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BDC Common Stocks Market Recap: Week Ended December 20, 2019

Posted on December 23, 2019

BDC COMMON STOCKS

Continuum

There’s no need to re-invent the wheel where our discussion of BDC common stock prices is concerned.

This last week was very much like the week before, both in terms of sector price momentum and many of the metrics.

The UBS Exchange Traded Note with the ticker BDCS, which holds virtually all the sector’s common stock securities, was up.

Again.

Records Breaking

BDCS closed at $25.56, up 0.29%. 

During the week, the ETN reached a new 2019 high of $20.66, before dropping slightly by Friday December 20, 2019.

Likewise, the Wells Fargo BDC Index, which provides a better perspective on the sector’s total return, moved up to a new high of 2935.45 intra-week.

By week’s end, the Index was marked at 2921.32, up 0.52% on the week, but slightly off the summit.

This late year BDC rally which began October 14, 2019, is now up 6.5%.

Broken Record

However, like last week, we continue to question whether the upsurge in BDC prices is sustainable once the year comes to an end or if the broader market rally ends.

By the way, the S&P 500 – coincidentally or not – was also up in price this week: 1.6%.

Even more illustrative of our view that the BDC sector is, like Santa’s sleigh, being pulled along by the major indices reindeer is this chart from October 14 till last Friday:

As you see, BDCS – the purple line in the chart – has been following the broader market trend northwards.

Half Hearted

As we suggested last week, this rally does not have the unbridled enthusiasm of other ones we’ve witnessed.

For example, this week there were 27 BDCs that were flat or up in price, and of those 4 moved up 3.0% or more in price.

(For those who are curious, these winners for the week were a random assortment: OFS, PTMN, OCSL and GARS).

Still, there were 19 BDCs that dropped in price of which 6 fell (3.0%) or more – our threshold amount.

(Just for the record these were: MRCC,OXSQ, CSWC, BKCC, WHF and FSK).

We’d be hard pressed to find a common thread uniting all the week’s uppers and downers given the little amount of new developments and the disparity in size and performance.

Instead, we suspect investors tidying up their portfolios in advance of the new year ahead.

Mind The Gap

Another reason we’re skeptical about the sustainability of this rally is our price comparison of where BDC stocks stand versus the height of the last rally on February 22 of this year.

That’s data we’ve been looking at weekly for several months and continues to show that most BDCs are still trading below their price back in the beginning of 2019.

By our count, as of this week 16 were higher than on February 22, but 29 were still below…

This does not suggest the broad based enthusiasm more typical of a sector rally.

Furthermore, with 27 BDC stocks trading below book versus 17 at or above, there does not seem to be that wide-eyed enthusiasm that sometimes grips market participants.

It Was A Very Good Year

Which is not to say that it’s not been a great year to be a BDC investor.

Going by the best indicator for this subject – the Wells Fargo BDC Index – the total return in 2019, with two weeks missing, is 25.77%.

Front Loaded

More pertinent to our point, though, is that BDCS has increased only 1.5% in price since late February.

Or, in other words, virtually all the increase in the total return from the BDC sector has come since February 22 from dividends received.

We’ll hold off making any projection for 2020 until we gather up all this year’s results.

Newsies

Despite the lateness of the hour, there were still multiple material developments underway during the week which deserve mention, and which might affect future results.

From the BDC Reporter’s perspective, most notable was saying goodbye to OHA Investment (OHAI), which was de-listed during the week and its assets absorbed into Portman Ridge Financial (PTMN).

We’d been tracking the BDC since it was named NGP Capital (ticker: NGPC) , and essentially represented a sector play on energy.

The drop in the price of oil in the back half of 2014 and a number of ill advised investments caused NGPC to become OHAI, but the new manager could never catch the falling knife.

On the contrary, the BDC – despite eventually shedding most every energy investment made – become something of a “zombie” BDC forever waiting for the results of a “strategic review” to start life afresh.

Damage Assessment

In the interim, total portfolio assets dropped to just $72mn as of September 2019, including U.S. Treasury bills

Ten years before the NGPC that was had $203mn in portfolio assets and $84mn in cash ready to be deployed.

Over the next decade, under two managers, shareholders would lose 75% of the BDC’s portfolio and cash value.

So, it has made sense that OHAI – too small to be effective and with too much “baggage” – should be effectively closed and its assets adopted by a new lender.

