BDC COMMON STOCKS

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With every BDC except Capital Southwest (CSWC) having reported earnings, investors and analysts had time to mull over IQ 2020 results.

Apparently, their almost unanimous conclusion was that BDC stocks are undervalued.

This caused the BDC sector to move up 8.6% on the week, using BDCS as our measuring stick.

That was the biggest single positive weekly move since April 9 and brought BDCS back to the level in mid-March.

Happy Days

44 of 45 individual BDC stocks were up in price on the week.

Of the 44, a remarkable 43 were up 3.0% or more.

Furthermore, 19 went up 10% or more, headed by Capitala Finance (CPTA) which went up 19.6%.

Furthermore, the number of BDCs trading over book value increased to 5 from 4 the week before and 1 two weeks ago.

Exception

The only BDC not invited to the High Hopes party was Medley Capital (MCC), down (6.6%).

As always, we heard nothing new from the management and Board of the worst performing public BDC and the only stock trading under $1.0 a share.

Where We Are Now

Since the beginning of the Covid-19 crisis, which we’ve established as beginning on February 21 for the BDC sector, BDCS is down roughly by a third.

As we’ve shown in the BDC:NAV Change Table and mentioned last week, BDC investors may be reassured by the fact that 27 of 45 BDCs have not reduced their distributions.

Or that the average drop in book value per share – now that Apollo Investment (AINV) has reported its latest results – is only (15%).

Way Off

Where only a few weeks ago most every BDC was making unfortunate new all-time price lows, that’s been completely turned around.

No BDC – even those which have reported huge drops in book value or in dividend outlook – is anywhere nears its lowest point.

This week’s price leader CPTA reported a (31%) decrease in book value in the first quarter and that a fifth of its portfolio companies were on non accrual.

PennantPark Investment (PNNT) , whose NAV dropped (12%) and who cut its dividend, still managed to post a 17% price increase this week.

Those are just two examples amongst many.

We calculate that on average BDC prices are 81% above their 52 week lows…

Lesson

That demonstrates above all else how panicky investors were just a few weeks ago.

With a clearer head; much of the bad news already out there and with money to spend BDC investors are back in a buying mode.

What’s more, there’s plenty of room for prices to rise.

We calculate that for BDCS just to move back to 85% of its price on February 20 – before the virus struck – it’s price would increase by 29%.

Cold Water

With all that said, the BDC Reporter does not share the optimism of the markets when we peer – as best we can – into the rest of 2020.

This skepticism comes from our assessment of the prospects of each BDC out there – except CSWC – that we’ve been totting up on the BDC: NAV Change Table.

Paying Out

We’ve been estimating – from everything we’ve heard from the BDC managers – what the dividend outlook looks like through the end of the year.

Admittedly, there are a whole lot of assumptions and inferences being made by us.

With that caveat out of the way, we currently estimate that 31 of the 44 BDCs we’ve evaluated will reduce or suspend their distribution by the fourth quarter 2020.

At the moment, we’re confident of only 13 BDCs ability to maintain their payout, half the number currently doing so.

Report Card On The Run

Even more problematically – and controversially – we’ve divided up the BDC universe into 3 categories relating to their longer term prospects as participants in this sector.

Colorfully, and in a self-explanatory manner, we’ve named the categories: Thrive, Survive and Struggle.

Best In Class

The first category we’ve reserved for those BDCs who appear to have the resources to do more than just support existing portfolio companies but – to use many BDCS favorite term – go on the “offense”.

That might involve investing in new opportunistic investments or making acquisitions and – over time – growing both portfolio and book value. 

These are typically BDCs which have plenty of liquidity and are not bumping up against regulatory or lender leverage limits and whose credit troubles are of the manageable variety.

Hold On

Then there are the BDCs who, because of some combination of liquidity challenges; leverage capacity and credit difficulties are concentrating on their existing portfolio companies.

In most cases, these BDCs will have to contend with continued shrinkage in their portfolio size; book value per share and downward changes to the level and the form of their distributions.

The watchword at these BDCs will be limiting damage with a view to returning to business as usual in 2021.

Most Challenged

Finally, there are BDCs beset by high leverage; shortages of liquidity and – typically – many credit challenges.

Their management is taking – or will shortly do so – drastic evasive action to ensure that their BDCs can remain relevant in the BDC market marketplace.

These “struggling” BDCs are candidates for acquisition; merger; liquidation or becoming  what we’ll call “BDC zombies”, just barely ticking over.

