BDC Common Stocks Market Recap: Week Ended June 19, 2020Posted on June 23, 2020
BDC COMMON STOCKS
We’ve been poring over the metrics we gather every week to prepare the Market Recap, and we just don’t know.
The markets are just not telling a clear-cut message.
Let’s start by saying that the S&P 500 was up 1.9% but the BDC sector – as measured by BDCS – was off a modest (0.9%).
Unchanged from the prior week were the number of stocks trading above book value: still at 7.
Some of the other data, though, suggests a continuing downward bias for a second week in a row.
The number of BDC issues down by (3.0%) or more outstripped those up by 3.0% or more by a nine to one margin: 18:2.
Some of the percentage declines have been brutal.
Most notably, Oxford Square (OXSQ) dropped (19%) in just 5 business days.
Only a tenth of that drop can be explained by OXSQ going ex-dividend.
The BDC – to no one’s surprise – announced a lower than before monthly distribution of $0.035 per month from $0.0607.
However, that was back on June 2 so you’d have expected an earlier reaction than the one we saw this week.
It’s hard to believe that all those canny BDC investors have just woken up to the dividend cut and the heavy weighting of CLO investments in OXSQ’s portfolio.
We remain perplexed.
Also down in price was FS-KKR Capital (FSK) by (14.75%), according to Seeking Alpha.
This was the week FSK both undertook a reverse stock split and paid its $0.60 quarterly distribution.
We did note that the volume of shares traded reached very high daily levels – according to Yahoo Finance.
On its busiest day, FSK traded over 3mn shares, if the records are right.
The new reversed stock price dropped from an open of $16.52 on June 16 to $14.05 at the Friday close three days later.
That, by itself, saw FSK’s stock price drop (15%).
Like OXSQ, FSK has cut its distribution (by 21%), so this might be another case of delayed reaction by investors.
Presumably this was not the result the external managers of the BDC were aiming for when the reverse stock split was conceived.
Finally, the third Biggest Loser from a price standpoint this week was Capitala Finance (CPTA), down (12.3%).
In that case, CPTA has long ago suspended its dividend for the time being and there’s been no news this week.
All Together Now
What these three BDCs have in common – for what it’s worth – is that all are projected by the BDC Reporter to STRUGGLE in the months ahead.
See the BDC: NAV Change Table.
As the very busy chart below which shows the stock price of all 3 compared to BDCS since February 20 shows, they have greatly under-performed the sector.
Three months after the BDC Reporter – looking at the data for every public BDC out there – rated each player, there remain 12 in the STRUGGLE and 23 in the SURVIVE category.
Only 11 BDCs seemed poised to THRIVE through the rest of 2020.
Despite weeks of news developments very has little has occurred to change our outlook.
However, this week – when reporting on Saratoga Investment’s (SAR) new Baby Bond issuance- we did upgrade their Liquidity from FAIR to GOOD.
Generally speaking – and as you’d expect after having several months to adjust – most BDCs have decent amounts of liquidity, but – as the saying goes- “you can never have too much of a good thing”.
Old Misery Guts
That might be important going forward because this week included multiple reminders that many credit challenges remain for the BDC sector.
Over at the BDC Credit Reporter – fast becoming the Boswell of BDC bankruptcies – we reported 5 new portfolio companies filed for court protection in the week.
The most recent one was AAC Holdings (aka American Addiction Centers), which actually filed on Saturday while our readers were barbecuing.
Since the beginning of 2020, 26 different BDC-financed companies – public and private, big and small – have gone bankrupt.
A few were already circling the runway back at the end of 2019, but many more have turned up in court due to the impact of Covid-19.
By our calculations, these 26 companies had an FMV of $1.17bn at cost and $703mn at FMV.
By our count, nearly half the public BDCs have had one or more of their portfolio companies involved.
Getting less attention – but equally important – is the ever growing number of companies that we’ve rated CCR 4 on our 5 point investment rating system, just above non-performing.
We’ve identified 176 companies, with a cost just above $5bn and an FMV just shy of $3.5bn.
The loans involved in these investments – the bulk of the value – are still performing but are just one step away from becoming non-performing as well.
Some names may ultimately get upgraded, or may not fall into CCR 5 for a long time, but the numbers are ominous.
