jebmo’s posthaven

Ask the typical investor if a BDC can be safer than a REIT - and the average investor will reply with two questions: (1) What is a BDC (or Business Development Company)? And what is a REIT (Real Estate Investment Trust)? Ask an informed income investor - and the reply is probably "no way." This article will supply data that suggests the opposite answer is correct. At the same time, this article will supply the just reported calendar Q3-16 earnings metrics for Golub Capital BDC (NASDAQ:GBDC). Doing both tasks in the same article causes some significant topic shifts during this article.

Why should anyone be interested in this comparison? First - because the yields on the lower risk Senior Secured Floating Rate BDCs are so low, they tend to fall off the radar for many BDC investors. Second - it is probably the case that the mind of the average investor reading this could use some calisthenics when it comes to risk assessment. But be forewarned - I am not certified in mental calisthenics, so you are in some danger of spraining a neuron.

I am going to start with the year to date numbers for BDCs and for Healthcare REITs:

BDCs 11-16-16

Yield in the spreadsheet below is based on the Q4-16 'regular' dividend. Spreadsheet header abbreviations: Div = dividend; EPS = earnings per share; LTM = last twelve months; YTD = year to date. The dividend to EPS ratio is a measure of dividend safety. Due to calendar and fiscal years failing to overlap, I also include a dividend to the sum of the last four quarters of NII - in the Div/NIIltm column. After the Price/NAV ratio, the next column displays the percent change in price YTD. The next display price change plus YTD dividends accrued on the payment date - not the earned date.

For the last four columns - the first measures the percentage change in the 2016 EPS projection since the beginning of the year; the second measures the change in the price target since the beginning of the year; the third measures the change in the Q4-16 dividend from the Q4-15 dividend; and the last measures the change in NAV between Q3-16 and Q3-15. Special dividends are not included in this data. ARCC, FDUS, MAIN and TCPC have paid special dividends on a near regular schedule.

FULL has converted to Great Elm Capital Corp. and trades as GECC. On 8-05 AINV cut its dividend from $0.20 to $0.15/quarter. On 8-09 MCC cuts its dividend from $0.30 to $0.22/quarter. On 9-22 CPTA announced a 17% cut in its dividend to $0.13/month. On 11-02 HRZN cut its dividend from $0.34 to $0.30/share. On 11-09 TCRD cut its div to $0.27/share. On 11-09 CMFN announced a Q1-17 cut in its div to $0.25. I have temporarily encoded this as the Q4 div.

Health Care REITs Q4-16

Yields are calculated on Q3-16 dividends. The Dividend/FFO ratio uses the 2016 FFO projection. The percent change columns measures the changes since the beginning of the year. LTM (last twelve month) dividend growth uses Q3-16 minus Q3-15 normalized dividend/share divided by Q2-15 dividend.

LTM FFO growth uses Q2-16 minus Q2-15 normalized FFO/share divided by Q2-15 normalized FFO. LTM FAD growth does not use quarterly numbers - but the 2016 midpoint of the yearly guidance compared to the 2015 actual. VTR had a downward adjustment to its dividend and operating metrics when it spun off CCP. CHCT and MRT are too new and too small to be currently included in my coverage.

The specific companies I will be comparing are SNF Health Care REITs OHI and SBRA to Floating Rate Senior Capital BDCs GBDC, PFLT and SUNS.

The current yields for SNF Health Care REITs OHI and SBRA are 8.29% and 7.88%. They have LTM dividend growth of 2.44% and zero. The current yields for the Floating Rate Senior Capital BDCs GBDC, PFLT and SUNS are 7.20%, 8.64% and 8.70%. None have dividend growth based on the regular dividend - but GBDC will pay a special dividend this year that results in "total" dividend growth.
Given that the "yield + dividend CAGR" numbers are close to equal - the risk needs to be close to equal.

At this time, I will report the numbers on Golub - and return to the REIT to BDC comparative task toward the end of the article.

