TCPC Q3 2023 Updates By Scott Kennedy

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The rest of this post is from Scott Kennedy.

Summary

• This 26th earnings assessment article reviews TCPC’s NAV and NII performance during Q3 2023.

• This article also discusses how TCPC’s quarterly change in NAV and NII “matched up” to expectations. Earnings remain a key driver to stock performance.

• TCPC’s NAV was a minor underperformance while its NII was a very minor-minor outperformance.

• No change in TCPC’s percentage recommendation ranges or risk rating. TCPC is currently deemed appropriately valued (HOLD).

• TCPC's proposed merger with BKCC is expected to close during the first quarter of 2024.  If/When this merger closes (likely will), TCPC will implement a permanent base management fee reduction.

Introduction:

Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.

This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.

I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.

1) TCPC’s NAV and NII Q3 2023 Performance (Projected Versus Actual Results):

On 11/2/2023, Blackrock TCP Capital Corp. (TCPC) reported the company’s earnings results for the third quarter of 2023. Table 1 below provides TCPC’s NAV and earnings summary.

Table 1 – TCPC Q3 2023 NAV and Earnings Summary

Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data

Hi subscribers. I was able to review TCPC’s Q3 2023 earnings results in more depth. TCPC's Q3 2023 net investment income (“NII”) of $0.490 per share was a very minor - minor outperformance versus my projection of $0.480 per share. TCPC’s NII was $0.478 per share for the second quarter of 2023. As such, I projected a NII increase of $0.002 per share. In actuality, TCPC reported a NII increase of $0.012 per share during the third quarter of 2023. The institutional analysts’ consensus average was NII of $0.470 per share. Let us discuss how TCPC very slightly – slightly outperformed my quarterly NII expectations.

First, let us review TCPC’s quarterly investment activity. After a very subdued second quarter of 2023, TCPC recorded loan originations funded at close and add-on investments of $92 million during the third quarter of 2023. In comparison, knowing the recently-announced BlackRock Capital Investment Corporation (BKCC) merger/acquisition is in the works, I projected quarterly loan originations funded at close and add-on investments of $25 - $75 million (mean $50 million). TCPC recorded loan prepayments/repayments/restructurings of ($126) million during the second quarter of 2023. In comparison, I projected quarterly prepayments/repayments/restructurings of ($100) – ($150) million (mean of ($125) million). When calculated, excluding fair market value (“FMV”) fluctuations, TCPC decreased the company’s investment portfolio size by ($34) million during the third quarter of 2023. In comparison, I projected TCPC would decrease the company’s investment portfolio size by a mean of ($75) million. So, a slightly larger investment portfolio size (less severe decrease) when compared to my expectations. When quantified, including the incentive fee offset from higher total pre-incentive fee income, this ultimately resulted in a NII outperformance of $0.019 per share when compared to my expectations.

Second, TCPC continued to experience a rise in the company’s weighted average annualized yield during the third quarter of 2023 when compared to the prior quarter. Simply put, this was due to the continued increase in LIBOR/SOFR/PRIME. TCPC reported a weighted average annualized yield of 13.10%, 13.80%, and 14.10% for the first, second, and third quarter of 2023, respectively. When calculated, this was a quarterly increase of 0.70% and 0.30%, respectively. This past quarter, this matched my expectations. This metric should begin to plateau towards the end of 2023. In addition, it should be noted the higher LIBOR/SOFR/PRIME rises, the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2023 and into 2024. When quantified, including the incentive fee offset from similar total pre-incentive fee income (not applicable in this specific case), this directly led to no/a de minimis NII variance when compared to my expectations.

When the 2 variances noted above are combined, along with a remaining NII underperformance of ($0.009) per share scattered amongst TCPC’s remaining income and expense accounts (mainly larger-than anticipated base management fees and interest expense from a slightly larger investment portfolio size [including an amendment to a credit facility which slightly increased this facility’s stated interest rate]), this fully reconciles to the company’s quarterly NII outperformance of $0.010 per share during the third quarter of 2023 when compared to my expectations.

Moving on, TCPC reported a net asset value (“NAV”) as of 9/30/2023 of $12.72 per share (1.7% decrease) versus my projection of $12.95 per share (0.1% increase). I consider this a minor (greater than a 1.0% but less than a 2.5%) underperformance and was within my $12.60 - $13.30 per share range (towards the lower end). Simply put, for the 2^nd straight quarter, a slight NAV decrease which was a bit disappointing but nothing “overly alarming” at this point.

When taking a “deep dive” into TCPC’s investment portfolio, which contained 145 portfolio companies as of 9/30/2023, there were a handful of portfolio companies which experienced more severe debt and/or equity unrealized depreciation when compared to my expectations which directly led to a proportionately notable amount of the company’s quarterly NAV underperformance. This mainly included the following portfolio companies: 1) Thras.io LLC (Thras.io; mentioned last quarter); 2) Magenta Buyer, LLC (McAfee); 3) Khoros, LLC (Lithium); 4) CIBT Solutions, Inc. (“CIBT”); 5) Hylan Novellus LLC (Hylan; mentioned last quarter); 6) TVG-Edmentum Holdings, LLC (Edmentum); 7) 36th Street Capital Partners Holdings, LLC (36^th Street); and8) GACP II, LP (Great American). Within TCPC’s entire investment portfolio, the company recorded a combined net realized loss and net unrealized depreciation of ($16) million during the third quarter of 2023. In comparison, I projected a combined net realized loss and unrealized depreciation of ($2) million. When calculated, this ($14) million variance directly led to a NAV underperformance of ($0.24) per share when compared to my expectations.

