Trinity Capital: An Asset Manager In BDC Clothing (undefined:TRIN)

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Trinity Capital (NASDAQ:TRIN) CEO Kyle Brown explains how they’re an asset manager in BDC clothing (1:40). Dividend stability and growth (7:45). NAV stability and growth, EPS, ROE the metrics most focused on (10:50). TRIN stock valuation and momentum (12:00). Reasons for recent buyback (18:10). Private credit is real and liquidity is important (20:15).

Transcript

Rena Sherbill: Excited to bring you my conversation with Kyle Brown, CEO of Trinity Capital today, a special kind of BDC which he explains shortly its place in the financial sector, its place in the market.

What the macro picture means for BDCs and the financial sector.

Something we talk about is Trinity Capital’s valuation and its momentum rating on Seeking Alpha’s factor grades. Kyle later wrote what I thought worthy of sharing with investors.

Kyle wrote:

Momentum does not take into account earnings distributed which is also returns to investors. And a very important aspect of BDCs in the last six months, even though the stock price is down by approximately 4%.

Since we distributed the dollar and since we distributed a dollar and two cents in the same time frame, the actual returns are positive approximately 2.5%.

I hope that sheds some light on their take on the momentum grades. Hope you enjoy the full conversation. Let us know what you think in the comments.

Kyle Brown, CEO of Trinity Capital (TRIN). Welcome to Seeking Alpha. Thanks for joining us.

Kyle Brown: Thanks for having me, Rena.

RS: It’s great to have you. I feel like a great place to start is maybe sharing with investors, sharing with listeners, your part in the BDC industry, and maybe where you see BDCs in the financial world.

KB: Sure. So I think maybe even just starting off, we are a BDC, but we’re very different than 90-plus percent of the other BDCs. We are internally managed, which means there is no management fee, there are no incentive fees, there’s not some other management company that’s managing this entity. I work for the organization along with our executive team. I own the same shares as any one of your listeners who might own a TRIN share.

So we have the same incentives. And that really is a massive differentiator between us and really any other BDC that’s out there. There’s really, I think, there’s only four internally-managed BDCs.

And so what that means is we’re really focused on return on equity. We’re really focused on earnings per share, very focused on maintaining and building the dividend. It’s less so focused on AUM growth because there’s really no incentives to build AUM and grow for the sake of growth.

I’d say, maybe first and foremost, that’s the biggest differentiator. We’re an asset manager in BDC clothing and it works because we have five underlying businesses that we manage that are all lending businesses. They all generate current income. And so a BDC formation is really a great – it works for us because we generate a lot of income and we distribute out that income to investors.

So a BDC is a great place for us to sit. But biggest differentiator there, we’re not just a pool of assets. When you buy our stock, you’re buying, yes, a pool of assets, but you’re also buying into 100-person organization, an organization that also owns an RIA, manages third-party capital and generates income in a lot of different ways.

So that’s not known by most investors, but it’s one of the ways and it gives us the ability to continue to grow earnings, which you’ve seen for us now for 19 straight quarters.

RS: Can I ask a question in terms of how you’re differentiated, was there ever a question at the beginning to do it like most of the rest of the industry? And why do you think so much of the industry doesn’t do what Trinity does?

KB: Absolutely. We used to be a fund manager. We used to have a management company before we were BDC and we were forced to make that decision. Do we do an externally-managed BDC and just create a pool of assets that we manage for a management fee and incentive fee? Or do we go this different route?

And historically, and if you look at internally-managed BDCs right now, they are the top-performing BDCs in the country. They generate higher ROE, they trade at a premium to NAV, they’ve been able to grow their earnings. They just trade at higher multiples.

And so when we formed the entity in late 2019, we sat around and said, all right, we have ambition to really grow this thing to be the number one lender to growth-oriented businesses in the country. We need access to a lot of capital. And so the best formation for that would be the type of structure where incentives are aligned between management and shareholders.

