Technical Pressure Driving 12% Yield For Owl Rock (NYSE:ORCC)

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Quick BDC Market Update

As mentioned in previous articles, I’m expecting many Business Development Companies (“BDCs”) to report net asset value “NAV” increases, adequate dividend coverage, and reaffirming current dividends. Please see “Upcoming NAV Changes For The BDC Sector Yielding 14%” for discussion of why we will likely see many BDCs with increased NAV. BDCs have begun reporting results including Gladstone Capital (GLAD) with a 4% increase in book value, proper dividend coverage, and lower non-accruals:

Bob Marcotte: “The ramifications and impact of COVID-19 last quarter were certainly unprecedented; however, we are pleased to report that, on balance, our portfolio performed well, our non-accrual assets declined, and we were able to close on several attractive investments to grow our earning asset base and lift our core net interest income, which are all key drivers to maintain and grow our shareholder distributions. While there may be additional challenges ahead, and we have a ways to go to fully recover from the unrealized losses of the prior quarter, our investment principles and strategies are intact and we are well-positioned to expand our investment portfolio as a value-added capital provider to growth-oriented lower middle-market companies.”

Most BDCs report results next week that will likely drive some positive headlines and another rally in BDC pricing as investors are looking to improve portfolio yield/returns in this low-yield environment.

Clearly the potential for additional or renewed lockdowns related to COVID-19 is a concern driving markets lower, including BDCs that are now yielding over 13% (see list below). It’s important to note that yields below take into account special/supplemental dividends for 2020. As mentioned in previous articles, I’m expecting some of the higher-yield BDCs to cut dividends in August 2020. This article discusses Owl Rock Capital (ORCC) which has released preliminary results.

ORCC is the second-largest publicly traded BDC (much larger than MAIN, FSK, PSEC, GBDC, NMFC, FSKR, and AINV) with investments in 101 portfolio companies valued at almost $9 billion that are mostly first-lien secured debt positions. On July 22, 2019, ORCC closed its initial public offering, issuing 10 million shares of its common stock at a public offering price of $15.30 per share. ORCC is one of the few BDCs rated by all of the major credit agencies.

Source: ORCC Earnings Presentation

On Feb. 27, 2019, the Adviser agreed at all times prior to the 15-month anniversary of an Exchange Listing (which includes the IPO) to waive any portion of the Management Fee that’s in excess of 0.75% and the Incentive Fee (including, for the avoidance of doubt, the Capital Gains Incentive Fee). The management fee is 1.5% and excludes cash and after the offering, the advisor is entitled to pre-incentive fees NII of 17.5% with a hurdle rate of 6% annually as well as 17.5% of cumulative realized capital gains.

ORCC Previously Announced Distributions:

Source: Fidelity

The board previously declared the following special distributions that are likely temporary and only due to the five quarters of waived management and incentive fees. Given the current stock price and assuming only that there are only two more specials of $0.08 per share plus the regular quarterly dividend of $0.31 per share would imply an annual yield of almost 12%.

From previous call: “We are passing this fee waiver on to our shareholders effectively in the form of special dividend payments. For the fourth quarter of 2019, our board approved a dividend of $0.31 per share, which we think of as our long-term dividend. As a reminder, our Board set this dividend with a long-term view at a level which we felt was a very achievable, conservative dividend level.”

Source: ORCC Earnings Presentation

ORCC Pre-IPO Share Lock-Ups

ORCC’s stock price is trading almost 20% below its projected June 30, 2020, book value or NAV likely due to technical pressure related to 100% of pre-IPO shares that are now available to trade (as of July 17, 2020).

  • The Company’s common stock began trading on the New York Stock Exchange (“NYSE”) under the symbol “ORCC” on July 18, 2019.
  • Previous share lockup expirations: Jan. 14, 2020, April 13, 2020.

for 365 days, a shareholder is not permitted to transfer (whether by sale, gift, merger, by operation of law or otherwise), exchange, assign, pledge, hypothecate or otherwise dispose of or encumber one third of the shares of common stock held by such shareholder prior to the IPO. This means that, as a result of these transfer restrictions, without the consent of our Board, a shareholder who owned 99 shares of common stock on the date of the IPO could not sell any of such shares for 180 days following the IPO; 181 days following the IPO, such shareholder could only sell up to 33 of such shares; 271 days following the IPO, such shareholder could only sell up to 66 of such shares and 366 days following the IPO, such shareholder could sell all of such shares.

