Fifth Street Finance: A Miserable Fourth Quarter

Fifth Street Finance's (NASDAQ: FSC) disappointing calendar fourth-quarter results follow several quarters of poor performance. The market clearly isn't happy with what it's seeing, pushing shares down more than 5% on heavy volume, despite the fact that its earnings were pre-announced in January.

Fifth Street's calendar 4Q by the numbers
The table below, which compares key metrics to the year-ago period, really sheds some light on why shareholders aren't thrilled with the company's fourth quarter.

Source: SEC filings and company IR

Over the last year, Fifth Street Finance's operating income declined by roughly $0.05 per share, while credit performance has deteriorated. Book value fell by $0.77 per share from the year-ago period, more than erasing $0.69 in dividends paid to its shareholders during 2015.

In other words, what shareholders received in dividends was more than offset by capital destruction, resulting in a negative economic return.

The company noted that approximately 40% of the decline in book value during the fourth quarter could be attributed to mark-to-market movements in its portfolio, with the remaining 60% the result of significant credit deterioration.

One credit, Ameritox, appears to be the leading cause of declining NAV this quarter. Fifth Street carries its $101.5 million loans to the company at a fair value of $65.6 million. The investment was marked down by about $27 million this quarter, or roughly $0.18 per Fifth Street Finance share.

What have you done for me lately?
Fifth Street Finance pre-announced its fourth-quarter results in January in tandem with a permanent fee cut that reduced its management fee to 1.75% of assets from 2% of assets. Unfortunately, it seems likely that what shareholders save on fees will be spent elsewhere, resulting in little or no net benefit.

Take note that Fifth Street Finance is currently the subject of several lawsuits, the details of which are discussed on page 73 and 74 of its most-recent quarterly report. While many believe that the company's external manager should foot the bill for the associated legal expenses, the costs are currently being borne by Fifth Street Finance shareholders. The company's "professional fees" line item grew to nearly $7 million this quarter, up from $1.2 million in the year-ago period.

This is not an insignificant sum. On a per-share basis, professional fees increased by roughly $0.04 per share this quarter over the year-ago period. The quarterly report suggests some of the expenses may be reimbursed by insurance, but that the company can give no assurance these expenses will be reimbursed "in whole, or at all."

Similarly, the company's $100 million stock repurchase program approved in November remains dormant, despite the fact shares trade at a substantial discount to book value. The company only repurchased shares in sufficient quantity to paper over issuance through its dividend reinvestment program in the fourth quarter. The company says it intends to use its authorization in the quarter-ended March 2016, but to what extent is unknown. 

Shareholder discontent is justified. While the market will tolerate periods of underperformance resulting from credit issues, it's becoming increasingly clear that the interests of the management team come before the interests of its investors.