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BDC Market Recap: Week Ended October 27, 2017

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BDC COMMON STOCKS

Whole Lot Of Shakin’ Going On

For the first week in a long time, the BDC common stocks  endured a volatile few days.

The group as a whole – as measured by the Wells Fargo BDC Index – dropped (1.8%).

If we use BDCS as a measuring stick and look at the closing prices (see the screen shot below ), there was a lower close 4 days in a row.

With BDCS closing at $21.08, we were at a YTD low on a price basis, and (12%) off the highest point in 2017.

Jumping back to the Wells Fargo Index – which calculates a Total Return – the last 4 months have been loss making.

Year To Date, the index is only up 0.98%.

Moving Around

Throughout the week, the BDC Reporter and the new BDC Daily News Table called out an unusually high number of BDC stocks hitting new lows and new highs.

5 BDCs took a shellacking in the week: ABDC, CPTA, FSIC, TCAP and PSEC.

All are BDCs which have recently cut, or are expected to cut, their distributions.

By week’s end, there were 9 BDCs within 5% of their 52 Week Lows and 21 within 10% of that mark.

Sunshine Amidst The Raindrops

Earlier in the week, though, several BDCs hit new highs of one kind or another.

These include GAIN, MAIN, MVC and WHF.

What’s Going On ?

Last week, we opined that investors were positioning themselves in advance of earnings season with a relatively straightforward strategy of buying the Winners and Selling The Losers.

We called this a bifurcated market then, and that has continued for another week.

For existing investors in BDC common stocks it’s a strangely reassuring trend, which suggests there is no general unease with the BDC Sector, but also none of the unbridled enthusiasm for any BDC with a pulse that existed earlier the the year.

More Down Than Up

That will be poor consolation for BDC investors this week, with only 10 names going up in price and the rest flat or down.

Word Of Warning

The Biggest Loser on the Week was a BDC we would not have expected – because there was no news besides an earnings date announcement – CMFN, down (5.2%).

The BDC Reporter had placed the sustainability of CMFN’s distribution At Risk back in September when we wrote a long review of its latest financial performance. Here are some extracts from what we wrote at the time:

From our standpoint CMFN is too risky for the return involved…Buying or holding onto CMFN stock with both the BDC and the sector on the precipice could have painful consequences, while the upside is limited with the balance sheet almost completely leveraged.

We project that by 2022 the distribution and the NAV could be 30% lower or more, especially if we get a recession in between.

Paying 10X earnings for a BDC with that AT RISK* outcome does not compute for us.

CMFN is neither on our Income portfolio Prospect list (we focus only on what we believe to be the soundest credit underwriters) nor a Special Situations candidate given the still high price.

If we were a Big And Famous Analyst, we would have a SELL rating on CMFN because of the balance of risk and reward even if the BDC suddenly has no non accruals and NAV rose and Net Investment Income was flat.

[*We changed our nomenclature since writing the article. We used to call AT RISK distributions, POSSIBLE – as in candidates for a potential cut].

Since we wrote the article, CMFN has dropped another (11%) in price, mostly last week.

Guess Work

The institutional investors who monitor these things might have decided that the risks to PR Wireless (which we mentioned in the September article)- which are so obvious as not to need further discussion- might be reason to lighten up on their CMFN exposure.

Another portfolio company- YRC Worldwide – is also impacted by the terrible weather we’ve been having in parts of the country, and has been projecting much lower EBITDA.

The $13.9mn loan to YRC Worldwide is carried at par as of June 2017. If something were to go awry there or to the $15.5mn owed by PR Wireless, the impact could be substantial on a BDC with roughly $250mn in portfolio assets.

It’s hard to know if Mr Market actually “knows something” – thanks to the uneven playing field between institutional investors with their Bloomberg terminals and subscription services to financial news aggregators – and retail investors.

This may just be another example of investors being careful or the result of some shareholders with better market intelligence than others.

Coming Up

We’ll know more on November 7 about CMFN, but BDC earnings season begins in earnest on November 1.

As usual, there will be some very routine results announced, and a few surprises. Notwithstanding all the re-aligning that’s been going on, investors should expect the unexpected.

Two factors will be weighing more heavily than the norm this quarter: the continuing impact of “spread compression” and dog-munching-on-dog competition for new loans which will impact yields and investment income more than usual.

..AND the impact of new credit problems at a number of portfolio companies.

When we’re not trawling the BDC Sector and writing up the Daily News, we’ve been scanning the 6,000 name strong universe of BDC portfolio companies.

As usual – and as you’d expect given the economy – most are performing to plan.

However, with the plurality of  BDC balance sheets and earnings maxed out (see the canine reference above) even a small number of bad debts can reverberate strongly.

Expect to see bad news about more than a dozen new portfolio company names – some held by multiple BDCs – and continued deterioration at many other already wounded warriors.

The market is very efficient and is already running ahead whether or not they have all the facts or can estimate all the outcomes (which they can’t).

We can’t claim to have done the deep dive into every BDC portfolio that we’d like, but judging from the price movements we’ve seen of late the combination of the two factors above could result in Bad News at as many as a third of all the BDCs out there.

One Last Point

The BDC Reporter likes to make lists, and we count 29 BDC names that we expect to report lower earnings in this current fiscal year versus the last. That’s nearly two-thirds of the universe.

At the moment, we don’t any catalyst to change that trend.

We’ll undertake a recount once earnings season has passed.

BDC FIXED INCOME

Calm

The BDC Reporter can only handle so much drama, so we’re glad to report the BDC Fixed Income segment was stable this week.

Our median price on the 35 issues we track was $25.48, up from $25.42 the week before, and just 1 cent above two weeks ago.

As usual, all the issues with the exception of Medallion Financial’s MFINL traded above par.

Like last week, 3 issues traded over $26.0.

Most everybody else traded in the normal narrow range.

Lucky ?

Existing BDC Fixed Income investors were relatively fortunate, after a fashion.

Hercules Capital (HTGC) issued a new 2022 Unsecured Note placed with institutional investors (which we were able to get an allocation of) but only promised to redeem a portion of its existing 2024 Baby Bond.

So HTGX will live on a while longer on the BDC Reporter’s ever updated Fixed Income Table.

Solar Capital (SLRC) – presumably flush with cash – is going to redeem its 2042 Baby Bond with the ticker SLRA.

Like HTGC, though, SLRC is only paying off  a portion of the issue.

Moreover, newer public BDC Capital Southwest Corporation (CSWC) indicated a first time Baby Bond offering is in the offing. (Try saying that three times in a hurry).

On The Docket

On the other hand, Great Elm Corporation’s (GECC) Baby Bond inherited from its acquisition/merger with Full Circle and with the unwieldy ticker FULLL got retired this week.

Soon to leave us will be Horizon Technology Finance‘s Baby Bond (HTF) on October 30.

That should leave our list – assuming CSWC goes ahead – at 35 issues.

(We may delete the Alcentra Inter Notes from the list as we are not sure most investors can access them in the market and we want the BDC Fixed Income List to be a practical tool).

Ending On A Sour Note

Notwithstanding the partial redemptions by HTGC and SLRC, the BDC Reporter remains pessimistic – on behalf of existing BDC debt holders – about prospects in the short and medium term.

While prices should remain flat, we still expect many of the current Baby Bonds out there to get repaid in full – by one means or another – in the weeks ahead.

So does the market.

BDCs are too hard pressed – as we discussed above – to leave any money on the table and will be seeking to use every opportunity to reduce their interest expense bill.

Notwithstanding all the recent talk about higher interest rates in the bond market, we don’t see much prospect for that phenomenon where new  BDC fixed income issues are concerned…

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