BDC Common Stocks Market Recap: Week Ended April 17, 2020

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As we reported last week, the BDC common stocks sector had its biggest one week rally in a very long time in the 4 market days ending April 9, 2020.

The BDC sector was up 29.3% in that short period.

We did wonder aloud, though,  in last week’s Recap whether that was sustainable:

“Even if the coming week does not bring any bad news, will BDC investors continue to push prices up knowing there will be some sort of reckoning in the weeks and months ahead ?”

 

Go No Further

Now we can see that our doubts were – in large part –  justified.

The measuring stick we use – the UBS Exchange Traded Note with the ticker BDCS – dropped (2.67%).

Mixed Up

Instead of every BDC being up by double digit percentages, 23 were up in price this week and 22 were down.

14 BDCs were down by (3%) or more, with the Biggest Losers on the week being Apollo Investment (AINV), Portman Ridge (PTMN) and Golub Capital (GBDC).

The percentage drops were (18%), (16%) and (12%) respectively.

Everything Relative

Still, this was a modest pullback in the context of the huge swings we’ve become accustomed to eight weeks into this new world.

There were 17 BDCs whose price continued to rise during the week and by more than 3%.

Top of the heap was Investcorp Credit Management (ICMB), up a massive 47%.

44 Below

Like last week, though, only 1 BDC trades above its latest reported book value – Main Street Capital (MAIN).

News Fed

Overall, the news that came in during the week was pretty good, at least compared to investors tempered expectations.

We’ve covered just about every shred of new developments in our continuously updated list of post-Covid BDC information.

The most notable positive item was the update by TPG Specialty (TSLX).

As we’ve discussed in an in-depth review, TSLX estimated NAV Per Share in IQ 2020 would drop only modestly; earnings would remain flat in the first quarter of 2020 and – most importantly- the regular dividend would remain unchanged.

The unchanging nature of the regular distribution was also the message from Main Street Capital (MAIN).

You Can’t Have Everything 

Both MAIN and TSLX – to varying degrees – were less bullish about supplemental payouts.

Gladstone Capital (GLAD) has “only” reduced its dividend by (7%) and – as we’ve seen earlier – Golub Capital’s (GBDC) regular distribution haircut is of the same order.

Not So Good

Which is not to say all the news has been sunshine and teddy bears.

Harvest Capital (HCAP) is “deferring” the payment of its next two monthly distributions for a period.

Prospect Capital (PSEC) – in its Dividend Re-Investment scheme – will be paying shareholders in more shares, rather than in cash.

Newtek Business (NEWT) – usually eager to project and reproject its distribution up to a year in advance – has pulled any estimate and gone quiet on what shareholders should expect.

Silence Is Not Golden

What’s worrying the BDC Reporter most of all is how many BDCs – even those who have made some preliminary damage assessment by way of press release – are keeping quiet.

We understand the situation is very fluid and nobody wants to do what Capital Southwest (CSWC) had to by cancelling its partial Baby Bond redemption or HCAP with its dividend.

Nonetheless, silence speaks volumes at a time like this and that’s a cause for concern.

Railing

Not aiding the situation is the absence of any hand up from the U.S. Government to either the BDCs or the non-investment grade companies they finance.

As everyone knows, the Payroll Protection Program (PPP) ran out of money in mid-week, a victim of its own success and a reflection of the dire need in the country.

We have no doubt the program will get a top off once Democrats and Republicans trade barbs and political horses but the $250bn of additional funds being considered will not do the trick.

The minute those funds are allocated, the hundreds of banks of every size that have geared up in recent days with varying degrees of success, will be spitting forth more loan requests for ever more desperate borrowers.

I Ask You This

Does our government have the nerve to look the situation with a clear eye and double or triple the initial one-third of a trillion dollars allocated ?

We think both parties – with an eye on funding the states, hospitals and representatives favorite programs in their states and districts – will balk.

Wrong Format

This is as we expected and why we suggested that an actual loan program rather than a disguised grant would be a better way to keep small business afloat.

The debt would still be guaranteed by the Federal government – otherwise all those helpful bankers would suddenly stop answering would-be borrowers phone calls – but the money would eventually circulate back.

Instead, we have a PPP with some of the most complex rules and requirements in the history of a one page loan application and most of the funds allocated being forgiven.

Federal generosity is likely to give out before the very limited limited needs of millions (!) of borrowers can be met.

Back To Our Constituency

Even if we’re wrong, and the SBA continues and expands pumping money into smaller companies, most BDC borrowers will still be left out.

Moreover, another week has gone by with very little happening around the Middle Market Lending Program, as you’d expect from a new, never previously attempted initiative from the Fed and run through the banks.

Whatever help eventually comes from that direction is still weeks off and must be too unreliable for most borrowers to place high on their survival list.

Taking A Lot Of Meetings

Nor are we hearing much about either the leveraged lenders  or the private equity community doing much more than gathering information rather than injecting new capital into troubled companies.

Bankruptcies are rising from a low base – we’ve counted 6 BDC portfolio companies filing Chapter 11 this week, and as many making noises about following suit.

