What happened
Shares of Triangle Capital Corporation (NYSE: TCAP) are down by more than 11.6% as of 2:04 p.m. EDT after the company reported disappointing second-quarter earnings stemming from poor credit selection.
So what
Triangle Capital makes its money by making debt and equity investments in small businesses located across the United States. Increasingly, its investments are taking a turn for the worse, dragging down operating income and book value on a per-share basis.
Image source: Getty Images.
From a straightforward view, the company reported that 5.4% of its portfolio at cost is on its non-accrual list, a designation given to investments that are performing so poorly that Triangle no longer recognizes income from these investments.
But that's if you're only looking on the surface. The fact is that which assets go on non-accrual is very much a subjective issue, and investments can become "troubled" well before they receive a spot on the non-accrual list. That's the real issue at Triangle Capital, where deeper digging reveals five relatively large investments are underperforming, but haven't yet been placed on non-accrual. Importantly, investments in these companies are held at an average discount exceeding 20% of cost, a level which is generally viewed as the dividing line for distressed investments.
|
Portfolio Company |
Fair Value as a Percentage of Cost |
|---|---|
|
CRS Reprocessing |
12% |
|
Frank Entertainment Group |
63% |
|
Frontstreet Facility Solutions |
52% |
|
Nomacorc |
74% |
|
PCX Aerostructures |
64% |
Data source: Triangle Capital 10-Q filing.
Add up Triangle's reported values for its investments in each of these companies and you'll find that they constitute as much as 8.4% of Triangle's net asset value (book value) on a combined basis, or roughly $1.25 per Triangle Capital share, which stands in stark contrast to the reported non-accruals, which make up $0.37 of book value per Triangle Capital share.
For a business development company like Triangle Capital, which is obligated to pay out virtually all of its earnings in the form of dividends, future non-accruals bring higher risk of a dividend cut. Notably, the company earned net operating income of $0.41 per share this quarter, below its current dividend of $0.45 per share.
Now what
Triangle Capital has explained that many of its poor performers come from a cohort of bad investments made during a period spanning from 2013 to 2015. Management suggests that Triangle has since strengthened its underwriting process, and that as many as 50% of its investments were originated after Triangle's process improvements.
Only time will tell, but Wall Street isn't comfortable with the narrative, fearing that future non-accruals and capital losses could pose a risk to its beefy payouts and the premium valuation it has long enjoyed compared to industry peers.
