Looking a Little Deeper into Capitala Finance

June 17, 2014  8 pm

With the discovery of Capitala Finance Corp (they came public in late September, 2013, but we just noticed them with a note from a reader) and now a new debt issue that we have an interest in we decided to look a little deeper into the company.

Capitala Finance (ticker:CPTA) is a Business Development Company (BDC) that was formed last year with the roll-up of a number of private partnership investment funds.  The IPO in September 2013 generated funds giving the company investable funds going forward.  The company is lead by a young CEO, Joseph Alala, who also is the chairman and founder of Capitala Investment Advisors which manages Capitala Finance.  Alala has been involved with Capitala since day 1 in 1998.

A review of the portfolio holdings finds the typical wide array of investments found in almost all BDC’s.  A total of 43 companies are represented in the portfolio which has a fair market value of $391 million on a cost basis of $334 million. 70% of their investments are in debt with about 16% in equity and 14% is cash on hand (all numbers as of 3/31/2014).  Capitala has 4 investments on non accrual (not receiving payments) and these investments represent 1.4% of total assets. This is fairly typical–BDC’s make loans that are fairly high risk so loans ‘going bad’ is to be expected.  Remember that the loans Capitala makes are at 10-15% interest rates.

Capitala common has a current yield in the 10% area and the company is fairly close to covering the dividend (they covered the 1st quarter, but fell a couple pennies shy on the most recent quarter).  This is important to us as we really want all of our investments to be in companies that earn their distribution. 

When we first began looking at the offering prospectus for the new debt offering we immediately calculated the asset coverage ratio on their debt–as a BDC they are required to have a 200% coverage ratio–again we want to see this as a senior security holder because the coverage allows us to sleep at night.  The new debt issue added to the prior debt already on the balance sheets gives Capitala a coverage ratio of 188%. Further digging and we find that Capitala has received a waiver on the 200% coverage ratio from the SEC, because they have debt which is largely guaranteed by the Small Business Adminstration.  For the time being we are giving Capitala a ‘pass’ on the 200% ration—but this is important to us.  Like preferreds and debt of all closed-end funds we sleep well at night because of the substantial level of safety high asset coverage ratios provide senior security holders.

We notice as we research that Capitala Finance pays a management fee to Capitala Investment Advisiors that is 1.75% of assets annually.  We always question whether these are fair amounts–but we believe these are relatively fair–in particular if they can cover their common dividends each quarter.

While we have received quite a few notes from readers on Capitala with opinions all over the board we believe the new Capitala 7.125% Notes represent a relatively safe investment (relative to other BDC senior securities) and we will buy some tomorrow—it began public trading today in a range of $24.80-$25.00 on 150,000 shares.  Our reader Jay indicated he was able to pick some up at $24.75 grey market yesterday.  Remember this issue has a maturity date in 2021 and while the coupon is just 7.125% it fits our strategy of shortening maturities without killing our income substantially.

As always with all BDC’s we worry if we are heading into a recession, but with asset coverage ratios and the high common dividend we think we will be just fine with this investment for the foreseeable future.

The Capitala Finance website is here.