BDC Common Stocks Market Recap: Week Ended June 12, 2020Posted on June 15, 2020
BDC COMMON STOCKS
Back To The Future
Maybe you thought the days of BDC common stock prices shooting up and down by several percentage points in a single day were behind us ?
If you did, what happened in the markets this week – and not in the BDC sector alone – will have dissuaded you of that notion.
Volatility made a comeback with big swings northwards and southwards.
The S&P 500 ended up down (4.8%), essentially erasing the prior week’s 4.9% increase.
Last Minute Rally
The BDC sector – as measured by BDCS – dropped a more modest (3.2%), but that was helped by a 3.1% Friday price increase.
35 of the 45 public BDCs we track dropped in price, and only 10 remained unchanged or increased.
Some 20 stocks dropped (3.0%) or more in price – the highest number to the downside we’ve seen since a month ago – also at 20.
Just 2 BDCs increased 3.0% or more versus 35 the week before.
(For the record, the two biggest movers were Medley Capital– MCC- and Portman Ridge Financial – PTMN. Both are thinly traded, priced below or just above a buck a share and not very representative of anything).
Clearly, the shoe was on the other foot where BDC prices were concerned.
After three weeks of the BDC sector, and most everything else, rallying this was no great surprise.
What was disconcerting were the sharpness of the jolts.
For example Garrison Capital (GARS) dropped (15.4%) and BlackRock Investment (11.0%).
You’d think by now that the market would have made up its mind about these and other BDC stocks but that’s not the case.
BDCS has now dropped (29.6%) off its February 20, 2020 level.
Short Term Moves
With hindsight, we can now see that intra-day BDCS reached a post-Covid high of $15.68 on June 8.
At the Friday close, BDCS is off (7.8%) that recent high, even when the last minute bounce back is figured in.
Even the number of BDCs trading above book value – which had been trending upwards for weeks – fell back to 7 from 9 the week before.
There were quite a few material developments at individual BDCs during the week, which we’ll review shortly, but none that justified the sharp price movements.
Most notably – but not unexpectedly – Bain Capital Specialty Finance (BCSF) completed its Rights Offering.
Everything went to plan, with 12mn new shares issued at a market price of $10.2163.
The move may have been necessary, but the BDC’s shareholders will remember wistfully that BCSF’s stock price was tickling the $20 a share level not very long ago.
A very substantial dilution in book value has now occurred as the BDC greatly increased its shares outstanding at a (40%) discount to IQ 2020 book value.
That’s reduced the BDC’s dividend from $0.41 to $0.34, as foreshadowed on the BDC’s May 7, 2020 Conference Call:
Subsequent to quarter end, our Board declared a second quarter dividend distribution equal to $0.41 per share based on the current number of shares outstanding for a record date shareholders as of June 30, 2020. If all rights are exercised and approximately $12.9 million shares of our common stock are issued pursuant to this offering, this will be adjusted to $0.34 per share. This is intended to maintain our historical distribution rate of approximately 8% annualized on book value.
By our count, BCSF’s dividend reduction brings to 19 the number of BDCs that have shaved; suspended or deferred their dividend since Covid-19.
(The number is 20 when you include Great Elm’s (GECC) dividend which is nominally unchanged but only 10% paid in cash).
What the BCSF Rights Offering did undeniably achieve was improve the liquidity of this very large BDC.
The external manager has now provided an emergency $50mn Revolver; raised $115mn of unsecured debt and now an additional $132mn from the equity raise.
All of those monies will bolster liquidity that would otherwise be lacking and has allowed the BDC Reporter to raise our Liquidity Rating to GOOD from FAIR in the BDC: NAV Change Table.
There has been little of late to alter any of our assessments but this improvement in BCSF means there are now 28 BDCs (roughly two-thirds) with a GOOD rating in this critical category.
We did have confusing news in another key category this week: dividend payouts.
Newtek Business Services (NEWT), which had cut its dividend back to $0.44 in the IQ 2020, from $0.71 the quarter before, announced its payout for the second quarter 2020.
Much to the delight of its shareholders, the BDC actually increased the quarterly dividend – which gets reset every period – to $0.56.
We imagine earnings have been much boosted by the income being generated from originating Payroll Protection Program (PPP) loans.
The Company has not been shy about announcing the huge volume of PPP loans booked in these last few weeks, which will benefit IIQ 2020 results: $1.15bn of commitments at last count.
That’s good news – but like the PPP itself – might not provide a sustainable increase in earnings and distributions.
To date we have projected – see the BDC: NAV Change Table again – that NEWT’s full year 2020 distribution will be beneath the 2019 level ($2.15).
Despite what is likely to be a bumper second quarter for NEWT from an earnings standpoint, we continue to believe third and fourth quarter 2020 dividends will be lower- both compared to IIQ 2020 and to last year’s performance.
