BDC Common Stocks Market Recap: Week Ended April 3, 2020

BDC COMMON STOCKS

Told You

In the week ended March 27, 2020 the BDC sector – and stocks generally – moved up strongly.

That was the seventh time since February 20 – when the crisis began – that investors evinced optimism sufficient to move prices upward, if only briefly.

The most recent upsurge, though, seemed different, with prices moving up as much as 27% over several days.

For the week, despite a drop at week’s end, BDCS was up 14.45%.

Doubting Thomas

We had doubts, though,  as we expressed in last week’s report:

“The BDC Reporter is far from convinced that we have seen the infamous “market bottom”.

Unfortunately, we were mostly right this time as the BDC sector – and 44 of 45 BDCS we track – slumped back in the week ended April 3, 2020. BDCS dropped to $9.65.

Air Pocket

Over the week, BDCS dropped (20.5%), the second biggest weekly drop in the current crisis.

The only BDC to move up in price was Investcorp Credit Management (ICMB), which had been beaten up in prior weeks.

ICMB was up 23% !

However, over a week time frame the BDC is off (55%), somewhere in the middle of the pack.

Back Of The Pack

The Biggest Losers this week were three mid-sized and very different BDCs: New Mountain Finance (NMFC); Newtek Business (NEWT) and BlackRock TCP Capital (TCPC).

The BDCs were down in a range from (32%) to (39%). 

Worst Hit

Over a 1 month time frame the BDCs most abandoned by investors are Garrison Capital (GARS); Medley Capital (MCC) and Capitala Finance (CPTA).

In that time frame, the range of stock price drop goes between (65% and 76%).

That’s an incredible loss of confidence in a very short period and in the absence of anything but meager of material new information.

“Best”

Still, even the “best” performing BDC  – Owl Rock Capital (ORCC) – is still down (31%).

They’re followed by Prospect Capital (PSEC), off (32%) and Barings BDC (BBDC) at (34%).

Since the beginning of the crisis on February 21, the BDC sector – as measured by BDCS – is down  (53%) using end of day prices, more if we use intra-day.

That’s not yet back at the lowest of all – March 23 – when BDCS closed at $8.99.

BDCS will have to drop a further (7%) to re-plumb the depths, but did get to $8.45 Friday at its lowest point.

Through A Glass Darkly

Pressing on BDC prices – besides the miserable medical and economic environment – was the increasing realization that there’s much trouble ahead for the public BDC sector.

As readers know, we’ve been accumulating  – as best we can –  all the latest developments and announcements from the 45 BDCs we track, trying to divine what’s happening in these new circumstances.

Emergency

Disturbingly, two large, well-respected and previously well performing BDCs – whose earnings and dividend and NAV were historically unusually stable – announced rights offerings this week.

We’re talking about Bain Capital Specialty (BCSF) and Golub Capital (GBDC).

No BDC ever resorts (with one exception we can think of where WhiteHorse – WHF – was concerned a few years  ago) to a rights offering unbless the need is very great.

That’s doubly the case if market prices for its stock is already way below historically reported book value and the market is crashing.

Typically, a BDC manager would seek a half dozen other solutions before resorting to inducing shareholders to buy new shares in a hurry and at a great discount.

Stiff Upper Lip

Admittedly, both BDCs have put a brave front on the proposed offerings, mentioning all the great investment opportunities that will be arising post-crisis.

The truth of the matter – as our recent analysis of the BCSF situation suggests – any capital raised will be used more as rescue money than to boost the portfolio.

We’ve not had the opportunity – or the data – to dig as deeply into GBDCs liquidity issues, but we’d guess that the rights offering there is mostly defensive as well.

Glum

In neither case did existing shareholders cheer the opportunity to buy more shares at a much lower price than before.

BCSF’s price has dropped (30%) since announcing the new initiative and GBDC is down (25%) in the last few days.

We won’t repeat what we’ve written in our two articles about the rights offerings, but will add that we expect other BDCs will follow in  BCSF/GBDC’s footsteps.

If each new rights offering brings down the stock price of the BDC involved by (25%-30%) that’s going to exert downward pressure on the sector.

Spin ?

To be fair, several BDCs have sought to paint a promising picture of where they stand and taken steps that SUGGEST their financial condition is in pretty good shape.

Owl Rock Capital (ORCC) , thanks to a recent IPO, was under-leveraged as of IVQ 2019, indicated in a press release that its liquidity looked good:

“As of March 25, 2020, ORCC has approximately $1.8 billion of cash and undrawn debt capacity. We have approximately $0.5 billion in undrawn commitments to our portfolio companies, of which $0.3 billion are revolving credit facilities, which means we have enough liquidity to fund all of our undrawn commitments over 3.5 times. This strong liquidity position will also allow us to continue to support our existing borrowers and selectively deploy capital in additional investment opportunities”

Unfortunately, the BDC had not yet upped its regulatory leverage from 1:1 to 2:1, and will now be rushing through a shareholder approval to adopt that laxer rule rather than wait a year as initially intended.

Change Of Heart

By the way, Prospect Capital (PSEC),  which had pledged in better times not to move its regulatory limit up to 2:1, has changed its mind and is asking shareholder approval to do just that.

Otherwise the BDC might find itself in violation of the tighter regulatory limit which would temporarily result in the deferral of cash dividends; no further borrowings and – possibly – a default under its loan agreements.

