BDC Market Recap: Week Ended March 10, 2016
Week 10 saw volatility return to BDC securities prices in a big way.
The UBS Exchange Traded Note with the ticker BDCS, which we use as our rough guide to the sector as a whole, was up and down.
Monday was up, Tuesday-Thursday down, and up again on Friday. See price table.
From highest to lowest point, BDCS dropped (2.7%) intra-week to reach $23.04.
From Friday close to Friday close, BDCS was (1.4%) off.
At one point on Thursday, BDCS had given back 5 weeks of gain, and still ended at a one month low.
Readers of the BDC Reporter would not be terribly surprised as this was Week Two of the current pull-back, which we signaled last week.
Just 22 of the 45 BDCs we track are trading above their 50 Day Moving Average. Last week that number was 33.
Still, 34 are trading above the 200 Day Moving Average, but that’s down from 38 a week ago.
Likewise, the number of BDCs trading within 10% of their 52 Week High-which we use as an indicator of investor enthusiasm-was down to 33 from 35 and 39 the week before that.
COMPLICATING THE PICTURE
However, as we all know there are “lies, damn lies and statistics” so note that 12 BDC stocks are still trading within 2% of their highs.
Newtek Business Credit (NEWT), a fish out of water BDC, announced earnings and saw its price reach a 15 month high on the week.
TPG Specialty (TSLX), too, is at heights not seen since July 2014.
BACK TO FOUR
For a short time there were only 2 BDCs trading within 10% of their 52 Week Low, and as we explained last week one of those was a statistical anomaly.
However, we are back to having 4 under-performers this week:
Great Elm (also 6% off its 52 Week High), Fifth Street Finance (still in the dumps), OHA Investment (waiting on IVQ results) and Horizon Technology Finance.
Only the last one with the ticker HRZN had much new to report in the week. HRZN maintained its recently cut distribution but did not endear itself to investors.
The stock dropped $1 from $11.33 before the earnings release.
WHERE ARE WE HEADED ?
As always, it’s hard to tell if this two week downward shift is just the pause that refreshes or an early indicator that investors should be putting away their rally hats for awhile.
If our hunch is right that BDC investors are counting on higher earnings from an increase in interest rates they received confidence boosting news from the apparent certain increase in the Fed Funds rate this month.
That’s probably already baked into prices. However, should the upward trend in short term rates appear to be set to continue, that might give a fillip to investors looking for an easy income boost.
(The BDC Reporter is on the record as saying that any earnings boost from the Fed’s moves will be eaten up in different ways over the medium term, but in the short term a press release gilding boost is possible).
WHAT IF SHORT TERM RATES STALL ?
If the Fed raises and stops most BDCs will have higher interest expense and very little extra investment income thanks to all those loan floors and a dog-eat-dog pricing world to contend with on existing loans.
WASHINGTON IS QUIET. TOO QUIET.
No word on legislative changes has reached the BDC Reporter’s ears, but we have not dug very deep to find out what’s happening in those smoke-free conference rooms in Washington.
The BDC Reporter has doubts about the continuing nature of the BDC price rally, but is not ready (as we mistakenly did just before the election in November 2016) to call an end to an upward path that began 13 months ago.
WHOLE LOT OF SHAKING GOING ON
BDC Baby Bonds got roughed up in Week 10 of 2017.
The median price of the 35 issues we track dropped to $25.55 from $25.69, or just over (0.5%), and only a third of the drop in BDC common stocks.
Nonetheless, there was a negative shift in market tone, even if prices moved up on Friday.
MOVING AVERAGES DOWN
For the week, two thirds of the Baby Bonds we track were trading below their 50 Day Moving Average. Last week, 2/3rds were trading above…
More than half are also trading below the 200 Day where last week less than a third showed red ink by this measure.
Where we had no Baby Bonds trading below $25.00 par (except for Medallion Financial ‘s Unsecured Notes), we now have 3 (including MFINL).
The two additions are both from Fifth Street, but their price drop may have more to do with interest rate than credit risk, as both are longer dated issues.
STATING THE OBVIOUS
Of course, the likely reason for the price drop in Baby Bonds is the well covered increase in longer term rates.
The 10 Year Treasury went up from $2.48 to $2.62 on Thursday before settling at $2.58. The 5 Year Treasury yield went up even more in percentage terms.
As usual there’s a push pull between investors willing to pay up for what are seen as credit safe BDC Notes (part of the general sense of confidence about risk in the debt markets) and the possibility of being stuck for years with lower yielding instruments than what’s available in the market as interest rates rise and borrowers pony up higher yields for new issues.
INTEREST RATES RULE
The BDC Reporter believes the increase in Baby Bond prices due to credit confidence has pretty much run its course and the direction of interest rates will be the bigger deciding factor going forward.
OR DO THEY ?
However, we are not overly concerned that BDC Baby Bonds will join in the implosion in bond prices that some commentators are projecting if long term rates continue to rise.
(Here’s a great article culled from Zero Hedge quoting Albert Edwards of SocGen-and apparently an alumni of my old alma mater Kleinwort Benson-using terms like “bond market bloodbath.”)
More than a third of BDC Baby Bonds mature in the next three years, and two thirds in the next 6 years.
Moreover, even if rates rise, a number of those issues (including the longer term Notes) are likely to be redeemed anyway before their final maturity.
COST SAVINGS EXERCISES
It’s got to do with the how BDC managers are seeking to maintain their distributions in an increasingly difficult environment.
(We’re talking about lower spreads on loans which affects every BDC and credit problems, which affect about half).
Many BDCs have found that repaying their expensive Baby Bonds is a good way to reduce costs (Revolver expense can be 3%-4% cheaper) and keep their distribution intact.
Ironically, the weaker BDCs are amongst the most interested in paying down their expensive capital regardless of what the 10 Year Treasury is doing for obvious reasons
We refer readers to Apollo Investment, TICC Capital, Fifth Street Finance, KCAP Financial, and Pennant Park Investment-all of whom have paid off (or plan to) some or all Unsecured Note or Convertible issues in recent quarters.
EVERYBODY IS DOING IT
However, even successful BDCs can change their attitude towards issuing Baby Bonds.
Ares Capital boosted its earnings by redeeming some of its bonds when lower income from its GE JV threatened to materially impact profits, which seems to have paid off for the high flying BDC.
Newtek is doing well (see above) and wants to reduce the high interest cost from its two public Notes.
BABY BONDS UNDER THREAT ?
In the BDC Reporter’s view, the greatest risk to BDC Baby Bond investors is an existential one:
Will changes in BDC strategies and in the capital markets result in a massive redemption of the three dozen publicly traded Baby Bond issues out there in the next several quarters ?
That would be a great shame for investors who want exposure to the BDC sector but seek to avoid much of the credit risk and price volatility involved.
It’s out of investors hands (BDCs are going to do what BDCs are going to do).
Until we get clarity (and that will take several years), the BDC Reporter will continue to provide this riveting weekly play-by-play of what’s happening to BDC Baby Bonds.