What GBDC Earned

Golub Capital BDC reported for calendar Q3-16 Net Investment Income of $17.228 million ($0.3215/share). With Total Investment Income of $34.503 million ($0.6439/share) - the NII/TII ratio was 49.93%. GBDC's Net Increase in Net Assets Resulting from Operations was $16.099 million ($0.3004/share) due to $1.129 million of realized and unrealized losses. The NAV was $15.96 compared to $15.88/share last quarter. Over the last twelve months, there has been $0.11 added to NAV due to issuance of shares; twelve cents added from realized gains and four cents subtracted from unrealized losses.

The consensus earnings projections from Yahoo Finance:

Earnings per share were in line with projections while Total Investment Income beat the projection by over a million. GBDC had both a public and private share offering during the quarter. Those new funds were deployed quick enough to boost total earnings. But that earnings boost was offset by the growth in new shares. My earnings metric spreadsheets for GBDC:

The spreadsheet above is an important data set for setting risk assessment. GBDC has had positive gains in 12 of the last 15 quarters. We also know from data in the 10-K (and also reported above) that GBDC has had "twelve cents added from realized gains and four cents subtracted from unrealized losses" over the last twelve months.

I want to make two quick notes on issues that could merit a long explanation. First - both Golub and Ares appear to capture "accelerated amortization of upfront fees" in the realized and unrealized gains line of their earnings while most BDCs include that line with interest income. This results in superior performance on gains while net investment income is under reported. Second - I will use similar spreadsheets on Omega and Sabra to show their history over the last 9 quarters on gains.

For BDCs - I show the change in per share numbers because the change in the gains is the dominant influence in NAV change. I show the change for REITs in terms of percent of revenues because the difference in this line helps explain significant variations in REIT cap rates.

And with those potentially overly brief notes - I will move on to more of the Golub numbers.

Almost all BDCs report what I have called in prior articles their PWAY or Portfolio Weighted Average Yields. I have the expectation that in the herd of reported numbers in the release, this important metric is often overlooked. I want to quote from the Golub earnings release the source of this metric to assist you in finding it in other BDC releases:

"For the three months ended September 30, 2016, the weighted average annualized investment income yield (which includes interest and fee income and amortization of capitalized fees and discounts) and the weighted average annualized income yield (which excludes income resulting from amortization of capitalized fees and discounts) on the fair value of income producing investments in the Company's portfolio were 8.5% and 7.8%, respectively."

This number is a "big deal" - and here is why:

The Correlation of Weighted Average portfolio yield to BDC yield and weeding out ACSF, FULL, KCAP, OHAI, SAR, MFIN and TICC
The following companies had weighted average yields at or under 9%: FSFR, GBDC, PFLT and SUNS. Their average yield is 8.63%.
The following companies had weighted average yields between 9% and 10%: CMFN, FSIC, MAIN and MRCC. Their average yield is 9.81%.
The following companies had weighted average yields between 10% and 11%: AINV, FSC, NMFC, SCM, SLRC, TCPC, TCRD and TSLX. Their average yield is 10.42%.
The following companies had weighted average yields between 11% and 12%: ABDC, BKCC, GARS, GSBD, PNNT and WHF. Their average yield is 12.42%.
The following companies had weighted average yields over 12%: CPTA, FDUS, GAIN, HCAP, HRZN, HTGC, PSEC, TCAP, TICC and TPVG. Their average yield is 12.05%.

If one wants an explanation of why one BDC has a yield of x and another has a yield of y - look at the differences in the PWAYs along with differences in the NAV change trend and dividend coverage. There are investors who have trouble using metrics in arriving at a valuation assessment. It is my perception that you are lost if you do not use the numbers. The numbers above are evidence of how strong an explanation one can get from fairly simple data.

And now for the final Golub spreadsheet:

I have the expectation that the ending amount of debt understates what would be the weighted average amount of debt for the quarter. And the "weighted average" number would be the one that correlated to the interest expense. So I would have the expectation that the calendar Q4 "annualized interest expense to debt ratio" to return to the low threes.

