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BDC Common Stocks Market Recap: Week Ended February 9, 2018

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BDC COMMON STOCKS

BDCs Wild Ride

It goes without saying the week just ended was wild.

BDC common stocks dropped sharply, then rose almost as much they’d lost.

Then dropped again. Then rose. Then dropped at the close on Friday.

The BDC Sector – as measured by BDCS – found several new 52 Week Lows during the week.

BDCS opened at $19.70, slipped as low as $18.72 and closed the week at $19.22.

Making Sense

Three factors were at play – with the benefit of a little hindsight:

First, there was the traditional repricing and re-assessment that accompanies the first week of any Earnings Season.

With 13 BDCs reporting results, there was plenty of pencil sharpening and re-doing of financial models.

However that was only part of the story as there have been very few surprises in the releases that have come to market.

Shall We ?

The second factor is the portfolio re-balancing many investors are undertaking in the face of new macro conditions (higher rates, higher inflation, higher PROJECTED GDP growth).

“Should we overweight or underweight leveraged lending (including the BDC Sector)”  is a question presumably being asked at investment managers around the country.

We’ll Take The Cash

The third factor is the fear engendered by the huuuge spike in volatility (threatened for months but never realized) which caused many investors to question whether they wanted as many chips – or any at all – invested in the markets generally.

As a result of this maelstrom of factors – none of which were in play just a few weeks ago – BDC common stock prices are up in the air and all prior bets are off until all 3 phenomena run their course.

Been There

The BDC Reporter has been through these storms – each one different from the other yet carrying a strong sense of deja vu.

Two Roads Diverged

We offer up – not very usefully for anyone craving a sense of certainty – two potential short term outcomes for BDC investors.

One possibility is that investors will pull themselves off the floor; dust themselves off and start buying the numerous relative bargains that have come available in recent days (MAIN, GBDC, ARCC at 52 Week Lows !).

After all, LIBOR is going up which will offset spread compression and boost BDC earnings; equity stakes in portfolio companies are being sold for fat gains left right and center; easy money is making restructuring of troubled loans as easy as lenders could hope for and borrowing costs for BDCs remain low (3.8% for 5 Year Unsecured Notes !). Plus, if the U.S. economy does continue to expand, credit conditions may even get a second wind, especially with the new EBITDA rules for highly leveraged lenders – perhaps – engendering safer loan structures.

Down Scenario

The other possibility that we’ll mention –  among the untold billions of potential alternatives – is that BDC stock prices continue to step down in the weeks and months ahead. That would be continuing a process that is already nearly a year old.

Stock prices – as you’ve been told knowingly every day on CNBC – tend to overshoot on both the upside and downside. If that’s going to happen in 2018 for the BDC Sector, we’ve got plenty further distance to go before investors can sleep soundly.

Another 10%-20% drop in BDC Sector prices (with even larger individual stock percentage drops possible) is plausible. We refer doubters to BDC prices in February 2016 for a sense of How Low Prices Can Go.

After all – investors will be telling themselves – “higher LIBOR means higher debt service costs and higher credit losses for lenders; spread compression will continue to squeeze earnings and credit conditions can only get worse so late in an economic expansion with deal and financing multiples at record highs and borrowers drunk with power. Most BDC earnings are being held together with twine (or PIK income; waived management fees and income from borrowers headed in the wrong direction) and will shortly follow OCSL’s example with large dividend cuts. Aren’t the distributions of MCC, ABDC, ARCC, CPTA, ACSF, TCAP, OFS and yes-even PSEC– at risk ?”

Then, if 2019 brings a Recession, disaster will follow for anyone holding leveraged loan assets whatever the pedigree of the BDC. “Let’s get out now before the 50%-90% stock price drops that occurred in 2008-2009”.

With Apologies To The Who: We Might Be Fooled Again

These polar opposite views are both legitimate surmises of what the future might hold and which direction markets will turn is impossible to tell.

We watched in horror back in 2011 when – in a few weeks – the BDC Sector dropped 28% in price because investors were worried about the potential knock-on effects of the Euro-crisis IF push were to come to shove.

Then was a lot of shoving in Europe but no push and the markets – including BDCs – roared back in late 2011 and went on a two year upward run to reach their All Time High in November 2013.

Then on July 2014 the price of oil began to drop from $100 a barrel. Coincidentally or otherwise, so did BDC prices and that continued till February 2016 – with 13 to 15 misleading false dawns along the way.

That was followed by one of the strongest price rallied in BDC history (partly because of how low prices had gone) which peaked in March 2017 – with only a brief break around election time 2016.

In the spring of 2017 – not so long ago after all – many BDCs were trading at their All Time Highs. Even the Troubled BDCs got a partial Hall Pass in many cases.

Since March 2017’s highs – and helped by the week’s drama – the BDC Sector has gone from Correction Mode to full blown Bear Mode (down 21.3% from highest to lowest).

Data shows that only 5 BDCs are trading above their level of 52 weeks ago.

Going Forward

Given the divergent potential outcomes, making the right call will be critical to BDC investors results in the next 12 months.

If the BDC sector bounces back even halfway to its March 2017 level, Total Returns could exceed 20% by this time next year.

If we get more bear mauling Total Returns could be 10% or more negative.

Individual BDC results will vary even more.

Good luck !

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