Fifth Street Finance Corp.'s (NASDAQ:FSC) fiscal fourth-quarter earnings failed to cover the company's new dividend rate. It reported net investment income of $0.25 per share during its fourth fiscal quarter, below its current dividend rate of roughly $0.27 per quarter.

Net asset value per share also fell to $9.64 per share, down from $9.71 per quarter.

The ups and downs
Fifth Street Finance's dividend has been all over the map. The dividend was lowered to $0.083 per month at the start of 2014, and then adjusted upward in the summer to $0.0917 per share.

Fifth Street Finance hoped to generate a better dividend on the back of a senior loan fund which uses higher leverage on lower-yielding assets to generate a more attractive return. That was its rationale for increasing the dividend starting in August 2014. So far, the senior loan fund is generating attractive returns -- the press release pointed to an annualized return of 17% on the SLF in the fiscal fourth quarter. That rate will decline, however, as one-time fee income makes up a smaller portion of the return in future quarters.

Miche Bag, a portfolio company, remains troubled. It was placed on cash non-accrual in the fiscal fourth quarter. Fifth Street Finance invested another $500,000 into the company, but the marks on the balance sheet barely budged. Investors will have to watch carefully to see if the company can manage a successful workout of this investment in future quarters.

Going into a robust quarter
The fourth calendar quarter is typically Fifth Street Finance's largest in terms of new originations. That bodes well for earnings in the current quarter, given new originations mean new fee income and a higher leveraged balance sheet.

Fifth Street Finance reported that its balance sheet was 0.63 times levered at the end of the quarter ended Sept. 30. Typically, the company likes to keep leverage between 0.6 and 0.8. If originations follow historical trends, Fifth Street Finance should be able to walk up its leverage ratio and thus improve its dividend coverage.

However, investors should be warned that higher leverage won't be a perfect solution to its dividend woes. In its fiscal fourth quarter, interest income produced only 79% of the company's revenue -- volatile fees made up more than 20% of its top line. Thus, higher leverage may create more interest income, but the gains could be offset by a decline in one-time fee income on an on-going basis.

The company's conference call should shed some light into Fifth Street Finance's options for covering its dividend going forward. For now, though, I'm left to believe that the rising dividend won't be covered from interest income alone -- it will almost undoubtedly require the support of one-time fee income that has proven to be a volatile source of earnings. That gives me pause. While it's clear fee income should support the dividend in the current quarter, subsequent earnings may fail to cover its recently increased monthly dividend. It's still too soon to call it's dividend "safe" for the long haul. 


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