BDC Common Stocks Market Recap: Week Ended June 26, 2020

BDC COMMON STOCKS

Not Looking Good

Last week we admitted to being a bit confused with the markets giving out mixed messages.

Nonetheless, we opined that there was a “downward bias” to BDC stock prices.

One week further down the line – and just two business days from the end of the quarter – and that bias is growing.

Lower

For a third week in a row the standard by which we track the sector – the Exchange Traded Note with the ticker BDCS – dropped by a material (3.8%).

That’s the biggest weekly drop since April 3, 2020.

Now, BDCS has dropped (7.95%) in the last 3 weeks.

The sector has returned to the level achieved in the third week in May.

BDC shareholders are not alone this week: the S&P 500 dropped (2.86%).

Losing It

All those headlines warning of a “second wave” (or is it still the first wave but worse and does it matter ?) and of an over-stretched stock market are having an impact.

Confidence – that necessary adrenaline for investing – is weakening.

This was also reflected in the number of BDCs trading up or down 3.0%, where the results were savage.

4 BDCs were up 3.0%+ this week but – more notably – 27 were down.

That 27 is the highest since May 15.

No Good Deed

Tellingly, the BDC with the largest loss was Portman Ridge Financial (PTMN), off (17.7%) in the week that the BDC announced a merger with Garrison Capital (GARS).

The BDC Reporter undertook a deep dive into both BDCs portfolios just hours after the news came out.

A glance at what we found may explain why the market seems to have been unimpressed by the marriage of these two underperforming BDCs.

Guesswork

The second biggest price loser was OFS Capital (OFS), which dropped (12.5%).

The BDC’s stock price had been on the road to recovery, reaching $5.78 on June 8.

Now OFS trades at $4.54.

This week’s retreat may be related to finally getting enough shareholders to accede to issuing new shares below book value, if Board and management deem that essential.

Maybe the BDC’s shareholders believe that’s just what will happen.

Big Group

To be fair many BDCs – as is traditional – have asked for and received their annual blank cheque in this regard but none – except Prospect Capital (PSEC) – have cashed in.

Investors have to constantly evaluate who REALLY needs the money and who does not.

Usually Suspect

Not surprisingly, we also find Medley Capital (MCC) on this list of weekly price descenders, off (12.2%).

There was no news this week.

Sometimes – when confidence is high – that causes investors who like a flutter on a speculative situation to step up.

When confidence drops so does the willingness to risk capital based on guesswork as to what is happening to MCC’s endless shopping of itself to the market.

We’ve heard from others who spend more time MCC-watching than we do is that the whole Medley Management (MDLY) construct  – manager of MCC – is up for sale.

Thus, MCC has to be either sold or liquidated and cannot continue limping along paying only its managers.

We have no confirmation of that fact, so we’ll just have to wait and see.

We’re nearly two years away from when management and the Board of the three Medley entities began their campaign to reorganize their holdings.

It’s been one of the saddest, most complete collapses in shareholder value that we’ve witnessed in this sector of the market in our now twenty one years of BDC-watching.

Beneficiary

Ironically, the Biggest Winner this week was Garrison Capital (GARS) – up 13.3% to $3.24.

Clearly the opportunity to receive a chunk of cash, as well as as stock in PTMN, was considered preferable to remaining independent.

Still, there’s a long path ahead before this merger/acquisition gets put to bed.

Two sets of shareholders have to give the nod; as do the lenders involved and much may yet transpire with the publication of the second and third quarter results.

The diametrically opposed ways the shareholders of the two BDCs involved reacted may give pause to the crafters of this “merger of the weak”.

We’re not taking anything for granted including this transaction going ahead on the current terms.

Always More

There were several other notable news stories during the week, but which might have been overshadowed by the PTMN-GARS merger.

Out of the blue, New Mountain Finance (NMFC) published a slide presentation providing an “interim update”.

In the middle of the March crisis we did get a large number of BDCs offering up “stakeholder letters” and the like, but not this quarter.

Nine times out of ten – as with every Main Street Capital (MAIN) press release about a portfolio company sale – the news on offer is good.

Better Vitals

This was the case with NMFC which reported that its leverage has dropped substantially from the decidedly high levels at March 31, 2020.

Regulatory debt to equity is projected to drop from 1.56x to 1.35x at the end of June.

