DBRS Morningstar Downgrades TCG BDC, Inc.’s Ratings to BBB (high) with a Stable Trend

DBRS, Inc. (DBRS Morningstar) downgraded the Long-Term Issuer Rating and Long-Term Senior Debt Rating of TCG BDC, Inc. (CGBD or the Company) to BBB (high) from A (low). The trend on the ratings has been revised to Stable from Negative. The Company’s Intrinsic Assessment (IA) is BBB (high), while its Support Assessment is SA3.

KEY RATING CONSIDERATIONS
The ratings downgrade reflects CGBD’s profitability and credit performance, which were weaker than anticipated through the challenging economic environment due to the Coronavirus Disease (COVID-19) pandemic. The BBB (high) ratings remain at the high end of our rated business development company (BDC) peer group, with various strengths supporting the current rating level, including the benefits to the Company’s franchise from its relationship with The Carlyle Group L.P. (Carlyle) that provides significant competitive advantages. Carlyle is one of the largest global credit managers with $260 billion of AUM, including $59 billion focused on credit strategies. The Company’s preferred equity issuance to Carlyle in May 2020 is viewed as a strong demonstration of support and is reflected in the ratings.

The Stable trend reflects DBRS Morningstar’s view that some key sources of uncertainty related to the Coronavirus Disease (COVID-19) pandemic are behind us, contributing to the broader market certainty and investor conviction. Most businesses have adapted to social distancing practices and periodic government restrictions on activities that address recent waves in new virus cases. The successful vaccination roll-out to communities across the U.S. continues which should support a more permanent reopening of the economy. Consistent with our moderate economic scenario published May 4th, 2021, expectations are for a strong economic recovery in 2021, buffered by government stimulus and central bank actions that should produce robust origination pipelines for BDCs.

RATING DRIVERS
DBRS Morningstar sees CGBD’s ratings as well placed at the current level, which is underpinned by the strong franchise and demonstrated support provided by Carlyle. Over the longer term, a sustained improvement in earnings while maintaining good credit quality and a conservative leverage profile would result in a ratings upgrade. Conversely, a meaningful increase in non-accrual investments or a sizeable loss that materially reduces the Company’s cushion to regulatory leverage requirements would result in a downgrade. Weak performance in the investment portfolio, which erodes net asset value (NAV), or if net investment income (NII) does not cover the base dividend for an extended period of time would result in a ratings downgrade.

RATING RATIONALE
CGBD’s strong franchise is underpinned by its relationship with Carlyle. CGBD is managed by Carlyle Global Credit Investment Management LLC (Advisor), a subsidiary of Carlyle. While there is no explicit guarantee or support agreement in place between CGBD and Carlyle, the Company received a $50 million convertible preferred equity investment from Carlyle at the onset of the COVID-19 pandemic in early May 2020, when the financial markets continued to be dislocated, with CGBD trading at a low of 0.26x P/NAV a month prior to announcing the transaction (0.44x P/NAV, a day before announcement compared with 0.88x P/NAV as of June 8, 2021).

Realized and unrealized losses on the investment portfolio have been headwinds to the CGBD’s earnings. The Company reported a net increase in net assets from operations to common (net income) for 1Q21 of $35 million, a significant increase from the net loss in 1Q20 of $121.1 million, which was impacted by mark-to-market fluctuations related to the disruptions in the market as the COVID-19 pandemic intensified. For full year 2020 net income was $4.6 million, a significant decrease from $61.3 million earnings in 2019. Profitability has been challenged as compared to other BDC peers with a quarterly average return on average equity of 4.8%, and return on average assets of 2.4% over the last nine quarters. However, we expect earnings to improve as 2021 progresses, which will be supportive of the current ratings.

CGBD focuses on sponsor-backed U.S. middle market companies, and maintains a diversified portfolio of primarily senior secured debt instruments, with the top 10 borrowers consisting of 19% of the total investment portfolio at fair value (FV), and top 3 industries (high tech, business services and healthcare and pharmaceuticals) as 24% of the total investment portfolio at FV. The percentage of second lien investments is elevated versus our BDC peer group, but that is partially mitigated by the portfolio comprised of predominantly sponsor-backed portfolio companies (approximately 6% non-sponsored). Additionally, LTVs of new originations in the portfolio have decreased as financial sponsors write larger equity checks as a percentage of total enterprise value to acquire businesses.

CGBD’s risk profile is acceptable. The Company has sold off or written down non-performing loans, driving the investment portfolio losses, but resulting in a cleaner portfolio. We expect that the Company’s highly selective investment process, rigorous underwriting and diligent portfolio monitoring will contribute to solid credit performance going forward. CGBD’s $1.8 billion investment portfolio is comprised of 164 investments in 119 portfolio companies across 27 industries at 1Q21. Non-accruals have largely been in line with other BDCs over the past few years. As of 1Q21, non-accruals consisted of 5 portfolio investments totaling $104 million or 5.4% of the portfolio at cost, modestly lower than the peak of 6.0% of cost in 2Q20. Non-accruals consist primarily of two investments ($91 million) with Abry Partners as the original sponsor (Direct Travel and Derm Growth Partners III).

CGBD has developed a fairly broad and diversified funding profile, having accessed multiple different investor markets and funding channels, including private placements and CLOs. At 1Q21, the Company had $995 million of debt outstanding comprised of secured borrowings (including credit facility), institutional unsecured debt, CLOs, and convertible preferred equity. The debt maturity profile is well-laddered and there are no near-term debt maturities, with the first maturity in December 2024 of $190 million of its private placement issuances. The Company had strong liquidity with $358 million of undrawn capacity based on collateral already pledged to the credit facility as well as cash on the balance sheet of $35 million compared to unfunded commitments of $149 million at 1Q21.

The Company has kept its capitalization and leverage at a manageable level, and well within its target of 1.0 to 1.4x, which we consider acceptable. Regulatory leverage was 1.16x at 1Q21, accounting for the preferred equity as debt, and is at the higher end of our BDC peer group. Financial leverage was 1.04x at 1Q21, accounting for the preferred equity as equity on a converted basis. The off-balance sheet investment funds were levered at 1.5x D/E (MMCF I) and 1.7x D/E (MMCF II), but there are no cross-default or guarantees from CGBD to the investment fund credit facilities. Importantly, we see CGBD’s leverage target and current leverage levels as having sufficient cushion to the asset coverage ratio (ACR) regulatory limit. DBRS Morningstar estimates that the Company would have to incur a loss of $363 million, or 20% of the investment portfolio at fair value to breach the 150% ACR limit.

Dividend coverage (net investment income / dividends declared) at the base dividend level ($0.32 per share) was sufficient at 113% for 1Q21. We consider dividend coverage from recurring sources of income important for BDCs, given their reliance on access to equity markets for capital to fund originations and balance sheet growth. BDCs that can consistently cover dividends from NII are less likely to have to reduce their dividends during periods of weaker operating conditions and more likely to maintain access to the equity markets. In November 2020, CGBD’s Board approved the continuation of the Company’s share repurchase program and expanded the authorization to $150 million in the aggregate. The Company also received shareholder approval to issue new shares below NAV. We view this positively as it provides management with additional flexibility in times of stress to manage its capital levels. As a BDC, the Company is required to distribute 90% of its net investment income as dividends for tax purposes, and as such, this inherent inability to retain organic capital to support balance sheet growth is a ratings constraint for the BDC industry.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 29, 2020): https://www.dbrsmorningstar.com/research/367510/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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