And so we chose this, we chose to be kind of long-term greedy in the idea – in the sense that if we performed and we did well, we would have access to capital and we would be able to grow this while also growing earnings for shareholders.

There’s not been a lot of BDCs that have been formed recently who have gone public, but this is a better structure for shareholders. Long-term, it’s a better structure for management and employees, I think. Short-term, an externally-managed BDC is better for management and better for the owners of a management company.

So those are the kind of the key differentiators. We are long-term greedy here. We really do want to build a large successful business that has growing earnings for shareholders.

RS: Do you hear a lot of enthusiasm? I know it’s hard to hear enthusiasm from shareholders much of the time. But do you hear enthusiasm from shareholders around the makeup and around your strategy in general? Is there – are there questions around it, pushback? What do you hear from the community?

KB: We’ve got institutional investors that still make up around 30-plus percent of our shareholder base. We’ve been doing this since 2008. So we have investors that have been with us for over 15 years, high net worth, family office, and they love this structure.

We just had an investor event in New York for institutional investors the other night. And I just had multiple groups that said, hey, I bought shares in 2020. I still have them. And you’ve distributed out over $7 per share in that timeframe and you’re still doing it. So thank you.

I think investors who have been with us for the long-term, they get it, they’re holding. We have continued to see our kind of primary institutional investors either hold or buy more over time. That’s all – that’s public. You can see it.

For new entrants and new investors that are considering us, they can look at our track record and they can say, they can see that, hey, this is a great dividend and they’ve consistently increased their earnings per share and they’ve been able to cover that dividend and they’re excited about that.

So I see enthusiasm. You see in the stock, we’ve traded a premium to NAV because we’re generating so much income for investors. And so I think the feedback has been good. I think the dividend is extremely high right now because the stock is traded kind of below, I think, its inherent value. And it’s a nice entry point for investors right now.

RS: Well, maybe let’s stick with the dividend for a second as long as we’re there. What would you say to those maybe cautiously concerned about the dividend and the stability of that dividend? How do you encourage investors to think about your dividend?

KB: So we’ve stayed steady or grown for 19 straight quarters, and we’ve over-earned the dividend in every one of those quarters. Sometimes it’s higher than other quarters.

That’s more of a reflection of maybe payoffs that we might have in any quarter. We might have some more gains that we’ve seen, but we’ve been able to cover that dividend and safely cover it for some time.

The reason is that $0.51 right now, and really kind of high, is because our core earnings are high. And as a BDC, we have to distribute out 90-plus percent of our income. And so the dividend is where it is because we feel comfortable with our ability to earn it, and then legally we have to distribute it to investors.

We have continued to show that we can earn the dividend, over-earn the dividend, create spillover income, and continue to deliver that dividend to investors.

RS: What would you say or how do you think about the macro factor in terms of interest rates? How do you think about that in context of how you’re trying to grow the business?

KB: So, I mean, we saw rates shoot up. We’ve seen rates now start trickling down. And during that timeframe, we’ve actually increased earnings per share. So I hope that could be a good reflection of what we think about it. We’re showing it through our earnings per share. It hasn’t impacted our ability to deliver on that dividend.

We actually have pretty limited down exposure to rate sensitivity. The majority of our portfolio, you can see it right in our Schedule Of Investments. The majority of our portfolio, 90-plus percent, has floor rates that are over 12%.

And so when rates come down, as they can – if they can continue to come down, we actually have pretty – some great kind of downside protections there because we have floating rates for our corporate debt. We have a $500 million revolver with KeyBanc.

When rates go down, our cost of capital goes down. So does our ability to raise bonds and private debt, that goes down, but our underlying portfolio does not decrease in the same way.

And so income is really not at risk. If rates go down, we actually have this slide in our presentation. If rates go down another 100 basis points, that’s only $0.02 per quarter. We’ve already got that covered in our earnings per share.

And then we also believe that the RIA that we launched, which we’re now generating new income above and beyond the loans that we have issued out there, that is more than making up for any kind of rate decreases and sensitivity that we have there.