Read between the lines and the metric might be even better if the market value of its assets are marked higher as anticipated.

(The BDC may have jinxed themselves because in the last few days leveraged loan prices have dipped after months of an upward trend).

Furthermore, NMFC indicated Net Investment Income Per Share is likely to be $0.30 per share in the second quarter and in line with its new distribution.

That’s also meant to be reassuring for shareholders who might be worried about a further cut from the prior $0.34 a quarter level.

Liquidity, too, was said to be strong at $230mn, always an important subject in volatile conditions.

Pulling The Lever

The lower leverage and improved liquidity was achieved by one of the traditional – and most popular methods  – BDCs have at hand: de-leveraging.

According to the presentation NMFC reaped ($232mn) from scheduled loan repayments and deliberate asset sales.

When possible at a decent price that’s a far better tool where BDC shareholders are concerned than a Rights Offering at a huge discount to book value.

Or suspending a distribution, or paying out the proceeds mostly in the form of additional shares.

Or doing nothing at all and potentially trip the leverage/asset coverage regulations, which can have a multitude of implications for loan covenants, borrowing and dividend paying.

Investors seem to have appreciated the update, pushing up NMFC’s stock price from $8.74 in mid-week to close at $9.02.

That’s a 3.2% increase in what – as we’ve seen – was a down week for most BDCs.

Tender

Also noteworthy this week was the decision by the new owners of THL Credit (TCRD) to proceed with a promised share buyback.

Back in April, First Eagle and TH Lee purchased $30mn of freshly minted TCRD shares at their then book value price of $5.34.

This boosted TCRD’s balance sheet and liquidity after many quarters of shrinking net assets.

In fact, between IVQ 2017 and IQ 2020 TCRD’s net book value per share dropped (50.3%) to $5.22.

That was the fifth largest percentage loss amongst the 46 BDCs we track.

Just in the IQ 2020 net book value per share went down (31.7%) – the fourth largest quarterly drop of any BDC.

Now TCRD will be taking $20mn of that valuable capital and buying back shares at a price of $3.25-$3.75.

The amount to be used for this buyback was supposed to be $30mn, but has been reduced by one-third to provide the BDC with needed capital and liquidity.

Critique

From the BDC Reporter’s perspective none of this makes much sense from a shareholder’s standpoint.

Yes, current shareholders will be able to “get out” at a price better than what TCRD was trading at before the Modified Dutch Auction was announced, which was just below $3.0 a share.

Still, that’s (40%) below the value ascribed when First Eagle bought in and (50%) below the price at the beginning of the year.

Moreover, this robs TCRD of $20mn of critical capital and liquidity even as its Revolver is being downsized and many of its investments remain illiquid.

If Anybody Asks

To our mind, if the new manager is confident about being able to fix what ails TCRD, shareholders would have been better off if the capital was retained and productively deployed.

Once a turnaround had been achieved a stock buyback – if even necessary – could have been undertaken at a substantially better price range than $3.25-$3.75.

In any case, for a once proud and popular BDC which peaked at a price of $17.00, this loss of 4/5ths of its market value is another sad story.

TCRD remains one of 11 BDCs that we expect to STRUGGLE in the medium future to justify its existence.

The Modified Dutch Auction only increases our concern.

Unremitting

We’ll close by returning to one of our regular themes: BDC credit quality.

This week, we’ve identified only one new BDC-financed company filing for bankruptcy protection: General Nutrition Inc. on June 23.

However, on Friday we wrote in the BDC Credit Reporter about Mood Media, which is already planning a filing in July.

This will be a “Major” bankruptcy by our standards – i.e. over $100mn of BDC capital at risk.

Then there was a downgrade at Electronics For Imaging, where $84mn and 4 BDCs are involved.

That’s just a selection from the two dozen companies which the BDC Credit Reporter updated the status of in its database this week.

Through A Glass Darkly

Credit trends – and the number of underperforming companies and assets continue to increase even as a few businesses restructure and exit bankruptcy, like Foresight Energy.

Based on where BDCS sits currently, the markets seem to expect the public BDC sector to lose 33% of its equity market value from the level at February 20, 2020.

At one point that might have seemed like investors over-reacting to the Covid crisis.

Now, we’re not so sure.

However, we will need at least a couple of years to determine how many of the prospective losses go the way of General Nutrition, Mood Media, AAC Holdings and all the rest.