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BDC News Wrap Up: Wednesday December 20, 2017

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INTRODUCTION

There has been very little Important News coming out of the BDC complex in the run-up to the holidays. However, with many investors hanging up their ornaments and going to Christmas parties, many BDC common stock prices have been quietly moving around in unexpected ways. We’ve tackled the subject before in our Stock Watch section. We’re going to bring readers up to date with another snapshot with just a handful of market days left in the year. We’re not just mentioning who is up (nobody this week) and whose down ( much more crowded field) because readers can do that just by looking at the Daily News Table in the Tools section on the front page where we cover these moves as they’s happening or by looking at their own spreadsheets. We’re trying to provide the background of several BDC stock moves, which also speaks to what might be happening to the BDC market more generally. We’re mixing in disclosures about the BDC Reporter’s principals own investment approach in this shifting environment. 

STOCK WATCH

Ever More

As we hurtle towards the end of the year, the BDC Reporter has been noting an ever increasing number of BDCs approaching or breaching new 52 Week lows, and even longer period price records.

We wrote an article on December 14 on the subject.

We mentioned MCC, BKCC,  CGBD and TCPC.

One week on and the phenomenon continues and broadens.

At the close on Wednesday December 20, 2017, the number of BDCs trading within 5% of their 52 Week Lows was 19.

Then there were 7 more between 5% and 10% off.

That’s 26 in total, out of 46 BDCs we track.

Let’s look at several individual examples:

CMFN

The stock hit a 52 Week Low of $7.40 intra-day on December 19th, shortly after the $0.25 quarterly dividend was paid out.

The NAV is $12.79, which means CMFN is trading at a large discount to book and yields an eye popping 12.6%.

The yield suggests that the market does not believe the new $1.00 a year dividend level is sustainable, and has knocked CMFN’s price down from a high of $10.80.

From Highest To Lowest, CMFN is off by (31%).

What’s Wrong ?

The BDC Reporter has been concerned about CMFN for months.

Back on September 7, we reviewed the FY 2017 results, which closed in June.

Here’s one of our conclusions at the time, when the stock price was still $9.750:

Looking forward, CMFN is going to be hard pressed to maintain its current earnings level.

After the 2018 fiscal IQ results , we wrote a new article with a more explicit headline: “CMFN: Why We’re Concerned”.

Our Answer

In a nutshell, we worry that any wobble in the BDC’s credit portfolio, when added to the already strained earnings caused by “spread compression” could gut the dividend.

On the other hand, management is making all the noises one would expect from a BDC whose payout should remain unchanged.

We had to choose – with the stock price at $8.70 at that point – between a glass half full and half empty. We chose the latter and CMFN has dropped (15%) in the interim.

The market, too, is firmly in the “dividend is unsustainable camp”.

Value. Eye. Beholder.

Nothing goes down forever and CMFN has already taken a licking. Is the stock price good value at this level ?

From the BDC Reporter’s standpoint – having just unsuccessfully sought to catch falling knives at CPTA, ABDC and TCAP – the answer is No.

Moreover – as a general rule we’ve noted that even when the market seems to expect a dividend cut, when the Day Comes, there is -more often than not- yet another step down before any bottoming out occurs.

Sorry To Say.

Finally – and more fundamentally and controversially – we have grave doubts about whether CMFN’s business model and credit execution works over the long term.

The BDC has a relatively small number of portfolio investments and a modest asset base – and continues to make a Big Bet on the energy sector.

Since coming public public in 2014 at $15.00 CMFN has recognized Realized and Unrealized Losses equal to 15% of its equity capital raised. For what it’s worth that’s a 4.25% per annum loss.

The dividend has dropped (29%) from its level back in in the IVQ of 2016. Another drop to an annual dividend of $0.80 will mean the payout will have been reduced by (43%) from its best level.

When the BDC Reporter projects forward – after examining the risk profile of the BDC which takes into account various credit issues – we envisage potential credit losses which will erode the current distribution at a 6% a year pace.

That’s very high  and does assume a Recession somewhere in the next 5 years.

Either Way

Speculators may have some short term success with CMFN both because of the already big drop that has already occurred and the uncertain credit status of several loans which may yet be alright.

Longer term investors, though, will need to be wary. Here is a link to the stock price chart of CMFN, which shows the ever descending trend since February 2014 – with occasional upside enthusiasms.