So we feel really comfortable, kind of regardless of what rates do in our ability to keep that dividend steady and growing.

RS: What would you say are the metrics that you’re most focused on, either in this particular moment or in general as CEO?

KB: Yeah. So NAV stability and NAV growth that reflects portfolio health and it also reflects the ability for Trinity to leverage the management side of our business and grow these new earnings off the balance sheet.

So NAV stability. Earnings per share, we’re really focused on growing that. We’ve done a great job of that over time, and dividend stability. So we really want to see that dividend just stay stable and grow. And then ROE, return on equity, that’s a great reflection of really our ability to generate best-in-class returns for investors and the equity that we’re working with.

Internally, those are really our key metrics that we’re focused on. When someone is buying TRIN, they should know that those are the things we care about, high ROE, best-in-class, kind of earnings per share, and then it’s really stability of the NAV, which should give you a nice reflection of our portfolio health.

RS: I’m curious how you think or how you discuss the valuation of the stock at this point. Also specifically, so Seeking Alpha has these ratings and Valuation for Trinity is an A+ and then Momentum is lower down, in the D category. How do you articulate your thoughts around Momentum and Valuation right now?

KB: So if you look at other internally-managed BDCs, they are trading at 140% to 180% of NAV. We’re trading at 110% of NAV. If we just simply move towards the mean of other internally-managed BDCs over time, there’s some real upside there, and just the stock price. Forget about growth of earnings per share, dividend, et cetera. I’m just talking about where we are at today.

We’re inherently undervalued. The dividend being at 15%, I don’t know where it ended today or where it’s at right now, but 14%, 15%, I would call that extremely high. It’s not a reflection of the risk we’re taking out there, it’s just a reflection of the stock price being too low. I think it’s low.

I just bought a bunch of shares. We just sent that release out, so did our Board and our other members of our management team. And that was not some planned thing. That’s just what people did because it’s paying – the dividends too high.

We’re not going to lower the dividend. Again, we’re a BDC. Regulations require us to distribute out 90-plus percent of our income. Our core income has continued to increase to where we have to distribute it out. So it is what it is. We’re going to distribute out that income.

I think over time, we’ll probably get credit for being stable and being consistent. I don’t know where the kind of derating over time comes from. You’d have to tell me and then I could give you some feedback on that.

But our analysts who cover us, we’ve got, I think, Buys across the board, except for maybe one bank that we never talked to. The rest of them have Buys across the board because they see our ability to continue to deliver that earnings per share, cover the dividend.

RS: So what would you say you’re most focused on in terms of keeping consistent while also growing?

KB: Yeah. So we run five unique businesses at Trinity. We have a venture debt business, which is about 30% of our deployment. That’s run by a team of professionals and an industry leader, 20-plus year veteran. They’ve got their own sales team, their own portfolio management team, credit team. It’s 30% of our deployment.

We have an equipment finance business, non-correlated to the venture market. They’re financing mission-critical equipment. It’s really asset-backed lending. That’s a big part of what we do. Independent team, we have a life science and healthcare business. That’s run by again, an industry pro who’s built multiple businesses.

We have a warehouse lending, that’s just traditional ABL, advances against financial receivables. And then we have a sponsor finance business, which is P/E buyout. It’s kind of $3 million to $50 million of EBITDA, primarily enterprise SaaS companies.

Each of these businesses are unique to one another. They have a different risk profile. They are all somewhere between late-stage VC, think about a pre-IPO, pre-M&A, into lower middle market, $3 million to $50 million of EBITDA.

Each is growing at their own kind of clip and pace, but that is a really niche great place to be right now. You have a massive amount of retail dollars and institutional dollars that are flowing to private credit. It’s a big buzzword, right? Private credit, private credit.

The majority of that capital is flowing to 12 large trillion-dollar firms. Those firms are all chasing the same deals in the upper middle market, and it’s been a race to the bottom on pricing. And they’re all chasing beta-type returns at this point. They can’t write $20 million to $100 million checks and we can’t.

