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BDC Market Recap: Week Ended July 7, 2017

BDCs:
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NOWHERE

If we told you the BDC market went nowhere last week, would you be surprised ?

Of course, that’s what happened for an eighth week in a row.

BDCS was at $22.71 versus $22.73 last week.

As this chart shows, BDCS is off just (0.39%) from the May 9, 2017 level.

19 BDCs ended up trading over their 50 Day Moving Average and 14 above the 200 Day.

Last week the respective counts were 18 and 15.

(Back in our Recap on May 12th, when we wrote a long review of the 2016-2017 BDC rally, the numbers were 13 and 28).

MAJORITY NEAR THEIR HIGHS

Of the 46 BDCs we track, 26 are still within 10% of their 52 Week Highs versus 25 last week.

Conclusion: Investors are not willing to sell the “better” BDCs, but new investors are not willing to bid up for them either.

A FEW SPECIFICS

Top of the table in the 52 Week High category was PennantPark Floating Rate (PFLT), just half a percent off its highest level and up 0.26% on the week.

MVC Capital (MVC)  was the silver medalist and was buoyed by the successful sale of its utility subsidiary, but only moved up 0.9%.

Even Fifth Street Finance (FSC) – last week’s Biggest Winner on the back of the news of an impending change of Investment Advisor – was slightly off this week.

YOU HAVE BEEN WARNED

FSC and sister BDC Fifth Street Senior Floating (FSFR) could go sharply either way next week with the enduring radio silence on that big change, as we’ve warned.

NOW FOR SOMETHING COMPLETELY DIFFERENT

Down at the bottom there are 11 BDCs (nearly a quarter) less than 10% off their 52 Week Lows.

Ten was the number last week.

However, if we eliminate BDCs also within 10% of their 52 Week High (this is a narrow range BDC market) the number is 7.

What’s interesting is less the presence of long time price under performers like Garrison Capital (GARS) and KCAP Financial (KCAP).

UNEXPECTED GUESTS

We’re noting the presence amongst the Sad Seven of well regarded BDCs like FS Investment (FSIC) and Triangle Capital (TCAP).

And Hercules Capital (HTGC).

FSIC is down (11%) since suggesting on February 20, 2017 its dividend might be reduced. TCAP also began to drop on that same day and is (9%) down since.

We assume the market is uncertain about dividend sustainability in both cases in the months ahead. The two BDCs are yielding about 10%, which suggests the markets have doubts.

(For a BDC example where the market has no doubts -rightly or wrongly- look at GBDC, GSBD, TCPC or MAIN. There the yields range between 5.8% and 7.8%. High flying PFLT is at 8%.

HTGC has its own narrative. This week we learned very little from a corporate press release, but the market appears to be worried about pace of investment activity and the unresolved change of advisory status.

MARKET RHYMES

Here’s what the market seems to be saying – stated alliteratively:

“If they’re strong, hold on”.

“If you have doubts, sell them out”.

OPENINGS

For investors looking for buying opportunities in a BDC sector just (4.1%) off its May 2, 2017 high that’s creating a few Watch List opportunities for buyers not interested in buying at the highest highs.

VERY DEAR

Nonetheless, this remains a very expensive market by the BDC Reporter‘s lights.

We’ve “fair valued” every BDC using an 8% discount rate and adjusting for expected dividend performance over the long term (i.e. risk adjusted returns) and find exactly zero stocks trading in the green.

(That’s what we do with our time when not writing BDC News Of The Day and all that other content for the BDC Reporter).

Some BDCs are trading at 30%-50% over what we would pay…

COMING OUR WAY ?

The “good news” ? There are 9 names within 10% of our Fair Value Price and 6 of those are BDCs we’d be willing to own for the long term if they came available.

We’re crossing our fingers.


NEUTRAL

As we’ve mentioned before, BDC Baby Bonds are stuck in neutral as well.

The median price on our list of 34 issues was $25.59 last week, and $25.60 this week.

CEF Advisors oft-mentioned Baby Bond Index was up 0.09% on the week and 0.84% on the month.

15 and 19 Baby Bonds on our list were above their 50 Day and 200 Day Moving Average, similar to the last few weeks before.

Likewise, those other metrics we pick away at every week were very stable.

6 issues traded at $26.00 or higher and only 1 traded below $25.0 par.