Source: ORCC SEC filings

As shown below, the Regents of the University of California (ORCC’s largest shareholder) have been selling its pre-IPO shares each time the stock rises above ~$12.60:

Source: Gurufocus

ORCC Share Repurchase Plan:

On July 7, 2019, the board approved its 10b5-1 Repurchase Plan to acquire up to $150 million in stock at prices below NAV per share starting Aug. 19, 2019, ending on Feb. 19, 2021 or “as the approved $150 million repurchase amount has been fully utilized.”

The company has repurchased 10.3 million shares for approximately $122 million through April 30, 2020, and will likely continue as “the plan is nondiscretionary active on any day the stock trades below our most recent NAV.”

Under the terms of our programmatic buyback program, through April 30, we purchased 10.3 million shares, which equated to approximately $122 million. Given the programmatic nature of the plan, the repurchase amount is governed by a preset buying formula and as a function of liquidity in our stock. As a reminder, the plan is non-discretionary active on any day the stock trades below our most recent NAV per share, and operates within the parameters of Rule 10B18 which set the maximum daily volume restriction for buying back stock at 25%. Under the Company’s previously authorized 10b5-1 Plan, the Company’s agent will repurchase shares of common stock on the Company’s behalf when the market price per share is below the most recently reported net asset value per share. This corresponds to a market price of $14.08 based on March 31, 2020 NAV per share of $14.09.”

Source: ORCC Earnings Release

However, there’s now only around $27.8 million of available capacity to make additional repurchases and I’m not anticipating “an additional buyback program put in place in the near term”:

Over time, to the extent that the programmatic buyback runs out, we would certainly engage in a discussion with the board about whether we should do a different type of program. The programmatic program was really put in place on the context of the IPO and trying to make sure the IPO was successful. We may consider that or others but I would say it is not a big focus for us right now. And I would not want to set expectations that you should expect to see an additional buyback program put in place in the near term.

Source: ORCC Earnings Call

Source: ORCC SEC filings

ORCC Q1 2020 Quick Update

For Q1 2020, ORCC reported slightly under its best-case projected earnings mostly covering its total quarterly dividends of $0.39 per share. Please keep in mind that this is only due to waived management and incentive fees (discussed earlier) until the company can grow the portfolio using increased leverage.

Craig W. Packer, CEO: “We were pleased with ORCC’s performance during the quarter as we continued to execute on our strategy of lending to high-quality, upper-middle market companies. Additionally, as we closely monitor the COVID-19 situation we are confident that we are entering these challenging times from a position of relative strength thanks to our robust liquidity position, high quality portfolio, low leverage, an experienced and well-resourced team, and strong track record of credit quality. Thanks to this relative strength, we are well positioned to continue to support our portfolio companies while also prudently deploying capital into new opportunities. However, given the uncertainty our bar for new investments is especially high, as we remain focused on protecting the capital our investors have entrusted us with.”

Similar to other BDCs, ORCC’s NAV per share declined by $1.15 or 7.5% (from $15.24 to $14.09) due to unrealized losses:

The primary driver of our portfolio’s unrealized loss was due to current market conditions and credit spreads widening. During the three months ended March 31, 2020, we experienced both a decrease in originations, which reflects the lower levels of private equity deal activity in that time period, and an increase in repayments. For the three months ending June 30, 2020, we expect the performance of our portfolio companies to continue to be impacted by COVID-19 and the related economic slowdown, and therefore, while we have highlighted our liquidity and available capital, we are focused on preserving that capital for our existing portfolio companies in order to protect the value of our investments.

Source: ORCC Earnings Release

Source: ORCC Earnings Presentation

As expected, internal investment performance ratings declined with 11.6% considered Investments Rating 3 or 4 which are borrowers performing “below” or “materially below” expectations indicating that the loan’s risk had increased “somewhat” or “materially”:

Source: ORCC Earnings Presentation

80% of the portfolio remains in first-lien secured debt positions:

Source: ORCC Earnings Presentation

ORCC Shareholders Approve Reduction in Its Asset Coverage Ratio to 150%

On June 9, 2020, ORCC announced that its shareholders approved reducing its minimum asset coverage ratio to 150% from 200%. The company over time plans to target a debt to equity range of 0.90x to 1.25x and will maintain its direct origination strategy with no change to its investment philosophy.

We welcome our shareholders’ approval of this step, which will give us increased capacity to pursue our strategy of lending to strong upper-middle market companies,” said Craig W. Packer, Chief Executive Officer of Owl Rock Capital Corporation. “This greater flexibility will enhance our ability to support our existing portfolio companies and selectively originate new investments, which in turn will allow us to deliver attractive risk-adjusted returns to our shareholders. The increased cushion to the regulatory limit will help us to continue to prudently manage risk and maintain a very strong balance sheet.”