And we love that kind of lower middle market space, particularly with enterprise SaaS deals.

There’s actually a massive amount of opportunity right now. And M&A activity for us has picked up 20% quarter-over-quarter, 15% year-over-year in Q3. We’re seeing a lot of acquisitions begin. And so the opportunities there, there’s less competition because the bigger alternative asset managers have moved upstream and then banks are lending less because of regulations that have come down on them since the banking volatility began.

So we’re seeing just great opportunities, great spreads, less competition. And that’s giving us the ability to generate great kind of low to mid-teens kind of gross yields, which ends up being a great return for our shareholders.

And so we’re thinking about, how do we capitalize this business? If the growth is there and the opportunity is there, how do we do it in a way that’s accretive and good for investors? And we do it in two ways. 1, I mentioned the RIA, we got SEC approval last year for TRIN, the public company, to own an RIA, and it’s really just a management company, okay?

TRIN shareholders own 100% of the benefits of this entity. Most folks don’t even know we have it, but we got SEC approved for last year. We now manage about $500 million of third-party capital and that’s growing. We’re out there raising money right now. The big part of our success in the future will be continuing to raise third-party capital from pension funds, institutional investors, and down into even a retail.

We’re charging management fees and incentive fees on that capital. We use it to just co-invest with the public company, but we charge management fees, incentive fees, 100% of that benefit flows to our shareholders. And so you’re seeing NAV accretion there. Last quarter, you saw about $0.04 of new earnings flowing from that entity. And we have the ability to grow that asset management business kind of infinitely.

And so a lot of our success in the future is going to be finding new ways to raise capital, so that we can grow the business, but grow it profitably for investors.

RS: And how does the recent buyback figure into this conversation and your plans for growth?

KB: I mean, I’ve given you my opinion on the stock and I think it’s low. And to the extent that we start trading at or around NAV, that means that we’re getting zero value or very minimal value for being an internally-managed BDC and having a management company and generating fee income above and beyond our loans. To the extent we get close to NAV, we’re absolutely going to be buying back shares because it’s trading at a massive discount.

RS: If anything, what has you the most concerned, either in general or in this upcoming year, let’s say?

KB: So liquidity is really important. Equity, liquidity and money flowing is really important, I think, for really kind of all of our businesses. There’s a massive amount of dry powder sitting on the sidelines and it has been for a couple of years. Record amounts of venture capital, record amounts of private equity.

Money flowing is really important. I think right now with the administration changing over, there’s a lot of uncertainty. This could be good, but it could also, I don’t know, there’s scenarios where maybe it’s not great for the industry, or maybe inflation sticks around longer than we thought. But I don’t know.

I think primarily our biggest concerns from like a macro sense are that we cannot figure out this debt situation, which is going to drag down all industries and all kind of financial stocks. We have a really significant kind of overhang on debt in this country. And we continue to kind of kick the ball, kick the can down the road. And that’s a problem for all stocks, but certainly for financial stocks.

Our ability to raise capital in our private funds is really important. So I’m not losing sleep over it and I don’t even see it as a problem. I’m just pointing it out as it is something that is a big differentiator for us. And if we’re really going to continue to stand out compared to our peers, we got to be successful raising that capital.

RS: What else would you say about the financial sector and things that investors should be paying attention to, broadly speaking?

KB: I kind of touched on it. But private credit is real. I think it’s here to stay. Banks are going to be lending less. They have regulation that’s coming down on them.

They have less deposits, which means they can lend less. And so I think just generally speaking, banks are going to be lending less and they’re going to be doing more receivable-type financing. So there’s a gap, right?

Everyone is looking for access to private credit and the majority of investors have decided over the last couple of years to move it into large entities. Those entities are having a very difficult time deploying that capital, which has created less than desirable returns, I think. And larger asset managers are really dependent upon M&A activity picking up.

And with the new administration, there’s a lot of euphoria around the idea that, hey, things are going to be better in the economy and that will probably lead to this dam breaking and M&A activity picking up.

