BDC Fixed Income Market Recap: Week Ended March 30, 2017Premium Free
BDC FIXED INCOME
Just when analysts were calling for 10 Year Treasury rates to burst through the 3.0% level and march on to levels unknown, the opposite happened.
Last week, the “risk free rate” dropped from 2.82% to 2.74%, the lowest level all month on the last business day of March.
(The highest level for March was 2.90%.
That’s a 5.5% move within a month, relatively high in the basis point world of interest rates.
Just as important, the 5 Year Treasury was down as well to 2.56%, and only 0.18% below the Ten Year.[Also intriguing – and with many consequences to come – 3 Month LIBOR closed at 2.32%.
More on that in future articles].
Anyway, for the BDC Fixed Income Sector the result of all these moves was that the creep down of the median price stopped.
As of Friday March 30, the median price was $25.29, within a cent of the week before.
Also as of late, no BDC Fixed Income issues traded over, and 5 were below $25.00.
Just like last week.
The lowest priced issue remained Great Elm‘s (GECC), whose Baby Bond with the ticker GECCM moved from $25.30 to $25.40.
11 Fixed Income issues out of 36 are trading at prices above their 50 Day Moving Average, but only 2 over the 200 Day Moving Average.
That’s according to somewhat spotty records from Yahoo Finance.
There was no major BDC Fixed Income announcement during the week.
However, Main Street Capital’s only remaining publicly traded Baby Bond – with the ticker MSCA – was redeemed on April Fool’s Day.
We are removing the issue from the World Famous BDC Fixed Income Table, which drops back to 35 issues.
Also being redeemed in part are 3 other issues, so there are only 32 not in play at the moment.
However, we increasingly expect that could change very soon with the new BDC increased leverage rules.
As we write this two huge asset managers have already pushed through Board resolutions approving taking advantage of the new lower asset coverage requirements.
That’s FS Investment (FSIC) and Prospect Capital (PSEC).
That will surprise very few close observers of the BDC scene.
Both BDCs managers/Investment Advisors pushed hard for the new rules and both have a long history of being focused on increasing their fees.
For example, FSIC earned $123mn in Management & Incentive Fees last year even while booking ($141mn) in Realized Losses, seeing NAV drop, cutting its distribution and changing co-managers.
In return the Investment Advisor offered up $2.575mn in fee waivers to shareholders.
In turn, FSIC paid out $210mn in distributions, of which 20% or so was in the form of non-cash items.
PSEC – on an annualized basis using the IVQ 2017 results – earned $192mn in Base and Incentive Fees.
There were no fee waivers.
Also in 2017 PSEC saw its Realized Losses grow to ($445mn), its NAV drop and its dividend reduced. Again.
About 20% of Investment Income and over 40% of Net Investment Income was derived from CLO equity investments.
CLO vehicles are typically leveraged 8x-14x.
Since coming to market PSEC has lost (16%) of its equity capital raised through equity issuance below book, and Realized and Unrealized Losses.
(Some observers would say that’s more like 20% to 25% if investments were correctly valued but we won’t get into that controversy).
FSIC’s aggregate Realized Losses “only” amount to 11% of capital raised, but that BDC was formed after the Great Recession and has yet to face the credit loss realities of a full cycle.
We mention all these metrics because they will – presumably – in the minds of lenders and Note Holders (whether retail or institutional) who will be asked to finance the new debt which these BDCs will need to raise to take advantage of the new regulations.
We wonder aloud if new Unsecured Notes can be raised at the relatively low yields achieved previously.
FSIC – for example – has issued 3 series of Unsecured Notes at rates between 4.0% and 4.75%.
Will the institutional investors – drawn partly by an investment grade rating – continue to finance FSIC’s asset growth as the credit risk increases.
If so, at what rate ?
Or will FSIC turn to the Baby Bond market – and its retail investors and add to our list of public issues ?
Ditto for PSEC.
The BDC Reporter will be keeping an eagle eye on the terms of the BDC Fixed Income issues – and how the rating agencies react – to determine if it’s business as usual for debt raising or whether all that extra debt ranked pari passu will cause would be Note Holders to demand better terms or just stay away.
Unfortunately, the fact that two of the BDCs with relatively weak credit records (and both with histories of restructuring under-performing credits which avoids the booking of Realized Losses) have rushed to adopt the new, looser leverage rules does not bode well.
The Piper will not get paid for years yet – if at all – but he’s warming up just days after Congress slipped the new uber-leverage rules through in the dark of night.
Now we’ll have to see how the debt markets -whose long term track record of doing the right thing (Tesla bonds anyone ?) is not spotless – will respond.
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