TRIN - Solid 10% Yield From Blue Owl Or Sixth Street?

Comparing Dividend Coverage

The three biggest mistakes that new BDC investors make are:

• Focusing on historical dividend coverage instead of projected dividend coverage which is heavily reliant on portfolio credit quality.
• Not taking the time to dig into portfolio credit quality and assess which investments could potentially have a negative impact on earnings and NAV.
• Not understanding why BDCs trade at different prices and thinking that price-to-NAV is the only measure to find a "good deal." Please see the end of this article for a quick discussion of how BDCs are valued.

Each quarter I update the financial projections for each BDC with base, best, and worst-case scenarios to test the sustainability and/or changes to the current dividends. Below I discuss many of the drivers used for projecting dividend coverage including the base, best, and worst-case projections similar to what we provided in the "ARCC: Assessing Dividend Coverage For Its 10% Yield" article linked earlier.

Blue Owl Capital ( OBDC )

OBDC has better-than-average dividend coverage mostly related to:

• Previous increases in interest rates
• Reinvesting repayments at higher yields
• Increased dividend income from Wingspire and its OBDC Senior Loan Fund
• Prepayment fees and accelerated OID
• Maintained higher leverage

For Q1 2023, OBDC beat its best-case earnings covering its dividend by 140% mostly due to increased dividend income from its OBDC Senior Loan Fund and Wingspire and slightly higher-than-expected portfolio growth.

The current market environment remains a very attractive one for direct lending. With the public market mostly unfavorable for new issuance, we continue to see direct lenders financing nearly all of the deals that are coming to market. These opportunities are attractive because they are for high-quality borrowers with enhanced spreads, documentation and leverage levels. ORCC [OBDC] is currently benefiting from this environment, largely through amendments and other repricing events which continue to help increase the overall spread on our portfolio.”

“Recent volatility in the credit markets and general capital constraints have underscored the benefit of scale for direct lending platforms. Given the potential challenges to come over the near to medium term, we believe that the market environment over the next couple of years will favor larger platforms like ours. Size and scale are increasingly important when it comes to fundraising, deal flow and access to financing as well as hiring and retaining top talent. And we believe that the strength of our platform will be even more apparent during this time. When conditions are more challenging, people naturally gravitate to the stability and security that larger platforms provide, and we expect to be a beneficiary of this dynamic.”

OBDC management mentioned the more lender-friendly environment with higher overall yields and better terms, including stronger covenants (safer investments) taken into account with the best-case projections:

Even with lower rates, we're going to have terrific earnings at ORCC because they're still much higher than they were a year ago and our spreads are elevated as well . So even in an environment, if you take the forward curve, we should have very strong earnings this year and next year. So I feel really well positioned on that. To your question, is there some -- can we grind that spread even higher? I mean look, this is something we've been really focused on. And if you've watched us quarterly, we have, for the last six quarters, really been able to grind spread higher in the portfolio as we rotated out of some lower-spread investments . It's been a very active and deliberate strategy, patient, thoughtful. So possibly, we could do a bit better. It really depends where market spreads go as the market strengthens. But I think our spread is very high already relative to the peers. But we'll have to see how that aligns with where new deals are coming at the time that's happening.”

OBDC previously reaffirmed its regular quarterly dividend of $0.33 per share plus a supplemental dividend of $0.06 per share for a total of $0.39 per share for Q2 2023, which was the previous best-case projection .

Our Board approved a supplemental dividend of $0.06 per share, which is an increase of $0.02 from the prior quarter. This is in addition to our previously declared $0.33 regular dividend which results in total dividends of $0.39 for the quarter. In total, this represents an annualized dividend yield of over 12% based on the current share price, which we believe is very attractive in today's market. We also delivered an ROE of 12.1% for the quarter, and we would expect to deliver an ROE in excess of 12% over the full year based on our current outlook for rates and credit performance.”

Many BDCs have opted to take a conservative approach when setting their regular dividends (just in case rates head lower) and using supplemental/special dividends to pay out excess earnings. This means that if portfolio yields decline, we will see lower amounts of supplemental/special dividends but the regular dividends will be maintained especially "Level 1" dividend coverage BDCs. OBDC management discussed this on the recent call:

Going into the third quarter of last year, we were confident that rising rates and continued credit performance were going to drive significant improvement in earnings. As a result, we increased our regular dividend by $0.02 and added a formulaic supplemental dividend to our quarterly dividend structure. We recognized that we would significantly outperform the regular dividends in a rising rate environment and wanted to create a predictable mechanism to share that upside with shareholders. Compared to the second quarter of 2022, the average base rate in the portfolio increased roughly 300 basis points and the NII has grown by over 40%, which has driven the growth in our supplemental dividend. We instituted a supplemental dividend on the back of our continued earnings momentum to ensure that our shareholders benefit from the higher rate environment. We expect to continue to evaluate our dividend policy going forward to ensure we are striking the optimal balance of sharing upside while also protecting the stability of the dividend across all market environments .”

