TICC Capital: New Letter To Shareholders. BDC Activist Comments.

• August 29, 2016 : TICC Capital’s (TICC) Board, in a press release, reiterated one last time, before the Company’s contentious shareholder vote, their recommendation on how to vote.
• The BDC Activist re-publishes their arguments here for any TICC shareholder still in doubt about which way they should go, along with the BDC Activist’s own comments in italics below, in order to provide some balance.
• Source: TICC Sends Letter to Stockholders Urging Them to Vote White Proxy Card Today
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• “DISTRIBUTION: TICC’s distributions have increased from $0.60/share in 2009 to $1.14/share in 2015 – a 92% increase. TICC has consistently maintained its distribution policy despite market volatility.
• BDC Activist says: ” Factually true as TICC Capital transformed itself from a technology-focused lender (which was a disaster and resulted in huge Realized Losses and poor returns. The T in TICC used to be for Technology before a name change) to a CLO equity focused lender. To their credit, TICC’s management-which also owns Oxford Capital- a publicly traded Closed End Fund which invests exclusively in CLOs under the ticker OXLC-made the transition at an auspicious time. CLO values were hugely down due to the Great Recession and most of the CLO investments made by TICC ended up generating very high returns.
• Adds:” In addition, TICC managed to maintain a high dividend-even as those so-called 1.0 CLOs were refinanced and replaced with lower returning 2.0 versions by increasing both the proportion of these high paying but highly volatile investments in the portfolio, and increasing total leverage.
• At June 2009 , TICC had essentially no borrowings whatsoever. Seven years later, total debt to equity was 103%, in excess of BDC rules. “
• Adds: “The juicy pay-outs from CLO investments include both an income return and a “return of capital”. However, all the distribution is considered Taxable Income from the standpoint of the IRS and under BDC rules all counted as Taxable Income and all distributed to shareholders. As a result, there has been an ever increasing gap between the Company’s GAAP income you’ll see in the earnings reports and what shareholders actually receive. Some of the Company’s very high dividend goes to pay a higher than usual tax liability by shareholders as well as being a return of capital as CLO investments -which have a finite life-wind down”.
• Analogy: “CLO investments are like investing in an oil field. Holding oil prices constant, returns are very high in the early periods as oil gets pumped out, but drops over time as the field depletes”.
• Adds:” To date TICC has managed to avoid the impact of depletion by re-investing in new CLOs even as older investments drop sharply in value. This was the case even in the last quarter when 54% of all new investments were in CLOs.
• As TICC points out this has resulted-over the 7 year period in question-in high Total Returns, where losses on the capital roundabouts are made up by gains in the distribution swings, if you’ll allow the analogy.  However, this has been achieved in a period of relatively positive credit conditions and by stretching the balance sheet to the max.
• The BDC Activist warns that higher credit losses in the CLO arena or a deterioration in other metrics could result in temporary or permanent suspension of CLO equity distributions, and potentially huge drops in both income and market Net Asset Value.  Even without worse credit conditions, investing in CLOs will result-due to the discrepancy in tax and GAAP treatment-in ever dropping Net Asset Value in the years ahead even if market values (which jumped in the second quarter) normalize.
• Ends: “Shareholders may have to decide if maintaining the high distribution (and the high tax liability associated) by voting for maintaining the current TICC advisor is worth the possibility of very large pay-out cuts if conditions change, and the steady erosion of their capital because of the anomalies involved in CLO investing.”
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• RESULTS: TICC has generated 323% total shareholder return since the current strategy was adopted in 2009 – significantly higher than the 147% total shareholder return generated by TICC’s BDC peers – and TICC has generated a 17.9% total shareholder return year to date. 
• SUCCESS: TICC’s current strategy is working. In 2Q2016, NAV/share increased by 11%, and GAAP Net Investment Income rose by 62% compared to 1Q2016. 
• BDC Activist:  Technically true, but some that return is a return of capital.  See above.Other BDCs which do not invest in CLOs cannot be fairly compared. Any BDC could achieve any shareholder return by paying back capital as well as income.
• Adds: As for the year-to-date return, much of that is due to the bounce back in the value of credit investments, not something that can be counted on to continue indefinitely. A little misleading to TICC shareholders.
• Also: “The BDC Activist finds it amusing that TICC is touting the success of its “current strategy”. Just a year ago, the BDC Reporter wrote breathlessly about how TICC’s advisor had shocked the BDC community by deciding to sell out to Benefit Street Partners. One of the key reasons given was that investing in CLOs (now nearly 50% of TICC’s income and 100% of Net Investment Income) was deemed the wrong way to go. 

• This is what we wrote at the time about the Q&A on the Conference Call and a question from uber-analyst Greg Mason about TICC’s decamping from CLO investing:

• “Greg Mason-in the equivalent of an “exit interview” question- asked Mr Cohen what he thought of CLO investments inside a BDC structure. The CEO said he believes the market has spoken and their response is negative. CLO investments are kryptonite in the BDC format. He said Mr Market’s antipathy causes a loop effect where the hostility to CLO investments makes the BDC stock drop, which then makes it difficult for the BDC to be successful in at investing in this controversial segment of the market. That suggested TICC saw the writing on the wall: no more new capital to raise and the prospect of big asset value drops in the Next Recession, which would cut results (and fees). Given we don’t yet know the terms of the management contract “sale”, it’s hard to say much more”.