MAKING OUR LIST

We have money to spend in a couple of our portfolios so we’ve been using the opportunity to re-check each Baby Bond issue before we go on a buying spree.

It’s like checking your tires and oil levels before a long trip, even if your car has been performing normally.

OBSERVATIONS

We’re not quite finished, but we know many readers are very interested in Baby Bonds (we get mail to that effect) so we’ll make a few market observations.

NO BARGAIN BIN

First – and no surprise to anyone – there are no “bargains” out there. The market has been stable for months and buyers have pushed prices up and effective yields down.

Expect to achieve all-in returns of 6.0% per annum and below thanks to having to buy at a premium to par and ever lower nominal yields as BDCs trade out higher coupons for lower.

AVOID RATE RISK (AND PAY THE PRICE)

Second, there are plenty of shorter term issues still to choose from for investors shuddering at the risk of higher long term rates.

However, there is also a great risk of being redeemed at any time as most of the issues maturing in the next three years have passed their non-redemption date.

You can invest in XYZ Note today and find out the next day the BDC will be redeeming the whole issue (or even  portion as KCAP Financial just did with KAP) within a few weeks.

You paid a premium to par and you’ll be getting back only par and very little interest. Net result: A small loss and hard feelings.

As we said, we’re still working on our lists but there are at least twenty issues which fall in this category of Redemption Beware.

Would-be investors are going to have to assess what the likelihood of early redemption is and invest accordingly. The downside is not huge but nor is the upside on these shorter run remaining Notes.

EMBRACE RATE RISK (AND PAY A DIFFERENT SORT OF PRICE)

Some investors gravitate to the somewhat newer and longer term issues with maturities to 2023 or beyond to avoid this imbroglio.

Unfortunately, the market is very efficient and those issues tend to trade at higher premiums to NAV.

You’ll get your interest for longer but with a lower yield and not all your principal back somewhere in the next decade.  The total return will probably be the same or thereabouts.

We don’t get too scientific because when a Baby Bond will get redeemed is a moveable feast. None have gone to their nominal maturity yet.

CREDIT ? WHO CARES ‘BOUT THAT ?

As to issuer credit quality. The subject matters when the issue first gets priced and come to market.

Ares Capital (ARCC) – by way of example – is going to borrow at a much better rate than a minnow like Harvest Capital (HCAP).

In the secondary market, though, issues like redemption dates are the drivers of price change, not credit quality.

Many a BDC has had a dreadful quarter from a performance standpoint and seen its stock price drop like a stone while its Baby Bond remains unfazed and unchanged.

(One of the few exceptions was Medallion Financial’s Baby Bond with the ticker MFINL. Investors digging into the filings realized there might be little in way of assets to support the Notes if the issuer went Chapter 11 as feared.

Even there, the price of MFINL has clawed back up as the odds of a bankruptcy or other credit disaster appears to have receded).

FEET OF CLAY

There are other non-bullet proof BDC Baby Bonds out there which might suffer if their issuer went to the wall but the market will not reflect that till something very untoward happens.

With the warm and inviting environment for credit right now there are no examples to point to.

The BDC Reporter does have a small list of “Baby Bonds We Wouldn’t Want To Own If The Issuer Tanked” but that’s a state secret.

TEACHING MOMENT

We mention this to point out i) we like making lists ; ii) the number is small; iii) notwithstanding current prices, not all Baby Bonds will play out the same way when and if their issuer gets into trouble.

Much delving into the financial performance and corporate structure of each issuer is needed, and then there are unknowables as to what sort of crisis may topple or trouble the BDC and how its creditors may or may not respond.

BDC Baby Bonds are not U.S. Treasuries and risk remains, even if today’s prices appear to suggest otherwise.

It’s a Good Thing for the BDC Reporter and keeps us gainfully employed analyzing “What If” scenarios. As we all know, there are many “What Ifs” out there.

CONCLUSION

BDC Baby Bond prices remain stable and all priced within a very narrow range of about 4%-6% of each other, with the variation more to do with technical factors than credit risk.

If and when the market and credit environment shifts expect BDC Baby Bond prices to trade with much greater dispersion.

Most all of them are likely to survive most any normal financial crisis but the market may have its moments of indiscriminate great doubt in the future in the same way that it has no such concerns right now.

As we’ve said before: investing is hard but looks easy.

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