BDC Common Stocks Market Recap: Week Ended March 27, 2020

BDC COMMON STOCKS

Simple

The narrative of the week is pretty straightforward: BDC common stocks hit an all-time, bone crushing low on Monday March 23, 2020 before moving back up part of the way the rest of the week.

At the very bottom, the UBS Exchange Traded Note which owns most of the stocks of the sector  – BDCS –  dropped to $8.50, down from $20.54 on February 20, 2020 – the last day before the sector was impacted by the crisis.

That was a (58.6%) drop in just over a month that will serve as the worst period for value destruction in BDC history.

Reversal

Then, BDC prices began to move like a freight train upwards, reaching as high as $13.29 intra-day on Thursday, only to slump back to $12.04 at the close on Friday.

For the week, BDCS is up 14.45%, but that number by itself does not tell the story of a market in turmoil.

Where We’ve Landed

At this point, BDCS is down (41.4%) from the starting in February.

On the week, 42 individual BDC stocks were up and 3 were down.

Whizzing Around

Like in prior weeks the percentage change in the price of many BDCs was incredible:

16 BDCs moved up 20% or more in 5 days, with the biggest mover up 58.6%.

That was Newtek Business Services (NEWT), probably because all week we heard about the SBA coming to the rescue of small business.

We doubt that investors had cooly estimated the gains and losses to be made on all the rest of the BDC’s SBA-related investment activities and discounted future cash flows.

In The Corner

Three BDCs were not invited to the party, led by OFS Capital (OFS), down (55%).

Also down were Prospect Capital (PSEC) and Oaktree Strategic Income (OCSI).

One Month League Table

That tells us little because over a 4 week period, the losses at those 3 BDCs are not even in the top 5 price percentage losers.

The wooden spoon in that category goes to Garrison Capital (GARS), off (70%).

Next is Medley Capital (MCC) off (69%) and Investcorp Credit Management(ICMB), down (66%).

Tellingly, amongst the better performers over 4 weeks is PSEC, “only” down (22%).

The median BDC price loss over the last 4 weeks is (42%)...

The range of price change over a month is (15%) – (70%). 

Damage Assessment

At this point, the worse seems to have passed, with only 6 BDCs within 5% of their 52 week lows, most which were set in the last few days.

So we’re done.

Doubt Creeps In

Or are we ?

The BDC Reporter is far from convinced that we have seen the infamous “market bottom”.

With all humility, we don’t have have a crystal ball and admit we’re in uncharted territory.

Counting The Ways

However, there are a multitude of factors that have not yet come into focus and which could go any number of ways, all of which could affect future BDC stock prices.

Most of all there’s the very thing that started off this market and economic crisis: Covid-19 itself.

All the public health officials are showing us charts with numerous possible outcomes over undetermined periods of time.

In a country as big as the USA a one month clamp-down costs a very big deal, but we could be talking about an even longer period and an uncertain and uneven return to work.

Spoilers

We are just at the beginning of the Covid-19 story and yet markets – as they have always done – are trying to suss out the ending.

Wither ?

Then there’s the impact on the economy.

Even if Covid-19 ended today, no one can really know how the U.S. and global economies will respond to this across the board cessation of economic activity.

Optimists see us all back to work and GDP growing by the third quarter, others are looking to coin a description of an economic collapse as we’ve never experienced before.

We are neither optimists nor pessimists,  nor even realists because there’s nothing to be realistic about.

The data is just not there because everything has happened so fast and is still going on and no-one knows what will happen tomorrow, let alone in the third quarter.

Feeling Our Way

As regular readers will know we’ve been trying to get our arms around what little “hard” information is out there about the economy and the BDC sector.

This week we began accumulating – BDC by BDC – all material information we’ve learned since the beginning of the crisis.

Nice To Hear From You

Several BDCs have penned letters to shareholders and other “stakeholders” in an effort to reassure.

As a perusal of any of the letters involved shows, most of the information is a reiteration of the highlights of the BDC’s strategy and portfolio as of IVQ 2019 – which now seems a universe away.

There has been very little new information divulged and nothing tangible about capital requirements; the number of portfolio companies in trouble now and those that might be later.

Payout

We know nothing – except from Great Elm (GECC) – about what happens to future dividend – both as their absolute level and what portion will be paid in cash.

