Fitch Affirms BlackRock Capital Investment Corporation at 'BBB-'; Outlook Remains Negative
These actions are being taken in conjunction with a broader industry review, which includes 10 business development companies (BDCs). For more commentary on the broader sector review, please see the release, 'Fitch Takes Several Negative Rating Actions Following BDC Peer Review', available at www.fitchratings.com.
KEY RATING DRIVERS
Today's affirmation of BKCC's ratings reflects its demonstrated ability to operate through a cycle, strong asset quality, appropriate leverage, sound liquidity and available capital, and solid dividend coverage. Rating constraints include the capital markets impact on leverage, given the need to fair value the portfolio each quarter, prudent growth, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.
The maintenance of the Negative Rating Outlook reflects strategic uncertainty and potential execution risk associated with a change in strategy resulting from the recently announced transition of BKCC's management responsibilities to BlackRock, Inc. (BK) from Blackrock Kelso Capital Advisors LLC (BKCA), along with BKCC's riskier asset profile, in Fitch's view, as reflected by significant exposure to equity investments, as well as relatively high investment yields despite the seniority of the debt portfolio. Two concerns previously cited by Fitch when BKCC was placed on Rating Outlook Negative on April 28, 2014 - balance sheet leverage and dividend coverage - have improved.
On Nov. 5, 2014, BKCC announced a transaction which will effectively change its external advisor to a wholly-owned subsidiary of BlackRock, Inc. (BK) from Blackrock Kelso Capital Advisors LLC (BKCA), which was 32% owned by BK. Fitch believes the transaction could provide enhanced strategic, operational, risk management and financial benefits to BKCC, similar to those observed with other BDCs that are affiliated with large asset managers. That said, the expanded partnership is unproven and could have unintended consequences particularly if aggressive growth is pursued in what is viewed by Fitch as an extremely competitive environment.
Total equity exposure, including preferred stock, decreased slightly during 2014 to 21.1% from 21.9% of the portfolio at fair value, despite the sale of three large equity positions. The exits were offset by appreciation and new/add-on equity investments. Fitch believes BKCC will continue to opportunistically sell equity positions in coming quarters, but continued appreciation, while indicating improved performance of the positions, could act as a headwind to reducing the exposure.
In October 2014, BKCC established Gordon Brothers Finance Company (GBFC). BKCC, as controlling shareholder, invested \$94.6 million, along with Gordon Brothers Group (GBG) which holds a \$35 million interest. GBFC acquired a \$269 million diversified pool of asset based loans, utilizing third party leverage facilities. BKCC's investment consists of a \$23.6 million equity stake and \$71 million of unsecured notes. As BKCC is the majority owner, and in a first loss position, Fitch views the entire investment as a levered equity position, but recognizes the underlying diversity which may mitigate valuation volatility. On an adjusted basis, as of Dec. 31, 2014, BKCC's equity positions accounted for 26.8% of the investment portfolio.
Leverage, as measured by debt to equity, declined to 0.57x from 0.67x during 2014, as portfolio gains boosted shareholders equity by 10.2%, and net portfolio proceeds were used to repay 6.2% of outstanding debt. Fitch views the decline in leverage favorably, given the outsized equity exposure, and expects leverage to remain at-or-near current levels absent a meaningful shift out of equity investments. BKCC's equity investments could experience significant valuation volatility, and the company may be unable to offset declines with an equity issuance, as the stock was trading at a 12% discount to net asset value (as of Mar. 11, 2015).
At Dec. 31, 2014, senior secured loans and notes accounted for 61% of the investment portfolio, consisting of 32.6% first lien loans and 28.4% second lien loans. However, despite BKCC's senior focus, the yield on its income-producing portfolio, at cost, was 90 basis points higher than the peer average, at 11.6%. Fitch believes the yield premium could be indicative of a higher-risk portfolio, consisting of loans to smaller companies and/or higher underlying leverage levels. Fitch believes the strength of the firm's underwriting will be observed over time, as recent vintages, which were originated in a very competitive market, season. BKCC had no non-accruals at Dec. 31, 2014, but the portfolio's 11.1% concentration in energy investments was slightly above the peer average.
In May 2014, BKCC reduced its quarterly dividend from \$0.26 to \$0.21, a move deemed prudent by Fitch given declining net investment income (NII) coverage. NII coverage of the dividend, adjusting for the GAAP accrual of incentive income on gains, was strong, at 102.4%.
BKCC's liquidity profile remains sound with \$10.3 million of balance sheet cash and \$261 million of borrowing capacity available, subject to borrowing base requirements, at Dec. 31, 2014. Cash flows from investment repayments and exits were significant in 2014, amounting to \$581.5 million, which outstripped portfolio cash generation of \$442.6 million in 2013.
BKCC has \$158 million of senior secured notes maturing in January 2016. Fitch believes the company may seek to refinance these notes with an opportunistic market issuance, secured revolver borrowings, or portfolio proceeds. BKCC has been relatively less active in the unsecured markets as compared with peers, having accessed the market only once, with a convertible bond offering in February 2013. Fitch expects the company may try to establish itself in the unsecured markets over time to improve funding flexibility, and believes this is one area where the BDC should be able to leverage its connection with BK for better execution.
RATING SENSITIVITIES
Ratings could be downgraded should BKCC fail to improve its market positioning and funding flexibility following the acquisition of its advisor by BK. Asset quality deterioration, an inability to refinance near-term debt maturities, a reduction in core earnings coverage of the dividend, and/or a meaningful increase in leverage without a commensurate decline in portfolio equity holdings, resulting from increased borrowings, realized losses or unrealized portfolio depreciation could also yield negative rating momentum.
Conversely, a revision of the Outlook back to Stable would be dependent upon Fitch's assessment of the new management team's execution on the stated strategy. An Outlook revision to back Stable would also be conditioned upon the maintenance of appropriate balance of leverage, relative to the risk profile of the portfolio, an absence of material portfolio losses (realized or unrealized), improved operating consistency, an extension of the debt maturity profile, and the maintenance of strong dividend coverage.
Fitch has affirmed the following ratings:
BlackRock Capital Investment Corporation
--Long-term IDR at 'BBB-';
--Secured Debt at 'BBB-'; and
--Unsecured Debt at 'BBB-'.
The Rating Outlook remains Negative.
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