BDC Common Stocks Market Recap: Week Ended September 3, 2021Posted on September 7, 2021
BDC COMMON STOCKS
Week Thirty Five
Coming To A Close
Unofficially, this was the last week of summer for Americans – and for the markets.
This is typically a time when many stock market participants are on vacation; trading volumes are lower than usual and little tangible activity is underway.
There are exceptions to this rule, but not in 2021 where the BDC sector is concerned.
This week, the UBS Exchange Traded Note with the ticker BDCZ, which owns virtually all the sector’s public stocks, moved up in price, but only modestly: by 0.25%.
Trading volume was beneath its daily average 4 days out of 5.
Going by the Wilshire BDC Index, using the “total return” calculation, the increase in the BDC sector was only 0.19%.
18 individual stocks were up in price or flat versus the week before, and 23 were down.
Only 3 BDCs increased by 3.0% or more in price and 2 were down by (3.0%) plus.
The number of BDCs trading above book remained unchanged from the week before at 20.
The little that was notable was that two BDCs reached new 52 week highs this week.
Both the BDCs involved – coincidentally or otherwise – were smaller cap players focused principally on the middle market.
Impressively, Fidus Investment (FDUS) reached a high of $18.16. As this chart below shows, that’s almost a 5 year high for FDUS :
The BDC went public in 2011 at $15.00 a share and – for a brief period of elation in late 2013 to early 2014 – traded above $20.0.
BTW, FDUS currently trades at a multiple of 11.6x projected 2022 Net Investment Income Per Share.
Change Of Plan
Also reaching a new 52 week high – as well as the highest point since becoming a debt-oriented BDC – was Capital Southwest (CSWC), topping out at $28.33.
That occurred intra-day on Friday when CSWC announced an increase in its regular distribution AND a big jump in the “special” payout the BDC has been paying since 2020.
However, CSWC closed the day at $27.62.
Investors might have begun to recognize that the announced increases in the two sorts of distributions might have a downside.
Before this latest announcement, CSWC has been paying out a “regular” quarterly dividend, last set at $0.44.
Also being paid every quarter was a “supplementary” distribution of $0.10 from the net proceeds of realized gains achieved.
This was a “program” that began back in mid 2018, kicking off with a $0.60 supplemental, which then downshifted every quarter to $0.10.
If our numbers are right – and including the big payments in 2018 and the $0.50 per share scheduled now for the IVQ 2021 – CSWC will have paid out $2.40 in “supplementals”.
The bad news ?
That $0.50 over-sized supplemental dividend coming in December is the last one shareholders will be receiving.
By our count that will bring total distributions in 2021 to $2.5600, substantially higher than the $2.0400 in 2020 (but below the $2.7200 in 2019).
More importantly, with no supplementals scheduled for 2022 on, even with the increase in the regular quarterly distribution, the likely total payout should drop.
Our estimate is for calendar 2022’s total CSWC payout to reach $1.88-$1.92.
The analyst consensus is for $1.80 in pre-tax earnings per share in FY 2022 and $1.92 in FY 2023.
Of course, there could be non scheduled supplemental top ups , and we’re not clear how much in the way of undistributed taxable income CSWC retains, but it seems like shareholders will have less jingle in their pocket going forward.
That might mean a drop in CSWC’s stock price after the record date of December 14, 2021 when $0.97 in distributions happens.
At the moment, CSWC is trading at 14.4x FY 2023 projected earnings and a 67% premium to NAV.
However, we’re not sure that CSWC has handled its dividend policy optimally with this sudden end of the supplemental program, disclosed in an intra-quarter press release rather than on a conference call.
We shall see by the end of the year if this causes a major defection amongst shareholders not sure what the future might hold.
Little Of Note
Otherwise in terms of news during the week there was little to write about.
We did get quarterly dividend announcements from PennantPark Investment (PNNT) and Monroe Capital (MRCC).
We continue, though, to be concerned about the “sustainability” of MRCC’s dividend going forward, despite this sixth distribution announcement in a row.
The BDC is saddled with 12 non performing loans out of 85 portfolio companies.
Moreover, IIQ 2021 Adjusted Net Investment Income Per Share (NIIPS) was just 100% of the distribution, and that was after the manager waived $0.420mn in fees to make its bogey.
Even then, a good portion of those recurring earnings were in the form of pay-in-kind income (i.e. non cash).
If you deduct PIK income from Adjusted NIIPS, MRCC is earning on a pro-forma basis $0.16 – or just two-thirds of the distribution.
Moreover, MRCC’s regulatory leverage is over 1x, not far off its self imposed 1.1x-1.2x limit, leaving little room to boost earnings by increasing assets under management.
The analysts are projecting earnings of $0.99 per share in 2021 and $1.00 in 2022, hardly an expectation of material growth.
To be fair and balanced, MRCC’s management does not seem concerned about its ability to “cover” its distribution with earnings.
The subject was – briefly – addressed head on during the most recent conference call:
“When considering our targeted leverage and the current credit performance at MRCC. We continue to believe that on a run rate basis, our adjusted NII can cover the $0.25 per share quarterly dividend without significant fee waivers in the future, all other things being equal”.
