Fifth Street Finance Corporation plans to shift its portfolio away from riskier investments and alter its fee structure to reverse its declining net asset value, executives said on during its earnings call on Thursday.
The business development company’s net asset value dropped to $7.31 per share as of 31 December, down from $7.97 per share at the end of the September quarter, due to “credit weakness in portfolio companies”.
This represents more than a $1 drop in NAV over a one-year period and nears a $2 dip in NAV over two years. The firm’s NAV per share was $8.41 in December 2015 and was $9.18 per share in December 2014, according to US Securities and Exchange Commission filings.
Patrick Dalton, who officially assumed his new role as chief executive officer on 2 January, outlined on Thursday’s call several proposed changes to the portfolio and investment strategy, aimed at stabilsing the firm’s “NAV volatility”.
Dalton said the firm will reduce its exposure to certain industries, particularly its portfolio concentrations in healthcare, technology, and for-profit education companies. FSC will also scale back its non-accrual investments in order to reinvest the proceeds into less risky, performing senior secured loans, he added.
He also proposed changing the firm’s fee structure to a total return hurdle rate. Doing so could decrease the incentive fee by 25 percent per quarter after taking into account any realised and unrealised losses.
Chris Testa, an analyst covering FSC at National Securities, said the rate change will take into account total return rather than net investment income.
FSC proposed dropping the hurdle rate – the return FSC must make before it starts to generate incentive income – to 7 percent as it moves toward less risky investments. Testa noted, however, that it would take time for the company to unload the riskier assets.
The lookback period will start 1 January. The company said taking into account total return rather than net investment income will be in the best interest of the shareholders.
Company executives will receive a larger share of executive compensation based on FSC's performance, the company added.
The new chief executive hopes to create more joint ventures, like its current JV with Kemper Corporation, and expects to fill multiple key roles, including those of chief credit officer, chief accounting officer and other originations and underwriting team members.
Shareholders will vote on the proposals during a special meeting sometime this year, the company said.
Steven Noreika, chief financial officer, said on the call that the firm is increasingly focused on reducing its leverage. FSC was able to deleverage on an absolute dollar basis by $75 million during the quarter, he added.
But FSC ended the quarter with a debt-to-equity ratio above its target regulatory leverage range at 0.84x, which was “driven principally by the effect of credit weakness on our NAV”, Noreika said.
For the quarter, the firm generated $23.3 million of net investment income or $0.16 of per share. This is down from the same quarter ending December 2015, when the net investment income was $26.6 million or $0.18 per share, according to the earnings release.
FSC closed $118.3 million of investments in five new and three existing portfolio companies over the last fiscal period.
The firm exited or sold investments or were paid down by $225.5 million, taking the value of its portfolio from $2.2 billion as of 30 September to $2 billion as of 31 December. Net unrealised and realised losses amounted to $97.5 million, reducing assets from $2.3 billion as of 30 September to $2.2 billion as of 31 December.
—Andrew Hedlund contributed to this report.