BDC COMMON STOCKS

Unimpressed

In a week where there was an avalanche of BDC quarterly results, the market just shrugged indifferently.

The price of the UBS Exchange Traded Note which covers most of the BDC common stocks – ticker BDCS – dropped. On Friday BDCS closed at $19.85, down from $19.93 the week before.

As for the Wells Fargo BDC Index – to which BDCS is tied but provides a total return picture – that was off (0.6%). The index had risen in each of the prior 3 weeks, and had just come off a YTD high. So had the Closed End Funds Advisor’s “debt focused BDC index“.

One Step Down

However, the market pulled back from those new 2019 heights. That was reflected in many of the other data points we cover. Only 14 individual stocks were up in price, while 31 were down.

The prior week, the number in the green was 30, and 35 the week before. There were 2 stocks that moved up 3.0% or more in the week , but 5 were down. The prior week, no BDC stock dropped 3.0% or more.

Not Such A Big Deal

Of course, in the bigger scheme of this longer in the tooth BDC rally the change is modest. There are still no stocks trading within 5% of their 52 week low. The number trading within 5% of their 52 week high has dropped by only one, from 17 to 16.

From a momentum standpoint, only 26 stocks closed trading over the 50 day moving average. That was down from 36 the week before.

Using the more stable 200 day moving average measuring stick, though, the week over week change was less pronounced. That number dropped to 29 from 31, a not very significant differential. Likewise, the number of BDCs trading at or above book value remained unchanged at 17.

Over a 4 week time frame, 25 BDCs are up in price and 20 are down. As has been the case for many weeks now, that suggests a BDC common stock sector in stasis.

Looking Forward

We’ll be interested to see how the BDC market moves in the week ahead. By now, with virtually all the players having reported results, analysts and investors will have updated their models and earnings expectations. Will that cause investors to pay more for those discounted cash flows?

Glass: Half Full

On the positive side, numerous BDCs have promised higher earnings coming down the track in 2019-2020. In most cases, that boost is said to be coming from the higher income generated by taking advantage of the Small Business Credit Availability Act (SBCAA).

A few BDCs have already boosted distributions, buoyed by higher assets one year after the announcement of the SBCAA. Ares Capital (ARCC) started 2 quarters ago. Hercules Capital (HTGC) increased its quarterly payout this quarter. So did Barings BDC (BBDC), which raised its payout from $0.13, from $0.12 the quarter before.

Many more BDCs may join the dividend increasing club by the end of 2020. TPG Specialty (TSLX), Solar Capital (SLRC); BlackRock TCP Capital (TCPC) and Triple Point Venture (TPVG) come to mind. That list is not comprehensive.

Glass: Half Empty

On the other hand,most of the increases in earnings – both those that have occurred and are projected – may already have been discounted by the market. In fact, the BDC Reporter has been a little surprised – speaking in general terms – by the relative modesty of expected future earnings levels.

Despite the fact – by our calculation – that the SBCAA may result in overall increase of 20% of BDC investment assets, only a trickle of the increased investment income may find its way into shareholder pockets.

Income Paths

Many BDCs will use the extra income to pay themselves fees that have been previously deferred or waived. Some of the income will offset a slowly rising tide of bad debts, which is eroding investment income. Some more may be kept as a reserve on the books against rainy days as more BDCs keep maintaining a wide berth between what is earned and what is paid out.

Big Kahuna

Worst of all – from a shareholder perspective – is the risk that floating rates will drop in the months ahead. Should that happen – and it’s a big but not inconceivable if – investment income will drop much more than floating rate tied borrowing costs. Especially shocked will be the many BDCs who’ve borrowed unsecured debt at fixed rates and may end up paying for several years more a higher interest bill than they might have otherwise.

Unwelcome Surprise 

All this to say that BDC distributions – especially the regular monthly and quarterly kind which investors most prize – may not increase as much as the surge in sector investment assets might suggest. It may not take analysts – with their ever being tuned models – to come to that conclusion, if they haven’t already. That possibility and the prospect of much higher borrowings against an unchanged amount of equity could act to depress BDC prices.

Absence

All in all – and as we’ve said before BDC earnings season – there is no obvious catalyst for higher BDC prices that might cause the BDC rally to gain a second breath.

(The only exception might be a change in the 3% rule, which keeps institutional investors from owning large chunks of BDC stock or a re-inclusion of BDCs into some of the stock market indices from which they were banned for technical reasons some time ago).

On the other hand, there is not yet any immediate catalyst to cause investors to don their safety equipment and run for the exits either.

Plodding along is the most likely way forward.