BDC COMMON STOCKS

Poor Start

The first week of BDC third quarter earnings season did not go well.

If we start with the stock price of sector tracker BDCS, we see that price drop as much as (3.3%) intra-week, before rallying  to end (1.40%) down at $20.70.

Ditto for the Wells Fargo BDC Index, on which BDCS is based.

New Record

When BDCS hit $20.26 on Thursday November 2, a new YTD low was reached; minutely above the 52 Week Low as well.

On a price basis, BDCS ended the week down (8.77%) for 2017, and down (1.07%) on a Total Return basis.

From it’s highest high on March 31, 2017, BDCS has dropped (13.5%), as of Friday’s close.

To place all this into a bigger context, the BDC Sector has given up half the gains of the Great Rally that began February 2016, peaked March 31 2017 and petered out in early August 2017 with a 10% move downward.

For months – notwithstanding a brief bounce in most of September –  the BDC Sector has been headed down.

Back To The Week That Was

Other data we track demonstrates that this was a Week to Forget:

Of the 46 public BDCs we track, only 9 went up in price or were flat. 37 dropped in price.

Even when we expand the time frame to the last 4 weeks, only 14 are up and 32 are down.

14 BDCs are trading above their 50 Day Moving Average price, but 32 are trading below.

The numbers are even bleaker using a 200 Day Moving Average.

Market Mix

As we discussed a couple of weeks ago, we have a bifurcated market, with some BDCS whose fundamental performance remains good still moving up in price.

On the other side, under-performers – both actual and unexpected – are being sharply punished from a price standpoint.

Using the BDC Reporter’s own internal table that we use to track the market, we count no less than 13 BDCs within 5% of their 52 Week Lows.

At least half those 52 Week Lows were set in the past week.

On the other hand, no less than 9 BDCs are trading within 5% of their 52 Week Highs. Many of those price records were set this week.

Highlights/Lowlights

Gladstone Investment (GAIN) reported positive IIIQ 2017 results in the week, to accompany an earlier distribution increase, and reached its highest price level in 8 years.

Remarkably for a BDC that has been at a often huge discount for years, GAIN now trades at a premium to book, notwithstanding a higher reported NAV.

MVC Capital (MVC) – buoyed by the high hopes for more stock buybacks and the effective investment of its $100mn in cash – also reached a multi-year high a few days ago.

However – and ironically – since the failure of the Metage Capital dissident shareholder proposal – the stock price has slumped back slightly.

Main Street Capital (MAIN) – bless them – increased their regular distributions starting in 2018 and were rewarded with a new All Time High.

Off A Cliff

However, the Story Of The Week was the meltdown at Triangle Capital (TCAP).

The well known and long established BDC announced even worse results than an already pessimistic market expected, as we discussed in our just-in-time BDC Reporter premium article before the open.

The headline we used was “Credit Implosion”. A price implosion followed:  a drop of a third of the BDC’s market value.

To add insult to price injury, management made clear that TCAP was not out of the woods and was exploring “strategic options”.

The BDC Reporter had been alerting readers to trouble in the TCAP portfolio since February this year, referencing the IVQ 2016 results.

Here’s an extract from our earlier article:

The BDC Credit Reporter’s keeps its own [Credit] Watch List. Our first cut look confirms that a good portion of TCAP’s investments are under-performing. From our perspective 23 of the 88 companies in the BDC’s portfolio are under-performing, based on valuations and other information at hand. [Please note: Unlike TCAP-and most BDCs -our Watch List counts all exposure to any under-performing company, rather than just the facilities that have been marked down from par. After all, from our perspective, where there’s smoke there’s likely to be fire and the damage may not limit itself to just some of the exposure over time]. With that clarification, the fair market value of the BDC Reporter’s Watch List totals nearly $180mn, or 17% the total portfolio, at fair market value.

Unfortunately for TCAP – and its shareholders – matters have only gotten worse since the end of last year and reached a crescendo in the IIIQ 2017.

Epic

The BDC Reporter likes to make lists. In this case, we are adding TCAP to the BDC Hall Of Shame: BDCs that have reported epic credit fails and not (as yet) recovered.

We’ve been around for over a decade at this point so the list covers a long period.

TCAP is Number Twelve, joining the following BDCs that have tripped up “in a major way” at one time or another, causing their NAV to drop; their distribution to be cut and their shareholders to be shellacked:

AINV, BKCC, CPTA, OCSL [FSC], KCAP, MCC,MFIN, OHAI, PNNT, PSEC, TICC and now TCAP.

Fool Me Once, Shame On You. Fool Me 12 Times Shame On Who ?

If nothing else, TCAP’s management can comfort themselves that they are not alone and the fact that one of four BDCs are in this unwanted category may say something about the BDC model and how investors should approach the subject.

Those Who Do Not Learn Epic Fails Are Born To… 

Those meltdowns are in the history books now, but looking down our BDC list we can identify – based on recent downward price changes – that Mr Market is girding for ANOTHER 7 potential Epic Fails in the weeks ahead.

We won’t know until this quarter or next quarter’s results come in, but here are the tickers of BDCs which the markets are expressing doubts about, as evidenced by recent price pullbacks:

ABDC, ACSF, CMFN, FSIC, GARS, GECC and TCRD.

