2023-05-12 10:56:24 ET
Summary
- Crescent Capital recently acquired another BDC.
- A larger, combined investment portfolio translates into better diversification and more origination opportunities. The acquisition it’s expected to be accretive to NII.
- Crescent Capital, on a stand-alone basis, had an 85% dividend pay-out ratio.
Crescent Capital BDC, Inc. (CCAP) is a specialty finance business development company with a catalyst in the form of management's recent acquisition of another business development company, First Eagle Alternative Capital BDC, Inc .
The merger is expected to increase net investment income and create a larger BDC with a $1.6 billion pro-forma investment portfolio.
Throughout 2022, Crescent Capital covered its dividend with net investment income, and the combined company has a significant focus on floating rate debt investments.
Merger Leads To Larger, Better-Diversified Investment Portfolio With A Strong Floating Rate Focus
In March, Crescent Capital completed its merger with publicly traded business development company First Eagle Alternative Capital BDC, Inc. The business combination makes sense because both business development firms specialize in highly secured, floating rate loans. Floating rate debt accounts for 98-99% of both companies' investment portfolios.
The combined portfolio includes approximately 200 different companies and investments, mostly debt, valued at approximately $1.6 billion. According to Crescent Capital's acquisition announcement , the transaction is expected to result in a larger and more diverse investment portfolio, as well as increased financial flexibility for the BDC.
The merger is also expected to have a positive effect on the BDC's adjusted net investment income. Crescent Capital should be able to recognize cost synergies and increase its NII as duplicate functions are eliminated, which could lead to an improved dividend pay-out ratio.
Crescent Capital Offers Passive Income Investors A 12.1% Covered Yield
Based on its net investment income pay-out ratio, Crescent Capital has had good dividend coverage in each quarter of 2022. Crescent Capital earned $1.93 per share in net investment income in 2022 and declared total regular dividends of $1.64 per share, for a dividend pay-out ratio of 85%.
Because of the BDC's focus on floating rate debt, the pay-out ratio gradually improved in the second half of the year. Including the business development companies special distributions of $0.15 per share in total, the dividend was still well-covered by net investment income (total dividend pay-out ratio 2022: 93%).
Trading At A Discount Valuation
The turmoil in the U.S. banking system, which began with the failure of Silicon Valley Bank last month, has resulted in larger NAV discounts for business development companies, even those with good credit quality and net investment income to cover dividends.
Crescent Capital's stock is presently trading at an 18% discount to NAV. A lot of business development companies are now trading at discounts to their net asset value, but I think that Crescent Capital is particularly promising on the sector downturn as the company has an actual catalyst for NII growth: The business combination with First Eagle Alternative Capital BDC.
Why CCAP Could See A Lower/Higher Valuation
Crescent Capital had a non-accrual ratio of 1.2% (based on fair value) at the end of the fourth quarter, which is expected to rise to 1.5% once the merger is completed. Crescent Capital has some levers to pull in terms of credit improvement, which could result in higher net investment income in the future.
The business development company's greatest strength may also be its greatest weakness: because Crescent Capital has built a 99% floating rate debt portfolio, a key risk for the BDC is that the central bank will cut interest rates. If the central bank lowers interest rates, business development firms that have positioned themselves to profit from a rate-hiking cycle may see falling NII in the future.
My Conclusion
Crescent Capital BDC recently merged with First Eagle Alternative Capital BDC, which is expected to boost net investment income.
The combined portfolio will be primarily composed of highly secured senior secured floating rate loans, which are expected to generate higher net interest income as long as the central bank focuses on containing inflation.
CCAP currently pays a 12.1% yield, which has been easily covered by NII over the last year. Crescent Capital has NII upside potential due to its recently completed merger, and the BDC's stock is also available at a discount to net asset value.
Overall, I believe CCAP is a suitable passive income investment for more risk-averse investors who want to bet that the central bank will continue to raise interest rates in the future.
For further details see:
Crescent Capital: Get A Covered 12.1% BDC Yield And A Catalyst