What we can’t determine as clearly – but we expect is a growing phenomenon – are the many non-investment grade companies running out of time and money and calling up bankruptcy attorneys and advisers, who are sitting at home in their pajamas.

Put Off

Complicating the situation is that companies already in bankruptcy  are requesting – and often getting – the right to hold off on their bankruptcies given the stay-at-home orders.

We can foresee a much overloaded bankruptcy system when all the new entrants arrive and the existing bankrupts all call upon the finite resources of our legal system.

Listing Our Assumptions 

If you presume – as we do – that there will be little in the way of external governmental help and only a modicum of support from lenders and owners and that business activity will not MEANINGFULLY revive till June or July, the result has to be a flood of defaults and bankruptcies.

Should the resumption of business activity be pushed off to the fall – and no one should say that would never happen  at this point – we are even more pessimistic.

At this stage only a great deal more flexibility from lenders – including the BDCs – could save hundreds of non-investment grade companies in the leveraged loan universe from going from performing to non performing in a matter of weeks.

Exception To The Rule

Rare is the company like Full House Resorts – a casino chain that we wrote about in the BDC Credit Reporter– which can furlough all its employees; mothball its properties and still hope to survive by reducing its outgoing expenses sufficiently to survive several months.

More companies are like die-cast manufacturer Pace Industries – which despite laying off 70% of its employees – filed for Chapter 11 this week.

Walking Wounded

Admittedly, most of the companies throwing in the towel and heading to bankruptcy of late were already under-performing before the crisis.

Unfortunately, that was a very large group of companies in a wide range of industries that were particularly vulnerable to a downturn.

If only those “Worry List” companies – as we’ve dubbed them – get caught up in this situation, that’s still $4.8bn of investment assets at cost in the BDC sector by our count.

That will add to the $4.0bn of investment assets that are held by already non-performing companies.

New Admissions

The coup de grace is if the number of companies on our Watch List – or CCR 3 – continues to grow and start to migrate towards non-performing status.

At the moment, we’re burning the midnight oil keeping this list up to date, but there are just so many new additions…

As we write this, we’ve – very roughly – identified 171 companies and nearly $7.0bn at cost involved. 

Without being alarmist, we could see that number double if things do not improve and we can get each cataloged.

Tough Math

Add all that up and there could be over $20bn of BDC assets at cost rated between 3 and 5 on the 5 point scale that we’ve adopted in imitation of the BDCs themselves.

According to Advantage Data, total BDC assets – both public and private – amounted to $120bn at 12/31/2019.

Roughly two-thirds of BDC assets are in the public realm, and the net assets there amounted to $43bn before the crisis.

Not Right

The government, and the many political and economic commentators talking highly and mightily about “moral hazard” may be complacent about the risks non-investment grade companies face, but we are not.

Like roiling waters building up behind a cracking dam, we could be headed for a credit disaster if either conditions do not improve or the powers-that-be do not take remedial action.

Both Sides Now

For the large asset managers who may have credit funds in harm’s way, there is the consolation of the opportunity – like Mr Howard Marks at Oaktree Capital  – to pick up at distressed assets for a song.

If we were cynical – but we are not – that conflict of interests may explain much of the relative inaction of the asset management industry at this critical time.

After all, as one door closes, another is opening…

In The Line Of Fire

Public BDC shareholders, though, will have little to console them if we get credit losses on the scale of the Great Recession – or worse.

We were there the last time around and witnessed the capital destruction that saw some BDCs suspend dividends altogether; many others distributions reduced and only a fifth of the BDCs hold their payouts unchanged.

Yes, the industry recovered but untold hundreds of millions of capital were lost.

This time – and with greater capital invested and BDC leverage higher than the last time (thank-you Washington D.C. !) and the economic outlook potentially more dire – the pro-forma permanent loss could be in the tens of billions of dollars.

No increase in the yield of future loans will make up for the loss of income from existing investments written off.

Not Complacent

Of course, nobody knows how this will play out.

The GAAP net asset value of the public BDCs was $42.5bn at the end of 2019, while Friday’s market capitalization was $27.2bn, or (36%) off.

That implies – if you believe such things – that investors are expecting ($15.3bn) of write-downs, which is equal to almost a fifth of total BDC investment assets at cost.

Reason Why 

The wild swings in both sector and individual BDC prices in the last two months shows that investors remain highly uncertain about the outlook, and thus about valuations.

Even those (mostly) reassuring missives from MAIN and TSLX only managed to stabilize the stock price of what were already well regarded names.

Investors seem to realize that the credit tsunami that may be forming because of Covid-19 is bigger than any individual BDC and anything could yet happen.

We will be keeping an eye out both for whatever BDC information we can gather before, during and after the coming earnings season and what is happening or not in broader economic, political and financial environment.

Last Metaphor. We Promise

We are still very much tossed on stormy seas, with no compass and no land in sight.

Last time round, we had a 16 month decline in prices, followed by 4 1/2  further years till the BDC sector hit its post-Great Recession high point.

This time we are 8 weeks in.

We’re all having to get used to being tossed around for some time to come.