Fifth Street Finance Corp (FSC), the publicly-traded business development company (BDC) of Greenwich, CT-based Fifth Street Asset Management, reported net investment income of $29.5 million or $0.19 per share for the quarter ended 31 March, compared to $34.2 million at the end of the first quarter in 2014, representing a 14 percent decrease. Its distributions per common share went down to $0.15 from $0.25 over the same time period. Though management said on the earnings call yesterday (11 May) that the current dividends are now set at a manageable size and the firm expects to be able to cover them going forward.
“We have set our dividend at a level that we believe should consistently be covered by our sustainable net investment income. We feel comfortable with our current dividend level and we continue to believe that last quarter’s dividend reduction was an important step in putting FSC on a sustainable path into the future,” said Todd Owens (pictured), FSC’s chief executive officer, on the earnings call.
The vehicle, which has been going through a strategic review to improve performance, has been taking steps to get it in better shape. One of these steps includes reducing its regulatory leverage to 0.75 times from 0.83 times debt-to-equity and working on an agreement to reduce management fees on future equity offerings. “By reducing fees on prospective capital raises we are creating operating leverage and allowing our shareholders to benefit from economies of scale as FSC grows,” Owens said.
The firm has formed several joint ventures in the past year, and plans to increase their size or form new ones as well. “FSC’s joint venture with an affiliate of Kemper Corporation continues to perform well generating a 16 percent weighted average annualized return on FSC’s investment during the March quarter,” said Ivelin Dimitrov, FSC’s president and chief investment officer, on the earnings call. As of March 31, the JV had $308 million in net assets, including investments in one-stop and senior secured loans to 27 portfolio companies, an increase from $265 million in December. The vehicle is in the process of expanding its credit line for the JV and expects to increase that to $400 million from $200 million soon.
Analysts on the earnings call brought up issues with whether these steps will even help to improve FSC’s existing shareholders value. “The income, as a shareholder, just hasn’t been there. The growth has not translated to shareholder value. It’s not translated to more income because of the high fees, as you look forward what can you do to increase the ROE and increase the return for shareholders going forward?” questioned Troy Ward, a managing director and BDC analyst at KBW. “You talked about lowering the overall leverage. You’re at the high end. That doesn’t help,” he added.
“I think one of the big levers we have to pull is to increase the size of the JV, which we are working on accomplishing or to have additional JVs. That’s one of the things we’re working on and we’re trying to manage down our borrowing costs,” responded Owens.
Several analysts also brought up the fact that cutting management fees on future capital raises doesn’t benefit current shareholders and the firm ought to consider offering these fee breaks to existing shareholders. “The reduction of management fees on new equity raises seems to be at least, in part, some admission that past raises haven’t been as successful for shareholder as it has been for the management company. So why not extend the fee reduction to the existing portfolio, which would arguably lead to better investment income coverage of the dividend, improve dividends and give you the opportunity again, to improve dividends and/or higher share repurchase programs, which could in turn lead to better stock performance and get FSC back to the point where they can raise new equity?” questioned Casey Alexander, director of equity research at Gilford Securities. To which Owens responded that he’s working on these initiatives, as well as growing the JVs and credit facilities and pulling several levers to improve operating performance.
FSC’s total assets are at $2.7 billion, a $64 million decrease from the first quarter in 2014. Portfolio investments at fair value equaled $2.5 billion across 137 portfolio companies as of March 31. The weighted average yield on these investments has declined slightly to 10.4 percent from 10.7 percent quarter-over-quarter. The average size of a debt investment was $21.4 million, with the average company EBITDA at $32 million, as of 31 March.
FSC is publicly traded on the NASDAQ stock exchange. It’s trading at around $7 per share as of this morning (12 May). It peaked at around $14 in 2011 and has continued to trade down since.