DBRS Morningstar Downgrades THL Credit, Inc. Long-Term Ratings to BB (high), Trend Negative

DBRS, Inc. (DBRS Morningstar) has downgraded the Long-Term Issuer Rating and Long-Term Senior Debt rating of THL Credit, Inc. (TCRD or the Company) to BB (high) from BBB (low). The Trend on all ratings is Negative. The Company’s Intrinsic Assessment (IA) is BB (high) and its Support Assessment is SA3.

KEY RATING CONSIDERATIONS
The ratings action and Negative trend take into account the larger than expected loss generated in 4Q19 by TCRD, and the expectation that 2020 financial performance will be weaker than anticipated as a result of the Coronavirus Disease (COVID-19) outbreak and the contraction in the investment portfolio as the Company completes the repositioning of the portfolio. The ratings action considers DBRS Morningstar’s view that ongoing turmoil in the global markets resulting from the coronavirus outbreak could result in a fair value markdown on TCRD’s investment portfolio that could potentially pressure the Company’s asset coverage covenant under its bank facility. Investments on non-accrual status are likely to rise over the near-term although we expect private equity sponsors to provide some support to the portfolio companies, at least in the near-term. These pressures are somewhat offset by a solid franchise bolstered by the recent acquisition of the Company’s advisor by First Eagle Investment Management.

RATING DRIVERS
While not expected in the near-term, a return to sustained profitability driven by solid net investment income and growth in the investment portfolio could result in the trend on the ratings returning to Stable. Also, approval of the new investment agreement with First Eagle Alternative Credit and an amendment of the bank facility to include less restrictive covenants could result in the Negative trend returning to Stable. Conversely, a sizeable loss that materially reduces the Company’s cushion to the bank facility covenants could lead to the ratings being downgraded. Sustained negative earnings generation would lead to the ratings being lowered, as well as an elevated level of non-accrual investments.

RATING RATIONALE
TCRD’s earnings generation from the investment portfolio has been weakened by the contraction in the size of the investment portfolio, as well as the Company’s strategic shift to lower yielding but lower risk first lien senior secured investments. For 2019, TCRD reported a net decrease in net assets from operations (net loss) of $24.6 million driven by a larger than anticipated $15.4 million net loss in 4Q19. Earnings were impacted by $52.2 million of realized and unrealized losses on the investment portfolio, which more than offset the $27.4 million of net investment income generated in 2019. DBRS Morningstar expects near-term earnings generation to remain challenged given the difficult economic conditions in the U.S. resulting from the Coronavirus outbreak. Further, the outbreak could slow the Company’s exit from the remaining non-core assets.

We note that the BDC investment valuation process includes a meaningful amount of subjectivity given the illiquid nature of the portfolio investments held. Indeed, at December 31, 2019, the majority of TCRD’s debt investment portfolio were considered Level 3 assets. While credit spreads have widened and the outlook for the U.S. economy has deteriorated, the impact these inputs will have on 1Q20 fair value marks remain uncertain. Further, fair value marks also include consideration of the credit profile of the underlying portfolio companies, which may offset some of the pressure from general market inputs. As of December 31, 2019, TCRD’s average portfolio investment company score was 2.17, on its internal rating scale from “1 (outperforming)” to “5 (very weak)”, indicating that the majority of the portfolio was performing within expectations. Two portfolio companies were on non-accrual status accounting for 3.9% of the portfolio at fair value.

Leverage (debt-to-equity) was 0.77x at year-end 2019 within its bank covenant limit of 1.0x, and well within the regulatory limit of 2.0x to maintain its registered investment company status. With TCRD’s stock price trading below net asset value, the ability of the Company to issue new public equity is limited. However, DBRS Morningstar notes that First Eagle Investment Management, owners of the Company’s Advisor, First Eagle Alternative Credit, as well as certain members of management have agreed to acquire $30 million of new common equity in April 2020, at book value, which could alleviate some pressure.

As of December 31, 2019, the Company had unfunded delayed draws and revolver commitments to portfolio companies totaling $26.1 million. While it is likely that some portfolio companies have drawn on these lines, TCRD had approximately $130 million of available liquidity, including capacity on its bank facility, which is subject to borrowing base requirements.

DBRS Morningstar continues to view TCRD’s franchise as acceptable. On January 28, 2020, the acquisition of THL Credit Advisors by First Eagle Investment Management Company, LLC (First Eagle) was completed and the advisor to the Company was renamed First Eagle Alternative Credit. DBRS Morningstar continues to see the acquisition as potentially a credit positive for TCRD over the longer-term. Pro-forma to the THL Credit Advisor acquisition, First Eagle had more than $118 billion of AuM as of year-end 2019, including about $23 billion of AuM in its credit strategy platform. We see First Eagle as providing TCRD with access to a larger investment manage platform with a long operating history with roots back to 1864, and a wider origination funnel with greater sourcing and execution capabilities.

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 Financials (September 2019) , which can be found on our website under methodologies and criteria: https://www.dbrsmorningstar.com/research/350802/global-methodology-for-rating-non-bank-financial-institutions

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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