When the variance noted above is combined with the NII outperformance of $0.010 per share discussed earlier, this directly reconciles back to TCPC’s NAV underperformance of ($0.23) per share when compared to my expectations. I correctly anticipated TCPC would not repurchase any outstanding shares of stock during the third quarter of 2023.

Regarding credit risk, TCPC put 1 new portfolio company on non-accrual status during the third quarter of 2023. TCPC’s first lien debt investment in Whele LLC (PerchHQ), with a principal balance of $19 million as of 9/30/2023, was placed on non-accrual status during the quarter. As such, a medium-sized loan. In addition, 0 portfolio companies were taken off non-accrual status during the third quarter of 2023. Heightened credit risk continued to be exhibited in the following portfolio companies not mentioned above: 1) Syndigo LLC (Syndigo); and 2) NEP Group Inc. (“NEP”). Both portfolio companies have second lien debt investments. As a refresher, second lien debt investments “take a back seat”/are behind all first lien debt investments in the capital stack/hierarchy. Simply put, there is inherently higher credit risk in second lien debt investments when compared to first lien debt investments. This is typically reflected in valuations at the first “hint” of heightened credit risk. Furthermore, heightened credit monitoring also needs to be performed on the following recently restructured portfolio companies: 1) Autoalert, LLC (Autoalert); and 2) Fishbowl Inc. (Fishbowl). That said, to remain non-bias, I was pleased with the improved operational performance within Astra Acquisition Corp. (Anthology).

I was also pleased with the slight decrease in TCPC’s quarterly capitalized “payment-in-kind” (“PIK”)/deferred income. Capitalized PIK/deferred income is booked as accrued interest under Generally Accepted Accounting Principles (“GAAP”) but, technically, it is not actually being paid in cash yet. Simply put, it is analogous to an “I owe you” (“IOU”). This deferred interest is capitalized and added to the principal balance of the loan. TCPC reported PIK/deferred income of $1.6, $3.9, and $3.5 million during the first, second, and third quarter of 2023, respectively. When calculated, this was an increase (decrease) of $2.3 and ($0.4) million, respectively. Put another way, TCPC’s capitalized PIK/deferred income comprised 3.15%, 7.31%, and 6.48% of the company’s total investment income during the first, second, and third quarter of 2023, respectively. This was a rapid increase during the second quarter of 2023. However, I am glad this rapid increase slightly “reversed course” during the third quarter of 2023.

Some loans, usually technology-focused loans, have PIK/deferred structures at the loan’s origination. Other loans are modified where a partial PIK provision is added as the loan ages (usually due to struggling operations but it is a case-by-case basis). Worst-Case, a non-PIK loan becomes a 100% PIK loan as the loan ages and the portfolio company experiences a material deterioration in operational performance. Some subscribers have recently asked why PIK percentages are rising across the financial sector (and in particular the BDC sector). In a nutshell, the recent rapid increase in effective interest rates (since basically all BDC loans are floating-rate in nature) have created some pressure on the underlying portfolio companies to pay their entire interest payment in cash. Hence, a majority of BDC peers have amended their loan agreements (or certain provisions were already embedded in the loan agreements) where more capitalized PIK/deferred income is accrued for. A BDC having a rapid increase in capitalized PIK/deferred income, as a percentage of total investment income, is a negative catalyst/trend. Again, something I have pointed out for nearly 10 years on Seeking Alpha so this concept is really nothing new (even if it appears to be a new/recent concept for other analysts/contributors/market participants).

So, all-in-all, a very minor - minor outperformance on TCPC’s NII (variance of only $0.010 per share) and a minor underperformance on the company’s NAV (variance of 1.8%). TCPC reported another good quarter regarding the company’s NII growth. However, the severity of TCPC’s NAV decrease was a bit of an underperformance; both to sector peers and my expectations. So, similar to the prior quarter, a bit of a “give-and-take” with TCPC’s quarterly results in my professional opinion.

TCPC announced an unchanged quarterly dividend of $0.34 per share for the calendar fourth quarter of 2023. In comparison, I/we projected TCPC would declare a dividend of $0.34 - $0.38 per share for the calendar fourth of 2023 (as shown in last quarter’s BDC sector comparison article [PART 2]). So, the bottom-end of my/our projected range. However, on brighter news, TCPC also declared a $0.25 per share special periodic dividend for the calendar fourth quarter of 2023 (versus a special periodic dividend of $0.10 per share for the third quarter of 2023). In comparison, I/we projected TCPC would declare a special periodic dividend of $0.00 - $0.10 per share for the calendar fourth of 2023. So, above my/our projected range. So, a positive surprise on the size of this quarter’s special periodic dividend. TCPC continued to slightly grow the company’s cumulative undistributed taxable income (“UTI”) balance as of 9/30/2023 when compared to 6/30/2023. This was basically the reason for the special periodic dividend.

When taking TCPC’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our TCPC percentage recommendation ranges (relative to CURRENT NAV) or risk rating (remains at a 3.5). Remember, upon the announced TCPC/BKCC merger in early September 2023 (which includes a base management fee reduction), I/we upgraded TCPC by 5.5%.

At a closing price as of 11/20/2023 of $11.80 per share, TCPC is deemed to be APPROPRIATELY VALUED/a HOLD recommendation (price target of $12.80 per share). Currently, TCPC is not one of the most undervalued BDC stocks that I/we cover but, in my opinion, is not one of the most overvalued either.

Conclusions Drawn + BUY, SELL, or HOLD Recommendation: