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BDC Fixed Income Market Recap: Week Ended May 4, 2018

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BDC Fixed Income

Turning Point

This was a critical week in the short history of BDC Fixed Income debt, which we’ll be getting to in a minute.

Same Old

However, you’d never know that by the price action amongst the 37 public BDC debt issues we track, all of which are trading currently.

The median price for the week ended May 4, 2018 was $25.37.

That’s within a few cents of the closing prices of the last several weeks.

Last week, the BDC Fixed Income median was $25.34, and $25.30, $25.32 and $25.33 in the weeks before.

That’s less than a 0.3% range over a five week period !

Very Familiar

There was no issue over $26.00, but we’re getting used to that.

However, there were only 4 issues below $25.00.

That’s down by 1 since last week, but hardly a dramatic move.

In The Market

No new issues came to market in the week, but OFS Capital‘s (OFS) Baby Bond with the ticker OFSSL began to trade publicly.

OFSSL closed at $24.89.

Here’s what we wrote about the OFSSL back on April 12, 2018.

Portents

If nothing much was happening to BDC Fixed Income prices on the week, much else was brewing which could impact the market in the weeks,months and years ahead.

Joining The Club

First of all, during this first week of BDC Earnings Season, we learned a lot more about BDCs interest in adopting the new higher leverage rules of the Small Business Credit Availability Act.

Unsurprisingly, many, many BDCs are very interested in the opportunity – at the stroke of a pen or the cost of a Proxy – to double their balance sheet leverage.

Kill-Joy

At the moment, S&P Global Ratings – like the little Dutch boy of legend – has been keeping its finger in the dike of the flood of new debt that could be unleashed.

Much to the frustration of many BDC managers and the analysts of the firms who might benefit from said flood, the ratings group has been adamant:

Adopt the new lower asset coverage/higher leverage rules and get your credit rating downgraded.

As we’ve mentioned before Apollo Investment (AINV) dared to ignore S&P, and its Baby Bond due in 2043 with the ticker AIY was reduced to “junk” status.

Another One Bites The Dust

This week – as we mentioned in the latest BDC Common Stock Weekly Recap – Goldman Sachs BDC (GSBD) got dinged after its Board joined the higher leverage club.

Here’s most of what S&P said in a press release:

 

S&P Global Ratings said today it placed its 'BBB-' issuer credit and senior unsecured debt ratings on Goldman 
Sachs BDC Inc. (GSBD) on CreditWatch with negative implications. 
 
The CreditWatch placement follows GSBD's proxy filing, which includes a proposal to approve the adoption of a 150% asset-coverage requirement, as 
permitted by the Small Business Credit Availability Act. The board of directors recommends that shareholders vote in favor of the proposal, which 
would become effective the day after the shareholder vote and would effectively increase the BDC's maximum allowable debt-to-equity ratio to approximately 
2:1 from 1:1. Concurrent with the approval, GSBD would lower its management fee to 1.0% from 1.5% of assets. 
 
We could also lower the ratings on GSBD's unsecured convertible notes by an additional notch if we lower the issuer credit rating. We expect unencumbered 
assets to fully cover the unsecured debt. If unencumbered assets do not fully cover unsecured debt, then we could rate the unsecured debt two notches below 
the issuer credit rating. 
 
CreditWatch 
We will evaluate the details of GSBD's plans, and we expect to resolve the CreditWatch following the shareholder vote. It is likely that we will lower 
the ratings if the reduced asset-coverage requirement is approved. We likely would affirm the ratings if the existing 200% asset coverage requirement is 
maintained. 

(GSBD’s unsecured debt is rated, but is institutionally placed and does not trade and is not listed in the BDC Reporter’s Fixed Income Table).

Daunted

The position taken by S&P has kept some other BDCs from adopting the new leverage rules yet, even while waxing lyrical about the opportunity on Conference Calls.

Hercules Capital (HTGC), which recently issued a new Baby Bond with an investment grade rating (HCXZ) has held back from adopting the new rule, while expressing great interest in jumping aboard.

As we’ve mentioned before – bowing to S&P- both Prospect Capital (PSEC) and FS Investments (FSIC) first adopted then rescinded their adoption of the new rules.

Irrepressible

However, the BDC Reporter doubts that S&P (which has been abandoned in its stand by Fitch Ratings and Egan Jones) will be able to hold back the debt tsunami building in the BDC sector.

For every BDC saying “no, thank-you for now” to the new leverage limits there are 3 others saying “Please Sir, can I have some more ?”.

Even the BDCs that have not pressed the higher leverage button have suggested they would be open to changing their vote if circumstances change.

