11.7% Yield Positioned For Rising Rates And Ready To Rally

Business development companies (“BDCs”) were pulling back (since May 2017) and as mentioned in “BDC Buzz Begins Purchases Of Higher Quality BDCs,” I have been buying additional shares of higher-quality BDCs, especially given the oversold conditions driving higher yields. As shown below, TriplePoint Venture Growth (TPVG) currently has a much higher yield than the average BDC:

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Since March 1, 2018, the average BDC has easily outperformed the S&P 500 even before taking into account dividends paid. I am expecting BDCs to continue higher for many reasons, including:

The recently announced Q1 2018 results reported by most BDCs included higher portfolio yields and management guidance for increased portfolio growth potential in 2018. Also, many BDCs reported higher-than-expected earnings and dividend coverage with increased net interest margins.

As shown in the following chart, I recently purchased shares of TPVG as it was below my short-term target price. Also, I use the BDC Google Sheets to identify when stocks are “oversold” with a Relative Strength Index or RSI near 30 which it is currently approaching:

This information discussing TPVG was previously made available to subscribers of Sustainable Dividends, along with real-time changes to my personal BDC positions, target prices and buying points, updated rankings and risk profile, any changes to dividend coverage and worst-case scenarios, suggested BDC portfolio as well as timing of Upcoming Public BDC Articles.

TPVG Interest Rate Sensitivity Analysis:

As mentioned earlier, BDCs have been experiencing higher portfolio yields mostly due to rising LIBOR:

Source: FRED

Interest rate sensitivity refers to the change in earnings that may result from changes in interest rates. As of March 31, 2018, around 64% of portfolio debt investments bore interest at variable rates, all of which are subject to interest-rate floors and 56% of borrowings at variable rates.

“At quarter end, 64% of our debt investments carried floating rates, and we project that every 25 basis point increase in prime will generate approximately $0.03 of additional investment income per share annually.”

Source: TPVG Earnings Call

Source: SEC Filings & BDC Buzz

Upcoming Q2 2018 Earning Beat for TPVG:

TPVG provides financing primarily to venture capital (“VC”) backed technology companies at the venture growth stage, similar to Hercules Capital (HTGC) and Horizon Technology Finance (HRZN). Earlier this week, HTGC announced public offering of 6,000,000 shares (plus potentially 900,000 shares at underwriters’ options). Also, the company announced “Hercules Capital on Pace to Potentially Exceed $1.0 Billion in Total New Debt and Equity Commitments in 2018”

“We are off to a tremendous start for 2018 and well positioned to achieve another record year with nearly $580 million in closed new debt and equity commitments to date,” stated Manuel A. Henriquez, founder, chairman and chief executive officer of Hercules. “Our momentum and pace of new loan originations from the first quarter has both continued and accelerated, as evidenced by our strong new commitment activities already realized during second quarter-to-date, and further exemplifies our industry leadership as well as strong brand, reputation and scale of the Hercules platform within the venture capital and private equity community. Although we remain guardedly optimistic, we are nonetheless witnessing unprecedented loan demand, as evidenced with our closed and pending commitments of nearly $725 million in just the first five months of the year, putting us on pace to originate and close over $1.0 billion in new commitments for the full year. To meet this demand, we are continuing to actively manage our liquidity by opportunistically accessing both the debt and equity capital markets to fund this demand and growth. We will also, of course, be actively monitoring for critical changes in macro-economic conditions or geopolitical developments, including the administration’s new fiscal and trade policies and the impact of the mid-term elections.”

Source: HTGC Press Release

On the recent earnings call, TPVG’s management mentioned large amounts of VC equity capital that has been raised and will likely be leveraged using debt capital from companies such as TPVG, HTGC and HRZN:

“The demand we are experiencing for venture growth stage lending also continues unabated during the quarter. Our originations pipeline for venture growth stage companies again hit a new all-time high at the end of the quarter. There is no lack of deal flow nor are we finding any reduced demand for debt financing. The demand, in fact, has only increased every single quarter since the beginning of 2017.”

Source: TPVG Earnings Call

BDCs will begin reporting calendar Q2 2018 results in less than two months and as discussed in “This 12% Dividend Yielding VC-Backed Tech Investor Will Likely Beat Q2 Estimates”, TPVG’s $50 million loan to Ring, Inc. was repaid in Q2 2018 resulting in prepayment-related income which is reflected in the fair market value marked up $3 million over cost as shown below.

Source: SEC Filings & BDC Buzz

Q. “And then just one last one on Ring, and I’m not sure if you guys said this and I missed it. To me, it looks like on our calculations, you guys should realize about $2.5 million of kind of one-time fees. Is that in the ballpark?”

A. “Yes, I mean I think during the quarter, during Q1, we marked the position to what we thought the asset value was and we took a mark-up of $2.4 million, on just the debt position during the quarter and then on the warrant position there was also about $600,000 mark-up during the quarter.”

