BlackRock TCP Capital Stock: 11% Covered Yield, But There Are Risks (NASDAQ:TCPC)

BlackRock TCP Capital Corp. (NASDAQ:TCPC) is a well-managed business development company that has produced a high degree of excess dividend coverage in the last couple of years.

The portfolio is well-diversified and management has handed investors a 13% increase in the regular dividend in the last year.

Though I consider the discount to net asset value as another positive, the business development company is too heavily invested in floating-rate loans which suggests a drop in net investment income in a lower-rate environment as well as a potentially lower margin of dividend safety.

Taking into account the interest rate headwinds widely anticipated to hit the BDC sector in 2024, I think BlackRock TCP Capital only justifies a Hold stock classification.

Floating-Rate, Well-Diversified Business Development Company

BlackRock TCP Capital is an externally-managed specialty finance company structured as a BDC under the Investment Company Act of 1940 that is focused on middle market lending.

Business development companies that invested heavily in floating-rate senior loans in the last couple of years have profited handsomely from sustained net investment income tailwinds.

BlackRock TCP Capital was one such business development company that made a big bet on floating-rate loans and reaped the benefits of this forward-looking decision as well: The BDC’s net investment income rose 16% YoY in the third quarter of 2023 to $28.3 million.

BlackRock TCP Capital’s net investment income per share grew 17% YoY which in turn allowed management to hike its regular dividend from $0.30 per share in 3Q-22 to $0.34 per share in 3Q-23, reflecting an increase of 13% YoY.

The ability to hand investors such a high dividend raise was primarily related to the BDC’s floating-rate investment approach. The BDC has developed a core focus on floating-rate loans which accounted for 95% of investments in the third quarter.

The company engages in capital lending activities and primarily invests in floating-rate First and Second Liens as a means to produce recurring interest income from its portfolio companies. The majority of investments fall into the First Lien (76%) and Second Lien (13%) class, though the Business development company also has exposure to Equity investments (11%).

BlackRock TCP Capital had $1.59 billion in investments in the third quarter, spread out over 143 different portfolio companies.

According to the BDC’s latest sensitivity table, which quantifies its exposure to rising and falling interest rates, BlackRock TCP Capital is going to profit from a 100 basis point increase in interest rates to the tune of $0.21 per share annual in extra net investment income. Thus, BlackRock TCP Capital was a solid bet on rising net investment income growth during the last rate hiking cycle.

With that being said, though, the central bank said in 4Q that it strives to slash short-term interest rates up to three times in 2024 which substantially lowers the attractiveness of BlackRock TCP Capital as a passive income investment, in my view.

Moving forward, interest rates are significantly more likely to drop by a large amount than they are to rise by even a modest amount.

BlackRock TCP Capital’s portfolio as such is well-diversified and consists mainly of loans that are handed out to sectors with predictable revenues and cash flows such as Internet Software, Financial Services and Diversified Consumer Services.

Analyzing TCPC’s Dividend Strength And Potential For Incremental Growth In 2024

BlackRock TCP Capital paid a total of $1.69 per share in dividends in 2023 and $1.34 of that amount related to regular dividends. The BDC also paid $0.35 per share, in total, in special dividends, in order to distribute excess portfolio income.

Based on the regular dividend pay-out only, BlackRock TCP Capital had a dividend coverage ratio of 141% and the BDC has outearned its dividend with net investment income over the years and consistently achieved a high margin of safety.

This record is why I have confidence that BlackRock TCP Capital will continue to pay at least its regular dividend in 2024 and I don’t see a dividend cut on the horizon.

Selling At An 8% Discount To Net Asset Value

I would say that most of the business development companies that I cover are priced between a 10% discount to a 10% premium of net asset value which makes sense considering that the potential for differentiation in the middle market segment is not that great.

BlackRock TCP Capital is presently priced at an 8% discount to net asset value compared to a 11% NAV discount for BlackRock Capital Investment Corporation (BKCC). Both business development companies are planning to merge, the benefits of the deal I discussed in my article.

Business development companies like Ares Capital Corp. (ARCC) or Oaktree Specialty Lending Corp. (OCSL) are selling at premiums to net asset value which is a reason for me to not recommend them right now either.

Why TCPC Might Be Set To Outperform

The attractiveness of BlackRock TCP Capital as a passive income and high-yield investment depends primarily on the central bank’s interest rate path. The U.S. economy grew at a blistering pace in the fourth quarter, which gives the central bank a strong argument to put the foot on the brake with respect to short-term interest rate cuts. Higher-for-longer interest rates would thus point to incremental net investment income upside for BlackRock TCP Capital.

My Conclusion

BlackRock TCP Capital is a well-managed business development company with a primary focus on First and Second Liens that combined accounted for 89% of the BDC’s investments as of 3Q-23.

The BDC has profited from the central bank’s rate hikes in 2023 which equated to double digit net investment income YoY. In the context of the central bank announcing a shift in its interest rate policy, BlackRock TCP Capital will probably not see such profound tailwinds for its net investment income in the current year.

As a consequence, I expect slowing net investment income growth in 2024 as well as a narrower margin of dividend safety for investors. Hold.