BDC COMMON STOCKS
Up And Down And Across
The week ended August 16, 2019 was a volatile one for the broader markets.
The Dow Jones – by way of example – had its worst day of the year on August 14, 2019.
Yet, when the dust settled by week’s end, the S&P 500 was down “only” (1.03%).
Still, that 3 weeks in a row to the downside, off (4.59%).
The BDC sector – as happens 9 times out of 10 – was not immune to the mercurial changes in investor mood showing up in the broader markets.
The UBS Exchange Traded Note with the ticker BDCS – which holds most of the sector’s common stocks – was off for a third week in a row as well.
However, after BDCS dropped to $19.17 and (2.0%) off the prior Friday’s high, BDC investors calmed down and pushed prices up, like in the rest of the markets.
For the week BDCS was off (0.20%).
Hardly a disaster and less than the broader stock markets .
In fact, the Wells Fargo BDC Index – which offers a “Total Return” calculation – was up 0.25% on the week, breaking a two week losing streak.
Not So Bad After All
At the end of last week, we had expected a weaker market after reviewing the first two week of BDC earnings season’s results, but the dramedy going on in about tariffs and the global economy, obscured the picture.
Judging by the relatively low pull-back in the days since most every BDC reported its results (we count two earnings reports yet to come) investors and analysts are more optimistic than we expected.
The same unwillingness to leave the party showed up in the leveraged debt markets – both in loans and high yield bonds – where prices and spreads were impacted, but not by much.
(Before we write these Recaps, we like to check high yield and leveraged loan prices, yields and spreads).
Maybe there’s another shoe to drop shortly or else investors are not buying the apocalyptic predictions being made for the world’s economy in much of the financial press.
Nonetheless, by the BDC Reporter’s way of measuring, market conditions are far from being in bull market mode.
For a third week in a row, more individual BDC stock prices were down (25) than up (21).
By way of comparison, in the first nine weeks of 2019 a majority of BDC stocks were higher than the week before on every occasion.
This week we did have 2 BDC stocks increase by 3.0% or more.
A deal of some sort was in the cards for months, so the market reaction was less extreme than one might have expected.
By week’s end ABDC, which should be absorbed and disappear from the BDC scene before the end of the year, was up 8.5% on the week.
At one point, the stock price jumped to $9.40, but closed Friday at $8.82 as investors consider what value will be created from the part cash, part stock deal and the advent of a new manager.
Also up by more than 3% on the week was Main Street Capital (MAIN) – increasing 3.6% – and hitting a new 52 week and all-time high on the way.
Quite differently than ABDC, there was no “new news”, just a continuing investor affection for the steady eddy BDC, despite the announcement of several bad loans during earnings season.
On the downside, there were 4 BDC stocks down (3.0%) or more: all apparently due to investor dissatisfaction with recent performance and future outlook.
Worst of the worst this week was Monroe Capital (MRCC) , down (6.88%) and whose stock price threatens to crash below double digits.
MRCC – still talking up is long unchanged quarterly distribution – has now dropped (37%) in price since its high point in 2017.
Back in IQ 2017 MRCC earned Net Investment Income Per Share of $0.36 and NAV Per Share was $14.34.
Nine quarters later, NIIPS has barely dropped – to $0.35- while NAV Per Share has fallen (13%) to $12.52.
The market clearly expects a dividend cut.
Fall From Grace
Also being “punished” by investors for worse-than-anticipated results is formerly high flying Stellus Capital (SCM) , off (6.6%).
The fall from grace is less pronounced than at MRCC, as NAV Per Share barely dropped in the year and is up in the YTD period.
We never really know why a stock drops in price, but our guess is that word about a new non-accrual being added to the three already on the books might have sparked concerns about credit quality.
As MRCC has shown for multiple periods, once investor confidence in the creditworthiness of the portfolio is shaken, getting it back is no easy task.
SCM is now trading at a (9%) discount to book.
The BDC’s manager has chosen to ask shareholders – who have obliged – for the right to issue shares at a price below book.
We wonder if concern that SCM will take advantage of that option may be keeping the stock price low as well.
Finally, the two other (3.0%+) BDCs on the week were Portman Ridge Financial (PTMN) and Medley Capital (MCC), both in the midst of transformative mergers.
This week, the BDC Reporter had an in-depth look at MCC’s credit portfolio, and was not impressed.
As soon as we can, we propose to review PTMN’s portfolio.
We did have a look at the investments in the OHA Investment (OHAI) – soon to be integrated into PTMN – and found only two troubled companies amongst the 31 on the books.
One of those was health care company OCI Holdings – once OHAI’s biggest investment – but which has been greatly discounted on an unrealized basis over the years.
We wrote about the Texas-based company – which relies heavily on what that state’s legislature budgets – in a BDC Credit Reporterarticle.
How OCI Holdings performs could materially help OHAI/PTMN in the quarters ahead, but a further deterioration would do little damage as the debt is on non accrual.
More broadly speaking – while we were reassured that so many of the loans in the OHAI portfolio were performing well – we were struck how many were second lien or unsecured.
By our count, of 29 performing companies, 27 had these higher risk type of loans outstanding, many of them booked relatively recently.
This will raise questions about the risk profile of PTMN once the merger has been completed and what strategy the new manager might employ going forward.
Will there be a wholesale attempt to get those second lien loans off the books or will the manager be content with an admixture of risk-return from the merged portfolios ?
The answer to these questions will partly determine the enlarged PTMN’s earnings and book value in the coming years.
Getting back to the broader issue of the BDC sector and its own future direction, we continue to be trading in a narrow range well below the February 2019 high.
The BDC sector seems to be looking for its guidance from the broader markets, which are themselves confused about whether we are just slowing down modestly or at the gates of Hades.
Of course, we don’t know what the future will bring where tariffs, global economic growth, negative interest rates and all those other question marks in the financial zeitgeist.
This We Believe
However, we are more confident in saying that we still don’t see much chance of a renewed BDC rally – which petered out in May of this year – happening in 2019.
Back in May, we wrote in our BDC Best Ideas newsletter that we were “hunkering down” – just in case.
Admittedly, nothing terribly bad has happened to BDC stock prices since then, but we do calculate that 26 have gone down in price since May 31 when we made that “call”, and only 20 have gone up.
Every Number Tells A Story
Furthermore, since earnings season began, the BDC Reporter notes that only 10 individual BDC stocks are higher in price as of Friday August 16, while 26 are down.
Also notable, 11 of the 26 are off by (5.0%) or more in a short period.
With a huge wall of worry to climb and half the BDCs reporting results – again by our BDC Reporter analysis – that were “Mixed” or “Poor” in the second quarter, we don’t see what the catalyst would be for a rally.
More likely is a continuing erosion of BDC prices as the sector – like a slowly leaking balloon – gives up the outstanding price performance of the first few weeks of the year.
As of Friday, 36 of 46 BDCs are trading below the February 22 high point, and – on average – are (3.5%) lower in price.
Given that the average BDC yield is just over 10.0%, lower prices are damaging the BDC sector’s 2019 performance.
It’s the bold investor – and more power to them – who will project that the BDC sector – bruised by increasing credit troubles and lower LIBOR (both actual and predicted) – will be getting a second wind once the summer holidays are over.
Depend On Us
In any case, we’ll be here to keep score and bring all material developments to readers attention.