Source: TPVG Earnings Call

My updated base and worst case projections use conservative assumptions including no benefit from prepayment-related activities with the exception of Ring, Inc. likely driving quarterly net investment income (“NII”) above the analyst expectations for Q2 2018 as well as its current quarterly dividend of $0.36 per share:

Management indicated that there will likely be additional prepayments such as Rent the Runway that could drive ‘lumpy’ but positive results in the coming quarters:

“While we’re happy with the outcome of Ring and another recent portfolio successes, such as MongoDB, Blue Bottle Coffee and others, only one has to take a look at some of the progress in a publicly announced fundraising activity and valuations of some of our current portfolio companies, such as Runway and Revolut as basis for our belief that we will continue to see more successful exits in the future. And this doesn’t include unannounced developments at other portfolio companies.”

Source: TPVG Earnings Call

However, management expects to deploy the proceeds from the Ring repayment during Q2 2018 and is expecting healthy portfolio growth for 2018 and has already signed $80 million in new term sheets subsequent to quarter-end:

“So far in Q2, we signed $80 million of term sheets, closed $70 million of debt commitments and funded $16 million of investments. We expect to deploy all the Ring repayment proceeds into investments this quarter and to receive a higher level for investment portfolio. Although, as usual, we expect of the majority of fundings to occur at the end of the quarter.”

Source: TPVG Earnings Call

Upcoming Shareholder Vote to Increase Leverage:

As mentioned in “CGBD Update: Shareholders Approve Higher Leverage – Impact To Dividend Coverage Potential”, TCG BDC Inc. (CGBD) recently became the first BDC with shareholder approval to reduce its asset coverage ratio. As shown below, the “required majority” of shareholders voted for Proposal 3 and the 150% minimum asset coverage ratio became effective as of June 7, 2018.

Source: SEC Filing

Michael Hart, Chairman and CEO of TCG BDC, shared the following: “We are appreciative of the overwhelming support from our shareholders regarding the adoption of the revised minimum asset coverage ratio. The reduced asset coverage requirements provide immediate operational flexibility and present a further opportunity to increase returns to our shareholders while maintaining the same credit discipline and selectivity that we have exercised since our Company’s inception. I would like to thank both our Board and our Shareholders for each providing their support for the asset coverage ratio proposal, as well as for their ongoing support and long-term partnership.”

Source: CGBD Press Release

Earlier this week, New Mountain Finance (NMFC) shareholders also approved a minimum asset coverage ratio of at least 150%, permitting the company to double its amount of debt incurrence based on the following votes:

On June 21, 2018, TPVG’s Special Meeting of Stockholders will be held for the following purposes:

  1. To approve of the Company immediately becoming subject to a minimum asset coverage ratio of at least 150%, permitting the Company to double its amount of debt incurrence earlier than the current effective date of April 24, 2019, pursuant to SBCAA.

On April 24, 2018, the TPVG’s board of directors unanimously approved the application of the modified asset coverage requirements. As a result, its asset coverage requirements for senior securities will be changed from 200% to 150%, effective April 24, 2019. On May 2, 2018, the board also recommended the submission of a proposal for stockholders to vote in favor of the company to immediately become subject to a minimum asset coverage ratio of at least 150%, permitting the company to double its amount of debt incurrence earlier than April 24, 2019.

Clearly more leverage implies higher risk and hopefully higher returns. It mostly comes down to how much additional leverage and the quality of assets in the portfolio. However, there are a few other considerations:

  • Less need for frequent equity offerings as management can increase leverage during periods of lower stock prices
  • Ability to take on lower yielding assets
  • Larger portfolio would likely result in more diversification and/or the ability to take on larger (usually higher quality) investements
  • Higher leverage will likely require BDCs to diversify funding sources using ‘matching’ and a mix of lower cost utilized credit lines (less unused fees)

“We believe that having the flexibility to incur additional leverage would allow us further grow and diversify our assets and investment portfolio while capitalizing on the strong demand for venture growth stage lending. We expect to continue to be prudent in our utilization of leverage. We intend to expand our target leverage ratio range to 0.6x to 1.0x from our current target leverage ratio range of 0.6x to 0.8x. We anticipate incurring additional leverage through both long term and short term debt with floating and fixed interest rates to optimize our cost of capital and the amount of debt outstanding with the primary goal of growing and diversifying our assets and investment portfolio while capitalizing on the strong demand for venture growth stage lending as well as using lower cost debt capital while potentially delaying higher cost equity capital raises until we believe conditions are optimal for such an equity raise.”

Source: SEC Filing

Potential Rally For TPVG?

I am expecting a rally for TPVG’s stock price as well as higher earnings for TPVG over the coming quarters due to:

  • Stock is likely oversold with RSI approaching 30 and giving it a current dividend yield of 11.7%
  • Prepayments of larger investments (including Ring) driving accelerated unamortized end-of-term (“EOT”) fees
  • Rising portfolio yield (including prepayment-related)
  • Increased use of leverage and portfolio growth

Disclosure: I am/we are long TPVG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.