BDC COMMON STOCKS

Denial

This was the week that the major markets decided not to worry so much about tariffs; global economic slowdown and the threat of war or military intervention just about everywhere.

As a result, the S&P 500 increased 2.79% and the other key indices moved up as well.

Follower

Not surprisingly – given what we’ve seen before – the BDC sector followed suit, albeit more modestly.

The Wells Fargo BDC Index – which provides a “Total Return” picture – was up 0.41%, as was the UBS Exchange Traded Note with the ticker BDCS which we use to measure sector price changes.

Of the 46 public BDCs we track, 27 were up/flat in price and 19 were down.

That was the largest number of BDCs climbing in price in the past 5 weeks.

Ups And Downs

Nonetheless, when we look at how many BDCs moved up and moved down 3% or more, the numbers were balanced.

There were three in each category.

Too Far ?

To the upside, micro-BDC Portman Ridge Financial (PTMN) moved up a spectacular 10.7% on no new news.

Investors may have felt that the preceding drop in the BDC’s stock price had gone too far.

In price-terms alone, PTMN dropped from $3.80 on April Fool’s Day to $2.15, a (43%) drop that reached its nadir on August 23, 2019.

(That followed the one-time $0.67 per share payment to shareholders as part of the switch from an internally managed to an external format, whose record date was March 29, 2019).

Despite the impending acquisition of OHA Investment (OHAI), PTMN’s stock price has been battered.

This week, the shareholders caught a break after nearly 5 months of pain.

The latest NAV of PTMN is $3.73, and its stock price $2.38 – a (36%) discount despite the week’s upward surge.

The latest quarterly distribution is $0.06 – or $0.24 annualized – indicating a price to dividend multiple of 9.9x.

Related

Also up on the week was OHAI (3.2%) to $1.30, as the day of the merger with PTMN – and its own one-time cash payment to shareholders – gets closer.

Flying High

Finally, Saratoga Investment (SAR) was up 3.2% to $25.16 and not far from its all-time high achieved recently of $25.78.

We imagine investors have bid SAR up to a 5% premium over book value because of the recent dividend increase and the nabbing of a new SBIC license.

However, we might see, though, the BDC take advantage of its popularity to raise additional equity by issuing new stock (and to fund the new SBIC subsidiary) in the weeks ahead.

That could – temporarily at least – knock the stock price down.

With analysts predicting fiscal 2020 Net Investment Income Per Share of $2.81, SAR trades at an earnings multiple just below 9x.

The current yield is 8.9%.

Three Down

To the downside, the three BDCs down by 3.0% plus were Capital Southwest or CSWC (3.7%); Prospect Capital or PSEC (3.5%) and MVC Capital or MVC (3.0%).

CSWC has been a high flyer – and with good reason – but investors may be taking profits.

The BDC  peaked at $22.90 on August 13, 2019 and has since dropped to $21.32, a (6.9%) decrease.

Hypothesis

What also may be weighing on CSWC’s stock price are concerns about a few of the credits in its portfolio.

AG Kings – a grocery chain – recently became the BDC’s first non accrual since becoming a BDC.

Then there’s AAC Holdings – aka American Addiction Centers – a public company with multiple troubles that we’ve highlighted in our sister publication BDC Credit Reporter.

This is what we wrote back on June 18, 2019 about AAC and CSWC:

We’ve read the latest AAC results and heard an update from CSWC. There’s a major disconnect between ourselves, S&P and the Company management and its lenders. AAC has had to get waiver defaults to remain operating but has another high hurdle of Adjusted EBITDA to hit in the IIQ ($11mn versus -$6mn achieved in the IQ). Maybe the lenders involved are taking comfort from the underlying real estate. Still AAC has $342mn in debt to carry and is making neither a profit nor positive EBITDA. The stock price has dropped from over $10 to under $1 a share. For AAC to avoid restructuring or bankruptcy one of the great turnarounds of the year will have to occur.