Source: ORCC Press Release

To be honest, the company should already have done this but was likely waiting to have a longer history of being a publicly-traded BDC with favorable credit history while it increased leverage. However, given the recent market volatility, management pulled the trigger so that they could have additional cushion over the coming quarter. I fully support this decision especially given that there will be some temporary NAV impairment issues driving lower asset coverage ratios.

Also, management has agreed to reduce its annual base management fee from 1.50% to 1.00% on all assets financed using leverage over 1.0x debt to equity, after the expiration of the fee waiver. The company believes this will enable it to potentially generate incrementally higher annual earnings for shareholders while maintaining its direct origination strategy with no change to its philosophy.

The company noted that the proposed reduction in the asset coverage ratio is not being driven by recent changes in the market and economic environment, but rather is part of the natural evolution of ORCC’s balance sheet over the last several years.

Since the passage of the Small Business Credit Availability Act in March 2018, all of our investment grade peers have already moved to reduce their asset coverage ratio; we are the last to do so. Since we have been operating well below our target leverage profile of 0.75x this has not previously been a priority for us, but we believe it is prudent for us to have the same flexibility as our peers. From the inception of ORCC, we have worked hard to build a strong reputation and track record with our important stakeholders including our equity investors, lenders, bondholders and rating agencies and feel we are now ready to take this step. In addition to this increased flexibility, ORCC will continue to benefit from its attractive financing structure, which is well matched with its assets from a duration perspective and diversified across financing facilities and lenders, with a robust liquidity position that includes $2.0 billion of cash and undrawn debt capacity.

Source: ORCC Press Release

Source: ORCC Earnings Presentation

ORCC Preliminary Estimates of Results – Liquidity and Portfolio Update as of June 30, 2020

The following information was included in a press release from the company on July 13, 2020:

As of July 13, 2020, Owl Rock Capital Corporation (the “Company”) estimates that its net asset value per share as of June 30, 2020 was between $14.45 per share and $14.60 per share, up from $14.09 as of March 31, 2020. As of June 30, 2020, the Company’s total portfolio was approximately $9.6 billion in aggregate par amount, up from $9.5 billion as of March 31, 2020.

As of June 30, 2020, the Company had $1.9 billion of liquidity in undrawn debt capacity and cash. During the second quarter, the Company added $140 million of commitments to its senior secured revolver, bringing total capacity to over $1.3 billion as of June 30, 2020. ORCC also completed its fourth CLO financing transaction with net proceeds to the Company of approximately $252.0 million. Estimated debt to equity as of June 30, 2020 was flat quarter over quarter at approximately 0.60x. ORCC’s debt funding mix at quarter end was comprised of approximately 42% unsecured debt and the Company had approximately $1.2 billion of undrawn capacity under its revolving credit facility.

As of June 30, 2020, the Company has not experienced any loss of original principal since inception. There has been no material change to the mix of the Company’s overall portfolio risk ratings from March 31, 2020 to June 30, 2020, with no companies rated a ‘5’ as of June 30, 2020. Two portfolio companies were put on non-accrual status in the quarter, Geodigm Corporation (dba National Dentex) and CIBT Global, Inc., which are the only investments on non-accrual and represent an aggregate par amount of approximately $200 million, or approximately 2% of the portfolio. The Company will release its financial results for the second quarter ended June 30, 2020 on Tuesday, Aug. 4, 2020 after market close.

ORCC Summary and My Plan

On July 17, 2020, ORCC priced $500 million of unsecured notes at 4.25% due Jan. 15, 2026. I have updated the projections and target pricing for ORCC to take this information into account including:

  • The portfolio increased slightly to $9.6 billion as leverage remains very low relative to other BDCs with a debt-to-equity of 0.60
  • NAV per share increase by around 3% to $14.45 to $14.60
  • Geodigm Corporation (National Dentex) and CIBT Global, Inc. added to non-accrual accounting for 1.9% of portfolio cost or 1.7% at fair value
  • No realized losses or material shift in risk ratings – no companies rated a ‘5’

The following table shows the two additional non-accrual investments over the previous two quarters but please keep in mind that they were NOT on non-accrual status until Q2 2020:

ORCC’s stock price will likely have continued selling pressure which is a good thing for new investors. The sky is not falling and many BDCs have carefully built portfolios to withstand an economic recession. In March 2020, I purchased 14 higher-quality BDCs and now collecting dividends and:

  • Waiting for BDCs to report Q2 results (see dates below),
  • Watching for preliminary result announcements (as discussed above),
  • Gathering information (portfolio and capital structure updates),
  • Updating projected changes to NAV and dividend coverage for each BDC,
  • Planning for future purchases.

The information in this article was previously made available to subscribers of Sustainable Dividends, along with:

Disclosure: I am/we are long ORCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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