TCP Capital (TCPC) is one of the higher ranked BDCs of the 25 that I cover and is a component in three of my suggested BDC portfolios: 'Risk Averse ', 'General' and 'Value & Growth'. TCPC raised equity capital twice in Q4 for net proceeds of over $146 million used to pay down debt. This article will focus on the amount of leverage that TCPC uses and the direct results to shareholders at various levels. I believe the company has two key competitive advantages: low cost of debt capital and lower fee structures both of which will ultimately benefit investors as it grows its portfolio. I believe the current dividend yield of 8.6% is low and will increase over the next few quarters as the company deploys the new equity capital, increases its use of low cost leverage and returns more to the shareholders due to its investor friendly fee structure. TCPC has a higher quality of portfolio investments than most BDCs that can support a debt-to-equity ratio of 0.80, which would give the company the ability to grow the portfolio to $1 billion without additional equity capital. At that point, I believe the return to investors would be around 11% including regular and special dividends.
TCPC recently expanded its $50 million revolving credit facility to $100 million with an accordion feature to $200 million and extended the maturity date of its credit facility with Wells Fargo. Last year TCPC submitted an application for an SBIC license and has received a Green Light letter from the SBA inviting them to proceed with the application process that could provide an incremental $150 million of borrowing capacity at favorable terms. Currently its average borrowing rate is around 1.2% and is well below most BDCs. This is a key advantage for TCPC but as rates begin to rise so will its expenses. However, if the company is approved for its SBIC debentures it would be at fixed rates for ten years and again at lower rates than most BDCs.
TCPC has a preferred debt-to-equity ratio of around 0.65 to 0.75 that I believe is conservative given the higher quality of investments in its portfolio as discussed in "Leverage vs. Portfolio Investment Quality." The debt-to-equity ratio for TCPC was 0.71 at the end of Q3 but does not take into account the recent equity offerings that were used to repay amounts outstanding under the revolving facilities. The table below shows the pro forma leverage levels assuming the proceeds were only used to pay down debt, reducing it to 0.25. Obviously, TCPC has been growing the portfolio and some of the proceeds are being used to fund new investments. The table also shows various levels of leverage and the related portfolio growth up to $1 billion without the need for additional equity capital.
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When investing in BDCs it is important to understand how the company uses borrowings (leverage) to enhance returns to its equity investors. Using leverage and investing in higher-yield riskier investments are two of the standard methods to increase returns for higher dividend yields or capital gains to investors. However, it is important to look at these two metrics combined because when a BDC has higher leverage on an already leveraged portfolio there is much more risk than a BDC that borrows against a portfolio that is mostly first lien. The chart below takes into account the quality of portfolio investments compared to the amount of leverage to identify which BDCs are using higher or lower amounts of leverage compared to its average portfolio grade. The grey line is the statistical trendline of the two measures.
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But how do these levels of leverage impact earnings to pay higher dividends? The table below takes into account the two key competitive advantages of TCPC (lower cost of debt capital and management fees), a full quarter of income at similar yields (currently 10.8%), and excludes other income to show the resulting EPS at the previously discussed debt-to-equity ratios. I have included a slight increase in borrowing rates to take into account the higher rates for using the revolving credit facility.
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TCPC will always have a certain amount of portfolio turnover as well as continue to grow the portfolio so it will never realize a full quarter of income from the portfolio. But I believe this is an indicator of the level of dividends TCPC could pay using only recurring income on a sustainable basis. Obviously, the company will continue to earn more than it distributes and use the spillover income to pay special dividends (as prudent BDCs do). The 'Implied EPS Yield' line is the annualized earnings divided by the current price of $16.71 and implies the potential return (regular and special dividends) to investors at the various levels of leverage. Currently I consider TCPC a 'Buy' and in my "TCP Capital: January Report" I discuss earnings projections over the coming quarters as well as interest rate sensitivity, pricing, future equity offerings, and projected total returns.
Investors should only use this information as a starting point for due diligence. See the following for more information:
Disclosure: I am long TCPC. 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. (More...)
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