Fidus Investment Corporation — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022; filed November 3, 2022. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions unless stated otherwise.
Business context
Fidus is an externally managed business development company (BDC) that provides debt and equity financing to U.S. lower middle-market companies. It also invests through SBA-licensed subsidiaries. Its objective is to earn current income from debt investments and capital appreciation from equity investments.
Financial and operating metrics
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total investment income | $25.0 | $21.2 | $66.7 | $66.3 |
| Net investment income | $12.7 | $5.1 | $34.1 | $22.7 |
| Net realized investment gains | $40.0 | $8.3 | $65.2 | $13.7 |
| Net change in unrealized investment value | $(41.3) | $15.3 | $(67.8) | $32.0 |
| Net increase in net assets from operations | $11.4 | $28.4 | $31.1 | $65.9 |
| NII per share | $0.52 | $0.21 | $1.39 | $0.93 |
| Dividends declared per share | $0.86 | $0.42 | $1.82 | $1.19 |
- Portfolio and NAV: Investments at fair value were $856.9 million, versus $719.1 million at December 31, 2021. Net assets were $474.4 million and NAV was $19.41 per share, down from $487.8 million and $19.96 at year-end 2021.
- Cash flow: For the nine months, operating activities used $117.4 million, primarily reflecting $268.0 million of investment purchases, partly offset by $128.3 million of sales and repayments. Financing activities used $11.7 million, including $34.0 million of dividends paid; cash declined $129.0 million to $40.4 million.
- Debt and coverage: Debt principal outstanding totaled approximately $400.0 million: $133.0 million of SBA debentures, $250.0 million of notes and $17.0 million of secured borrowings. There were no Credit Facility borrowings; $100.0 million was reported as unutilized commitment. Senior-securities asset coverage, including secured borrowings, was 277.7%.
- Income and expense indicators: The nine-month annualized net investment income ratio was 9.4% of average net assets and the total expense ratio was 9.0%. Weighted average effective yield on debt investments was 12.9% at quarter-end, compared with 12.3% at December 31, 2021.
Material changes versus comparable periods
- Q3 investment income rose 17.7% year over year, and NII increased to $12.7 million from $5.1 million. Management attributed higher income mainly to larger average debt balances and higher yields.
- Q3 operating results were lower year over year despite stronger NII and realized gains: unrealized depreciation of $41.3 million more than offset realized gains, compared with unrealized appreciation of $15.3 million in Q3 2021.
- For the nine months, investment income was nearly flat, while NII increased 50.3%. Total operating results fell to $31.1 million from $65.9 million, reflecting $67.8 million of unrealized depreciation versus $32.0 million of unrealized appreciation in 2021.
- Portfolio fair value grew, with first-lien debt increasing to 57.0% of investments from 49.4% at year-end 2021; equity declined to 12.5% from 23.1%. Variable-rate debt represented 72.0% of debt investments at fair value, up from 68.4%.
- Non-accrual debt investments increased from one portfolio company at year-end 2021 to three at September 30, 2022: EBL, US GreenFiber and K2. Their combined fair value was $4.6 million against $16.9 million cost.
Outlook, risks and unusual items
- Management said cash, the Credit Facility, potential SBA debentures and expected investment cash flows should provide adequate resources for operations, investments and distributions for at least the next 12 months. No numerical earnings or dividend guidance was provided.
- In August, the Credit Facility was amended to use SOFR instead of LIBOR, reduce applicable margins, extend maturity to August 2027 and revise covenants. The company reported compliance with its facility covenants at quarter-end.
- Interest-rate sensitivity is material: the filing estimates that a 100-basis-point increase would raise annualized NII by approximately $4.2 million, while a 100-basis-point decrease would reduce it by approximately $4.2 million, assuming the September 30 portfolio and borrowings remain unchanged. Floating-rate income may rise with rates, but funding costs, borrower stress and fair values are also risks.
- Most investments are privately held and valued using significant unobservable Level 3 inputs; the filing cautions that actual realizations may differ materially from reported fair values. Inflation, economic weakness, portfolio-company credit deterioration, COVID-19 effects and LIBOR transition are cited risks.
- Realized gains included significant portfolio monetizations, including a $24.3 million gain on a partial Pfanstiehl equity sale and a $15.3 million gain on the Pinnergy sale during the nine months. The filing also recorded substantial unrealized depreciation, notably on affiliate and non-control investments.
- After quarter-end, the Board declared additional Q4 distributions of $0.08 supplemental and $0.10 special per share, payable December 16, 2022. The company also disclosed subsequent portfolio investments/exits and $8.0 million of additional SBA debentures issued November 1.
- The company reported no material legal proceedings, no defaults on senior securities and effective disclosure controls.
Important facts for investors to verify
- Review the drivers and recoverability of the $67.8 million year-to-date unrealized depreciation, particularly the largest valuation declines and Level 3 assumptions.
- Assess non-accrual exposures, borrower performance and potential recoveries for EBL, US GreenFiber and K2; confirm subsequent developments, including the EBL restructuring.
- Confirm liquidity and borrowing availability against the pace of new investment commitments, dividend payments and the scheduled debt maturities; distinguish the $100.0 million unused facility commitment from immediately available borrowing capacity under its borrowing-base conditions.
- Evaluate dividend sustainability against NII, realized gains, cash generation and the tax treatment of distributions; note that PIK income can be recognized before cash is collected.
- Check the effect of rising rates, SOFR transition, portfolio-company credit conditions and investment valuation uncertainty on earnings, debt costs and NAV.