2023-11-15 16:07:41 ET
Summary
- BlackRock Capital Investment Corporation announces merger with BlackRock TCP Capital Corp., resulting in lower management fees and potential for NII growth.
- The BDC remains focused on First-Lien debt and easily covers its dividend with NII, but suffers from an increase in non-accruals.
- The merger deal is expected to yield advantages, including an enhanced portfolio size and a more diversified investment portfolio.
BlackRock Capital Investment Corporation ( BKCC ) is an externally-managed BDC that, in September, announced a merger with another publicly-listed BDC, BlackRock TCP Capital Corp. ( TCPC ) .
The merger is a positive for BKCC investors as it results in the lowering of the management fee and creates a more diversified BDC with potential for NII growth.
BlackRock Capital Investment remained a First-Lien focused BDC in third quarter and easily covered its dividend with NII. Since BlackRock Capital Investment, unfortunately, also suffered an increase in non-accruals in the third quarter, I think this 11%-yielding BDC is a Hold.
My Rating History
I developed a thesis on BlackRock Capital Investment about a year ago that I titled Get An 11% Yield At A Discount To NAV . I recommended the BDC to passive income investor on account of a large discount to NAV and a First Lien focus that provided downside protection.
Taking into account that the credit quality situation has worsened in the third quarter and that the non-accrual ratio has risen to 2%, my new stock classification for BKCC is Hold.
BlackRock Capital Investment’s Portfolio In 3Q-23
BlackRock Capital Investment had 85% of i ts assets invested in Senior Secured First Lien Debt and 11% in Senior Secured Second Lien Debt at the end of the third quarter with the remainder being invested in Subordinated Debt and Equity.
BlackRock Capital Investment’s portfolio was valued at $595 million in 3Q-23, so BKCC is a rather small BDC that passive income investors can invest in.
BlackRock Capital Investment’s portfolio did not grow in the last quarter as the amount of debt repayments canceled out new investment purchases. The BDC did make a number of investments, however, which were overwhelmingly First Liens.
BlackRock Capital Investment ended the third quarter with 120 companies in its investment portfolio, reflecting a decline of one investment QoQ.
Relatively High Amount Of Non-Accruals
BlackRock Capital Investment still has to work through some credit issues as the company’s non-accrual ratio rose to 2% in the third quarter (based on total debt portfolio value).
The fair market value of non-accruals rose from $15 million to $20 million, reflecting a relatively large 33% increase QoQ. I have repeatedly said that a non-accrual ratio between 1.5% to 2.0% makes me quite a bit uncomfortable and I’m generally trending towards a Hold rating for a BDC, even if the underlying dividend coverage looks good.
Dividend Coverage Continued To Improve In 3Q-23
From a dividend coverage perspective, BlackRock Capital Investment appears to be a solid investment for passive income investors. The BDC earned $0.13 per share in NII in the third quarter compared to a stable $0.10 per share dividend pay-out which led to a 77% pay-out ratio in 3Q-23.
BlackRock Capital Investment’s dividend is not growing, but the 11% dividend yield, based on dividend coverage, appears sustainable.
Merger Deal With TCPC
BlackRock TCP Capital Corp. announced in September that it plans to merge with BlackRock Capital Investment. BKCC will become a wholly owned (indirect) subsidiary of BlackRock TCP Capital and the deal is expected to yield major advantages for both companies. The combined company will trade under the TCPC stock ticker once the merger is completed. The transaction is expected to close in the first quarter of 2024.
There are a couple of benefits associated with the transaction including an enhanced size (the combined portfolio will be valued at around $2.2 billion), the advisor’s management will be slashed from 1.50% to 1.25% (for assets equal to or below 200% of the NAV of TCPC) and the merger deal is expected to be accretive to NII to the tune of $2 million or more annually.
The resulting portfolio will be dominated by Senior Secured Loans (90%), particularly of the First Lien variety.
The proforma portfolio will also be more diversified and include primarily investments in the Internet, Software and Diversified Financial Services industries.
17% Discount To Net Asset Value
The discount to NAV was a good reason for me last year to recommend BKCC to passive income investors, but the non-accrual situation has worsened again lately and it is a good reason to update my thesis and scale back my optimism a little bit.
BlackRock Capital Investment is presently selling at a 17% discount to NAV while other BDCs sell at smaller discounts to book value. Passive income investors that value dividend safety and credit expertise more than anything may want to read my thesis on Ares Capital Corp. ( ARCC ) which is one of the best BDCs that is available for long term investors, in my view.
Why BKCC May See A Lower Valuation Multiple
The non-accrual ratio is something that passive income investors should pay a lot of attention to because it can indicate the potential for a possible deterioration in underlying dividend coverage.
The present dividend coverage for BlackRock Capital Investment looks robust, but things can go out of hand if the trend deteriorates. So even though I think the deal with BlackRock TCP Capital Corp. is favorable (NII growth potential, lower management fee, more diversified portfolio etc), the non-accrual situation is a concern that should not be overlooked.
My Conclusion
There are some pros and cons when it comes to investing in BlackRock Capital Investment, as is the case with all BDCs.
BlackRock Capital Investment managed to cover its dividend with NII in the third quarter and the dividend coverage ratio improved QoQ due to a rise in NII per share. The deal with BlackRock TCP Capital Corp. is also promising since the management fee is getting slashed, creating NII tailwinds for the new BDC.
What I have issues with is the rise in non-accruals. My personal pain hurdle is a 2.0% non-accrual ratio at which point I think risks are escalating. Considering the pros and the cons of BlackRock Capital Investment’s third quarter performance, I am settling for a stock classification of Hold.
For further details see:
BlackRock Capital Investment: This 11% BDC Yield Is No Longer A Buy (Downgrade)