Nonetheless, the BDC Reporter is always sad to see any BDC fail to meet its initial promise and cause devastation to shareholders.

Even at a time when BDCs were able to borrow only 100% of equity, the NGPC/OHAI stock price managed to drop (93%) from its highest point to its last closing price.

Moreover, for the last two and a half years, the BDC was able to pay out only $0.08 per share of annual distributions, and mostly a return of capital rather than of earnings.

At a time when the BDC sector is having a golden moment price-wise; NGPC/OHAI is an instructive reminder of what can happen to investors when the managers strategy and execution misfires…

Speaking Of The Devil

This week, we finally received Medley Capital’s (MCC) fiscal year end results, which we discussed at length.

That closed out BDC earnings season several weeks after most everyone else had reported.

However, we learned very little about what happens next and when that might occur.

10-K filings tend to be backward looking by their nature, and the manager did not arrange for a quarter end conference call.

We know that if MCC’s results continue to deteriorate there will be a default coming where its Israeli Baby Bonds are concerned by mid-year 2020.

We also know that the principals involved – including the erstwhile “activist” shareholder are still arguing about money matters.

Good News/Bad News

Our review of the portfolio both concluded that MCC continues to have plenty of trouble spots while also enough “good” investments to repay both debt and equity holders, if need be.

Liquidity – in the short term – is no problem with MCC having $84mn in cash (unrestricted and restricted).

Even after its upcoming $33mn early repayment of a portion of the Israeli Baby Bonds , the BDC will still be cash flush.

In a pinch MCC can readily sell a loan off to raise cash and keep the wheels turning.

What Churchill Would Say

Still, at some point, SOMETHING has to happen and we’re predicting that – as Churchill famously said about something much more important-  we may not be at the beginning of the end but at least at the end of the beginning.

Keeping Busy

Year end is also the time that some BDCs tie up financing loose ends.

This week, we learned that Gladstone Investment (GAIN), which is up 67.5% (!) this year on a total return basis, is seeking to raise more equity.

The goal is to raise up to $35mn and at a price above book presumably.

Elsewhere, and following a trend that has been in play for years, Oaktree Specialty Lending (OCSL) got its lenders to be more flexible.

The BDC’s senior lenders have formally allowed assets to debt coverage to drop to 1.5x rather than 1.65x.

More To Come

In 2019 we have seen many BDCs pushing below the old 200% asset coverage limit and bringing regulatory debt to equity above 1:1.

However, the BDCs are far from done and 2020 could well see both AUM and borrowings spike even further.

We have numbers for that.

On a pro-forma basis, if every BDC reaches its target leverage, the public sector will see nearly $15 billion in new assets/regulatory debt.

That’s an 18% increase in portfolio assets and a 47% increase in regulatory debt.

For that to happen – and chances are that most of the increase will occur in 2020 – BDCs need an accommodating lender environment.

From what we’ve seen from secured lenders (such at OCSL) and in market reception to fixed income issues, capital market conditions are very favorable.

Getting To The Top

2020 is likely to be the year of maxing out the BDC credit card.

This year there are 4 BDCs – by our count – already bumping up against their new self imposed debt to equity limits.

If all goes to plan in the year ahead that number of fully leveraged BDCs could reach two to three dozen. 

That could happen in a number of different ways or in combination: including increasing borrowing and from drops in portfolio value that reduces the denominator in debt to equity.

Already Happening

We’ve seen both those factors occurring – and even accelerating – in 2019, and we expect both those trends to continue.

That augurs well for dividend stability, or even increases, in 2020, just as has been the case in 2019 where only a couple of participants have cut their payouts.

Other Side Of The Mountain

Of course, 2021 might be the year that BDC investors pay the piper, but we’ll not get ahead of ourselves.

Most investors average hold time for common stocks is 6 months, so what happens in 2021 must seem irrelevant.

All Sides Now

For our part, we will continue to look at the BDC market from all time perspectives.

After all, the 3 worst BDC stocks from a performance standpoint in the last year, are all doing very well over the last week and month from a price standpoint.

(Of the three top performers over the past year, one is in the red for the week and the month.

The other two are barely in the black over both periods).

Very Short Term Outlook

Before we get to 2021- or even 2020- the holidays will be upon us.

We wish all our readers a pleasant and restful break from the idiosyncrasies of the BDC market.


  Nicholas Marshi, BDC Reporter


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