BDC Common Stocks Market Recap: Week Ended January 8, 2021Posted on January 11, 2021
BDC COMMON STOCKS
And We’re Off
The first week of 2021 began relatively strongly where BDC prices were concerned.
The UBS Exchange Traded Note with the ticker BDCZ, which we use to track overall BDC sector price changes, increased by 1.85%.
The S&P BDC Index, which we’ve just added to our arsenal of performance measuring metrics, was up 2.12%.
Of the 44 public BDCs we track – now that MVC Capital has disappeared into Barings BDC (BBDC) – 35 increased in price.
What’s more, 20 of the BDC stocks in the black moved up by 3.0% or more.
First And Second
Tops was Oxford Square (OXSQ), which jumped 11.5%; followed by a very different BDC : Apollo Investment (AINV), which increased 10.1%.
Why these two BDCs suddenly gained favor with investors is unknown to us, and we won’t speculate.
Note, though, that over a 12 month period the price of the two BDCs are down (40%) and (33%) respectively.
We can speak with more confidence to the third highest gainer – Saratoga Investment (SAR) – up 8.5%.
As we reported on these pages at length, the mid-sized BDC reported IVQ 2020 results through November 2020 that were positive in almost every regard.
AUM increased, as did recurring income per share (despite a higher share count) and the credit picture – already in good shape – got that much better.
The only smudge on this picture is that net assets and NAV Per Share – despite all the above – increased by just 0.6%.
That notwithstanding, investors seem to have been reassured, although some of the week’s price increase came before results were published.
As we’ve said, SAR’s performance – although impressive only a few quarters after the BDC suspended its distribution out of an abundance/excess of caution – may not tell us much of what to expect from the larger-cap BDCs.
Ares Capital (ARCC) will be reporting in early February, which will be a better indicator of what’s happening in the large cap BDC segment (assets over $1.0bn).
Currently, 86% of public BDC assets at FMV are held by 20 BDCs.
This is becoming an increasingly top heavy corner of the leveraged lending market, with the top five BDCs by size accounting for 50% of all sector assets.
ARCC alone boasts $14.4bn in portfolio assets, 26x more than SAR…
However, the market leader did not get much love from investors this week – despite raising unsecured debt at a yield unheard of in BDC history.
ARCC’s price was up 0.65%, a third of the sector’s percentage change.
Still, ARCC trades only (2%) below its post-Covid intra-day high and (12%) beneath its 5 year, pre-Covid highest price, set early in 2020.
The two top losers this week were Newtek Business (NEWT) -3.6% and Stellus Capital (SCM) -3.5%.
There’s been no news of any kind out of SCM to move the needle since November, so the price drop must be considered part of the normal to and fro.
However, the situation at NEWT is a little different.
Once again this week this BDC with a unique business model raised more capital: $10mn in the form of unsecured notes due in 2025.
At a time when ARCC was tapping the institutional market for 2.150%, NEWT is paying 6.850%.
This follows issuing $5mn at the same rate to the same “accredited investor” in November of 2020.
Another $15mn in additional debt issuance may yet follow.
NEWT has said the monies are needed ” to fund investments in debt and equity in accordance with its investment objectives and strategies“, which tells us little.
Why is NEWT raising substantial new capital at this point ?
Does the BDC have a liquidity problem which is being addressed in this way or is there a lucrative opportunity available that justifies such a high yield ?
We scoured the most recent results and conference call for any hints.
The BDC indicated on November 5, 2020 that it is “currently negotiating term sheets with prospective joint venture partners that could create up to $150.0 million of additional third-party capital to originate up to $1.0 billion of non-conforming conventional loans and restart this program which was curtailed due to the pandemic“.
Maybe the new capital is intended to fund NEWT’s portion of these JVs.
However, there are a host of other potential candidates for new capital – including supporting funding of the latest round of PPP- so we’ll have to await further word from management.
Given where we are in the calendar, we can’t resist the ambition to pull out the old crystal ball and seek to project what 2021 will look like where BDC prices are concerned.
We should know better.
The BDC Reporter has been involved in this market segment for over 20 years and has been systematically data gathering and predicting for the last 15 years.
We know from harsh experience that the future is unknowable.
Who could have surmised at the beginning of 2011 that Europe would have a political and financial crisis that would cause BDC prices to drop (28%) ?
Or in early 2014 that in mid-year the price of oil would drop from over $100 and trigger a bear market in BDC stocks that would last a year and a half ?
Who knew as we broke out the champagne and welcomed in 2020 what horrors were to follow ?
Nonetheless, we can’t help ourselves, so here goes:
Let’s start with the good news.
Most of the elements that drive BDC prices upward over the long term are headed in the right direction as we begin the year.
Our numbers indicate that there are $85.5bn in public BDC portfolio assets at FMV at time of writing.
More. More, More
We expect that AUM to increase substantially in the quarters ahead as most BDCs are poised to increase the size of their portfolios and have the liquidity to do so.