This request was made in a draft Proxy on Friday April 3. The date of the shareholder meeting – which will be virtual – is still to be set, but cannot come fast enough for PSEC.

As of December 31, 2019 debt to equity was 0.67x, but that generous margin from the 1:1 limit may have been largely erased or even hurdled as of March 31, 2020.

Good And Bad

PSEC is one of three BDCs with heavy exposure to CLO equity whose value has been crushed by the crisis and could weigh heavily on the first quarter portfolio and NAV valuations.

Moreover, PSEC has been investing over the years in sectors like energy; personal loans and real estate, all of which have been even more impacted than the average in the past few weeks.

On the other hand, the BDC’s almost complete reliance on unsecured debt makes an uncomfortable conversation with its secured lenders unlikely.

Unchanged

Both PennantPark Floating Rate (PFLT) and Solar Senior Capital (SUNS) have announced in recent days unchanged monthly distributions, which is encouraging.

Furthermore, PFLT – which has not got round to a full scale shareholder letter – did issue a press release pointing to its numerous insider purchases of its share since the crisis began.

“We remain committed to our strategy and will continue to work hard for our investors as we proactively address the challenges created by the COVID-19 pandemic,” said Arthur Penn, Chairman and Chief Executive Officer. He continued, “We strongly believe that the share price of PFLT does not accurately reflect the value of the company and represents an excellent investment opportunity. These purchases by management show our confidence in PFLT’s long-term potential.”

 

Unclear

Stirring words, but no promise that the dividend won’t be reduced in the future or any tangible information about the PFLT’s liquidity or leverage.

As of 12/31/2019 PFLT was leveraged at 1.4x debt to equity, which is worrying.

On the other hand, cash at the end of 2019 was $56mn, way in excess of the $13mn of expenses the BDC expends per quarter.

Downgrade

S&P Global Ratings, though, does not seem to have given the BDC the benefit of the doubt, downgrading its Israel-placed unsecured notes to ilA- from ilA+.

As a result PFLT will pay an additional 0.5% on the 2023 Notes.

Clever Accounting

On the other hand, the BDC should benefit substantially from an obscure accounting election (ASC 825-10) which allows the BDC to mark its credit line and unsecured debt to market every quarter.

So when PFLT’s assets get hit with the decline in loan values that’s forthcoming in the IQ 2020, the value of two substantial liabilities – its revolver and unsecured debt – will decrease, offsetting some of the drop in NAV that’s coming.

Several BDCs have adopted this accounting technique – one of the lessons from 2008-2009 – and potentially critical in keeping BDCs from breaking through debt to equity requirements.

The theory – by our layman’s understanding – of this fair market value treatment is that while your assets may have dropped in value , but so have your liabilities and those could be bought back in at a discount.

That’s not unreasonable given that BDCs have bought back their own debt at a discount (which boosts earnings and book value) when the opportunity occurred.

Real Life Example

That’s what PSEC was – somewhat prematurely and controversially – trying to do at the beginning of the crisis when offering to redeem one of its Baby Bonds that had been issued at $25.00 at a price of $17.00.

That kind offer was almost universally passed up by the holders of the Baby Bond – ticker PBC.

So far,  that has seemed like a wise decision by the debt holders as PBC closed the week at a price of $18.27.

At its nadir, though, PBC dropped to $12.34, low enough to get PSEC’s CFO and advisers to jump into action.

The repurchase offer date has now passed.

Case In Point

Getting back to PFLT, we mention all the above to show how fragmented and inconclusive the available information remains, and presumably still in constant flux.

We don’t know how much – on average – portfolio assets have been discounted; whether secured debt facilities are in default or not or what availability might be; or whether PFLT might be in violation of BDC asset coverage rules.

Maintaining the dividend for one more month; insider purchasing of shares and optimistically worded press releases are more akin to good marketing than tangible evidence of where the BDC might be headed.

We’re not picking on PFLT. This same scenario of selective information release by BDCs large and small is occurring across the sector.

Not Enough

The BDC Reporter is glad to have any data to work with and the volume is growing, which is keeping us busy updating the BDC Status Post Covid article which seeks to capture whatever we know from every BDC.

(Time permitting we’ll be comprehensively going down the list of all 45 BDCs we track to ensure every piece of material information is reproduced in the article for the open on Monday).

However, in no way is the dataset available to investors sufficient to closely estimate any BDC’s portfolio value; book value; liquidity; leverage; current and future earnings; dividend etc.

You can only get there by making a series of assumptions – some more fanciful and grabbed out of thin air than ever before.

Compound one assumption with another assumption and before long your investor GPS could be taking you off in a completely wrong direction.

Time Framing

Only in a couple of quarters will we have a clear-ish idea about the financial condition and future prospects of every BDC and even that’s a potentially bullish assumption.

Do you know when America is going back to work and in what numbers and whether we’ll have a repeat of the nation-wide closures in the fall, as some epidemiologists are warning ?

We don’t, so please add a big pinch of salt to anything said here and elsewhere (including in BDC press releases).

One of the consequences of this being – as oft mentioned – an “unprecedented” event is that all conventional forms of investment analysis – which rely on great amounts of hard data – are inadequate.

This is very frustrating for the BDC Reporter and – presumably – our readers.

However, with every passing day and week, the true picture gets a little clearer.

We are just going to have to put one foot forward after another till we can write with a greater sense of certainty.