Golub has relatively low cost debt. For example - none of the Senior Capital BDCs use baby bonds as a source of funds. And the cost of debt correlates to the NII/TII ratio. The NII/TII ratio is a valuation metric. The third grouping messes up the appearance of the correlation. But the correlation is still easy to see with this hick-up.

The Correlation Between NII/TII Ratios and Price/NAV Ratios and weeding out FULL, KCAP, OHAI, SAR, MFIN and TICC
The following had LTM NII/TII Ratios over 60%: ACSF, BKCC, GSBD, MAIN and SUNS. Their mean price to NAV [where par = 100] is 112.37%. Their mean P/E is 11.12.
The following had LTM NII/TII Ratios between 53% and 60%: ABDC, CMFN, GARS, NMFC, PFLT, TCAP, TCPC, TCRD, TPVG and TSLX. Their mean price to NAV ratio is 95.96%. Their mean P/E is 9.16.
The following had LTM NII/TII Ratios between 50% and 53%: AINV, FSIC, GLAD, HTGC, MRCC, PNNT and SLRC. Their mean price to NAV ratio is 102.63%. Their mean P/E is 9.61.
The following had LTM NII/TII Ratios between 46% and 50%: ARCC, FDUS, FSFR, GBDC, HCAP, HRZN, OFS, PSEC and WHF. Their mean price to NAV ratio is 91.66%. Their mean P/E is 9.68.
The following had LTM NII/TII Ratios under 46%: CPTA, FSC, GAIN, MCC and SCM. Their mean price to NAV ratio is 78.85%. Their mean P/E is 8.35.

GBDC does not score well on the NII/TII metric. But you were informed earlier in this article that GBDC probably understates its NII. An understated NII messes with the NII/TII ratio.

And now we are about to have one of the dramatic topic shifts of which you were forewarned. I am about to get back to the comparison of GBDC to the SNF REITs. BDCs report changes in their realized and unrealized gains. REITs report portfolio impairments. So we do not have apples to apples numbers. But I expect we still have fruit to fruit numbers:

The value of the stuff that GBDC owns is roughly flat over time - and has relatively low quarterly oscillations. The value of what OHI and SBRA owns is falling over time and has high quarterly oscillations.

The cost of the debt that GBDC has is in the threes. The S&P credit rating is AAA or AA depending on the debt issue.

The annualized interest expense (68.316 time four) to debt (4433) ratio for OHI is 6.16%. The S&P credit rating for OHI is BB.
The annualized interest expense (15.794 time four) to debt (1205) ratio for SBRA is 5.24% - and SBRA reports that its average cost of debt is 4.55%. The S&P credit rating for SBRA is BB-.

Based on those metrics alone, GBDC is much safer of an investment than OHI or SBRA. The S&P says so. The financial market that sets the cost of debt says so. But... there is one more key metric that matters:

The payout ratio for the GBDC dividend is close to 100% of NII or net investment income. The payout ratio leaves no room for earnings shortfalls - and there is nothing retained for forward dividend growth.

The FFO or Funds from Operations payout ratios for OHI is 71.01% and for SBRA is 73.68%. There is room for earnings shortfalls and there is sufficient funds retained for forward dividend growth.

Is GBDC a buy?

GBDC sells at a yield of 7.20% compared to a PWAY of 7.8%. I would like to see a yield that is closer to the PWAY. But given the relatively good NAV trend, I understand why there is a premium. Add to that, the special dividend is not included in the yield calculation. GBDC is roughly fairly valued. PFLT and SUNS look to be the better values in the asset class at this time.

On the other hand, most BDC investors are using borrowed opinions to make their investment decisions - and those borrowing opinions may not be informed by the importance of such things as the gravitation pull of the PWAY to influence the yield of the equity. If that is the case with you - then you need to own one of the Senior Secured BDCs.

I would go so far as to say that if you own multiple BDCs and do not have one of the three (GBDC, PFLT or SUNS) in your portfolio, then you are not investing right. You are taking more risk than average. And you are in danger of having more "imploding income" than average.