• Apparently the TICC investment advisor-when the sale to Benefit Street was nixed, decided that their old strategy was not so bad after all ! Presumably TICC is counting on shareholders having short memories, and they may be right.
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• RISK OF SUPPORTING TSLX DISTRIBUTION POLICY THREATENED: TSLX has publicly criticized TICC’s distribution policy. What will happen to TICC’s distributions if TSLX’s agenda is adopted ?
• BDC Activist says: “A fair question, but as TICC says itself below, we don’t know what the portfolio might look like under “TSLX’s agenda” because this is a very strange tussle where the activist-shareholder-other BDC is not committing itself to buying TICC.
• Nonetheless, the BDC Activist will have a go at answering what is a rhetorical question.  If TSLX got control-or any mainstream larger asset management organization-we would probably see a very drastic change in the composition of the investment portfolio. The CLOs would be sold because too risky, and the lower yielding loan assets too because not risky enough and generating too low a yield. The new portfolio would consist of leveraged loans yielding 9%-11% to B rated or CCC equivalent borrowers (see the portfolios of Goldman Sachs BDC, FS Investment, Fifth Street Finance, etc). The Convertible Debt would be repaid (the 8.0% effective cost is very high). New, lower cost borrowing would be arranged to finance the portfolio. Total leverage would be reduced to meet the demands of new lenders and as a precaution against future market conditions.
• Finally: “Yes, the distribution would go down substantially but so would the risk. Unfortunately, this would involve constructing a new credit portfolio 7 years into an economic expansion when spreads are under pressure due to too much money around, and credit metrics are weak for the same reason. Would this be going from frying pan to fryer ? Or would the better analogy be “going from the devil you know to the devil you don’t”?””
• MANAGEMENT VACUUM: TSLX wants to terminate TICC’s investment advisory agreement. Who will manage TICC if the current advisor is terminated? A leading independent research analyst agrees that terminating the current advisor is a bad idea, calling it a “major risk”.
• NO TRANSPARENCY: TSLX has no clear plan – or worse, they just won’t disclose it. Their proposals may destroy stockholder value.
• BDC Activist says: ” TICC does have a point here. As we’ve said in earlier posts, just throwing the existing advisor out is not a plan. More of a punishment but as we’re on cliched expressions more akin to “cutting off your nose to spite your face”.
• “We agree termination without the identification of a new owner or even manager is a “major risk”, and uncharted territory for a BDC. Of course, TSLX is effectively standing in the wings but like a would-be unannounced presidential candidate would prefer to be drafted than publicly throw their hat into the ring.
• The BDC Activist would add that the shareholders of TSLX have a right to ask if it’s appropriate for their capital to be used in this circuitous effort to effect regime change at TICC Capital.
• The managers of TSLX-themselves a subsidiary of that huge asset management group TPG Specialty-have a fine (albeit short) track record of BDC management. Nonetheless, most shareholders of TSLX did not invest in that BDC with the anticipation that managerial time and capital resources would be spent on a hostile attempt to acquire another BDC with an entirely different portfolio profile.  This seems a crusade that should be conducted by the parent rather than using OPM (Other People’s Money) by having TSLX serve as point man.”
• HIGHER ADVISORY FEES: TSLX pays higher advisory fees than TICC.
• BDC Activist says: “Factually true, and in our estimation somewhat higher than fair. However TSLX shareholders have enjoyed good Total Returns too and do not seem to share our view.
• TICC,though, should get a prize for pot calling the kettle black. After all, TICC was charging a 2.0% Management Fee until pressure from TSLX and NexPoint (who appear to have entirely abandoned the field) caused the desperate TICC advisor to make concessions and “hold on to what you’ve got”, to quote the song. Those short memories again.
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• BDC Activist Conclusion: “Tough choice here for TICC shareholders. As we’ve said before, if we had money in the game we’d call a pox on both houses and sell out now with the stock price closing in on NAV (insiders buying more stock in anticipation of the vote or just that momentum which gathers around such drop dead dates ?). To have and to hold could result in short term benefit and long term disaster with a management group apparently bent on protecting their own interests at all costs. Even to the point of finally buying their own stock in recent weeks… However, the business model they’ve had to adopt to keep shareholders happy with a huge dividend is liable to a catastrophic (but not inevitable) implosion.
• To throw the advisor out is to enter new territory, replete with many questions and no immediate answers. TICC would be unlikely to collapse right away. There might even be a renewed interest by bargain hunting buyers and would-be asset managers. Where that would end up, though, is anybody’s guess. What happens in the interim as the captains of finance battle over the Company is unknowable. What happens if we get a credit crisis ? Or rates rise sharply ? What to do when there’s nobody at the helm and the Board and competing managers are in conference rooms every day duking it out over what should happen to TICC shareholders capital ?
• TICC, TSLX