BDC COMMON STOCKS
We’re nearly five months away from when the markets began to collapse, and still BDC investors remain jittery.
After a brief ray of sunshine in the days before the July 4 weekend, the sector’s prices dropped again last week.
BDCS was off (3.44%), wiping out the prior holiday-shortened week’s gain of 2.05%.
This week 38 individual BDCs were down in price and only 8 were up.
High anxiety is reflected in the fact that 25 BDCs dropped (3.0%) or more in price on the week, including 8 over (6%).
Of the BDCs in positive territory only three went over the 3.0%+ threshold.
Furthermore, in another telling sign that there’s some nail biting going on, only 5 BDCs are trading above their March 31, 2020 book values.
We can see clearly now that the BDC sector has been in meltdown mode since June 8, when BDCS closed at $15.68
This week BDCS reached as low as $13.30, before closing out the week at $13.46.
From that June 8 high to the lowest point reached on Thursday, the sector has lost (15.2%).
Going It Alone
Moreover, we can also clearly see that the BDC sector’s performance has detached from the popular broader indices.
See this 1 month chart which compares BDCS to the NASDAQ, the S&P 500 and the Dow Jones:
Tech stocks have boosted NASDAQ (IXIC) to a big gain in the period. The other two indices are lagging.
BDCS, though, is way off by comparison.
Looking back over the entire period since everything went catawampus, the numbers suggest one-third of the fierce rally that began March 24 has been erased in less than a month.
At this point BDCS is 58% above the March 23, 2020 Darkest Day level.
We’re even beginning to see a couple of BDCs start to retest their all-time low of lows.
Admittedly, there’s little to discuss except Capitala Finance (CPTA) which closed at $2.26, not so far off the $2.18 low.
Then there’s FS-KKR Capital II (FSKR), which FS Investments and KKR brought to the public market at a very difficult time just a few weeks ago.
Despite promise of market support and the benefit of its august sponsors FSKR has not fared well, peaking on day one at $14.60 and closing this week at $12.45.
At its lowest FSKR has been at $11.64.
That’s over one fifth of the new public BDC’s market capitalization gone before you can say “Bad Timing”.
All In The Family
Also worrying is the ever lower price of FSKR’s almost identical twin: FS KKR Capital (FSK).
After adjusting for the recent 4:1 reverse stock split, FSK continues to sag and is now just 8% above its all-time nadir.
In fact, on Thursday FSK was right there at the bottom before a Friday move up.
FSK is trading at a (56%) discount to book value, suggesting investors do not believe the $3.0bn of GAAP book value is tenable.
The “real” value of FSK might be under $1.5bn.
If that’s anywhere close to true and book value drops over time to what the market is indicating, that’s going to be a problem for a BDC with $4.2bn in debt…
Controversially, the BDC Reporter has suggested in the BDC:NAV Change Table that both the KKR-managed BDCs – whose combined asset value is $15.6bn – will STRUGGLE to survive in their current form.
We do so with no malice aforethought and recognize that the current managers are dealing with huge legacy credit problems.
FSK alone – and using its own investment rating system – recognizes that 43% of its portfolio is underperforming to varying degrees.
That’s $3.0bn of troubled assets; equal to the entire book net worth of the BDC.
FSKR’s credit metrics are better but its investors seem to be abandoning ship as well.
FSK and FSKR are not alone. At the moment, we still rate 10 other BDCs in the STRUGGLE category.
All the above notwithstanding, this week saw mostly positive news coming out from a number of BDCs as everyone prepares for IIQ 2020 earnings results.
Notably, Ares Capital (ARCC) – still the biggest BDC – tapped the unsecured debt market for a very large ($750mn) offering and was able to pay only 3.85%.
As we recognized in our second of two articles about the subject, the rate paid was not the lowest ever achieved by the multiple issuer of unsecured debt, but nothing to sneer at.
Also, Saratoga Investment (SAR) reported quarterly results through May 2020 which were better than the market or SAR itself seems to have expected.
In fact, SAR’s management – wearing its worries on its sleeve – had suspended its dividend after the prior quarter.
In its press release and May 7 conference call management expressed its anxiety about the unknown impact of Covid-19 on its portfolio of loans and equity investments and CLO.
The BDC suspended its dividend entirely at the time, much to the frustration of several analysts on the call.
Fast forward to this week and SAR reported large – but below average – unrealized losses of (6.1%).
Change Of Heart
Armed with the proceeds of the recent Baby Bond issuance; a CLO still paying out to its junior capital holders and only a moderate increase in underperforming assets SAR’s confidence visibly improved.
That’s reflected not only in the decision to resume paying a dividend after only one quarter of suspension but also the booking of new investments in the quarter and after.
Was all that drama justified ?
The BDC Reporter will leave that to our readers to decide.
We can report that SAR jumped in price from $15.00 before the results/dividend were announced to close at $16.30 on Friday, a 8.7% jump.
Confidence is contagious.
Still, SAR still trades at a (35%) discount to book value and (43%) below its 52 week high but its dividend is only (29%) below its pre-Covid level.
We have upgraded SAR’s outlook in the BDC: NAV Change Table to THRIVE, reflecting its availability under its SBIC program to fund new loans and its “lots of liquidity” (quoting Ladenburg).
Admittedly, the dividend is below its prior level but that could still increase substantially by year end.
Two other BDCs signalled during the week that they were open for (new) business: Horizon Technology (HRZN) and Gladstone Investment (GAIN).
As we’ve shown in the BDC:NAV Change Table both BDCs have GOOD liquidity and have not changed their regular distributions.
GAIN announced a new investment in a company called Mason West, where the sponsor was Chicago-based KCM Capital.
No amounts were mentioned but we told GAIN – as per the norm – provided senior debt and equity in what was an acquisition.
HRZN provided a full quarterly update on its investment activities – as is done every quarter.
The venture-debt lender boasted of six new loans in the period, including 4 to new companies.
ARCC, too, provided some metrics about new deal activity in the IIQ when publishing its unsecured debt Prospectus.
As we mentioned at the time, the level of new investment is substantially below historic levels.
Moving On Up
Nonetheless, these developments suggest that these BDCs – at least – are not just focused on fixing their existing portfolios or shrinking down as might be the case elsewhere.
These BDCs and SAR and eight other public players are in THRIVE mode, seeking to pro-actively grow their portfolios in the short or medium term.
That does not necessarily mean investors are not just as jumpy about these apparently better performing BDCs.
This week both ARCC and GAIN dropped materially in price: (3.1%) and (4.2%) respectively.
More Of Same
We expect much price volatility in advance of earnings as investors fret and worry.
For example, SAR saw its stock price drop from $17.47 on June 16 to $15.00 just before the May results – and the renewed dividend – was announced.
In that case, the hand wringers were wrong as we’ve seen above and now the stock is 8.7% higher.
This quarter we expect to see a lot more price dropping in advance of earnings than run ups but the markets have surprised us before.
One More Metric
What really matters is where prices go once the IIQ results – which will tell us much more than the IQ did – are released.
We’ll be tracking those metrics in this weekly update once the time comes.