Email us with questions or comments: nmarshi.bdcreporter@gmail.com           α

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

Premium Free

Update: On March 31, 2018, we made available this weekly Premium article to all readers after publishing the most recent update for the week ended March 30, 2018. 


BDC COMMON STOCKS

“Full Of Sound And Fury”

What a week for BDC common stocks, even if there were very few individual BDC news items.

What seemed like the Biggest Story Of The Week was TPG Specialty (TSLX) issuing new shares in an unfavorable market.

Then there was yet another Fed rate hike of a quarter percent and that almost automatic press release that follows from Hercules Capital (HTGC).

At The Mercy

However, the principal forces at work on the BDC Sector were happening in Washington and Wall Street.

Regarding the latter, and because of the President’s launching of a trade war (much signaled but apparently never believed by the Street) the markets lurched downward in unison.

The three main stock market indices – as if glued together – dropped over (5%) on the week.

The BDC Sector – as this chart shows – actually went up late in the week as the other indices dropped and ended up almost even on the week at $19.56 versus $19.52 the week before.

Divergent- Briefly

This would normally be surprising because BDCS is often pulled up or down in the wake of the major markets movements, as frequent readers will know.

This time was different because of what was slipped into the just completed $1.3 trillion budget on Wednesday and signed into law Thursday: the biggest change to the BDC rules in thirty eight years.

As we’ve reported, our legislators deemed this a good opportunity late in the economic cycle and with several BDCs already imploding due to bad debts during the most benign economic period in this century, to double allowable fund leverage.

Boosters

Analysts were found to say that the new rules, which allows BDCs to maintain minimum asset coverage of 150% versus 200% previously, would boost earnings by 20%.

Others jumped on the bandwagon and listed out 6 BDCs which would supposedly benefit from the new rules. Here’s KBW’s list as reported by Reuters:

The KBW analysts wrote in the report that they expect the biggest beneficiaries to be Ares Capital Corp (ARCC), TCG BDC (CGBD), FS Investment Corp (FSIC), Golub Capital BDC Inc (GBDC), PennantPark Floating Rate Capital (PFLT) and TCP Capital Corp (TCPC).

All this caused the prices of many BDCs to jump briefly as investors traded the headlines.

Sugar High 

However on Friday the BDC Sector joined the market panic late, dropping (1.8%) and giving up all the intra-week gain.

Unrelated

However, the only BDC which ended the week up more than 3% was none of the KBW anointed but much troubled Alcentra Capital (ABDC).

That stock jumped up 14.8% on the week as investors decided they had been unduly negative on the stock which had reached a low of $5.93.

That was 47% below the latest book value of the BDC.

Full Circle

For a few hours intra-week we witnessed in our own database a great diminution in the number of BDCs trading within 5% or 10% of their 52 Week Lows.

However, by the end of the period we ended up exactly where we were last week with 16 BDCs within 5% of their lows.

(The number between 5%-10% of the 52 Week Low actually increased to 15 from 10).

Another metric we look at – the number of BDCS trading above their 50 Day Moving Average – was also unchanged from the week before.at 16 (out of 45)

A week that seemed like it might go down in the BDC History Books as a turning point ended with a question mark.

What Matters Most

What factor will have the greater impact on BDC prices in the days and weeks ahead: what the markets are doing or the potential impact of the new BDC rules ?

The BDC Reporter does not know.

Too Soon 

However, we will opine that any rush to judgement about which BDC will benefit and which will not from the potential doubling of allowable leverage is premature.

There are multiple factors at work besides making calculations of what a BDC currently earns in investment yield and pays to borrow.

For example, risk tolerance  (i.e. the willingness to lever up) will presumably vary widely between individual players.

Some will rush to add on more debt for every dollar of capital, others will hold back.

Some may add more debt but move down the risk scale and end up earning no more and no less than before.

Are The Bond Markets Not Usually Thought To Be The Sensible Ones ?

The Unsecured Debt markets – not as stupid as some observers seem to believe -will also have to be taken into account.

BDCs might have been given blank cheques to leverage up but somebody has to cash them.

Ratings Gamed

Then there’s the reaction of the rating groups, who’ve watched with little demur as many Big Name BDCs have already breached the 200% asset coverage level by bulking up on off balance sheet Joint Ventures for years.

Will Moody’s, S&P and Fitch continue to hand out investment grade ratings if on balance sheet leverage starts to increase ?

Lastly

Then there are the BDC shareholders themselves.

Admittedly the managers – both internal and external – have locked up BDC corporate governance and will brook no opposition (even while having- in many cases – virtually none of their “skin in the game”) from worried or rebellious shareholders.

However, shareholders may just vote with their feet, pushing BDC prices well below book (only 7 BDCs trade above book currently).

If Pyrrhus Of Epirus Managed A BDC

This may result in a Pyrrhic Victory for the managers who’ve lobbied so hard to be able to add more debt without having to ask (unlike equity) for shareholder permission.

New debt can and will be raised, which will boost management fees in the short run. That’s the “Victory” part.

But will new equity capital be available to be placed under a growing mountain of secured and unsecured debt and equity siphoned off into joint ventures with their own molehills of third party debt ?

Have the asset managers who fought so furiously for the past several years for this (and other) changes to the BDC format effectively caused the future equity capital raising tap to be turned off ?

Those are the Pyrrhic questions.

One More Query

Are shareholders so focused on earning a slightly higher yield in the short run that they’ll ignore the vastly higher risk to the preservation of their capital in the long run ?

We don’t think so, but time will tell.

Certainly if there is wide adoption of higher leverage by BDC managers over anxious to boost their already extravagant compensation (often equal to 40% of all net recurring income generated and sometimes more than 100% of net income) we can expect much, much higher price volatility.

BDC investors accustomed to seeing BDCs like ABDC increase 15% in price in one week, or Capitala Finance (CPTA) drop 50% in a short period or the whole market swing 3% up or down in 24 hours may look back and remember these as the Good Old Days.

Ending With An Appropriate Biblical Flourish

What the lobbyists for higher BDC leverage and their willing accomplices in Congress have sowed, BDC shareholders will reap.

Maybe it’s no wonder that BDC stocks dropped back on Friday after that first flush of enthusiasm on Thursday when the passage of the new law was announced.

Already a Member? Log In

Register for the BDC Reporter

The BDC Reporter has been writing about the changing Business Development Company landscape for a decade. We’ve become the leading publication on the BDC industry, with several thousand readers every month. We offer a broad range of free articles like this one, brought to you by an industry veteran and professional investor with 30 years of leveraged finance experience. All you have to do is register, so we can learn a little more about you and your interests. Registration will take only a few seconds.

Sign Up