The word from Kelly Thompson at Direct Lending Deals – who tracks new loan activity – is that many new deals are getting booked and plenty more are in the hopper.
That should give a boost to AUM and earnings as 2021 begins to play out.
We were also impressed to hear that SAR – despite repeated concerns about the impact of the pandemic – added ten new company relationships since the pandemic began.
Lenders may be mostly sitting at home but financing is getting done.
Capital, too, is readily available.
As we’ve seen of late, the unsecured debt market is wide open for BDCs of all stripes which will provide not only less expensive debt capital but incremental amounts as well.
On a pro-forma basis if all BDCs leveraged themselves up to their “target” debt to equity levels, the result would be a 12% increase in sector AUM, or about $10bn.
Furthermore, with a quarter of the BDC universe already trading above book, the opportunity exists for many BDCs to raise accretive equity, which will boost both AUM and fully diluted EPS.
Also a positive for shareholders is that several BDCs – most recently BBDC after taking over MVC – are reducing their compensation costs by wayof lower management and/or incentive fees.
That process began last year – or arguably even earlier – but the benefit will continue to grow overall, even though some BDC managers (like Oaktree Specialty Lending-OCSL) have crossed their arms and are not joining in.
Two Sides To Everything
Now for the bad news.
Nothing that we’re saying is news to the market.
Thanks to that memorable November 2020 rally – one of the shortest, sharpest upward price shocks we’ve ever seen in this sector – BDC prices are riding high.
Admittedly if you compare today’s prices against 52 week or all-time highs many BDCs are still a good way off those metrics.
However, if you contrast today’s price with each BDC’s post Covid high – which began in March 2020 – most every BDC is close.
After all, most BDCs – thanks to lower LIBOR mostly – have registered material drops in EPS and dividend payouts since the IQ 2020.
Current price multiples are in line with pre-Covid levels in most cases, but on substantially different earnings levels.
Specially prized by investors are the handful of BDCs considered likely to increase their distributions going forward.
For example, Capital Southwest (CSWC) is trading at 100% of its post-Covid high; OCSL at 98% and SAR is at 99% of the high.
Even BDCs less likely to raise their payout – like Golub Capital (GBDC) – is trading at its post-Covid high.
Moreover, GBDC – and many others – are trading at very high price to future earnings (PE) multiples.
GBDC’s PE, using the analyst consensus for 2021, is 12.6x.
This for a BDC whose 2022 earnings are expected by the analyst community to grow not at all over the 2021 level and which reduced its dividend unexpectedly last year.
Apparently the message from investors to GBDC – and many other BDCs that reduced their dividends in 2020 – is: “All is forgiven”.
That other perennial investor favorite – Main Street Capital (MAIN) – has a 2021 PE of 14.5x.
MAIN has maintained its regular distribution but stopped paying its semi-annual specials.
It’s no wonder that many investors have been rustling around in the underperforming BDC bin in recent weeks for bargains because the BDCs with stable or improving fundamentals are far from cheap.
That means even BDCs which have suspended or greatly reduced their dividends; seen their EPS tumble and whose NAV Per Share has shrunk have seen their stock prices revive of late.
Let’s illustrate with Capitala Finance (CPTA) whose stock price reached $8.61 in early November 2020 but is now trading at $14.50.
That’s a 63% increase for a BDC which is still not paying a distribution.
We begin the year with BDC prices very full in almost every case.
Which is not to say that BDC prices overall cannot yet find their way to new heights.
Improving fundamentals at many players could still push prices even higher.
Furthermore, there are at least 12 BDCs – by our count – who are in “turnaround mode” and which trade at much lower multiples than their peers given the uncertainty about their viability.
If some of these BDCs “turn the corner” in 2021, that could result in higher prices.
For example, BlackRock Capital (BKCC) is trading at a 2021 forward PE multiple of 6.3x and AINV at 7.9x 2022 projected earnings.
On The Other Hand
Of course, this works both ways.
If the BDC underperformers cannot get off the mat and performance deteriorates further that would be likely to place downward pressure on BDC prices overall.
Likewise, if there is any setback at one of the better performing players their price would tumble and there’s a long way to fall.
For our part, we’re optimistic that most BDCs will perform pretty well on a fundamental basis.
We expect many of the underperformers will either be turned around this year or be weeded out, as occurred under much more difficult conditions in 2020.
However, it’s hard to envisage that overall BDC price levels will be that much higher than at year end 2020 when this year plays out.
According to the S&P BDC Index, the net “total return” for BDC investing in 2020 was (12.17%), the worst calendar year performance in its ten year history.
Second worst was 2011: off (12.17%) and the worst streak was 2013-2014, down (15.60%).
We expect 2021 will bring the BDC sector back into the black, but mostly from dividends received, with price appreciation a secondary contributory factor.
Our prediction/guess is for a “total return” of 14% in 2021.
Let’s circle back here in the early days of 2022 and see how well we did predicting the unpredictable.
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