In the most dire scenarios one or more of these strugglers could even be at risk of bankruptcy, though we don’t envisage that scenario for anyone at the moment.

Summing Up

By our count only 11 BDCs are currently poised to Thrive, 22 to Survive and 11 will Struggle.

Those sorts of numbers – if correct – do not support a sustained move up in BDC prices over the months ahead.

Of course, readers are likely to disagree with the categories that we’ve placed their favorite BDCs into.

We do not pretend to be infallible, but each one represents our best evaluation based on the large amounts of information we’ve gathered since IQ 2020 results came flooding in.

Moveable

We’ll be updating our dividend projection and summary outlook in real-time through the rest of the year as new information comes in.

The BDC Reporter hopes that all 45 BDCs will be thriving and their dividends will be unchanged – or better – than they were at year end 2019 and that our concerns about so many will be unfounded.

Looking Back

Unfortunately, in every other recession lenders have – almost universally – had to absorb large losses; lower payouts; undertake much balance sheet restructuring and endure plenty of drama.

We’ve already had a great deal of that occur in the first three months since Covid-19 changed everything and it’s hard to imagine that the near future will be any different.

Based on what we know about the destruction to the economy caused to date by the closing of the country and the state of BDCs portfolio companies constituents and balance sheet, it’s hard to imagine the final outcome will only involve modest damage.

Digging In

Now that BDC earnings season is (almost) over and we’ve read every BDC’s filings, conference call transcript and investor presentation at least once, we’ve been throwing ourselves into a granular review of all the portfolios.

There are over 4,500 separate BDC portfolio companies out there and we’re working through them all, dividing them up between performers and underperformers.

This is a Herculean or Sisyphean task, depending on your perspective, and we’re only in the early stages.

Busy Time

Partly that’s because we’re busy at the BDC Credit Reporter keeping up with major developments like the bankruptcy of 8 BDC-financed companies in May so far.

Also, the sheer number of companies that were previously performing like a Swiss watch through IVQ 2019 and have now been tripped up by the crisis is huge.

Exemplar

By way of illustration, we spent most of the day reviewing the portfolio of a large BDC with a “lower risk, lower yield” portfolio of upper middle market borrowers and were taken aback by how many names we were entering into our database of underperformers.

At this pace, one third to half the portfolio will be rated as underperforming, valued by the BDC and the market at a discount of at least (10%) and sometimes much more.

We’re not naming names because the work is still ongoing and because we found the same to be true when deep-diving into numerous other BDCs IQ 2020 portfolios.

Another “hot-off-the-presses” example of higher than comfortable credit metrics can be found in the BDC Reporter’s recently published credit review of AINV.

Turn Around

Investors are hoping that the bulk of these write-downs are temporary and – like in 2016 and 2018 – the companies will be shown to perform normally and the discount will be erased in the quarters ahead.

However – and we know we’re stating the obvious – the current market conditions are very different than in 2016 and 2018 when debt prices moved down but the economy did not follow.

What happens to BDC performance this time if a quarter or a half of portfolio companies do not recover in short order and begin to descend down the credit scale towards non accrual and some sort of realized loss ?

By The Numbers

We’ve been trying to quantify the situation as best we can and have already identified 145 BDC portfolio companies that are non performing with an FMV of $2.5bn.

Just one step higher are another 159 companies, which we believe likely to result in a loss  (our “Worry List”) with an aggregate FMV of $3.5bn.

Together, that $6bn of BDC assets in distress and there’s another $7.0bn at FMV in our Watch List: companies that are under performing but where the odds of full recovery are better than ultimate loss.

All in all – and with the calculations far from complete – we’ve identified over 500 BDC portfolio companies that are underperforming with $13.0bn of assets.

To put that into context, as of Friday May 22, the market capitalization of all 45 public BDCs is just under $32bn.

Not Convinced

By our lights those numbers, and much else that we’ve seen during BDC earnings season, do not jibe with a “soft landing” for the BDC sector when this is all over.

We hope we’re wrong but we’ll continue to seek to quantify the credit challenges ahead just in case we’re right.

By the way, we intend to have completed our review of every BDC portfolio company and have updated our list of all underperformers before IIQ 2020 earnings season rolls around.

Stay tuned for regular updates as we continue our credit data gathering process.

Thank goodness we’re not allowed outside.

In all events, Advantage Data is not a broker-dealer, shall not operate as a broker or a dealer, is not holding itself out as a broker or dealer and is not engaged in the business of buying or selling securities or otherwise required to register with the National Association of Securities Dealers.