BDC COMMON STOCKS
More Of Same
Guess what? Another week where BDC common stock prices went nowhere. Again, the UBS Traded Note which covers 36 of the 45 stocks in our universe, ticker BDCS, was essentially flat.
BDCS closed at $19.88, from $19.85 the week before. Outside the major markets rage up and down in price depending on their latest view on tariffs, the economy, impending war in the Middle East etc.
Up to a point, BDC prices move in tandem, but by week’s end we end back where we started. 15 stocks were up in price, and 30 were unchanged or down.
This becalming of the BDC market is approaching month three.
February 22, 2019 was the highest point price-wise.
These long stretches when BDC prices – in aggregate – neither rise or fall very much are not uncommon.
We have sat on similar quiet seas, with nary any wind in our sails, for even longer than this.
For anyone long BDC common stocks, these are good conditions.
Low volatility and time enough to clip those monthly, quarterly and occasional special distributions.
(That latest category is becoming less special and more routine as increasing number of BDCs are keeping regular distributions unchanged, while stepping up occasionally to dole out a bonus).
However, everything comes to an end eventually and these price doldrums very rarely end with an upsurge.
Investors pretty much know everything they need to and there’s little that can happen or be promised that wasn’t already assumed at these relatively high price levels.
In this case – as we’ve begun to point out in the last few weeks and noticing coming up in the Q&A section of many BDC Conference Calls – the risk of lower rates is beginning to color the future earnings outlook.
Like so many risks, this is just a possibility at this point and has had no impact on profits to date.
So investors – still in a positive frame of mind despite all the hand wringing you hear in the financial press – have not taken any evasive action.
However, we suspect that at the first whiff of the Fed dropping short term rates, the analysts will be revising their models and price targets.
Recommendations to take money off the table will go out and you know what will happen next.
After all, this is a broad based risk factor that will affect most every BDC out there, big or small and regardless of strategy.
Even the few BDCs heavily financed by the SBIC and with a large proportion of fixed assets have diversified their funding sources to Floating Rate Revolvers/loans.
It’s hard to avoid this big wave when you’re standing on the beach.
Getting borrowers to switch new loans to fixed rates takes time and is akin to herding cats.
Hedging at this point provides no benefit in the short term, and is expensive and hard to gauge.
So BDCs will just have to take the impact – should the rate drop occur – on the chin.
A 0.25%-1.0% drop in the interest rate might not seem like much but can actually be pretty impactful.
At the extremes, assuming a full 1.0% drop, a BDC could see net investment income drop of 15%.
We’ll be making some calculations for each BDC in the weeks ahead, assuming a 1% drop, and write an article on what outcomes might occur.
In the interim, and still very fresh – albeit lacking in much explanation or color- are the latest quarterly filings which each include an evaluation of the impact on net earnings from lower rates.
That other great sucking sound investors will be on the alert for is an increase in credit troubles.
We are still updating the credit outlook for every BDC – a process that takes weeks due to the thousands of portfolio companies we have to review.
Anecdotally, which is often another word for unreliably, there seems to have been a relatively broad uptick in under-performing credits even after many BDCs wrote off many long standing losers.
Confusingly, BDC managers continue to tout higher sales and EBITDA averages in their loan portfolios.
However, that’s no comfort to us as EBITDA numbers are notoriously unreliable and – most importantly – averages tell you little about what’s happening to that minority of companies that are not doing well, and which may be the thin edge of the wedge of future credit difficulties.
Instead, we’re looking at obvious items like valuation decreases, but also items like switches from current to PIK; increases in pricing; loans reaching maturity but being extended rather than refinanced and surprising increases in amendment fees.
We’re pretty sure the analysts are doing the same based on the tenor of questions on many BDC Conference Calls.
Inquiring minds are seeking more answers on specific credits, but – as usual – are getting rank, file and serial number responses. Apparently, confidentiality agreements keep managers from dishing to their shareholders.
Nonetheless, some managers are more forthcoming than others.
Whether that helps or hurts their stock price in the short run should be the subject of somebody’s PhD study.
Whether forthcoming or not, though, we can say with some confidence that most every manager is a born optimist – as one has to be in this industry – and investors should make their own assessment as best they can.
Both systematic credit problems and lower rates are hypothetical risks that will either occur in the future, or not at all.
In the here and now, BDC investors seem to be happy to just sit there and enjoy their average yield of about 10% per annum.red
The BDC Reporter does not the gall to predict when these quiet times might end.