2023-12-31 07:16:49 ET
Summary
- Crescent Capital is a mid-sized BDC focused on private credit financing for small and medium-sized enterprises, which are mostly located in the US.
- While CCAP could be deemed a rather conventional BDC with a sound structure, there are several areas of concern embedded in the portfolio, which make this vehicle suboptimal.
- In this article, I elaborate on these risk zones and lay out my thinking on why I would skip going long CCAP.
Crescent Capital ( CCAP ) is a mid-sized BDC with a market cap of ~ $650 million and with an area of focus that is very similar to the majority of the BDCs.
CCAP offers private credit financing to small and medium-sized enterprises, which are mostly based on the U.S. (representing 89% of the portfolio). The only structural difference between CCAP and a one notable bucket of BDCs is that CCAP does not issue credit to VC-type companies, which are at their early stages of getting the business viable and making sure to reach cash flow neutrality.
If we look at the total return performance above, where CCAP is compared to the overall BDC universe, we can also notice how similar the return patterns have been with 3-year total return results landing at almost the same level.
Having said that, it is still worth assessing CCAP's portfolio further to understand whether the Fund is well-positioned going into 2024, when the probability of recession and rising corporate defaults is not that distant.
Portfolio structure
While CCAP's market cap is not one of the largest in the industry, the portfolio is still rather diversified across different investment companies.
Crescent Capital BDC, Inc. Quarterly Earnings Presentation
CCAP holds, on average, 0.5% of the total AuM in one investment position and has limited the Top 10 largest investments to ~15% representation of the portfolio.
Typically, for similar scale BDCs the average investment position is roughly 1.5 - 2% and the Top 10 tends to gravitate towards a 20% position in the context of the overall portfolio.
A major driver behind the reduction of single company specific risk is CCAP's focus on the smaller end of the businesses, with an average EBITDA generation of ~ $26 million .
Crescent Capital BDC, Inc. Quarterly Earnings Presentation
In terms of the industry-wide diversification aspect, CCAP does not look that great. The Top 3 industries account for ca. 65% of the AuM and with Top 5 explaining almost the entire exposure.
Moreover, the asset mix does not send too positive signals either.
Crescent Capital BDC, Inc. Quarterly Earnings Presentation
While theoretically we could read from the table above that CCAP is heavily biased towards first lien category (~89% of all assets), thus implying a nice layer of safety that could offset some of the risks stemming from industry concentration, the real situation is not that straightforward.
Namely, the lion's share of asset mix and first lien is actually placed in "unitranche" sub-category, which per definition means that there is a combination of first lien secured and junior type of loans. The problem is that there is a lack of detail to see what percentage of this is attributable to more risky forms of financing.
From the portfolio perspective, CCAP seems a rather suboptimal investment, where the industry concentration risk and ambiguous (but most probably a notable emphasis on junior loans) asset mix could elevate the sensitivity towards any forthcoming shocks in the private credit market.
Thesis
With the portfolio issues in mind, there are two additional elements, which, in my opinion, substantiate the stance of avoiding CCAP.
First is the leverage profile.
Currently, when we can notice significant tailwinds in the BDC space and where many players have enjoyed superb returns, I think it is worth assuming a more defensive stance to make sure that the shareholder value (including the dividend) is not structurally impaired once the downturn comes.
One of the major risk drivers for BDCs is the external leverage, which has to be in place to decrease the cost of capital and thus capture attractive spreads from the portfolio yield. However, if the external debt load is too considerable, the risk of experiencing more magnified negative NAV corrections in the scenario of, say, increasing loan defaults could potentially force some of the BDCs to reduce the dividend.
In CCAP's case, the debt to equity level is slightly above the sector average , revolving around 118%. Given the risk that is associated with the presence of junior loans and industry concentration, having this level of indebtedness is not optimal.
Second element is the current statistics on the non-performing loans.
Over the past couple of quarters, CCAP has consistently recorded ~ 2 - 3% in non-accrual investments, which again is slightly above the sector average .
As stated earlier, in this economic conjecture and considering the recent run-up in BDC market cap levels, it is critical to gravitated towards more defensive BDCs.
So, the combination of above average leverage and relatively unfavorable portion of non-accrual investments makes the return prospects not that attractive, especially if we take into account the lack of rock-solid portfolio quality.
The bottom line
In a nutshell, CCAP is an interesting BDC, but with several underlying aspects, which, in my view, could potentially impose notable struggles under the scenario of a more challenging macroeconomic (systematic) conditions.
The current yield of ~ 9.5% (which is ~ 130 basis points below BDC average) is not that attractive either to compensate the identified gaps in the portfolio quality.
For further details see:
Crescent Capital: Suboptimal Choice Due To Unfavorable Portfolio Quality