BDC COMMON STOCKS
The S&P 500, Dow Jones and NASDAQ all moved up in the week ended October 25, 2019 so the BDC sector did as well.
That’s been the pattern of late, and nothing occurred to make things different.
The S&P 500 was up 1.22% and the UBS Exchange Traded Note with the ticker BDCS, which we use a proxy for price change, jumped 0.77%.
For reasons that are not clear, the Wells Fargo BDC Index moved up only 0.22%.
(Still, the Wells Fargo index has been up for three weeks in a row, just like the S&P 500).
Like last week, there was little in the way of BDC-specific news to move the 46 public entities that we track.
That will change next week as BDC earnings season begins in earnest on October 30.
(We have already heard from Saratoga Investment – SAR – with quarterly results through August).
We may see individual stock prices move up or down in anticipation more wildly than we have to date.
This week, though, there was relatively little shake, rattle and roll.
30 stocks were up and 16 were down.
However, no BDC moved up 3.0% or more on the week, despite the rising tide.
Sometimes we get anywhere from three to seven major movers.
On the downside, there were two BDCs dropping (3.0%) or more.
Those were Capitala Finance (CPTA) and Medley Capital (MCC).
The former has filed nothing new on its investor relations page since October 15, 2019.
CPTA dropped from $9.10 to $8.35.
Yes, there was a dividend payment in this period, but only $0.083.
Even after adjusted for the pay-out, the stock dropped (7.5%).
As we reported on August 28, 2019, IIQ 2019 results were POOR – under our rating system – and investors may be getting nervous about a repeat this earnings season.
We admit, though, that we’re just guessing.
CPTA reports results November 4.
Also down was MCC, as investors seem to be under-impressed by the prospect of a three way merger with and into Sierra Income and Medley Management (MDLY).
Since the Board of MCC announced that Houlihan Lokey – mysteriously to some – could not obtain a “Superior Offer“, we’ve heard very little from the principals or their advisors.
It’s all very murky and disturbing for investors who keep on waiting for some sort of resolution – any resolution – of the seemingly never ending saga of MCC’s reset.
We checked the MCC website and there has been no update of any sort since October 15 either.
Frustrated investors seem to believe that no news is bad news and brought the stock price down by (4.0%).
Just for the record, at its lowest intra-week price of $1.94 MCC was trading at a (57%) discount to book value.
MCC is, far and away, the most unloved BDC out there going by price to book.
Even More Numbers
Other metrics support the thesis of slightly better BDC prices, but nothing very dramatic and more in line with our view that we’re in a waiting period.
As in prior periods, the number of BDCs trading at or above book remained unchanged at 16.
Like last week, 5 BDCs traded within 5% of their 52 week low.
However, there were 9 trading within 5% of their 52 week highs, up from 7 the week before.
In terms of market momentum, also not much change.
24 stocks are trading above their 50 day moving average, off from 28 the week before.
If we look at this stat over a 200 days horizon, there are 20 in the black versus 21 the week before.
In this quiet week, the most notable item was New Mountain Finance‘s (NMFC) secondary stock offering, which was done at a price of $13.25.
9.2mn shares were issued.
NMFC managed to make the new issue “accretive” only by way of financial gymnastics, as detailed in the press release:
The Company’s investment adviser, New Mountain Finance Advisers BDC, L.L.C. (the “Adviser”), paid a sales load of $0.41 per share payable to the underwriters (other than the 400,000 shares purchased by certain officers and interested directors for which no sales load is payable to the underwriters). In addition, the Adviser paid the underwriters an additional supplemental payment of $0.35 per share, which reflects the difference between the actual public offering price of $13.25 per share and the net proceeds of $13.60 per share received by the Company in this offering. The net amount received by the Company is believed to be in excess of book value and is therefore accretive to shareholders.
Book value of NMFC at June 30, 2019 was $13.41 per share.
At a time when most every BDC is growing its balance sheet by borrowing ever more heavily, growth by issuing equity is a bit of a rarity.
Not that NMFC is not as convinced of the necessity for high leverage as its peers.
In fact, the BDC had regulatory debt to equity of 1.22 to 1.00 (net of cash, 1.33x without counting cash) at June 30, 2019 and is targeting 1.65x.
The first number makes NMFC one of the top 5 most leveraged BDCs and the second one is as high as any BDC has dared to project as a goal.
(GAAP leverage, which does not deduct SBIC debentures, is even higher at 1.47x).
This latest equity raise, which comes on the heels of another one in July – at $13.68 – will very temporarily bring down leverage.
In the past, though, as a matter of policy NMFC has been very quick to deploy new investment assets to ensure the portfolio can generate the very consistent earnings (usually around $0.34 per quarter) which NMFC is famous for.
Note, though, that all those on balance sheet borrowings (and more besides in its joint ventures with nearly $0.8bn in third party borrowings) – and all the risk entailed – has done little to boost shareholder returns.
Return on equity is 10.1% but GAAP debt to equity (leaving out cash) has increased by 58% since the IQ of 2018 – just before the Small Business Credit Availability Act (SBCAA) was enacted.
By the way, NMFC management compensation has increased over this period from $15.1mn to $18.6mn, a 23% increase.
The management fee portion of the compensation has jumped by 34%.
As we anticipated in more general terms back when the SBCAA was first enacted the new rules are a boon for external managers but may not result in much of a boost in payouts for shareholders.
And much more risk.
What we are seeing much more of are BDCs underwater in terms of “covering” their distributions, or being just about at break even, looking to higher profits down the road from adding assets by borrowing to get into equilibrium.
In the past – under the old rules – a BDC might have taken a deep breath and cut its pay-out.
Today, many of those same BDCs are maintaining their dividends unchanged and projecting that a bigger – debt funded – AUM will sustain their dividends a little longer.
Of course, that will – and is – working but when the new leverage limits are reached and earnings falter, the chances of a much bigger cut than would have been the case before will be much greater.
With more loan assets that could go wrong against an unchanged amount of equity capital it’s an inescapable reality.
That’s unlikely to happen much before 2020-2021 but investors might want to keep an eye on the relationship between leverage, target leverage, earnings and distributions.
For our part, we’ve been updating the BDC Earnings Preview Calendar as fast as we can.
We have to wonder if we’ll be able to get to all the BDCs before the tsunami of third quarter results washes over us, but we’ll do our best.