I don’t know that that happens. I think it’s leaking. But what’s happened in 2021 and 2022, or companies with that policy, zero interest rate policy was companies receive valuations that were just astronomical.

And over the last two or three years, they have really been trying to work into those valuations, but they did that with rates increasing, with a lot of macroeconomic and geopolitical kind of issues going on. They haven’t been able to work into those valuations.

So for the dam to really break and for M&A activity to pick up and for P/E dollars to flow and for all of this to happen, it’s going to require companies to kind of face the music on a valuation standpoint and take the dilution that’s really been continued to just get kicked down the road.

And so there’s a lot of money. There’s a lot of money that wants to do deals in that. And once it starts, that money flows. It flows downstream. It flows back to private equity. It helps with fundraising. It flows into the VC world. It helps with fundraising that flows to companies like it will all be good. But it does require companies to bite the bullet on valuations that are just unrealistic.

RS: Do you find that there’s points in the market where people are more interested in BDCs than they are less interested? What do you feel like is that’s predicated on for the most part?

KB: Well, there certainly has been an increase in interest in BDCs. That’s more of a statement on just private credit. Investors are trying to understand how do I get into private credit, right? And you really, you have limited options if you’re a high net worth or family office, you can dump your money into Blackstone’s umpteenth fund that they just launched, or you can search outside of that.

And BDCs, it’s a really interesting entry point for investors who are wanting to invest in debt in private companies.

And so the reason it’s picked up is because there’s been more interest there for groups trying to figure out more niche and different strategies other than some of the big boys.

RS: Just curious, you mentioned the funds. I’m curious your thoughts about the nature of the market these days, the preponderance of ETFs out there. Any thoughts about that?

KB: No, not really. It’s definitely an expensive way, right, to invest. And there’s a race to prop up an ETF for just about everything, right? TBD on whether that’s a good strategy or not, or whether they’re getting that diverse kind of exposure that they claim. So, the proof is in the pudding, I think we’ll see what happens over time there.

RS: Kyle, I appreciate this conversation. I’m curious in your time as CEO, as we’re winding down the conversation, if there’s been anything that has surprised you that you haven’t been able to do that you wanted to do, or on the flip side, something maybe you thought you wouldn’t be able to do and you were able to do it much sooner-than-expected.

KB: What’s interesting is as being a public company, we’re running a business where we lend primarily to private companies. Those companies are funded by private sponsors, for the most part. And our – the business and the operation of our business is really not correlated to the stock market. It’s just not. And – but the stock is correlated to the stock market.

So I’d say that maybe that was just a naive mindset thinking that, hey, we’re not correlated to the stock market, our underlying business isn’t, but the stock certainly is. And so it’s been interesting to see those swings in valuation for seemingly, in my opinion, kind of no reason, right.

When you perform, that should be reflected in the stock price. And I think with BDCs right now, it’s just – it’s still a developing environment, right? And so investors are entering it. There’ll be more stability with more volume and more understanding of what they are and how they work. But we’ve seen more volatility than we had probably hoped for or imagined all while delivering growing and consistent returns.

So maybe wishful thinking for me over time to see some real stability that kind of corresponds and correlates to the actual underlying performance of the business.

RS: Happy for you to share where investors can find out more about Trinity, where they may be able to get in touch with you, happy for you to share that.

KB: Our site has got a lot of great information, trinitycap.com. You can see the investments we’re making, but I think I’d leave where I started. And when investors understand this, it’s to their benefit. We are an internally-managed BDC. When you buy us, you’re also buying into a management company with 100 employees, the ability to generate growing returns. And our goal, Trinity’s goal is to be the number one performing BDC in the country with really stable NAV and growing earnings per share while being best-in-class on return on equity.

And so that’s been our goal since we launched this thing in the beginning of 2020 and it’s still our goal today. And I think we have continued to perform in the top five really kind of BDCs since then. And it feels like we’re just getting going. So I’ll leave you with that.