Reasons to Watch Your BDC’s – FS Investment

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Yesterday our reader John sent us a message on mega BDC FS Investments (ticker:FSIC)–an investment grade rated Business Development Company. He noted that the company had changed their dividend payments from monthly to quarterly.  That was news to us–but he was correct–as noted in this 8-K filing by the company on Tuesday.  Now it would seem to us that something that is important to some of us investors would be more prominently announced.  Studies have shown that whether a distribution is paid monthly or quarterly there is no measurable difference in returns so this isn’t really about real money–our gripe is with communications. What the heck is the secret here? Announce the change!! 

Now if you have followed FS Investment you know they are a investment grade BBB company–but I am wondering if in fact this is one of those credit ratings like we had pre financial crisis. If you recall banks were taking large packages of subprime loans and mixing them into a large securitization package and passing them off as investment grade–the presumption is that if you mix a lot of crappy loans together you end up with something better than the individual parts. Is that the case with FS Investment? Is that the case with many BDC’s?

The reason I ask the above questions is because as I was checking out the dividend change that John had pointed out I stumbled across the company’s portfolio, which I had looked at quickly prior to investment last year, and was surprised by what I found there as I looked it over once again. FS has a 2.9% portfolio position in Caesars Entertainment Company (actually numerous loans to various Caesars units) which filed for bankruptcy today. So my question is how long has Caesars been in trouble and what was the carrying value in the FS filings? Lo and behold Caesars bankruptcy rumblings have been around for at least a full year (maybe longer). Our thought was that FSIC must have written down the debt to some degree by now. Checking the most recent 10Q for the quarter ending 9/30/2014 we find that they are carrying the loans at full value. What the heck is this about?? We have alot of trouble believing that these notes etc. were trading at par at that time, but we have no way of checking. We would guess that FSIC will take at least a 50% haircut on these loans (about 1.5% of their portfolio). Now this is a pure guess as the company will not comment on this issue at all. We did send a message to FSIC asking for a comment on this issue and their reply was pretty much as expected–we have filed the 10Q for the quarter ending 9/30/2014 and we will be releasing the information on the quarter ending 12/31/2014 in early March.  As expected she really told us nothing we didn’t already know–they seldom do.

So our question to the company is – Why was the debt of Caesars carried at full value even though it was known that bankruptcy was a very high probability?

The lesson we have learned is that you have to actually pick through the significant holdings of your BDC’s and do a deeper due diligence than normal. At that point you have to wonder if investing in BDC’s is worth the effort. At this time we will continue to hold FSIC (we hold 600 shares in personal accounts–as well as in the models).

We look forward to the earnings release in early March.

 

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