OBDC has adopted a formula-based supplemental dividend in an amount to be determined each quarter calculated at 50% of earnings in excess of the regular dividend. Also, when calculating supplemental dividends, management takes into account a “NAV constraint test” to preserve its NAV per share. Supplemental dividends will be capped such that the decline in NAV over the prior two quarters plus the supplemental dividend is no more than $0.15 per share.

The supplemental dividend will be variable each quarter, calculated at 50% of NII in excess of our regular dividend, rounded to the nearest penny and subject to certain measurement tests. It will be announced with quarterly results and paid in the following quarter. OBDC shareholders will receive a dividend 8 times a year.

The company can easily support dividend increases in the base and best-case projections:

We are pleased with the continued strength of our earnings. We believe this quarter's NII represents a sustainable level in the current rate environment. We could see further upside if repayments pick up or dividend income from our strategic equity investments and the senior loan fund increase. Conversely, we could also see a decline in NII if rates drop or non-accruals increase, although we do not currently see evidence of either happening in the near term.

The updated projections take into account increases in dividend income from Wingspire Capital Holdings and from its OBDC Senior Loan Fund, which combined currently account for 5.8% of the total portfolio but likely higher over the coming quarters. During Q1 2023, these investments provided dividend income of over $20 million:

Wingspire previously acquired an equipment leasing company (Liberty Commercial Finance) and there was an increase in the Senior Loan Fund that will likely drive additional dividend income during 2023. Also, on Aug. 2, 2022, Owl Rock announced an investment in Amergin Asset Management , a newly formed portfolio company created to invest in a leasing platform focused on railcar and aviation assets.

We've been really pleased with the performance in Wingspire. As a reminder, we built that business organically working with a very experienced management team. It took a few years for them to sort of hit the momentum that they're at now. It's performing quite well and delivering very attractive dividends and ROE for ORCC. There, we talk to them regularly. And I think they're seeing good market conditions already just given the environment. And we will -- we do expect to continue to provide additional capital to Wingspire as they find opportunities . It stands to reason that if regional banks pull back from credit support, that will provide additional opportunities for Wingspire . I don't think we've seen that effect yet. In addition, generally in a weaker economy, companies will turn to asset-based financing more frequently . So I think that I agree with the supposition of your question. There will be more opportunities for Wingspire and we can put more capital in it and earn really attractive returns .”

In November 2022, the company announced the approval of a $150 million stock repurchase program, a portion of which may be executed under Rule 10b5-1 in order to make purchases outside of the company's open-market window. Also, certain affiliates and employees of Blue Owl have indicated that they intend to participate in an investment vehicle that will be authorized to buy up to $25 million of OBDC common stock, which will be held for investment purposes. During Q1 2023, the company repurchased another 1.8 million shares for $22.1 million or around $12.27 per share (an 18% discount to the previous NAV per share). As of May 10, 2023, a total of $73.7 million of common stock was purchased at an average price of $12.22 per share.

We have also continued to work towards our previously announced repurchase target of $75 million through the combined buying power of the company's share repurchase program and the Blue Owl employee investment vehicle. As of May 10, an incremental $22 million of ORCC stock was purchased bringing total stock purchased to $74 million at an average price of $12.22, of which $49 million was repurchased by the company.”

OBDC has higher-than-average amounts of payment-in-kind (“PIK”) interest income, currently around 11.4% of total income or 12.9% of interest income, which includes its non-accrual investment in Walker Edison Furniture , as mentioned later. Also, OB Hospitalist and Tall Tree Foods were partially/fully converted to PIK during Q1 2023. However, management discussed this on the previous call and mentioned that most of the PIK is not related to restructured investments and/or credit issues. My opinion is that OBDC has an excellent history of credit quality and continues to invest in larger companies that would likely outperform, so a higher amount of PIK is acceptable, but I will continue to watch over the coming quarters.

With the vast majority of our PIK income is not from credit problems , it's from specific deals where we were asked to structure our investment with either a portion or all PIK at the get-go, and we thought it was reasonable to do so for credit specific reasons. It's like 85%, 90% of our PIK income. We have very little PIK income from credit problems. So, it's just not an indicator of stress in the portfolio. If you're asking me, I think about where we are low double digits, it's about the right level of PIK. So I don't think we expect to take that number higher. As I mentioned before, we're not seeing request for PIK from troubled credit situations, but we are in a very comfortable place there and there is nothing – there is no so you should not look at as a cause of concern of the portfolio because that's not what it's an indicator of.”