BDC Hercules Capital Calls 7% Baby Bonds

Quality business development company Hercules Capital (NYSE:HTGC) has called for early redemption of their 7% baby bonds (NYSE:HTGZ and HTGY) effective 2/24/2017.  These 2 issues became callable on 4/30/2015 and 9/30/2015 respectively and had maturity dates in 2019.  The company has sold a large ($230 million) convertible issue with a 4.375% coupon to fund the redemption.  The redemption cost will be in the $115 million area–they will be using the balance of the proceeds from this offering for general corporate purposes.

Unfortunately, in a continued squeeze on income investors (and us in particular) we hold these bonds in all of the model portfolios as well as in our personal holdings.  Fortunately our positions are relatively small so the loss of a quality 7% holding won’t be hugely hurtful, but just the same every time we lose a 7% coupon issue it makes it more difficult to attain our modest 7% annual goal with a good level of safety.

Here is what we are going to do right now.  We will let the Hercules holdings simply be called in February, but we will make a couple of immediate purchases with cash on hand as we have had a buildup of cash as dividends/interests roll in and other issues are redeemed.

In the 2014/2015/2015 Short/Medium Duration Portfolio we will be adding shares of the Hercules 6.25% baby bonds (NYSE:HTGX).  While obviously we are giving up .75% by buying these baby bonds as compared to the bonds being called at least we are getting the funds deployed.  BE AWARE that the HTGX issue is callable on 7/30/2017 and we are paying $25.35 for our new shares.  Because it is callable soon there is a risk that we may have to replace it in the summer. We are willing to take that chance since we have little risk of loss (maybe 20 cents per share) and we really want baby bonds of this quality company.  As cash builds up it is most important to get these funds invested as our cash earns nothing.  Recall that this portfolio is designed to have shorter maturity instruments with a target return of 7% annually.  It is not designed to garner capital gains.  Since 10/2014 the portfolio has returned a low stress 15.42%.  Currently the portfolio has a cash balance of $12,671 which is too high on a total portfolio value of $98,108.  With this purchase we move the cash position down to $4,977.

In the 2015/2016 Moderate Duration Income with Zip Portfolio we have added 200 more shares of the Arbor Realty Trust 7.375% Senior Notes (NYSE:ABRN).  When this issue was originally bought for the portfolio only 100 shares were bought, which is kind of  a light position.  Given the companies performance in the last year (which has been respectable) it is reasonable to add some shares.  Please note that this issue (ABRN) is callable starting in May which again gives us a 20 cent or so risk by owning these shares.  This portfolio has $12,544 in cash so this will now be taken down to $7,400.  This portfolio was built to be primarily short maturity issues with a REIT or MLP (or 2) added in for potential capital gains.  In 17 months there is a gain of 12.24% which was helped by a gain booked in Independence Realty Trust (NYSE:IRT), which was later repurchased at a lower price as well as a gain that was booked on Stag Industrial (NYSE:STAG).

With these changes in the 2 Short/Moderate Duration portfolios we remain relatively well positioned for our 7% target–although it is becoming more difficult all the time.  We will see where the Fed takes interest rates in the months ahead as this may be helpful for these 2 portfolios.

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Bryan Perry

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