BDC Common Stocks Market Recap: Week Ended September 11, 2020

BDC COMMON STOCKS

You Go Your Way…

This was the week that the major indices – especially NASDAQ – continued to head downward while the BDC sector went the other way.

This divergence began in the last two days of the prior week, as discussed in the prior BDC Common Stock Market Recap.

The S&P 500 was off (2.51%), after being off (2.31%) the prior week.

By contrast, the BDC Exchange Traded Note with the ticker BDCS, which we use to measure price trends, was up 1.93%.

That’s back to the level of a month ago, after a little short term sagging.

All Together Now

The rest of the metrics were also favorable in most every case.

For example, 34 of the 46 individual BDCs we track increased in price or stayed put and only 12 dropped.

Amongst the stocks in the black, more than a third (12) jumped in price by 3.0% or more in a holiday shortened week with few price catalysts.

Number One

For the record, the week’s Biggest Winner in this ephemeral category was the smallest BDC of all – Harvest Capital (HCAP).

This week, the stock price – which is thinly traded and subject to dramatic price changes – was up 7.24%.

We’re not drawing too many conclusions or backing up the proverbial truck.

HCAP is the third worst performer over 1 month and has lost two-thirds of its value YTD.

Maybe somebody believes they know something favorable about the future of the BDC – currently in the process of paying off its secured lender.

Or – maybe – the price had just dropped too much.

After all, even after this price surge, HCAP trades at 32% of book value.

That’s the second worst percentage of any BDC, beaten out to the wooden spoon by perennial worst performer Medley Capital (MCC) at 30%.

Worst

Of the 12 BDC stocks in the red only one fell more than the (3.0%) threshold we like to use: Great Elm Corporation (GECC).

The BDC – undergoing a change of strategy and Rights Offering at the same time – dropped a shocking (18.4%).

This was the second week for GECC in this unwanted spotlight, but not surprising.

As we noted in our prior article the stock price of the under-performing BDC had risen hugely for no discernible reason in the weeks before the Rights Offering was announced.

As happens just about every time – and especially for BDCs in any sort of trouble – that sounded the alarm bell for shareholders and speculators alike.

With the closing of the Rights Offering still a fortnight away, GECC has dropped one-third in value from its highest height on August 7th, 2020.

This 3 month chart tells the story of GECC’s rise and fall:

Implications

The worst part of this price decline for the BDC; its shareholders; bond holders and manager is that as the price drops so do the likely proceeds from the Rights Offering.

If the price was fixed today , GECC would be getting far less than the earlier price might have suggested; making the planned shift of strategy into investing in financial services companies that more difficult.

Markets are hard to predict so we won’t rule out a change of heart as we get to the last 5 days of trading before the Rights Offering price is fixed, but we could also have a further collapse.

Public Relations

Frankly management has not – in the BDC Reporter’s opinion – done a good enough job explaining what their new strategy will look like and what will happen to the existing bond and loan investments.

The subject has been mentioned in press releases and on the conference call, but only in passing and discussed only in generalities.

To our knowledge, there’s no Investor Presentation and no attempt to educate and reassure shareholders being asked to reach into their pockets.

As the BDC Data Table shows, GECC has seen its book value per share drop (59%) since the IVQ 2017.

Shareholders have a right to be skeptical with such a track record – very different from the situation as those other Rights Offerings this year at Golub Capital (GBDC) and Bain Capital Specialty Finance (BCSF).

GBDC’s Net Asset Value Per Share – for example – is down only (12%) since IVQ 2017, inclusive of the impact of the Rights Offering.

In any case, the way in which the Rights Offering is constructed, GECC is likely to remain a feature on these pages for the next couple of weeks at least.

Looking Forward

Although the BDC sector has dodged so far the change in tone affecting the broader indices,  that’s unlikely to continue if the sense of rising dread continues.

On one hand, the weakness in the major indices could be seen as simply profit taking after a massive run-up in prices.

The BDC sector never joined in the tulip-mania going on in technology stocks and should not be affected as prices – and investors – come back to earth.

However – as we’ve seen too many times before – these market moves can gain traction and cause a broader loss of confidence dragging down everything and every one.

We’ve been promised a “Major Correction”; a drop in stock prices that will make the March drop seem like a walk in the park and much  worse besides.

(How some investors are able to invest in the face of such headlines astounds us).

It would be unwise to say that a second market shake-down is impossible.

Resilient

What we can offer readers is our view that the BDC sector is in pretty good shape should a “Second Wave” of worry hit us.

As we’ve been noting in the BDC Data Table, BDCs have been scurrying around boosting their liquidity for months.

Liquidity is the most important factor in any market crisis and most every BDC has taken precautions not to be caught short again.

