BDC Fixed Income
The week ended October 12 2018 was dismal for BDC common stock investors.
Readers may not need our BDC Common Stocks Market Recap – published simultaneously with this article – to be alerted to the fact.
However, BDC Fixed Income – after enduring it’s own mini-meltdown the week before – perked up modestly on the week.
Of the 39 BDC debt issues that are actively trading (out of 40 in the universe), the median price came to $25.18.
On October 5, 2018, that equivalent median price was $25.09.
Moreover, the number of debt issues trading below par – pushed there by higher rates – dropped to 11 from 13.
Still, there were no issues trading over $26.00 – until just recently a frequent occurrence.
Still Lowest Of Low
Moreover, the lowest priced debt remained Hercules Capital’s (HTGC) most recent Baby Bond with the ticker HCXY, which closed the week at $23.83.
That was a smidge down from $23.95 the week before.
If you were wondering at what yield 15 year fixed rate BDC debt trades – complete with an investment grade rating from a less familiar rating agency – the answer is 6.5569%.
Other longer term issues like the granddaddy of BDC Baby Bonds Ares Capital’s (ARCC) 2047 issue with the ticker AFC are not much higher: 6.8069% in this case.
A medium term issue – like HTGC’s 2024 Baby Bond HTGX yields 6.2475%, trading as it does at par.
Comparing those yields against the average for the entire universe, which is 6.25%, we can see that there’s little premium offered BDC debt investors for taking on longer maturity risk.
Or – maybe – BDC debt investors looking at the long term picture don’t see interest rates rising that much further. And staying there.
A lot can happen between now and 2047 or even 2033.
After The Sound & Fury
Anyway, despite many changes in BDC Fixed Income prices in the last two weeks – as we noted last week – the overall impact of higher Treasury rates has been modest.
At $25.18, the BDC Fixed Income median price is down just (1.1%) on a year-to-date basis.
By contrast BDCS – the best indicator of price change amongst BDC common stocks – has now dropped (6.5%) since the end of 2017, after briefly topping the year end level as recently as late September.
Cause And Effect
Of course, the principal boost to BDC Fixed Income prices this week was the falling off risk free rate.
As this chart shows, the 10 Year Treasury yield, which got as high as 3.246% early in the week, ended up at 3.141%.
One of the smaller BDCs: OFS Capital (OFS) took the opportunity to issue a second Baby Bond only 6 months after its first issue launch.
Both the first and second debt issues by OFS were for a 7 year period.
This was instructive to those of use seeking to tie increases in the risk free rate to what BDCs need to offer to attract investors.
In this case, OFS priced its April 2018 issue (OFSSL) at a yield of 6.375%, and received an A rating from Egan Jones.
This week, the BDC’s most recent 7 year unsecured debt (OFSSB) got priced at 6.5%, and Egan Jones offered an A- rating.
That’s just an increase of 0.125%.
During that same time frame between the April 11 and October 12 issuances of these almost identical OFS Baby Bonds, the risk free rate increased by 0.330%.
We had worried that the drama in the broader Fixed Income markets might temporarily cause new issuance to dry up.
The issuance of OFSSB put our concern to rest.
One Possible Future
With ever more BDCs receiving shareholder approval to adopt the higher leverage allowed by the Small Business Credit Availability Act (“SBCAA”), and many others getting their capital markets houses in order, we may see more issues.
Potentially – and depending on what alternatives debt hungry BDCs have – total BDC issues could jump from 40, to 50, or 60, or even more in the next 15 months.
We didn’t pick these numbers out of the air.
We reviewed each of the 44 BDCs on our list (leaving out Capital Trust, which is about to merge with FS Investments) and asked the question:
Are they likely to issue some sort of INCREMENTAL unsecured debt in some form by the end of 2019 ?
We counted 36 Maybes.
Even that does not capture the potential growth in the number of BDC debt issues because some BDCs might become multiple issuers.
For example – till recently – Gladstone Investment (GAIN) has 3 Terem Preferreds outstanding.
And as we’ve see even smaller BDCs likes OFS – but also KCAP Financial (KCAP) and Great Elm Corporation(GECC) have come to the markets for unsecured debt twice.
Why not thrice or more ?
Maybe – just maybe – the BDC Fixed Income universe could one day reach 100 issues !
Higher Rates = Easier Placement
Ironically, the rise in fixed income rates means it’s more likely new debt issuances will hit the 6.00% plus annual yield which most BDC investors prefer.
29 of the 40 BDC issues yield between 6.0%-7.0% as readers of the BDC Fixed Income Table – the most comprehensive resource on the subject – shows.
(Not) Getting Ahead Of Ourselves
Of course, it’s only been a month since the 10 Year Treasury burst its 3.0% banks and resulted in shocks that have reverberated across all markets.
Much can happen for good or ill to issuers and investors.
Yet – at this point – the BDC Fixed Income segment is holding its own, and may be poised for surprising growth.