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BDC Common Stocks Market Recap: Week Ended February 23, 2018

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BDC COMMON STOCKS

No Revival

Last week, the BDC Sector revived marginally, ending the week – as measured by the UBS Exchange Traded Note with the ticker BDCS – at $19.67.

Then – as now – the BDC Reporter was not convinced, though, that there was not more slumping ahead.

In fact, BDCS dropped back this week to end at $19.40, and reached an intra-week low of $19.27.

Multiples

It’s never just one number.

We also noted that only 8 BDCs saw an increase in price on the week. That meant 38 were down or flat.

No individual BDC was up even 3% but 10 were down (3%) or more.

Just 9 BDCs price is ahead of their 50 Day Moving Average – an easier than usual hurdle.

Using the 200 Day Moving Average, there are only 3. Even then, only one (CSWC) is a “normal” BDC.

The other two are MFIN – which does not want to be in the club at all – and OHAI, whose market capitalization is equal to the bar tab of one of the larger BDCs.

Our Count

We have our own data set which we use through the trading day to evaluate price pressures. As of February 23 BDCs at the close were trading within 5% of their 52 Week Low.

That’s more than 17 last week.

If we total up all BDCS trading within 10% of their nadir there are 32, versus 30 last week.

There is only BDC still trading within 5% of its 52 Week High (CSWC), and 4 others between 5%-10%.

Non Stick

For BDC investors, it’s not just BDCs had another difficult week. It’s that the slide in prices over many weeks and months has made making any price gains well nigh impossible.

A BDC publishes bad results and the stock price goes down. Or a BDC publishes good results – as many have in this half finished earnings cycle – and the price goes down.

Look at the last 4 week period: only 5 BDCs are up in price, led by you-know-who (CSWC).

More depressingly, over the last 52 Week period only 5 BDCs are up in price and 41 are down.

Of those 41, 30 are off by double digits, ensuring that even on a Total Return basis investors are in the red.

Roughly speaking that suggests over a 1 year time frame two-thirds of BDCs have been losing propositions for their shareholders – even with those juicy 10% average yields, and only 10% are out and out winners.

We may not be technically in a Bear Market (though we were for an instant during the early February crash) but these are ursine conditions for most investors.

Cassandric Utterances

Unfortunately, things COULD get worse, judging by prior cycles.

BDCS is still trading 12% off the February 2016 low. That was the last time investors lost interest/confidence in credit assets (and much else besides).

Judging by what’s happening in the broader non-investment grade space we’re barely at the beginning of an unraveling, were one to occur.

Don’t Look Down

Investors know that BDC fundamentals – and their prices – will be hit very hard by the Next Recession (expect an average price drop of 50-70% if we get another Great Recession) and will be anxious to be out and sitting on the beach when the turn happens.

It’s that irony of investing that,  as we enjoy apparently strong economic conditions, the markets – at least in credit – seem to be beginning to worry about what might or might not happen in 2019 or 2020.

Not This Time ?

We may not get there in this down cycle. Paul Samuelson has famously joked that the markets have called 9 of the last 5 recessions.

For our own part- reading widely and keeping close tabs on credit quality across thousands of portfolio companies and with our own presence in the real world with our private equity exposure – we don’t see any tell tale signs.

(We own a plywood distributor with exposure to a broad range of end user markets – a very useful indicator of which way the business breeze is blowing we’ve found over 19 years).

Still, it’s important to recognize that investors have reason to be nervous about massive potential losses if things go askew in BDC-land.

A Potted History Of The Last Recession

Here’s how things played out over a decade ago. We know because we were there.

Last time round (2007) there was an almost across the board increase in Unrealized Depreciation across the BDC space which showed up, but very few actual bad debts, all happening in a short period of time.

However, income jumped at BDCs as borrowers begged for amendments and waivers.

BDCs involved in riskier segments of the market – as you’d expect – showed signs of stress earliest even while “mainstream” lenders appeared largely unaffected.

Many investors – ourselves included – thought we were in the midst of a temporary phenomenon and took comfort in increasing pay-outs and a BDC Sector where dividend cuts were a virtually unknown phenomenon.

Then all hell broke loose and within one or two quarters most every BDC was reporting many, many loans in various degrees of distress.

Roll forward one or two more quarters and the Realized Losses came which hammered 80% of the BDCs that were in the market at the time. With that came dividend cuts and even suspensions.

Bank lenders to BDCs panicked in some cases, only making matters worse and many players had to resort to  incredibly dilutive Rights Offerings at below book prices to stay solvent.

From beginning to end the process took 8 quarters, with the benefit of hindsight.

If You Thought This Pull-Back Was Bad…

One example will do for all to illustrate how drastically conditions can change. As this chart below shows ARCC – already a very large BDC  – was at over $20 a share in February 2007.

Just two years later ARCC’s stock price had dropped to its lowest level of $3.60, even as its dividend INCREASED !

That was a (82.5%) drop in price…

Maybe readers will understand why the BDC Reporter tries to keep close tabs on both short term and long term trends in this sector.

Miss reading the tea leaves and you can be facing catastrophic price drops.

Mining Analogy

One could argue that the troubles at TCAP, ABDC, TCRD and CPTA – most of which are concentrated in riskier second lien and mezzanine loans – are a canary in the credit coal mine.

Listening to the questions posed by some analysts on Conference Calls one gets the impression that a frisson of deja vu is going through the institutional investor group, even as we get the regular rounds of analyst price targets and recommendations.

(Reasonably) Confident

Call us hopeless optimists (though nobody ever has) but the credit problems at those BDCs have not shown up at other funds with similar strategies (GAIN,CSWC,MAIN,SAR) which have already reported.

We will get a better idea when the already troubled BDCs mentioned above as well as OFS, FDUS, WHF, HCAP and SCM report shortly.

Check out the BDC Reporter’s handy Earnings Calendar in the Tools section.

Moreover, from anecdotal reporting by the BDcs who’ve released results, most portfolio companies appear to growing both revenues and net earnings.

So we’re guessing that whatever slump BDCs are in, this is not the overture to the Big One.

Let’s gather in two years and see how that prediction has gone.

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