Notable this week was the downgrade of Forming Machining Industries from CCR 3 to CCR 4, triggered by Moody’s rating the company and debt “speculative”
Also downgraded this week – this time by S&P – was ASP MCS Acquisition – which was already rated CCR 4 by the BDC Credit Reporter.
These are just examples within a broader trend of company downgrades that – like with AAC Holdings – is more likely than not to end in bankruptcy court.
As of this week, the BDC Credit Reporter’s statistics – which are by no means perfect but which are instructive – indicate that all underperforming BDC assets – both public and private – exceed $14.0 bn.
That’s a big number both in absolute terms and compared against the sector’s total assets and net book value and bears watching.
For the moment we’re seeing the number and value of companies in the underperforming category both growing and their ratings deteriorating.
The now almost constant flow of bankruptcy filings is only the most visible part of a broader negative credit trend.
Two Way Traffic
It’s true, though, that a large number of companies were added to the underperforming list and rated CCR 3 after the IQ 2020 in the immediate aftermath of Covid-19.
We’ll be very interested to see how many of these new entrants make an immediate round trip back to “performing as expected” status now that there’s been more time to take stock.
Typically when companies slip into underperforming status, the direction is generally downward with only a chosen few regaining their footing.
These “unprecedented” times may cause the second quarter to be the exception to the rule and the universe of underperformers – and the dollars involved – may quickly shrink.
What’s Happening Next Door
We’ve already seen the leveraged loan market “heal” in this way with fewer and fewer loans valued under 80 cents or 90 cents on the dollar.
S&P Global Market Intelligence had this fascinating statistic which we quoted on our Twitter News Feed on June 19:
“The share of [leveraged loans] now priced at 90 or higher has risen to 81% as of June 18, from 66% at the start of the three-and-a-half-week stretch, and just 9% of loans are below 80, compared to 15% on May 18”.
Cheer or Hiss ?
One can see that a couple of different ways.
You can be impressed that such a large proportion of loans are returning to “normal” values or you can worry about the potential negative consequences if even 19% of loans are still viewed as problematic.
Likewise in the BDC sector we are concerned that there might be a June 30 mark up of many investments after the dark conditions of March 31, but that we’ll still be left with two to three times more underperforming assets than in normal times.
Over time, if those assets migrate southward and into non performing status the impact on income, earnings and distributions could be much more detrimental than current BDC sector prices seem to presume.
Of course – as usual – the impact will vary enormously by BDC.
Outside of the spate of BDC-bankruptcies, the biggest news story this week was the arrival on the public BDC scene – with barely any fanfare – of FS KKR Capital II, which has grabbed the ticker FSKR.
Bringing FSKR into the public arena is a bold move by the KKR and FS Investments partners.
The BDC has the advantage of being relatively underleveraged with a net debt to equity of 0.76x, one of 20 BDCs under 1:1 and below the 0.97x sector average.
In fact, FSKR has only just received shareholder approval to apply the looser asset coverage requirement and can now – theoretically – leverage up to 2:1.
In The Money
Its liquidity seems to be GOOD with lots of cash and plenty of unused availability.
That’s partly due to financing itself partly with an unsecured note which makes available more assets to be pledged to the secured lenders, growing gross availability.
Like its sister BDC FSK, though, FSKR has faced lower earnings and recently cut its distribution to $0.60 per quarter from $0.72.
Net Investment Income does not even “cover” the new dividend so management must be hoping that a larger portfolio might boost earnings in the near term.
Like with FSK, though, the biggest immediate challenge will be on the credit side.
By its own assessment, as of March 2020 FSKR’s portfolio included $1.2bn in underperforming assets, or 16% of the total.
This included 15 non performing borrowers, second only in the BDC sector to FSK by this metric, even though many names are shared.
(We counted 47 underperforming companies out of 113, but our credit review is far from complete).
More than a quarter (27%) of all FSKR’s equity capital raised has been written down or off.
If the BDC wants to compete with Ares Capital (ARCC) at the top of the BDC league tables getting credit results under control will be critical.
(BTW, (14%) of ARCC equity capital has been written down or off – a number that for both BDCs has been made much worse by the IQ 2020 write-down).
We Leave You With This
Can a BDC be both big and generate a decent ROE for shareholders ?
We believe that’s a fair question – especially as the sector is increasingly dominated by BDC behemoths – and the conundrum is far from resolved.
The next few months will provide a test of fire that will tell us much of what we might expect for years to come.
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