Humbling

The BDC Reporter has its own views on each name based on our portfolio research, but there’s only so much that you can surmise in advance.

Investors who want to avoid the possibility of waking up to a litany of credit troubles called out in an earning release – and the inevitable price drop that will follow as the Bloomberg terminals start ringing – might be better off on the sidelines.

The BDC Reporter has had mixed success in these potential “falling knife” situations.  When things go wrong, finding a “bottom” is no easy task. The better analogy might be a Leaky Boat.

That’s the story at TCAP, which has been dropping in price – often with big jerks to the downside – since 2013 and has managed to lose two-thirds of its value in the last 5 years.

Determining who’s fallen and can get up, and who can’t, is just as important as identifying potential Epic Fails in the first place.

Between the BDC Reporter and its readers, looking at the Hall Of Shame List above and projecting 5 years out, there are only 2-3 BDCs we expect to “Do A Gladstone Investment” in the years ahead.

Most of the BDCs on that sad list are more likely than not to be priced significantly lower than today when November 2022 rolls around.

We will bring you an update at the time…

BDC FIXED INCOME

Not So Bad

Using our measuring stick of the median price for the 34 BDC Fixed Income issues we track, this was a down week.

The median price dropped to $25.39, from $25.48 the week before.

That’s a (0.4%) decrease.

However, we don’t make too much of these small swings, either up or down.

After all – as always – all but one issue ended the week trading above par.

Also as usual, the only exception was Medallion Financial’s Baby Bond with the ticker MFINL, climbing up again in investors esteem to $24.37.

Sticking with prior patterns, 3 issues traded at or above $26.00 a share.

Nonetheless, worth noting is that only 4 issues are trading at prices above their 200 Day Moving Average.

That suggests BDC fixed income issues are mostly just treading water.

Smaller Universe

The number of public issues we track dropped from 35 to 34, as we expected.

Horizon Technology’s 2019 Baby Bond with the ticker HTF was redeemed in full, as promised.

The BDC will be glad not to be paying interest twice over, leaving its more recent Baby Bond with the ticker HTFA outstanding.

Note Worthy

This week TCP Capital (TCPC) issued another $50mn of 2022 Unsecured Notes with an interest rate of just 4.125%.

The $50mn is being added to an existing 2022 Unsecured Notes series.

This was notable for 2 reasons:

Swing Low

First – as has been the case repeatedly of late – the “better” BDCs (which includes TCPC) have been able to raise unsecured debt at very low rates.

We’ve mentioned before the 3.5% rate achieved by Ares Capital. Last week Hercules Capital raised 5 year Unsecured Notes at 4.625%.

This is a trend that, like the Energizer Bunny, should keep on going and going.

Isn’t It Lovely ?

These BDCs can borrow medium term monies, without having to contend with lender covenants, borrowing base calculations, etc – for almost no price differential.

Who wouldn’t borrow under those circumstances ? That’s especially true late in the economic cycle.

No Bonds For You

The second notable fact was that TCPC’s debt – and HTGC’s before that – was not issued as a tradeable Baby Bond with a ticker but as a “normal” Unsecured Note with just a cusip and aimed at institutional investors.

For retail investors getting an allocation of this paper is very hard. They are effectively locked out, which limits the size of the publicly traded Fixed Income market.

Trend

What’s happening here is that the BDC Fixed Income segment is going to divide into two sub-segments.

The “better” BDCS will increasingly issue unsecured debt to their institutional brethren at rock bottom rates.

Even there, though, rates will be lower and credit quality will be increasingly questionable.

A combination of worse pricing and worse credit. Welcome to Year 8 Of the economic expansion.

Watch Out

For publicly traded BDC fixed income investors who can stomach the new lower rates (after all, you can always invest somewhere else) a great deal more attention to the creditworthiness of individual issues will be called for.

We’re a long way from having a default occur in any of the weaker BDCs, but that could change very quickly if we move from Boom To Bust in this economy.

After all, about 40% of the BDC Fixed Income issues out there have been made by BDCs on the aforementioned BDC Hall Of Shame or on the prospect list therefore.

It’s not unfair to say that – due to this two tier trend, in the Next Recession institutional investors could sail through but some retail owners of BDC debt issues could get the shaft.

Would that be so unusual ?

Watch This Space

The BDC Reporter – with very, very few exceptions – is not interested in investing in BDC Fixed Income at rates below 5%.

However, we’ve always been very focused on determining – as best we can – which BDC debt issues  might endure the Next Recession and which might trip up given the right/wrong market conditions.

Internally, we’ve always undertaken a Stress Test analysis on each issue, which includes such variables as assuming portfolio value drops of 20%-30%; the impact of having capital tied up in SBICs and JVs and much more.

To date all the BDC Fixed Income issues have passed their BDC Reporter induced Stress Testing.

Warning

That may not last.

There are already several BDCs out there whose future as independent entities must be in question over the medium term.

The TCAP credit implosion should be a salutary lesson in how drastically values can disappear.

During the Next Recession there may losses that could hit even the BDC debt holders.

The BDC Reporter will name names – and the required conditions precedent – in the months ahead.