By then the PPP initiative will have ended and NEWT – like everyone else – will have to contend with lower economic activity, which will impact new financings, and increasing credit losses.
Apparently the analysts have come to the same conclusion, projecting the third quarter’s earnings will be just $0.09 per share from $1.46 estimated for the current quarter.
In Other News…
The long list of BDCs that have sought and received annual shareholder approval to issue shares below book value continues to grow.
This week Prospect Capital (PSEC) held a vote just on that subject and received the shareholders nod.
Ares Capital (ARCC) filed its Definitive Proxy and will be holding a vote on the same subject in August.
The BDCs seeking this special dispensation typically argue that they want to reserve this right in case some special opportunity comes along.
That’s much more palatable than saying : “We’re short on capital because we mismanaged the business, so we’d like you to give us more money on very poor terms”.
We’ve not had any surprise capital raises following these shareholder approvals in some time but that may change under current market conditions.
Shareholders are left playing a game of “Will They or Won’t They ?”.
If the answer is “They Will”, expect the stock price of the BDC involved to drop.
No BDC has clearly signaled its intention to sell stock below NAV so a decision to actually do so will surprise many investors and – most likely – be seen as a sign of weakness.
After the Great Recession – and thanks to many realized and unrealized losses – the BDC sector as a whole shrunk in size, as measured by assets under management.
This time round, the growth of the BDC format seems likely to continue despite the ($5.2bn) in unrealized losses in the public BDC segment in the IQ 2020.
Public BDCs AUM – at least – will shortly be boosted as Goldman Sachs (GSBD) on June 11 announced their merger agreement.
This will result in GSBD increasing in portfolio size from $1.4bn to $3.2bn.
The combination is expected to occur in the IVQ 2020.
As early as this coming week the FS-KKR organization hopes to launch – on June 17 to be specific – it’s non-traded giant BDC FS KKR Capital II into the public market.
JP Morgan and several other Wall Street luminaries have been officially announced as being in charge of the new public issue.
At March 31, 2020 the BDC – whose ticker will be FSKR – had portfolio assets of $7.5bn.
According to our list, FSKR will become – if this proceeds as hoped – the third largest public BDC.
In a case of sibling rivalry FSKR will be just slightly bigger than FS-KKR’s existing public BDC : FSK whose value has been beaten down of late.
(At one point the external managers had intended to merge FSK and FSIC II together to give ARCC a run for its money as the biggest BDC but that notion was abandoned some time ago).
Out In The Cold
That still leaves FS Energy & Power out there in the non-traded segment of the market.
A BDC whose principal investments are in energy oil & gas explorers and service firms is too hard a sell right now.
Now if oil goes back to $70 or $100 a barrel…
From a BDC perspective, looking down the road we still expect to see the Golub Capital organization to shift one or more private BDCs they manage to public status.
Ditto for several other asset managers.
Also this week, in the non-traded BDC segment, we heard that Owl Rock Capital is preparing to launch yet another fund: Owl Rock Capital Corporation III.
Even as public shareholders in BDCs have lost – for the moment – a third of their market value, the big asset managers are proceeding with their plans.
This will be taking the BDC sector further and further away from its original model, with ever more assets earmarked for upper middle market and large cap borrowers.
The syndicated loan market and even CLOs will feel the heat of ever more competition.
Wait A Minute
Yet at the very same time this is happening, the SBA appears to have emerged from a long slumber and is issuing “Green Lights” for future SBIC licenses all over the place.
Not so long ago Capitala Finance (CPTA) – despite being in default under its private debt facility – received a “Green Light”.
Capital Southwest (CSWC) – when asked by an analyst on the latest conference call about whether it would receive a license just winked:
“And I would say, let’s just leave it. I’ll tell you we’re ahead of you on that. And so more to come”.
Hercules Capital (HTGC), though, actually received a formal “go forth” letter – another term for “Green Light” – according to a June 8 filing.
More To Come ?
We’re guessing that the SBA will be approving a great deal of potential capital for BDCs interested in serving the lower middle market because of the current crisis.
Given that for every dollar of equity capital parked in a SBIC subsidiary, the BDC involved can eventually borrow twice as much, that should boost AUM.
Nor is the SBA just replacing SBIC licenses that are coming to maturity but appears to be opening the gates to new names – like CSWC – or adding incremental dollars to existing players.
Marching On Regardless
So the BDC sector appears poised to continue to grow at both ends in the years ahead.
We won’t presume to guess how much or how little. There are so many moving parts.
Nonetheless – at a time when some players are just holding on and can’t even arrange a secured loan facility – it’s a remarkable vindication of the BDC model – now in its 40th year.
This week we calculated that the BDC sector represents at least a tenth of the entire leveraged loan market.
Maybe in another decade that share will increase to one fifth ?
We’ll be watching and counting…
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