Barings is set to get its own public business development company by taking over Triangle Capital Corporation, while Benefit Street plans to buy Triangle’s portfolio.
Barings and Triangle could not be reached for comment. However, the triparty transaction has elicited no shortage of reaction from analysts – some more optimistic on the deal than others. A research note by KBW analyst Ryan Lynch summarised the deal as a “very positive transaction”, noting that the $982.1 million Benefit Street paid for the portfolio was an “attractive price” for the portfolio.
But another market observer had a different take.
“The transaction definitely could have been better, but the portfolio problems were pretty bad for non-recession credits,” said John Cole Scott, chief investment officer and chief compliance officer at Closed-End Fund Advisors, noting the lack of dividends for the next couple quarters could be a deterrent for investors. “If we owned it for our clients now, we’d be out of it today. There’s other funds that are far more attractive.”
As market observers ponder the deal’s merits, however, here are a few things to bear in mind.
Barings gets a public BDC without having a roadshow or IPO
First, it’s worth noting the two parts of the deal: Benefit Street picks up the loan book, Barings wins the advisory contract. The Barings BDC would use the proceeds from Benefit Street’s cash payment for the portfolio as fresh capital to build out a BDC portfolio, which results in a net $606.2 million after the repayment of outstanding debt, along with an additional $100 million from Barings itself.
The structure of the transaction leaves Barings starting with a portfolio of cash, hopefully avoiding the credit issues that plagued Triangle and were the catalyst for a sale in the first place. The firm plans to focus on investing in senior secured credits, a departure from Triangle’s previous focus on junior debt.
What’s more, Barings is picking up a publicly listed BDC at a time when the list of BDCs debuting on stock exchanges is pretty scant – The Carlyle Group’s TCG BDC broke a two-year drought last June, while KKR listed its Corporate Capital Trust on the New York Stock Exchange in November.
Any potential Cinderella story for shareholders would take time
Barings would start with a portfolio of largely liquid loans, meaning shareholders would not get the access to illiquid private credit investments immediately. The Charlotte-based credit manager would slowly build out a senior debt-focused loan book, something that Eric Lloyd, head of Barings’ global private finance group, noted would require patience.
“It takes time to originate high-quality investments that are attractive risk-return assets,” he said to analysts and shareholders on a call.
Barings needs to do good credit work, or it doesn’t matter what the fee structure is. BDCs are lenders. They have to do that well — John Cole Scott
Analysts don’t see a quick U-turn for the BDC.
“A turnaround story for Barings would be if they could get the BDC back to performing well with low non-accruals,” Scott said. “They are going to have to prove it, to me it’s a three- to five-year process at least.”
Mitchel Penn, an analyst at Janney Montgomery Scott that covers Triangle, agreed.
“They’ll have to show the market that they can underwrite middle-market credit,” said Penn, who added that he had taken several calls from institutional investors who he believes have money with Barings and seem to like the firm, “but you don’t know yet”.
Discounts and dividends (or lack thereof)
Triangle shareholders will get a $1.78-a-share cash payment from the $85 million payment from Barings to externalise the management contract. After that, the firm will halt dividends for the near-term.
On a call with analysts and shareholders, Triangle executives said they would not pay a second-quarter dividend, with Lloyd noting it would take three to six months before Barings would be in a place to do so.
“If you know BDCs, dividends are the reasons people buy them. It’s a nice time to look at other BDCs,” Scott said. “There’s going to be no more future [dividend] yield, so I think the price will probably trade below NAV.”
Janney’s Penn gave a price estimate of $12.50, below the $13.43 net asset value per share that Triangle reported, but above the $9.49-a-share price at which the stock ended 2017. His estimate included the cash payment of $1.78 a share from Barings plus about 89 percent, or $10.68, of the $12.02 net asset value per share resulting from the transaction.
KBW’s Lynch also set a $12.50 price target.
Benefit Street picks up portfolio at near-fair value, a book already marked down
Benefit Street, which declined to comment on the transaction, is set to buy the portfolio for $981.2 million, close to the $1.02 billion Triangle valued the book as of year-end in its annual report, which amounts to 97 cents on the dollar.
National Securities Corporation analyst Christopher Testa said he was surprised Benefit Street would take a haircut of only 3 cents on the dollar for the portfolio. “Triangle Capital shareholders got very lucky,” he said.
Testa’s research noted more than one-sixth of the Triangle portfolio at cost, 18.5 percent to be exact, is either on non-accrual or priced below 80 cents on the dollar.
Using the at-cost portfolio number, Benefit Street ended up paying 87 cents on the dollar. The at-cost value of the portfolio was $1.12 billion as of 31 December. Triangle had written the book down by 11 percent last year though, a market source said, and noted it had a “strong reputation” for marking their books accurately.
The sold portfolio, a majority of which are junior loans, will now be managed by a firm that presently has a large holding of senior secured loans.
Business Development Corporation of America, which is advised by Benefit Street, holds 79.5 percent of its book in senior secured loans, with 71 percent being first lien senior secured and 9.5 percent being second lien senior secured. Benefit Street Debt Fund IV, the firm’s flagship private fund that closed in late 2017, also focuses on senior loans.
A shareholder-friendly fee structure, but ‘good credit work’ comes first
Shareholders received a friendly fee structure. The management fee this year is 1 percent, which would increase to 1.13 percent next year and 1.38 percent in 2020. The hurdle rate is on the high end, at 8 percent, and Barings is charging a 30 percent carry with a three-year lookback that begins in 2020.
“We view this as one of the best fee structures in the space given the low base fee, high hurdle rate, and total return hurdle,” KBW’s Lynch wrote in his research note.
Barings said it will target an 8 percent-plus dividend yield once it is fully ramped up to an illiquid private debt portfolio. The firm will not immediately hit that target, though, as the portfolio will consist of more liquid investments in the transition period. During that timeframe, Barings will target a 6-plus percent yield.
“Barings needs to do good credit work, or it doesn’t matter what the fee structure is,” Scott said. “Fees are definitely not the only answer because BDCs are lenders. They have to do that well. Fees, to me, aren’t the first analysis.”