Value

We don’t know how the BDCs will value their portfolio assets at the end of the IQ, or even if that valuation might be delayed till the work can get done.

Idea

There would be an elegant partial solution that Tom Barrack at Colony Capital would agree with – suspending “mark to market” accounting for a couple of quarters.

That’s essentially maintaining the same valuation of assets as existed at December 31, 2019.

That would save many BDCs from seeing their asset values and net worths plummet, and cause them to trip over the minimum 150% or 200% asset coverage rules.

In turn, the BDCs involved would not be forced to re-negotiate with their banks ; suspend dividend payouts and stop borrowing (as per the rules) or be forced into selling assets at the worst possible time.

Coming Up

Still, sooner or later, the BDCs are going to have to contend with the damage caused by the crisis on portfolio companies ability to service their debt.

We can say unequivocally that credit will not be returning – whatever scenario ultimately plays out with the virus and the economy – to the status quo ante of February 20, 2020.

One Viewpoint

Predictions exist like this one from Fitch, that we commented about in our News Feed, give you an idea of what might be coming.

“Cumulative two-year US default rates for leveraged term loans and high yield bonds are forecast by Fitch to each be near 15% in 2020 and 2021….double-digit default rates in 2021 (are) a possibility in each market.”

 

Guesswork

Fitch, though, like everyone else, is just guessing – even if a spreadsheet is throwing out what seem like solid numbers.

If anyone really could project default rates one month into a crisis like this one, then there’s the question of what recovery rates might be in a U.S. economy where everybody has similar troubles and all at the same time.

Different Philosophies

Even more insidious for BDC shareholders is how your favorite BDC manager is going to strategically tackle the likely onslaught of troubled companies.

Will there be a collegial approach, where lender and borrower keep their eye on the long term and work together to maintain liquidity and business viability ?

That might see BDCs playing the role which the U.S. Government has with the airline industry –  serving as financial savior but being paid in stock and gaining unusual controls on how the companies are run.

Or, at the other extreme, will BDCs dust off their loan documents; call their counsel and force companies into bankruptcy as soon as possible before any further resources are lost.

And if they do that, will the BDCs – and other lenders – hand over the keys and collect what they can from some new owner group getting a bargain price or serve as turnaround firm themselves ?

Three to five years from now will we see companies grabbed by BDCs in debt for equity swaps taking their now-recovered investments public and ringing the bell at the NYSE ?

The BDCs themselves do not know – even those who have fully blown philosophies about such things – because of the myriad uncertainties involved and the limited human resources and time available.

Et Tu ?

Another major element which the BDC Reporter has been fretting about all week is what role the Fed and the U.S. Government will play, or won’t.

To date, the evidence seems to suggest that the government – broadly defined – has little interest in helping the non-investment grade company sector – from which all BDC portfolio companies are drawn.

Nor is there any indication that there’s much being planned to help out the non-bank financial sector – of which BDCs are a small but important player.

We would not be the last – but we may have been the first to say  – on the BDC Reporter News Feed and occasional soap box – that the indifference from the Treasury Department, the Fed and both Houses Of Congress is deliberate.

For a variety of different reasons, each of those parties with the power to make a difference, have their reasons to stand by and do little to help leveraged companies and those who finance them.

On the other hand, if and when the distress in non-investment grade credit reaches a sufficient pitch who’s to say that one or more arms of the government will not take some action that could materially mitigate losses ?

We remember in the 2008-2009 financial crisis after Lehman was left to fail – “pour encourager les autres” – the Fed found ways to support the financial system.

Preferred Approach

All of this is in the future and as far as the BDC Reporter is concerned the best approach to all this uncertainty is to acknowledge its existence.

To our mind the markets – in terms of BDC prices – did not do that this week and are unlikely to going forward.

The result is likely to be great fluctuation in both overall sector prices and those of individual BDCs as the medical; economic; credit and regulatory situation develops.

Unlike in normal times,  we are going to get compressed into a few weeks or months the amount of important, “market moving” developments that normally take years.

Get Ready

The BDC Reporter – and its readers – is going to be kept very busy for the remainder of 2020 just trying to understand the new shape of things in every category you can think of.

Exciting, terrifying and capable of causing the BDC sector to fracture as never before or demonstrate a resilience much mentioned in this week’s BDC shareholder letters and facing a true test in a very short period.