(Back at the beginning of the crisis, many players were caught flat footed by what has now become the new normal).

Lenders have been roped in with amended secured borrowing facilities; large amounts of unsecured debt has been raised;  portfolios have been right sized and leverage moderated.

Should we get another stock market shock – which would roll into lower asset values and into BDC net asset values – all but a few BDCs are ready and able to cope.

Credit Picture

Furthermore – as we’ve been pointing out in recent weeks – the expected wave of credit defaults has moderated; reducing pressure on both valuations and income.

Thank the Fed; the sponsor groups and the BDCs themselves for reacting aggressively and creatively to the most unusual financial shock in this generation.

Most Of All 

The greatest kudos – as one BDC was opining this week – is due to the management of the companies on the frontline.

Faced with a fast moving and unparalleled crisis, managers moved quickly to cut costs; find new income sources; re-negotiate with creditors and find a way through.

A lot has been written – including here – about the undue burdens of high leverage portfolio companies face.

In a few cases the combination of all that debt and the sudden downturn in business caused companies to fail.

As Per Expectations

Looking back over the BDC Credit Reporter’s list of bankrupt and non performing companies since March, though, it becomes clear that most of the casualties to date were the already walking wounded.

Companies that were performing well before the crisis have – with only a few exceptions – managed to stay afloat, and largely due to their own actions.

Even those companies that failed but have robust fundamentals have been able – in almost every case –  to restructure in or out of bankruptcy and get a second life with a new ownership group.

Flexible

In many cases, those new owners include the BDCs themselves;  unabashedly willing to step into the shoes of the very owners they previously financed.

That’s why we’ve seen more companies coming out of bankruptcy than going in over the last few weeks.

Show and Tell

Monroe Capital’s (MRCC) investment in restaurant chain TooJay’s Deli – which the BDC Credit Reporter wrote about this week –  is an example.

The chain went bankrupt in April; closed some locations aided by the Chapter 11 process and has re-emerged owned by funds affiliated with Monroe Capital, including MRCC.

Let’s Get Analytical

Let’s go from the anecdotal to a more quantitative analysis, using the BDC Reporter/Credit Reporter’s unique research.

In the BDC Credit Reporter database, we’ve identified 37 companies that filed for bankruptcy since May 1, or four and a half months.

Of those, 26 (70%) were already on the underperforming company list at year-end 2019, before any crisis had concerned.

The remaining 11 became underperforming and filed bankruptcy in 2020.

Of those 11, 8 were in the already compromised energy and retail industries.

The remaining 3 were in Travel (Lakeland Tours); Auto ( APC Automotive Tech) and Healthcare (Benevis Holdings) and all were hit head on by the pandemic.

Perspective

Given that there are some 4,000 BDC-financed portfolio companies, the number of failures to date of previously well performing companies is small and the dollars involved modest.

The three companies mentioned above had a FMV of $82mn, mostly in Benevis.

[In that case New Mountain Finance (NMFC) is the lender and has already committed to fund the business going forward.This is a set-back for the BDC currently, but should Benevis be rescued over the long term should have only a minor impact on results].

Not Growing

We’ve also been noticing as we update the credit status of every BDC portfolio using IIQ 2020 data that our Weakest Links list is not growing.

A Weakest Link is an underperforming company that we expect to default and /or file for bankruptcy in the next few months.

Of late, that list has been shrinking rather than growing as we might have expected.

Partly that’s because some names have actually defaulted.

More pertinent is that very few new potential trouble spots have been turning up.

The Weakest Links is currently composed of companies that have been teetering on the edge for some time.

In total, we’ve identified only 21 Weakest Link companies and the BDC Credit Reporter may have to do some pruning as some of the companies have proven to be more resilient than we originally expected.

Phew

In a nutshell, we can say with some confidence that the overall BDC credit outlook is significantly better than we or most everyone else expected back in March or after the IQ 2020 results came out.

Which is not to say a credit downside does not exist.

Vulnerable

A large number of companies were downgraded both by the BDC Credit Reporter from “performing as expected” to “underperforming” during the crisis.

Some have been returned to “performing as expected” but plenty remain on the underperformers list, but in the highest rungs.

Should the economy fail and we get an good old fashioned recession, there’s no escaping that both these companies, as well as others, will be at risk.

Reason Why ?

At the moment, though, the credit trend is positive given the extraordinary conditions we’re living under.

That probably explains why BDC stock prices are holding up pretty well as investors do not want to give up a good thing.

Should sentiment shift from profit taking to doubt about the economic future expect BDC investors – like everyone else – to cut and run.

For the moment – and based on what we know rather than what we fear – the BDC sector is in pretty good shape.

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