Why TICC Capital Stock Plunged 10% on Thursday

What happened

Shares of TICC Capital Corporation (NASDAQ: TICC) are down about 10% as of 4:00 p.m. EDT after the company reported disappointing earnings that failed to cover its dividend, even after favorable adjustments. In a puzzling move, it kept its dividend at $0.20 per share.

So what

TICC Capital is an oddball in the business development company industry because of its concentrated investments in collateralized loan obligations, or CLOs. CLOs use leverage to magnify the gains or losses earned on portfolios of senior loans, often generating yields in excess of 15% for their investors.

Accounting for the value of a CLO, and the income it produces, isn't a perfect science. Recently, declining yields on the loans inside the CLO have weighed on income they can pay to their investors. As time goes on, defaults and loan losses whittle away at the value of the CLO, leading to lower earnings. For this reason, a portion of the cash payments received from CLO equity is economically a return of capital, or the return of the initial investment.

TICC Capital discloses a figure it calls "core net investment income," or net investment income plus these return of capital distributions from its CLOs. In the third quarter of 2016, TICC reported $0.309 of Core NII per share. This quarter, TICC earned $0.132 per share under the same measure, the difference largely the result of smaller cash distributions from its CLO equity portfolio.

TICC Capital said declining cash distributions were largely due to some one-time refinancing expenses in its earnings press release. When asked to quantify the impact of those expenses on the conference call, however, management said only that yields would have been "decently higher" if not for refinancing expenses, giving investors little confidence in forecasting its steady-state earnings power.

Now what

It seems likely that TICC Capital's dividend, once supported by higher cash receipts from its CLO equity portfolio, is destined for a cut.

TICC Capital's Core NII figure is a very favorable measure of earnings, as most analysts look at unadjusted net investment income. On the earnings measure most commonly used by investors and analysts, TICC Capital earned just $0.131 per share this quarter.

Paying out large dividends in excess of earnings only serves to deplete the portfolio over time. Notably, TICC Capital reported that net asset value, or book value, fell to $7.43 per share this quarter, down from $7.51 per share last quarter, due to the payment of dividends in excess of net investment income.

Investors see the writing on the wall. Aligning TICC Capital's payouts with its unadjusted net investment income would leave investors collecting much smaller distributions. Given reported net investment income of $0.131 per share this quarter, a 35% dividend cut isn't out of the question.

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