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BDC Fixed Income Market Recap: Week Ended August 24, 2018

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BDC FIXED INCOME

Foreground. Background

For the week ended August 24, 2018, the BDC Fixed Income market was much unchanged, as we’ll discuss in a minute.

In the background, though, changes were underway.

First to market pricing, where the median price was at $25.32, ever so slightly down from $25.35 the week before and $25.40 before that.

The total number of BDC Fixed Income issues we are tracking increased to 38, with the addition of Gladstone Investment‘s (GAIN) new Term Preferred GAINL.

We first discussed the BDC’s new Term Preferred back on August 15, 2018, but trading did not begin till August 22.

We have now updated the BDC Fixed Income Table with the new Term Preferred and with the redemption dates for two existing GAIN issues, set for August 31.

(For those new to the BDC Reporter, the BDC Fixed Income Table is a complete list of all publicly traded issues, and much ancillary information and is exclusive to the BDC Reporter’s premium subscribers).

Not Long For This World

GAIN still has the Term Preferred with the ticker GAINM still uncalled but you can bet dollars to doughnuts the BDC will be calling in the issue shortly.

The no redemption period ends September 30, 2018.

GAIN will either call in GAINM right after the prohibition date passes or will wait till next year when the higher leverage rule – which the Board has approved – kicks in.

Either way, we don’t expect GAINM to be amongst us much longer.

Back To Basics

Anyway, most of the weekly metrics we look at suggested stable market conditions.

The 10 Year Treasury dropped back in yield to 2.83% from 2.857%, causing no pressure for higher yields.

There was no BDC Fixed Income issue trading over $26.00 this week, versus one last week.

This week there were 5 issues trading below par versus 4 the week before and 6 the week before that.

All the above suggests a business-as-usual pricing environment, consistent with conditions in recent weeks.

Action

However – as we forewarned above – there was other activity worth noting in the BDC Fixed Income space.

Of course, the biggest item was Saratoga Investment‘s (SAR) decision to issue a second Baby Bond.

This new issue will have the ticker SAF, and will join the 2023 debt with the ticker SAB – which coincidentally was the week’s highest priced at $25.94.

SAV – which Premium subscribers got to read about in the BDC Reporter when we first saw the preliminary Prospectus on August 21 – has a 2025 maturity.

This has added to the BDC Fixed Income universe, although the bond is not yet actively trading and thus not listed in the BDC Fixed Income Table.

Another Brick In The Wall

More importantly, SAR’s second foray into issuing publicly traded debt is yet another indication that BDCs of all shapes and sizes are laying the groundwork for permanently higher leverage.

Of course, SAR and 28 other BDCs have thrown their hat – to varying degrees – in the higher leverage ring by adopting the lower asset coverage requirements allowed under the Small Business Credit Availability Act.

We’ve seen New Mountain Finance (NMFC); Golub Capital (GSBD) and WhiteHorse Finance (WHF) all raise new forms of unsecured debt with similar objectives.

GAIN – to – as we’ve seen – is reshaping the liability side of its balance sheet to boost assets in 2019.

Split

However, the fact that SAR chose to raise its needed debt capital in the public market while the others did not reinforced the BDC Reporter’s frequently noted talking point about a split market.

Bigger BDCs who want to “leverage up” are mostly placing the debt in the institutional market – along with modestly tighter covenants.

Smaller BDCs – like SAR and GAIN – are relegated for the moment to tapping the public market, which requires more cost, more disclosure but may involve less in the way of covenant restraint.

Digging In 

We undertook a little analysis to determine what were the chances of more smaller BDCs coming to the public market if this dichotomy continues.

We count 18 BDCs with assets of half a billion or below.

Of those 12 (including SAR) have adopted the new leverage rules in some form and are candidates to raise public debt.

Moreover, we may get occasional offerings from larger BDCs notwithstanding the current mode for placing the debt with institutions.

On paper at least there seems to be a good chance – after all the dust settles – that the number of publicly traded issues could increase to over 50.

After all – as SAR and Newtek Business (NEWT) and GAIN  have shown – even smaller or mid-sized BDCs are not shy about having more than 1 public debt issue outstanding.

Hedge

Much can happen to both the BDC sector and to the capital markets in the next 18 months as this process plays out so we’re guaranteeing the BDC Fixed Income Table is going to swell.

Chances, though, are high.

One Step Back, Two Steps Forward

In the short run, though, we’re going to have three GAIN issues retired, as well as the two Triangle Capital Baby Bonds (TCCA and TCCB).

In addition, Gladstone Capital (GLAD) is likely to be retiring its own Term Preferred (GLADN) in the fall of 2019.

That will bring the current 39 public issues outstanding (including “grey market” trading SAV) down to a pro-forma 33.

Nonetheless – and taking those redemptions into account – there is a good chance we will see 50 public BDC Fixed Income issues by the end of 2019.

That’s essentially a 50% increase in the number of choices available to investors.

Affirmation

That validates the BDC Reporter’s long held interest in the segment as as investor  – which dates back to 2012 – and our several years of reporting to readers.

The future, though, is unlikely to be the same as the past.

We doubt price conditions will be as stable through thick and thin for BDC Fixed Income as they’ve been for the past 6 years from 2020 on given that credit and balance sheet risk parameters will have changed.

Moreover we expect that our internal Stress Tests of each issue that we conduct periodically to evaluate who is likely to withstand recession conditions will offer mixed results.

At the moment even the weakest BDC Fixed Income issues receive a passing grade after pro-forma assumptions of 20%-30% drop in portfolio values.

Nonetheless, we’re hopeful – even as we largely disapprove of higher debt for BDCs from a shareholders perspective – that the BDC Fixed Income sector will remain very stable as long as the sun is shining.

This will mean most Weekly Recaps will have little excitement to report where prices are concerned, just like this week.

BDC Fixed Income investors – earning a 6.0% – 6.5% average yield  – will be hoping as much.

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