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

Posted on January 21, 2020

BDC COMMON STOCKS

BDCs: SAR, MRCC, ORCC

Ongoing

It’s the second full week of 2020 and the S&P rally rolls on, and so does the upward movement of the BDC sector.

The S&P 500 was up 1.97% in price on the week, with BDCS – the UBS Exchange Traded Note which owns most of the BDC stocks – was up 1.19%.

The Wells Fargo BDC Index was also up: 1.25%.

BDCS at $20.30 is now only marginally below its 52-week high of $20.66, and when you figure in the recent $0.434 quarterly distribution paid, above.

Three To One

On the week, 33 individual BDC stocks were up or unchanged versus 12 that were down in price.

That was the same number in the plus/even column as last week.

Week’s Winners

A notable five BDCs were up 3.0% or more on the week, the highest weekly number since the end of November.

The numero uno was Saratoga Investment (SAR), up 5.2% after posting what we called “Very Good” results in the quarter ended November 2019.

We wrote the following on January 8, 2020 after our flash review of SAR’s performance:

“We expect that the stock price- which closed before the earnings release at $25.13 will find its way higher. Will the BDC’s stock price move above the freakish $28.30 reached for a nano-second back in June 2018 for reasons never fully understood ? It could happen. Management, though, will not have any time to celebrate as all those new shareholders will be looking for the mountain of capital available to the BDC to be fruitfully invested, and with the yield and low-loss characteristics that we’ve experienced in recent years.  This is a business where there’s no sleeping on one’s laurels”.

SAR ended the week at $28.14, and reached an intra-week high of $28.47, setting a new all-time high on the way and erasing the “freakish” $28.30 prior top.

Could SAR go higher? Maybe, maybe not. We’ve used up all our prognostication powers.

Invisible

All the other 4 BDCs up in price moved up without benefit of any material new developments.

To our eye, these upward moves are part of the pre-earnings release dance where some investors seek to position themselves for anticipated good results coming up.

Switch

Monroe Capital (MRCC) was much out of favor in 2019 and dropped below $10 a share in the summer, with a low of $9.91 on August 29, 2019.

At that point the effective yield on the $1.40 of annual dividend paid out was an eye opening 14.1%.

Since then, though, investors seem to have had second thoughts.

MRCC closed this week, continuing a more than 4 month upward run, at $11.76: a remarkable 33% increase.

Yet, if you look at the public record from September to today, very little has happened to explain that huge upward boost.

We reviewed all MRCC’s filings, which only amounted to an amendment of the Revolver and the IIIQ 2019 results.

In that time, Net Investment Income Per Share (NIIPS)  – both adjusted and non-adjusted – came to $0.35, exactly equal to the dividend.

That was unchanged from the quarter before.

Net Asset Value Per Share continued a long-standing downward trend, ending up at $12.34, down from $12.52 in the IIQ 2019 and way down from $13.77 at the end of 2017.

Looking forward, if the analyst community is to be believed, MRCC will achieve a NIIPS of $0.35 in the IVQ 2019 and $1.40 for all of 2020.

Twenty Four Quarters In A Row

All this suggests that investors who believed that MRCC would have no choice but to cut its dividend and bailed out of the stock accordingly have renewed confidence in the stability of the payout.

After all, the BDC has been paying the same $0.35 dividend every quarter since the beginning of 2014.

Subsidy

On the other hand, MRCC’s NIIPS result was only achieved thanks to the manager waiving $0.616mn of incentive fees.

Also, MRCC booked $1.621mn of Pay-In-Kind Income during the quarter.

Eliminate the waiver and the PIK income and NIIPS would have been just over $0.24.

Almost There

Furthermore, as the BDC itself admitted, regulatory debt to equity is reaching close to its target level, so any great increase in income from higher AUM seems unlikely.

This is what was said on the latest Conference Call:

At the end of the quarter, our regulatory leverage was approximately 1.29 debt to equity. This is nearing the top end of the targeted leverage range we have guided you to on prior quarters. This higher level of leverage was temporary as we were aware of a couple of portfolio paydowns that were expected to close shortly after quarter end, which have since occurred.Since quarter end, both total assets as well as our total leverage have decreased, with total repayments of $38.6 million received since September 30. We would expect to reinvest a portion of these prepayments in the fourth quarter of 2019″.

Inescapable

As always what happens next will probably be most affected by what happens on the credit front.

For a long time MRCC kept a very clean blotter but that has changed of late and explains the (43%) drop in the BDC’s stock price from April 2017 to that all-time low in August of 2019.

Investors seem to believe that an inflection point has been reached where credit troubles are concerned and that may be.

Long List

However, the latest 10-Q does indicate MRCC has “seven borrowers with loans or preferred equity securities on non-accrual status”.

“These investments totaled $30.7 million in fair value, or 4.7% of our total investments at fair value”.

That was substantially higher than at year-end 2018 (5 companies and 3.0% of FMV) and at the end of 2017 (1.7% of FMV).