As we write this the company’s stock price remains very low at $0.60, not far off its lowest ever level of $0.500.

CSWC has advanced $11mn in first lien debt to AAC Holdings.

Still, the BDC remains at a 15% premium to book, so any investor concerns are relative.

Disappointing

PSEC’s lower price is related to its weaker earnings reported in the week.

In fact, the initial reaction of investors to the IIQ 2019 results was more pronounced but the loyal fan base of the BDC saw the price increase from a low of $6.23 intra-week to close at $6.37.

With analysts projecting FY 2020 NIIPS of $0.81, PSEC trades at a 7.9x multiple of future earnings and a (29%) discount to book value, which also declined in the quarter ended June 2019.

Unclear

We have no theory as to why MVC’s stock dropped (3.0%) on the week.

Since June 2019, MVC had been on something of a mini-rally, rising from $8.91 to a high of $9.65 on July 24, 2019 (which included capturing the $0.15 quarterly distribution).

Now the stock has dropped to $8.77, below the June starting point.

This is a thinly traded and closely owned BDC stock and subject to sharp price variations so our readers guess is as good as ours as to why the stock price is down this week and for the past 5 weeks.

Our View

Taking a bigger perspective about the BDC sector than just the last week, we remain a little surprised just how high prices remain.

Admittedly, we are materially off the highs of February 22, 2019 when BDCS reached its year-to-date high of $20.23.

Even on a “Total Return” basis, the sector is off the 2019 high, which was reached July 30.

Also, two-thirds of BDCs are trading below book value.

Nonetheless, given the undoubted challenges facing the economy – which filters through to BDC borrowers credit performance – and the likelihood of lower LIBOR eroding BDC profitability – we would have expected more investor reaction.

Unmoved

BDC earnings season – almost complete except for CM Finance (CMFN) – has not moved the needle much.

We tracked the performance of all the BDCs since July 26, 2019 when earnings season began.

Admittedly, more BDCs were down than up in price over this period: 27 versus 19, and the average drop was (0.9%).

Those are hardly decisive price metrics even as the number of BDCs reporting lower NAV in the period ended June 2019 was much higher than those headed up: 29 down versus 15 up.

(We’ve not included CMFN and one BDC’s NAV was unchanged).

Our conclusion – which fits with the general upward trend in the broader market indices despite the intermittent freak-out about tariffs – is that BDC investors remain relatively optimistic.

Climbed The Wall Of Worry

Maybe there’s a sense that all the dire metrics pointing to a recession in our near future are just noise and that BDC performance will remain stable.

We compared the analysts projections for 2020 versus 2019, which showed a 2.9% overall increase, with three quarters of BDCs projected to report equal or higher NIIPS.

We Disagree

For the record – and we’ll be delighted to be proved wrong – we don’t share the apparent muted enthusiasm of the market for what lies ahead.

Even barring an actual recession breaking out, we believe a combination of lower LIBOR; higher credit losses and ever higher use of leverage by the BDCs argue for lower prices.

(In regards to BDC debt: the SBCAA Adoption Table suggests that by the time all the BDCs have reached their “target leverage” total REGULATORY debt will have doubled over the March 2018 level (i.e. pre-SBCAA).

Vulnerable

We worry that a change in market sentiment – which we’d currently characterize as unduly optimistic – could result in a major downshift in BDC prices.

As has always been the case in the past, though, there will need to be some major catalyst in the U.S. or global economy to cause investors to be shaken out of their complacency.

Word To The Wise

With two-thirds of 2019 in the rear view mirror, the BDC Reporter suggests that caution should be the watch word even as the relatively stable BDC price environment enters its seventh consecutive month.

Any potential upside in BDC common stock investing is far outweighed by the potential downside if just some of the direr scenarios facing us should happen to occur.

In any case, the BDC Reporter will be here every week to take the pulse and report to our readers.