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BDC Common Stock Market Recap: Week Ended May 4, 2018

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BDC COMMON STOCKS

Not Disappointed

Last week, we billed the IQ 2018 BDC Earnings Season, which started in earnest on Tuesday, as promising to be “the most interesting in years”.

That turned out to be true, with bells on. However, not in the way one might have expected.

Meeting Expectations

As we wrote in an article intra-week – and which remains true after a subsequent flurry of earnings releases – there was little in the way of surprises in BDC results.

In the past, we’ve been accustomed to several shockers, typically involving increases in bad debts and/or dividend reductions.

These are usually accompanied by huge stock price drops and much gnashing of teeth by investors.

In case BDC amnesia has set in (understandable for anyone involved in these incidents), we’ll remind you with a chart worth a thousand words of what has happened to Capitala Finance (CPTA) in recent months.

There have been similar reverses at Alcentra Capital (ABDC), Triangle Capital (TCAP) and BlackRock Investment (BKCC).

Here’s a combined 1 Year chart of all 4 names to drive the point home:

Mild

So far, in BDC Earnings Season we’ve not had any similar dramas.

Most every BDC has reported results in line with analyst and market expectations, with some doing a little better and some a little worse.

Not surprisingly that caused the number of BDCs whose price moved more than 3% to increase on the week, after a very dull time the week before.

There were 4 BDCs whose price moved up 3.0% or more:

OXSQ (5.4%), TSLX (5.0%), TPVG (4.3%) and NEWT (3.6%).

Not coincidentally, all reported results in the week, and all exceeded investor hopes.

Solo

Only one BDC dropped (3.0%) or more.

That was BKCC (down 5.1%) after posting IQ 2018 results and reversing a recent speculative upward boost in price that we had difficulty understanding, as explained in an April 30 article.

The article was written just before BKCC announced its first quarter numbers. Here’s a 1 month price chart that shows both ascent and descent:

Overall

The BDC Sector as a whole – as measured by our regular and slightly unreliable guide – BDCS was up on the week to $19.63 from $19.50.

That’s in the green, but only 0.7%.

(On a YTD basis, the BDC Sector is down (5.4%) on a price basis, using BDCS as our measuring stick and  down (1.3%) on a Total Return according to the good folk at Wells Fargo Research).

One After The Other

So results and the market reaction were relatively tame, but every BDC earnings release was exciting, and each in a different way.

That’s because the BDC Reporter – and investors generally – got to hear for the first time how each management group is choosing to address the passing of the Small Business Credit Availability Act.

Differentiated

In a sector where there’s much copycat behavior, we were surprised by how divergent different BDCs approaches were.

Some BDCs cheered the new Act, but declined to move the asset coverage goal posts. For now.

Others had already announced their intention to adopt the new rules, but chose to wait till next year to implement, forgoing a shareholder vote that would put the cat among the pigeons in the short term.

Yet others have been been preparing shareholder Proxies after receiving Board approval and are moving as fast as large institutions can in these circumstances.

Then there was Prospect Capital (PSEC)  and FS Investment (FSIC) – who’ve not reported results yet – but have already embraced and then spurned the new rules.

In The Dead Of Night

We put this great diversity of responses – partly = to the surprising way the new BDC law was passed, taking even its long time proponents who’d been lobbying Washington for years, by surprise.

Rethink

Then – and this also made the week very interesting – is the sense that we are at a watershed for many BDCs.

The new rules may result – over time – in drastic changes in business strategies, and in the economics of the funds involved.

In just the dozen or so Conference Calls we’ve heard so far a large number of prospective changes were mooted that were not even on the radar a few weeks ago.

New sectors of the leveraged lending market may be entered into; Joint Ventures may be wound down or de-emphasized, debt may be repaid prematurely and compensation structures might be revisited.

Goldman Leads The Revolution

Regarding that last point, Goldman Sachs BDC (GSBD) made the most drastic proposal: to reduce its Management Fee by a third in return for adopting the new doubled leverage limit.

This is something the shareholders of GSBD will have to come to terms with very soon as a Proxy will soon be in the mail, and a vote required.

Too Early ?

Many BDCs that reported results have punted.

Or, in other words, have deferred making any decision until the smoke clears.

Unpopular

As we’ve been mentioning since the subject first came up, some of that smoke involves S&P Global Ratings and its threat to downgrade to “junk” status any BDC with investment grade debt that adopted the new rules.

These are not idle warnings. We’ve previously mentioned that Apollo Investment was thus downgraded.

Late on Friday May 4, GSBD was placed on CreditWatch “with negative implications”…

There was much grousing by managers and analysts (mostly the latter, ironically) about S&P’s approach on the Conference Calls.

Everything Is Negotiable

Nonetheless, those BDCs that see the benefit of investment grade status (not as large a group as you might expect) have been careful to pull their punches about S&P.

We get the impression that much negotiating in conference rooms is in store, and some has already begun.

Flexible Banks

Equally important – but far more tractable – are the senior secured lenders to BDCs, most of whom are domestic and foreign banks.

Most of them have loan covenants requiring – as a mirror to the older asset coverage rules – the requirement that assets cover debts by AT LEAST 200%.

Waivers will be sought and received.

Opportunity Knocks ?

However, this might result in a more fundamental re-think by the bank lenders on how far they’re willing to go in providing debt to their BDC clients.

Of late, these have been some of the safest loans a bank can make – secured by diversified pools of mostly performing loans and protected by a small army of covenants.

That has kept borrowing costs relatively low for many BDCs.

The question now is whether some banks might stretch – for higher compensation – advance rates and covenants to please their BDC clients.

Knock On Effect

Indirectly that will affect the reliance – or otherwise – of BDCs on junior debt and the terms thereof.

This could dramatically change the liability structure of the BDCs; the nature of their expenses and the risks which secured and unsecured lenders will take.

We could go on for hours but we’ll spare our readers.

Metamorphosis Underway

The key take-away is that BDCs who adopt the new law (and most will if the last few days show us anything) will be transformed by the decision to different degrees.

Obviously that will take a long time to play out, but will inevitably result in the market having to re-think their valuations of each BDC.

That could cause material changes in BDC stock prices in the months ahead as greater clarity occurs.

No Guarantees

Nor is success guaranteed by adopting the provisions of the new law.

No one is more aware of that than the BDCs themselves.

Multiple times on Conference Calls this week we heard senior managers opine that only a small number of BDCs had the right credit skills, business model and liability management to successfully adopt the new leverage rules.

Of course, each manager was convinced that their institution would one of the anointed ones.

All Over The Place

The BDC Reporter agrees that every BDC’s outcome will be different, and there are likely to be Winners and Losers and with greater dispersion than before the Congress passed the new Act.

(By the way, there are other changes to the BDC rules being sought to encourage more institutional stock ownership which could subtly reshape the BDC landscape too).

It’s All About Choice

For investors who believe in fundamental research this will only enhance the importance of stock picking.

It’s time for BDC investors everywhere to re-sharpen their pencils and have a fresh look – in the months ahead – at all their prior assumptions and conclusions.

BDC Reporter Full Employment Act

For readers of this Weekly Recap, the likelihood is that BDC performance and stock price volatility will greatly increase, and we’ll have even more than before to review.

Could Be Either

This brought to mind the expression: “May you live in interesting times“.

Appropriately, some sources say this expression is a blessing, others say it is a curse.

Time will tell, but with only a third of BDCs having checked in with investors, we’re off to a very “interesting” start.

 

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