THL Credit (TCRD) is pursuing a change in its strategy that includes a move away from subordinated debt and unsponsored investments and an increased focus on first-lien debt and a change in senior leadership.
Speaking on Friday (5 August) on the firm's second-quarter earnings call, executives announced that TCRD president Hunter Stropp is leaving the firm in September, with co-chief executive officers Chris Flynn and Sam Tillinghast (pictured) assuming his responsibilities. TCRD reported a 2.9 percent drop in net asset value, which has been decreasing since the second quarter of 2015.
“While taking these steps can put pressure on our earnings capacity in the short term, we believe that it will benefit our shareholders in the long run. Our goal is to deliver a strong secured portfolio that pays to its shareholders substantially all of what it earns,” Flynn said.
Echoing these sentiments about steps to build what he labelled as a more resilient portfolio, Tillinghast explained the BDC's change in focus was in part a response to developments in the market.
“We continue to see a flight to quality by most lenders,” Tillinghast said. As a result, we believe that competition has increased for the largest and most stable businesses and pricing has come under pressure, especially in the first lien market. We are seeking higher quality assets and will pay out substantially all of what we can earn from these assets. We will not stretch for yield.”
The BDC announced a dividend of $0.34 per share for the second quarter and that on 2 August its board of directors had approved a dividend of the same size for the third quarter of 2016. Tillinghast reported that the second quarter net investment income of $0.35 per share ($11.7 million overall) exceeded the dividend primarily due to reductions in the firm's incentive fee.
TCRD's total investment income in the second quarter was $20.5 million, down from the $23.8 million reported for the same period last year. The decrease was attributed to the contraction in their portfolio and the placement of additional loans on non-accrual status.
Executives discussed three nonaccruals representing 4.4 percent of the portfolio on the call. Tri Starr, a supply chain logistics company, and Loadmaster, a manufacturer of derricks and oil field equipment, have each undergone restructurings that TCRD executives expressed confidence would set the companies on a stronger path.
The third, copper-based wire products producer Copperweld, is in the process of being restructured. Flynn reported that while Copperweld faced commodity price headwinds, TCRD is working with other creditors and the company's largest customer to reposition the balance sheet and expects to recover the investment principal over time.
At the end of the second quarter, TCRD had 49 portfolio investments valued at $692 million, a decrease in value from the $731 million reported at the end of last quarter that the company attributed to repayments in excess of investments and changes in value for some of its investments. Of these investments, 70 percent is invested in first and second lien loans.
TCRD made $17.5 million in follow-on investments during the second quarter, including a $5.6 million investment with its THL Credit Logan JV, a partnership formed in 2014 with Perspecta Trident, an affiliate of trust company Perspecta Trust. Additional investments included first-lien senior secured loans to both Virtus Pharmaceuticals and the John Gore Organization and a senior secured revolving loan to OEM Group.
In a research note published after the call, Wells Fargo downgraded its recommendation for TCRD from “outperform” to “market perform”, highlighting doubts that it will be able to maintain its dividend coverage in the quarters to come.
“We believe TCRD is now on an unsustainable dividend path and a 'reactive' dividend reduction is required to better align their cost of capital post quarters of credit losses and non-accruals. We expect a dividend reduction in the range of 10 to 20 percent,” senior analyst Jonathan Bock wrote.