Maybe management hopes to convert non performers back to accruing status. We’ll address that possibility when undertaking a credit review of the BDC.
Anyway, at the moment MRCC is trading at $10.74, or 10.7x projected future earnings and the dividend. The 52 week high was $11.71.
The stock trades at a (5%) discount to book value.
The above metrics suggest the market is relatively optimistic about MRCC’ s earnings and dividend “sustainability”.
However, if our skepticism proves well founded (our internal projection is for a drop of the dividend to $0.90 per annum, but the move could be more substantial) expect a material price drop.
Rightly or wrongly, the BDC Reporter expects a change in market sentiment in September, as summer fades away.
Looking up from our week-by-week analysis – as this chart shows below – the BDC sector (as measured by BDCZ) has been in a holding pattern since late May where prices are concerned – fluctuating in a narrow range of 0%-6%.
At this point, BDCZ remains only (2.4%) off its 52 week high set in June, and 35 BDCs (85% of the universe) are within 10% of their 52 week highs.
As mentioned earlier, half the BDCs out there are trading above book value even as that quarterly metric continues to increase for virtually everyone.
We’ve been tracking the number of above book BDCs weekly for years (since 2018 to be specific) and this is one of the best results we’ve seen.
Which is all to say that with BDCZ still up 22% in 2021, the sector continues to fly high.
The $64,000 question is whether the BDC sector can move higher after these several summer months on a plateau, or is this as good as it gets ?
Of course, BDC investors – whose long term return comes principally from collecting distributions – will probably be perfectly happy with the status quo.
Should prices remain unchanged we expect the Wilshire BDC Index for all of 2021 – using the “total return” calculation – will close the year close to 38%- 40% up, from 33.2% currently.
Even statis would result in an excellent year for the BDC sector.
As we’ve indicated before, the BDC Reporter is expecting sector prices to do even better than that.
Our instinct is that we may see BDCZ move up beyond the current 52 week high.
A 5% increase would bring the ETN to $21.30 a share, a less likely 10% boost would bring BDCZ to $22.32.
If that should occur AND sustain itself through the rest of the year – the total return for the BDC sector could be an astounding 50% or thereabouts.
On the other hand, we realize that all the major indices are at nose bleed levels and everywhere we turn a strategist is predicting a market crash of monumental proportions.
Unquestionably, if general investor sentiment turns dark there is no doubt the BDC sector will follow suit.
Our little corner of the financial sector is not immune to the larger forces at work.
Some or even all the year’s gains could be wiped out in a major market reversal, as has happened out of a clear blue sky before (think summer 2011 and February-March 2020).
Less dramatically, even a modest increase in short term rates (much discussed but still not happening) could push market prices down from the current highs.
All the above – and many other scenarios we’ve considered – notwithstanding, the BDC Reporter continues to plump for a higher BDCZ as the most likely scenario in the fall.
Fundamentals have rarely been so favorable for the BDC sector and credit conditions so positive, thanks to the billions of dollars the Fed has poured into the economy.
Then there’s continuing high demand for leveraged debt, caused by those very same factors.
More intangibly, BDC managers across the spectrum – with only a few exceptions – are behaving reasonably and sensibly, keeping their eye on their long term viability.
Maybe the potential earthquake of trouble that occurred in the early days of the pandemic – largely avoided subsequently thanks to the Fed – has kept BDC managers humble and careful.
Never in the history of the sector have BDC balance sheets – thanks to a very large proportion of covenant-lite unsecured, medium term debt added in the last year – been this strong.
Nor have borrowing costs for BDCs ever been this low.
Also – more subtly – there has been a secular shift by the larger BDCs towards investing in first lien debt which they have originated, at the expense of second lien.
That’s no guarantee against borrowers getting into trouble but places the BDCs involved increasingly at the table as the lead secured creditors when any restructuring or bankruptcies are concerned.
Today’s troubled loan can become tomorrow’s successful recovery, as we’ve increasingly witnessed of late if you’ve been regularly reading the BDC Reporter and BDC Credit Reporter.
With nine tenths of BDC investment assets held by $1.0bn+ BDCs (there are 20 of them) and most of that in first lien loans, the risk of catastrophic credit losses has reduced by comparison with – say – during the Great Recession.
All this won’t mean a fig for BDC stock prices in the short run if there’s a general run for the exits but, over time, for patient investors (with nerves of steel) these factors will matter.
Less Is More
There should be less needs in the years ahead for sudden dilutive Rights Offering or the sale of stock below NAV; less panic selling of assets to keep leverage within guidelines and – most importantly – less in the way of credit losses.
Plus, with many of the weaker BDC players closed down or absorbed by bigger, stronger asset managers, investors should face less situations like those engendered by Fifth Street Finance, Capitala Group; MCG Capital and Medley Capital.
(Note we did say less – not none – because a number of under-capitalized BDCs with questionable business plans remain active. The winnowing process continues).
Anyway, let’s circle back in a few months to see which way the markets and the BDC sector ended up going.
Even a few days or week away is a dark and unknowable territory.
We will need the bright light of hindsight to tell the story.
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