As we’ve cynically/realistically saying since S&P first drew its line in the sand, we expect the rating group to eventually cave.

Conversations will be held with distraught BDC clients; proposals and alternatives will be mooted and investment grade ratings will be maintained even as debt levels increase.

We’ll be looking for “compromise” on what type of assets are bought with the new debt.

Many Ways To Skin That Cat

In any case, whether S&P holds the line or not, the stakes are too high for most BDCs to be deterred.

We expect to see BDCs who’ve adopted the new higher leverage to just raise debt capital in one form or another on an unrated basis.

However, there’s one more obstacle in the way of mass adoption of the new law and much higher levels of debt.

(Besides common sense).

Promises, Promises

Some BDCs that have already issued Fixed Income instruments included covenants requiring the BDC to maintain 200% asset coverage of debt.

Unlike with secured lenders – whom BDC managers can readily request waivers of the 200% coverage rule – Note Holders cannot be expected to “bend the knee”.

Which brings us to another strand in BDC Fixed Income News this week:

The realization by BDC managers that to gain access to all that extra debt existing issues may have to be bought in.

Gladstone Capital To Redeem Early 

This was clearly spelled out in a back and forth between Gladstone Capital‘s (President) and an analyst called Mickey Schlein on its most recent Conference Call. The highlight is ours.

Mickey Schleien-Analyst

…And just in terms of the process, if I understand it correctly, even getting to one to one would require a negotiation with your banks, and I guess, potentially refinancing the preferred shares. Is that correct?

Bob Marcotte-GLAD President

The banks, as is typical, do have a specific reference to the asset coverage test of 200%. But it’s really – doesn’t have any bearing on their collateral coverage, the various concentration constraints that they have on the portfolio or the way they stress test the performance and clearing of their outstanding investments – their advances.

So it’s in the document, but it frankly does not – I believe, from what they’ve told us to date, it doesn’t affect their credit and their investment decision. So I think that is something that we’re anticipating to be able to move on fairly easily. With respect to the balance of the capital structure, you are correct. The 200% test is in our most recently issued preferred stock in September of last year. It is not callable until September of 2019.

Our intent would be to position ourselves to call that constructively in order to fully access any movement in our leverage. The exact timing of when that call might happen, the notice provided is really subject to continued refinement. But it definitely extends it beyond April date when the Board of Directors approval, it would be effective.

The GLAD news has caused its Term Preferred with the ticker GLADN to jump in price ever since the new law was announced as this chart shows:

Who Else Is Out There ?

This begs the question as to which other BDC Fixed Income issues may or may not be subject to a similar fixed 200% asset coverage requirement.

Under Investigation

We are not legal experts and are loath to draw any definitive conclusions which we’ll leave to others reading the BDC debt indentures.

Maybe GLADN is the only issue affected or there could be more.

Making Room

If the latter we could have an avalanche of BDC debt issues getting redeemed at the earliest opportunity to make way for asset coverage compliant new debt in the future.

On The Horizon

In any case – and given the multiple BDCs signing up for the new law, either right away (if shareholders approve) or in 2019 (if shareholders are left out of the loop)  expect unsecured debt to loom large in the future.

To take full advantage of the new regulations, BDC managers will have to both increase secured and unsecured debt financings.

The latter is where BDC Fixed Income in a public wrapper COULD come in.

(There’s also the possibility debt hungry BDCs will place any unsecured borrowings with institutions and by-pass the public market).

Even if secured lenders are more generous than in the past on their borrowing base requirements there is only so much they can offer BDCs.

To take typical BDC leverage from o.8 to 1.0 up to 1.6 to 1.0 (or higher), as several BDCs have suggested they might go, junior debt will have to be raised.

One Third And Counting

We count – and we may be missing some names as BDCs are often shy to divulge that their Boards have voted to double their leverage – 17 BDCs that have already taken the higher leverage plunge.

By the end of Earnings Season, we expect that could easily exceed twice that number.

Many of the early adopters have issued unsecured Fixed Income issues already – whether public or private.

Like The TV Show

This could POTENTIALLY mean billions of dollars of additional unsecured debt will be raised in the years ahead.

Stay Tuned

We expect more clarity with every coming week and for months to come as different BDCs announce which way they are going to jump and how.

Plus, we’ll be following S&P’s uncertain path forward.

Finally, we’ll be tracking how the debt providers themselves – both the secured lenders and the unsecured – react to the greater demands made on them.

Will advance rates change ? Will pricing change ? Will new forms of financing emerge ?

This may have been a critical week for BDC Fixed Income, but there are many more yet to come.

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