Updated Dividend Coverage Levels & Higher Yield Leverage Comparisons
Subscriber Update:
This week we are comparing dividend coverage ranked by using the 'worst-case' financial projections and the lower yield Leverage Analysis discussed in the Deep Dive Projection reports for each BDC.
Please skip to the end to see the 'Higher Yield Leverage Analysis' (my favorite) from each of the recent reports showing a longer-term run rate comparison of dividend coverage.
I have updated the Dividend Coverage Levels tables to take into account the recently updated projections for NMFC, PFLT, TCPC, CGBD, GAIN, GLAD, FDUS, FSK, OCSL, PNNT, ORCC, TPVG.
As a conservative investor, I plan for the worst-case scenario when ranking dividend coverage. Worst-case scenarios include increased portfolio credit issues, lower NAV, declining portfolio yields, higher borrowing rates/expenses, slower portfolio growth (declines), and lower amounts of non-interest income (from fees/dividends).
Basically, the worst-case scenarios assume a deeper and/or extended recession.
BDC Dividend Coverage Levels Update
The following Dividend Coverage Levels reflect potential dividend coverage mostly ranked by using the 'worst-case' financial projections and the lower yield Leverage Analysis discussed in the Deep Dive Projection reports for each BDC.
Worst-case scenarios for each BDC include increased portfolio credit issues, lower NAV per share, declining portfolio yields (not likely in this environment), higher borrowing rates and operating expenses, slower portfolio growth (or declines), and lower amounts of non-interest income (from fees and dividends). Basically, worst-case is assuming a deeper and extended recession over the next 6 to 12 months.
During the previously reported quarters, most of the ‘Level 1’ dividend coverage BDCs announced dividend increases and/or supplemental/special dividends. Please see the Q4 2021 and Q1 2022 “Earnings Report Cards” for more details. Keep in mind that CGBD/AINV reduced their regular dividends to include a variable portion (different from other specials and/or supplementals). The sector seems to be in a virtuous circle of improving asset quality, supporting relatively lower cost of capital driving improved earning, and dividend increases. Most BDCs previously issued very low rate unsecured notes and refinanced their balance sheets, locking in some strong quarters coming up.
It is important to invest in BDCs with higher historical and/or projected dividend coverage. BDCs that need to “reach for yield” to cover their current dividends could potentially invest in higher-risk assets driving potential credit issues, declines in net asset value (“NAV”) per share, and increased non-accruals resulting in a dividend reduction.
Realized Gains
Most dividend coverage measures for BDCs use net investment income (“NII”) which is basically a measure of earnings. However, some BDCs achieve incremental returns with equity investments that are sold for realized gains often used to pay supplemental/special dividends. Historically, these BDCs included GAIN, FDUS, CSWC, PNNT, TPVG, HTGC, and MAIN, but more recently GLAD, TSLX, and ARCC are now positioned to benefit from larger amounts of equity positions.
The following is from GAIN:
As a conservative investor, I plan for the worst-case scenario when ranking dividend coverage and do not cover all 50 BDCs due to bandwidth and would rather focus on higher-quality research for fewer BDCs. My preliminary analysis for BDCs that I do not actively cover predicted dividend cuts for companies such as:
ABDC, BKCC, CMFN, CPTA, GARS, HCAP, KCAP/PTMN, MCC, OCSI, OXSQ, SCM, TICC/OXLC
I have accurately predicted the cuts for the BDCs that I do actively cover and provided investors with plenty of warnings, including:
AINV, CGBD, FDUS, FSK/FSIC, FSC/OCSL, GLAD, MRCC, NMFC, PNNT, PSEC, SUNS, TCAP/BBDC, TCRD/FCRD
It should be noted that I still cover a few BDCs that I consider ‘lower quality’ because it is critical when establishing a range for pricing.
The following are the general descriptions for each Level but keep in mind that I have placed each BDC according to much more than simple averaging:
Level 1: BDCs that can mostly cover during worst-case scenarios and lower portfolio yields. These companies are the most likely to increase or at least maintain dividends with less need to reach for yield (generally safer). Only BDCs that can cover dividends by at least 90% using the lower-yield Leverage Analysis with a debt-to-equity ratio of 0.80 will be considered.
Level 2: BDCs with stable dividends but might have temporary dividend coverage issues. Only BDCs that can cover dividends by at least 80% using the lower-yield Leverage Analysis with a debt-to-equity ratio of 0.80 will be considered.
Level 3: BDCs that are likely to cut dividends, especially in worst-case scenarios and/or with lower portfolio yields and are at risk of becoming ‘Level 4’ if there are additional credit issues, lower portfolio yield, and/or less non-recurring income.
Level 4: BDCs that need to cut dividends.