCC, GBDC, HTGC, CGBD, and TPVG. It should be noted that ARCC, TSLX, and MAIN have all announced dividend increases and/or special dividends last month as predicted in “Dividend Increases For The BDC Sector”: Part 2, Part 3, and Part 4.

All of the BDCs with the largest declines in NAV per share over the longer term, have historically cut dividends including TCRD as predicted in “Dividend Cuts For The High-Yield BDC Sector“.



Sources: SEC filings and www.bdcbuzz.com

To be a successful BDC investor:

  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • Diversify your BDC portfolio with at least five companies. There are around 50 publicly traded BDCs; please be selective.

The information in this article was previously made available to subscribers of Sustainable Dividends, along with:

  • Real-time changes to my personal BDC positions
  • Target prices and buying points
  • Real-time announcement of changes to dividend coverage and worst-case scenarios
  • Updated rankings and risk profile
  • One-month preview of upcoming public articles

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.

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