TCPC - BlackRock TCP Capital: Should You Grab This 12.8% Yield For 2024?

2023-12-26 13:51:27 ET

Summary

• BlackRock TCP Capital is paying out a 12.8% dividend yield and is currently trading at a 10% discount to NAV per share.
• The investment grade-rated BDC has seen NAV per share dip for two consecutive quarters despite outearning its dividend.
• 2024 offers a step change in current optimal macroeconomic conditions, and BDCs will see more headwinds from what's likely to be 150 basis points of interest rate cuts.

Business development companies have had a great 2023 with the VanEck BDC Income ETF (BIZD) up 25% year-to-date on a total return basis. The US economy continues to record healthy GDP figures and low unemployment, set within the wrapper of interest rates at highs of 5.25% to 5.50%. This has built a golden era for private credit. BlackRock TCP Capital (TCPC) has faced more headwinds, with its common equity up 2.25% on a total return basis this year to reflect net asset value that has dipped for two consecutive quarters against a broader NAV downtrend since 2021. This is as TCPC last declared a quarterly cash dividend of $0.34 per share , left unchanged sequentially, for an 11.8% annualized dividend yield. There is also a $0.25 per share special dividend payment set to be paid.

TCPC's fiscal 2023 third quarter NAV came in at $735 million, $12.72 per share , and that was a 10% fall over its year-ago comp and a 22 cents per share dip sequentially. The continued decline means uncertainty and has driven the common equity to trade at a 10% discount to NAV. This discount has persisted despite a $50 million share repurchase plan that did not buy any of TCPC's shares during the third quarter despite the discount to NAV and against an investment grade " BBB- " credit rating from Fitch.

TCPC offers a double-digit dividend yield to income investors from an investment-grade balance sheet but NAV weakness has meant a flatlining of total investment returns this year. For certain investors, the dividend is all that matters with the protection of their principal investment forming a secondary objective. As some BDCs can achieve both objectives, TCPC is a less compelling buy.

Credit Underwriting Quality And Payment-In-Kind

Santa Monica-based TCPC focuses on senior secured lending to middle-market companies. Its total portfolio had a fair value of $1.6 billion across 143 portfolio companies at the end of the third quarter. This was 76% invested in first lien senior secured debt with a smaller 13% second lien exposure and around 11% of the portfolio allocated to equity. The credit portfolio had a 14.1% weighted average effective yield, up a substantial 280 basis points from 11.3% in the year-ago quarter. It was also 95% constructed from floating rate loans.

Third quarter total investment income of $54.2 million grew by 12.4% over its year-ago comp and beat consensus estimates by $1.55 million as TCPC's floating rate positioning helped boost interest income. Payment-in-kind income at $3.5 million was 6.48% of total investment income, up 220 basis points from 4.28% in the year-ago comp. Loans to three portfolio companies, totaling 1.1% of total investments at fair value, were on non-accrual at the end of the third quarter. These non-accruals represented 1.7% of the portfolio at cost.

Net Asset Value, Leverage, And Interest Rate Cuts

The NAV dip was led by unrealized markdowns of $0.27 per share on six positions. This countered a net investment income that at $0.49 per share grew by 17% increase year-over-year for 144% base dividend coverage. The rise of PIK income could mean higher loan non-accruals in future quarters, with non-accrual loans a year ago at just 0.3% of TCPC's portfolio at fair value. TCPC also does have a higher debt-to-equity ratio than the BDC peers closest to its market cap, but 1.3x is still broadly at a level of comfort.

TCPC is set to merge with BlackRock Capital Investment (BKCC), another BDC linked to BlackRock (BLK) early next year. The consolidated entity should benefit from lower operational expenses and a lower base management fee rate. Whether NAV recovers in the fourth quarter will depend on whether TCPC decides to pay out another special dividend. 2024 offers a material step change in the current economic zeitgeist. The Fed's December dot plot showed three interest rate cuts of at least 75 basis points next year, an outcome that would dampen net investment income growth for BDCs.

The market expectations are for 150 basis points of interest rate cuts, with the CME FedWatch Tool showing the current base expectations for next year is for rates to be at 3.75% to 4.00% at the end of 2024.

Interest rate cuts are of course not 100% certain next year, with current disruption to global shipping in the Panama Canal and the Suez Canal threatening to pose some inflationary pressure if they persist longer than a quarter. TCPC is a hold. I'd be inclined to consider the position for a buy if the NAV per share started to increase.

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