tadamichi
Late December last year, I issued my first article on Trinity Capital Inc. (NASDAQ:TRIN), which focuses on providing debt and equipment financing to growth stage and smaller size companies. In terms of the typical investments, which TRIN offers to these companies, there is nothing extraordinary as the lion’s share of the portfolio consists of floating rate term debt, and to some extent, also equipment financing with the equity-like investments constituting a relatively insignificant chunk of TRIN’s exposure.
What was something TRIN specific that distinguished the BDC from its peers was (and still is) the dividend yield, which is very high at 13.7%. The reason why TRIN is able to accommodate this high dividend yield is its decision to really go up the risk curve in its investment strategy by allocating towards more risky businesses than the average BDC out there does. For instance, as of Q4, 2023, the average effective portfolio yield stood at 16.7%, which is a clear indicative of high-risk investments (or loans).
So, this aspect of just too high skew towards inherently risky businesses (e.g., SMEs that have not yet reached positive cash generating phase) made me relatively bearish against TRIN.
Namely, the recommendation was to avoid TRIN as it was not worth, in my opinion, to chase extra 200-300 basis points in yield, while sacrificing the underlying quality.
Since the publication of my first article on TRIN, the BDC has slightly underperformed the market; just as it has done over the past 5-year period.
YCharts
Also, about a month ago, TRIN issued it Q4, 2023 earnings report, which revealed some new interesting data points that are worth contextualizing with my bearish thesis.
Let’s now review the thesis.
Thesis review
In a nutshell, the Q4, 2023 earnings report came in strong, where several fundamental metrics strengthened, ultimately allowing TRIN to deliver a somewhat stable adjusted NII figure. The NII landed at $0.57 per share, which marked an increase of 16% relative to the same quarter last year (albeit, if we adjusted for the changes in the share count, it was actually a decline of ~9%). Similarly, the NAV ticked higher by 7%, increasing by $0.02 per share from the prior quarter. The increase in NAV per share was largely driven by the surplus net investment income generation after the distributed dividends. So, as of Q4, 2023, TRIN’s dividend coverage was 114%.
If we take a step back and assess the main factors which helped TRIN boost the results, we will notice that it was the top-line, which explained the majority of the positive upward movement in results. This, however, has a lot to do with the record quarterly fundings of $267 million in Q4, 2023, which in the context of full-year funding of $642 million could be easily deemed as an excellent performance.
Most of these incremental fundings have been accommodated by, primarily, internal cash generation and cash on hand. We can also conclude this by looking at the external debt dynamics, where TRIN ended the year at slightly lower debt to equity ratio – at 104%, which is below the sector average.
With that being said, I still remain bearish on TRIN, and there are really two reasons for this.
First is the worsening of portfolio quality, where we can see a continued momentum in credit quality migration from “performing” category to “watch” and “default/workout” categories. Together in these two risky categories TRIN have placed 7.3% of its portfolio (expressed on a fair value) basis, and the number keeps growing quarter by quarter.
TRIN Investor Presentation
Given the focus on risky and extremely high-yielding investments, it should not come as a major surprise that there are some clear struggles with the portfolio quality / health. However, considering the recent strengthening of higher for longer, still shallow sector-wide deal activity and first signs of rising non-accruals across the entire BDC space, it just does not seem as the right moment to carry this kind of exposure in the portfolio.
The second aspect is more related to the fact of how the market has reacted to the Q4, 2023 earnings data, where at least on the surface, TRIN registered solid results. Even with another dividend increase, NAV growth and record fundings it was not enough for TRIN to exceed the BDC index. Plus, considering that TRIN has had a somewhat similar situation in the past 5-year period, where the Stock has consistently lagged behind the market, it indeed seems as if the market also recognizes the elevated risk profile that stems from the speculative investments in the underlying portfolio companies.
The bottom line
While TRIN has been able to keep the momentum positive on the core performance metric side (e.g., growing NAV base and stable NII generation) and delivered record new funding volumes, it has not been enough to beat the market, which I fully understand.
In the meantime, during Q4, 2023, the portfolio quality deteriorated, where there was a continued migration from performing loans to loans that should be put under watch list or which are already defaulted. As of now, the loans which fall below the “business as usual” status account for 7.3% of the total portfolio on a FV basis.
Against the backdrop of limited margin of safety in terms of the dividend coverage and worsening macroeconomic conditions (including rising non-accrual levels in the overall BDC space), TRIN still seems a subpar and overly speculative investment vehicle.