Uncommitted

Frankly, we’ve not undertaken our own company-by-company review of MRCC’s portfolio, so we’ll defer any estimates of likely future credit performance.

However, we will say that if MRCC suddenly does cut its distribution expect a big pull-back in the stock price, the recent trend notwithstanding.

Yo-Yo

Also up on the week was Gladstone Investment (GAIN), up 4.1%.

The BDC has been highly volatile of late after booking many realized gains of late.

Over the past month the stock is still actually down (9.1%).

A month ago, GAIN moved up to a 12 year (!) high of $15.19, but has settled as of Friday at $13.80.

Again, what happens on the next earnings release will have a lot to do with where the stock price goes from here.

For the record, the remaining BDCs in the 3.0%+ club are OFS  up 3.6%; and GLAD up 3.5%.

Unfamiliar Territory

The only BDC down (3.0%) or more is Owl Rock Capital (ORCC).

The newer public BDC dropped (6.1%) on the week and is down (11.9%) on the month.

That makes ORCC the Biggest Loser in both time frames.

In fact, ORCC has dropped (18%) in price since December 27, 2019…

This seems to having everything else to do with the “un-locking” of common shares held by the BDC’s prior institutional investors who were the original shareholders when ORCC was unlisted.

Just look at the volume of shares being traded.

Explanation Required

The drop in the BDC’s share price has been so pronounced as to cause the manager to issue an unusual press release aimed at shareholders to explain why it’s much vaunted stock buy-back program was not operating to cushion the fall.

As required by Section 23(c)(1) of the Investment Company Act of 1940, we are reminding you that the Board of Directors of Owl Rock Capital Corporation (“ORCC”) has authorized a stock repurchase program (the “Company 10b5-1 Plan”) to acquire up to $150 million in the aggregate of ORCC’s outstanding common stock.

Subject to its terms and conditions, the Company 10b5-1 Plan requires Goldman Sachs & Co. LLC, as ORCC’s agent, to repurchase shares of common stock on ORCC’s behalf when the market price per share is below the most recently reported net asset value per share (“NAV”). ORCC’s most recently reported NAV is $15.22 as of September 30, 2019.

The purchase of shares pursuant to the Company 10b5-1 Plan is intended to satisfy the conditions of Rule 10b5-1 and Rule 10b-18 under the Exchange Act, and will otherwise be subject to applicable law, including Regulation M, which may prohibit purchases under certain circumstances. Please see ORCC’s public disclosure for additional information about the Company 10b5-1 Plan.

The Company 10b5-1 Plan commenced on August 19, 2019 and will terminate upon the earliest to occur of (i) 18-months (tolled for periods during which the Company 10b5-1 Plan is suspended), (ii) the end of the trading day on which the aggregate purchase price for all shares purchased under the Company 10b5-1 Plan equals $150,000,000 and (iii) the occurrence of certain other events described in the Company 10b5-1 Plan. To date, no purchases have been made under the Company 10b5-1 Plan.

For the BDC Reporter, the key question is whether ORCC was “over-valued” when the supply of shares was artificially – and temporarily – limited and just now returning to a “fair” price.

At its $15.85 current price, the BDC is still in that minority of funds trading above book value: $15.22.

The analysts are projecting NIIPS of $1.58, indicating the Price To Earnings multiple is 10.0x and the yield is 8.8%, which includes a “regular” dividend of $0.31 and a “special dividend” of $0.04.

If we only take the $0.31 quarterly distribution into account, the yield is a more modest 7.8%.

We’ll leave to our readers to determine if a $15.85 price makes ORCC a bargain or not.

Note, though, that another recently public BDC of a similar size – Bain Capital Specialty Finance or BCSF – is trading at a 11.9x PE multiple but the largest BDC of all – Ares Capital or ARCC – is at 9.7x.

Back To The Sector

In any case, the BDC rally rolls on.

We are now in the fourth month of an upward trend that began in mid-October 2019.

Over that period, BDCS is up 5.6% (and has been higher).

Note, though, that the S&P 500 – reaching milestone after milestone, has moved upward at twice the pace of the BDC sector.

As long as the major indices train keeps moving forward, we expect the BDC caboose to follow.

Coming Up

However, there is a reality test coming up: BDC earnings season.

As we’ve discussed above with MRCC, it will be interesting to see if investor enthusiasm can be maintained if IVQ 2019 results do not meet investor expectations.

Since the end of 2017, 31 BDCs have seen their net book value per share erode and just 14 seen an increase.

Of late, the negative turn has accelerated.

Last quarter 35 BDCs reported lower NAV Per Share, up from 28 the quarter before and 27 the quarter before that.

Can the rally in prices be sustained if the downward trend in book value continues or accelerates ?

Moreover, projected 2020 earnings are flat to down overall for the sector.

What do investors see that the key metrics do not show ?

It’s going to make for a very interesting 2020.


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