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BDC Fixed Income Market Recap: Week Ended August 3, 2018

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BDC FIXED INCOME

Bit Better

In a quiet week, the BDC Fixed Income segment moved a little higher.

The median price of the 37 issues we track  – which was last at $25.27 – increased ever so slightly to $25.31.

Here’s the week’s end price chart, from highest to lowest and the issues below par marked in red and the median in green:

Other Fun Facts

There were no issues trading over $26.00 as of the August 3, 2018 close, versus 1 the week before.

At the other end, the number of Fixed Income issues trading below par improved from 7 to 5.

The 10 Year Treasury – which we glance at once in a while to keep up with the change in the risk free rate – was essentially unchanged from the week before.

Musings

We have to wonder with a U.S. GDP print of 4.1%, record low unemployment and all that jazz when that major spike in medium and long term interest rates is going to happen and disrupt fixed income’s quiet world.

As for Godot and a championship Lakers team, we’ve been waiting for a very long time.

Let us illustrate:

Here’s the price chart for one of THL Credit’s (TCRD) Baby Bonds with the ticker TCRX, dated back to January 2015:

As of Friday, TCRX was trading essentially at the same price as three and a half years ago.

Compare that price pattern to what’s happened to the 10 Year Treasury over the same period, rising from 1.80 to 2.95%.

Quiet Times

Price stability for TCRX – and most every other BDC Fixed Income issue – has been the order of the day regardless of what risk free rates were doing.

Even if rates do materially increase, we doubt existing BDC Fixed Income prices will move much given that many are short term in nature and investors seem to be hungry to have and hold them.

Back To The TCRX Chart

However, the first chart does also underscore that BDC Fixed Income – like all credit instruments – is not immune when market confidence weakens.

Back in late 2015 and early 2016 we had what turned out to be a passing case of market angst.

TCRX dropped from $25.44 in November 2015 to a low of $24.04, a (5.6%) drop, but quickly recovered and returned to flatlining.

Coming Attractions

That’s a preview of what might happen – and more – the next time the markets start to worry about the credit-ibility (to coin a word) of loan assets.

Thankfully there’s little sign of any fundamental frisson going through the markets at the moment.

We are aware that credit spreads for larger loans have increased of late, which is usually an early sign that credit committees are beginning to worry about lending to prospective borrowers.

However, in this case – and based on what we heard on several Conference Calls and other research of ours – the cause appears to be more technical in nature and should adjust in the autumn as a spike on new loan activity is absorbed.

We also note that high yield spreads – also a useful tell about credit risk appetite – continue to shrink, suggesting no widespread market worries about non investment grade debt.

Still, when the next drop in BDC Fixed Income prices comes – and we’ve been two and a half years since the last mini slump – we expect the fuse will be lit by credit rather than interest rate concerns.

In the short term, though, we expect no trouble from either quarter.

In Other News

There was very little in way of developments in BDC Fixed Income on the week.

Readers of the BDC Fixed Income News  will be aware that Prospect Capital (PSEC) issued a new set of InterNotes, in much the same size and pricing as just a few days before.

That was par for the course for the BDC which has the most active InterNotes program -typically aimed at individual investors – of any BDC, or maybe any company, out there.

Trawling

The BDC Reporter did read the Conference Call transcripts of the 15 BDCs who reported earnings this week for hints about their funding strategies going forward.

We were especially interested to hear who might be explicitly planning to tap the unsecured debt markets, and even more specifically, publicly traded securities.

Surprisingly, there was little tangible discussion on this subject even amongst the many BDCs who have chosen to leverage up under the Small Business Credit Availability Act. Or Act for short.

Speaking very generally most BDCs still seem to be in planning mode, and many are busy amending their senior secured debt facilities as a first step to increasing their debt profile.

We get the impression that even amongst the biggest and most sophisticated funds re-arranging liability management is still a work-in-process.

However, there were a couple of items worth noting.

On Our List

OFS Capital (OFS) – in answer to a direct question – admitted to considering a second trip to the Fixed Income public markets as part of their ambitious plans to leverage up in the next couple of years.

From the transcript, we get the notion that the Target Leverage of the smaller BDC might be as high as 1.8x its net assets.

We doubt we’ll see OFS in the market till 2019, but you never know.

Power Of Persuasion

Even more intriguing – and something we hope to learn more about next week – TPG Specialty (TSLX) announced that S&P maintained its investment grade rating despite the BDC electing the lower asset coverage rule allowed by the Act.

Admittedly, TSLX self imposed a leverage limit of 1.25x its equity (versus 0.8x currently) and admitted S&P’s rating might be dropped from “positive” to “stable”.

If true that would suggest that S&P – on a case by case basis – might be backing down from its blanket warning that anyone adopting the new rule would be dropped to non-investment grade status.

Hard To Say No

That would also validate our oft mentioned prior prediction that S&P – and the rest of the rating organizations – are unlikely to hold the line against their clients desires to increase their debt by 20%-100%.

In the case of TSLX we ran the numbers based on the BDC’s new “Target Leverage” and calculated that the BDC might borrow another $478mn, which would grow its portfolio by 28% and its borrowings by 56%.

The BDC Reporter has the greatest admiration for the way TSLX has been managed to date and its excellent track record.

Lest We Forget

Nonetheless, we should remember that the BDC’s average yield on its concentrated pool of loans (just 48 in a  nearly $2bn portfolio)  is 11.4%, almost twice what the large non investment grade borrowers in plain vanilla syndicated loans are paying.

Nor is TSLX promising – unlike OFS – that it will be adding “lower risk” new assets with all that extra debt capital.

Rightly or wrongly, TSLX (like ARCC, which is going the same way) will continue with “business as usual”.

Precedents

All this is just as we expected and will open the doors for other huge BDCs that have not yet committed to a policy vis a vis the Act.

The TSLX example will suggest that one can – by self imposing a leverage limit short of the regulatory one – “leverage up” AND maintain an investment grade rating from the top groups.

Other Ways To Go

Some will follow the TSLX and ARCC example and others will swing for the fences and not tie their hands at all like OFS and GSBD.

As we’ve said before, the different approaches being adopted by every BDC makes ever more important the need for individual risk analysis.

There will be “no one size fits all approach” and “your results will vary”.

When The Wind Changes Direction

That will make for a very differentiated impact on BDC Fixed Income prices next time the markets start to worry.

Expect much more price volatility across the entire segment than we would have had otherwise, and a much larger dispersion of results across both publicly and privately traded debt issues.

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