In less than 4 years, CMFN’s price has dropped by (50%). Who’s to say that could not continue when we revisit this chart late in 2022 ?

SLRC, FDUS

The BDC Reporter- and most market participants – have doubts about CMFN’s earnings and dividend outlook, so a stock price drop is not surprising.

More intriguing is that two BDCs whose dividend – at least by our lights – seems safe, and which have been churning out stable earnings for an extended period have also joined the ranks of the 19 BDCs within 5% of their 52 Week Lows.

In this case, we’re talking about FDUS and SLRC.

These are very different BDCs, with entirely different strategic approaches. However, both have been around for many years (much longer than CMFN).

FDUS closed at $15.38, just above its 52 Week Low of $15.27 and at the lowest point in just over a year. SLRC closed at $20.09, but was as low as $19.90 – a 52 Week Low – a few hours before.

Both BDCs are now trading below book value.

Yet at its recent heights FDUS reached $18.21 (back in April): 20% higher than the 52 Week Low and well above book value per share of $15.97.

At SLRC it’s a similar story. From highest to lowest, the gap is 15%. At its highest price (also in April…) SLRC’s stock price was 5% higher than the current NAV Per Share.

Respectively the yields of FDUS and SLRC are 10.2% and 8.1% currently.

The Reason Why 

What to make of all this ?

The BDC Reporter’s explanation is a shift in market sentiment.

We’ve been investing in the BDC Sector for over ten years and while we can’t tell you how long the phenomenon will last, or how strongly, but we can believe we can tell that the wind has shifted where investor confidence is concerned.

We’re not historians and seek to offer up our views on the subject in real-time.

When we’re talking about the markets in general, the Weekly Market Recaps often put their finger up in the air to check for direction.

With the benefit of hindsight we know that the BDC Sector peaked in March 2017 after a remarkable 13 month upward run. That’s easy enough to see in December looking at a YTD chart of BDCS.

However, back in August – when prices were still very high in most cases – the BDC Reporter went out of its way to note that a change had occurred. here’s what we wrote – in bold print no less:

Nonetheless, we’re officially worried that our long BDC “bull market” may be coming to an end.

Our neck is stuck out and we’ll be investing more cautiously accordingly.

Taking Action. Or Not.

In our case, that caused us not to take any position in SLRC through the year as the price remained over $22 a share as recently as November 14. Since then the price is down 10%, or more than a year’s worth of distributions.

Yesterday, we finally pulled the trigger on SLRC at a price just above that 52 Week Low. 

Where FDUS is concerned – a stock that we had bought  (in one portfolio) very close to its February 2016 lowest ever price level – we chose to close out recently.

We had no specific concerns about credit or other issues at either BDC, but decided not to “fight the tape”. 

Painting With A Broad Brush

From the ruminations we hear from analysts on Conference Calls and in private conversations, we get the impression that following the credit implosion at TCAP concerns are heightened about any BDC (Except for GAIN apparently) with large mezzanine debt exposure.

Of course, how low investors will let FDUS and other better performing BDCs that are in the grips of market doubt is the $64,000 question.

Is the drop in the prices of the Better BDCs, which also includes ARCC (3% off its 52 Week Low and 12% off its high); GBDC (4% off the 52 Week Low); GSBD( 7% off) ; MRCC  (5% off), NMFC (2% off); OFS (1% off) and TCPC (2% off) just a year end phenomenon or part of a longer term step down ?

We wish we knew.

What we do know is that many quality BDCs – most of whom should maintain or increase their earnings in 2018 over the 2017 level  and whose distribution gets an UNCHANGED rating from the BDC Reporter – are suddenly priced much better than they’ve been for several quarters.

That’s the problem with market sentiment: it’s hard to gauge except in the most general terms.

Both Sides Now

However – based on the experience of the past decade- we can say that if you’re a glass half empty investor that BDC stocks could drop another 20%-25% from here if market sentiment goes from concerned to deeply afraid, even without a recession.

If you’re a glass half full investor, you may be able to mark all the weakness in recently high flying stocks to year end profit taking and re-positioning and expect a bounce back in early 2018.

About Us

For our part, with this increasing uncertainty, we are dipping very selectively into a few quality names and hoping even better prices might be coming down the pike.

Otherwise, most of our investing continues to be aimed at the ever lower yielding BDC Fixed Income segment, which continues to exhibit very little price volatility (always a plus over the holidays) and where credit quality remains unimpeachable, with only a few exceptions. 

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