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BDC Common Stocks Market Recap: Week Ended November 29, 2019

Posted on December 2, 2019

BDC COMMON STOCKS

Back

As readers will know, the BDC Reporter has been on a forced hiatus for a few weeks.

We last wrote a BDC Common Stocks Market Recap in the week ended November 1.

Starting on Monday of this Thanksgiving week, we’ve been back to tracking everything that happens in the BDC sector and are in a position to resume these recaps.

Higher And Higher

While we’ve been out of commission, the BDC sector continued an upward surge that began in October.

This holiday-shortened week, the sector – as judged both by the UBS Exchange Traded Note with the ticker BDCS and by the related Wells Fargo BDC Index – reached new heights.

Not coincidentally, so did the major stock market indices.

The S&P 500 was at its YTD and all-time high on November 27 before dropping slightly on Friday.

Almost following suit was BDCS, which closed at $20.23, very close to the YTD high reached intra-day at $23.31.

On the week, BDCS was up 2.7%.

The Wells Fargo BDC Index was at a YTD high of 3,140.98, and up 1.0% for the week.

Back on November 1, that “all-in return” BDC indicator was at 3,066.91.

Like A Bird. Or A Rocket.

Most every other metric we use for our weekly insight supported a sector in full upward flight, to use as poetic a description as we can muster.

41 of the 46 public BDC stocks we track were up in price on the week, and only 5 down.

Of those in the black, a remarkable 13 were up 3.0% or more and none were down by (3.0%) plus.

To underscore that investors are in an optimistic mode, we note that 18 BDC stocks are trading within 5% of their 52 week highs.

Last time, we were “recapping” the number was six.

At the bottom of the table, there are only three BDCs trading within 5% of their 52 week range, versus eight on November 1.

Not There Yet.

However, while the BDC sector has been having a good run the minute we were not able to keep a close eye, we’re not yet in full “rally mode”.

Using a 50 Day Moving Average, 36 BDCs are trading above and 10 below.

The 200 Day equivalent is more mixed with 29 up and 17 below.

Furthermore, the number of BDCs trading above book value has not changed since the beginning of November, remaining at 17 with 29 still trading below book.

If we compare individual BDC stock prices as of Friday November 29 to February 22 of this year when the sector peaked, we find that 16 are up but twice as many are still lower: 30.

(That statistic surprised us so much we went and double-checked our database to be sure).

Strange-ish

Investors who are long the BDC sector will probably not want to look a gift horse in the mouth, but this late year surge is a little peculiar, and may not be sustainable.

We’re almost done with BDC earnings season (only Medley Capital has not reported and we don’t think shareholders should hold their breath) and the results have been mixed at best.

The BDC Reporter tracks all sorts of data and a telling one is that only 9 of the 45 BDCs that have reported saw their book value per share increase.

35 were down and 1 was flat.

Last quarter 16 were up and in the first quarter 18.

Headed South

We’re still evaluating the overall financial results of every BDC and publishing our findings and rating (GOOD/MIXED/POOR) but we already know many BDCs under-performed in the quarter ended September.

Most notable was Oxford Square (OXSQ), whose book value dropped nearly (15%) in one quarter !

That’s proof positive – if any more was needed – that investing in CLO equity can result in highly volatile results in a very short period.

OXSQ’s book value per share has dropped (28.2%) since December 2017, despite having only one loan on non-accrual.

Garrison Capital (GARS) saw net book value drop from $10.30 to $9.09, a (12%) drop.

Since the end of 2017, the GARS NAV Per Share is off (27.1%).

Also struggling by this 7 quarters key metric are Capitala Finance (32.4%); Portman Ridge (27.1%), OHA Investment (25.7%) and THL Credit (20.6%).

(BTW: since December 2017 only 14 BDCs have managed to increase their book value per share and 32 have registered a loss, 13 of which are greater than 10%).

Sweet And Sour

Elsewhere, there has been a definite trend of BDCs performing well from a recurring earnings standpoint – usually fueled by higher investment income from larger portfolios funded by debt borrowings- but reporting offsetting (or worse) realized and unrealized losses.

The culprit: a broad deterioration in credit quality, resulting in higher write-downs despite boosts to NAV from buybacks and retaining earnings.

Admittedly, we’ve not had much in the way of BDCs reporting unusually high levels of credit disasters at the same time as occurred to PennantPark Floating Rate (PFLT) earlier in the year.

Those sudden change of fortunes can permanently affect a BDC’s fortunes, as we’ve witnessed in the past with Fifth Street Finance; MCG Capital; Triangle Capital,  OHAI and several others.

Boomerang

(To their credit PFLT has been able to weather its sudden run of credit bad luck – announcing 4 non accruals at the same time – with only a modest impact on its stock price following an initial (18%) price drop.

The chart below shows how PFLT’s stock price fortunes have changed YTD, including its recent rekindling of investors affections:

Feel The Heat

From the BDC Reporter’s perspective, though, more insidious (i.e. worrying for the future) is the kind of broad based credit weakening we’ve seen of late.

Like the proverbial lobster in the slowly warming pot, the risk is that BDC investors may not catch on to the dangers that could lie ahead.

Based on our daily research into the credit worthiness of the 3,000 plus BDC portfolio companies and the several hundred under-performers we track, there is reason to be alert.

We’ve moved from a time when credit troubles were “idiosyncratic” and concentrated in only a handful of the industry’s lenders.

Now, virtually every BDC has a growing proportion of under-performers on its books.

The large number of BDCs reporting lower book value is just one of many warning signs.

We’re also hearing from multiple asset managers that there’s a slowdown in sales and EBITDA growth in their portfolio companies.

Counter Intuitive

Given this, we’re surprised that BDC investors – judging by the recent boost in prices – seem to be getting more optimistic at this stage.

As we’ve said in the past, this may have more to do with the general outlook – where we are at all-time highs – than with what’s happening in the BDC sector itself.

For example, we calculated this week-end estimated BDC earnings growth between 2019 and 2020 using the latest analyst estimates and found that in aggregate, NIIPS are expected to decrease (0.11%).

Half the players are expected to increase their recurring earnings and the other half remain unchanged or drop.

On the other hand, total portfolio assets and debt are expected to increase by a double digit percentage – according to our analysis.

This means risk will be increasing while return is expected to be flat.

Those are hardly the classic ingredients for a price rally !

Alternatives

It’s possible that the canny market has calculated that the recent tick up in troubled credits is only a passing phase and will be shortly remedied.

Or investors – in a low yield world – are more appreciative of the high yields available in BDC-land.

Only time will tell us if investors had reason for this late year optimism or not.

 

– Nicholas Marshi, BDC Reporter


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