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BDC Preview: Week Of November 12 – November 16, 2018

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The BDC Reporter is kicking off a new series for all readers: BDC Preview. Our goal is to provide a heads up at the beginning of every week of what lie ahead for anyone interested in the Business Development Company sector. For our Premium Subscribers, we hope this weekly reminder will dovetail with our ongoing stream of  “news, views and analysis” about the most salient stories of the day. For our Free Subscribers – many of whom may not follow the BDC on a daily basis – we hope to provide advance warning of what to expect in the short term this ever expanding sector (45 public companies trading on all the main exchanges and 40 traded Fixed Income issues). This is Week Three:

MARKET RALLY MARCHES ON ? : The BDC sector – as measured by the BDC Wells Fargo Index – was up 2.7% last week, reflecting a broad based rally across the 45 public companies tracked. That was the second week in a row that the BDC sector headed up in price, following 5 consecutive weeks of descent that ended the prior rally which had begun in March 2018.

As we discuss in our Premium feature – the BDC Common Stock Market Recap – that rebound may as much to do with trends in the broader markets as with BDC fundamentals. Anyway, as of Friday November 9, 2018 BDCS – the Exchange Traded Note sponsored by UBS which serves as a easy to use proxy for the industry – was at $19.76. That’s up 5.4% from the lowest point of the year back just before Halloween (October 26), but still (4.8%) below the level at the end of 2017. Just a few points slippage and the BDC sector could have a loss making 2018.

Even if the price of BDCS stays where it is, 2018 could end up being a mediocre year. Last time we checked only a quarter of the BDCs tracked were up in price over a 52 week period.

On the other hand, there’s still time for a third or fourth leg in this late year rally.

If BDCS moved back to the level reached at the end of August, the sector would end up in the green both in price terms and on a total return basis.

That’s just 6.2% higher than Friday November 12’s level. With very few weeks left in the year, how the market performs this week will tell us whether this winter rally has any legs, or whether we are headed for yet another low.

EARNINGS SEASON- CHAPTER THREE: This week a motley group of 5 BDCs will be reporting earnings.

These include OHA Investment (OHAI), whose stock price has been punching up and down sharply in recent weeks.

Shareholders have now been waiting for years for the results of a strategic review, which the Investment Advisor has initiated but will not discuss the progress of.

Maybe Godot will turn up this quarter, but more likely not if past is prologue.

Shareholders will be most interested in seeing what the status of troubled portfolio company OCI Holdings.

OHAI has been generously extending its $22.9mn subordinated loan to the borrower for several quarters, while booking into income a stratospheric interest rate (mostly paid in PIK form) above 20% per annum. This note in the 10-Q says it all:

During the fourth quarter of 2016, we executed a series of amendments to our note purchase and security agreement with OCI Holdings, LLC, or OCI, to allow the company to PIK its LIBOR+12% cash interest for November and December 2016. Also, default interest of $0.1 million and current unpaid interest of $0.4 million was added to the principal balance in the fourth quarter 2016. OCI remains in financial covenant default and while in default, we are earning an additional 2% cash interest and 2% PIK interest. During 2017, we executed a number of amendments to our note purchase and security agreement with OCI that allows the company to continue to PIK its LIBOR +12% cash interest during 2017. Through June 30, 2018, we have allowed the company to continue to PIK its 12% cash interest while paying the 2% default interest in cash. In June 2018, we executed an amendment to our note purchase and security agreement with OCI to extend its maturity date to August 31, 2019.

What with the interest income, the PIK premium and the default interest, we calculate that OCI may have contributed 45% of OHAI’s Investment Income in the IIQ 2018.

We wonder who needs who more and whether there’ll be any developments announced this quarter ? With the debt extended to the summer of 2019, this might not be decision time for OHAI and OCI.

Also reporting results is Great Elm Corporation (GECC).

As always shareholders will want to know about the status of the BDC’s largest portfolio company: Avanti Communications, a satellite operator

We’ve been reviewing and commenting about Avanti for years given its importance to GECC. We checked our archive and found 5 stand alone articles, not to mention all the other updates contained in GECC-related articles.

Some news items of late have been favorable, but recent GECC valuations of Avanti have been lower.

TCP Capital (TCPC) is also a lender/investor to Avanti – albeit with a smaller bite size. They’ve already reported IIIQ 2018 results and valued their equity stake in Avanti SLIGHTLY lower than in the second quarter.

Shareholders will also be interested in knowing more about the plans of GECC insiders – who own a huge portion of the BDC – to sell more of their positions after a big block sale a few weeks ago that has knocked down the stock price by (15%).

Finally, GECC seems poised to issue a third Baby Bond, which might materially affect risk and return going forward.

So there’s plenty to discuss at GECC.

We’re expecting more routine earnings releases and Conference Call confessions at PennantPark Investment (PNNT) and PennantPark Floating Rate (PFLT).

The former is in the late stages of a credit turnaround, having invested too much in energy credits, which have either been written off or converted to equity.

PNNT has promised “Never Again” where energy lending is concerned as the Investment Advisor seeks to return to its prior status as one of the most reliable credit underwriters and one of only 4 BDCs that got through the Great Recession without cutting its dividend.

PFLT – managed by the same investment advisor – has a shorter, but more stable history.

PFLT is about to complete a 4 year stretch of paying the same monthly distribution.

Setbacks at either PNNT or PFLT would likely set back their price given that both are deemed uncontroversial at the moment.

Finally, Gladstone Capital (GLAD) will be reporting its results.

This BDC – sister of Gladstone Investment (GAIN) – has been on an improving path for several quarters.

Between January 2016 and May 2017 GLAD’s price increased more than 100%, peaking at $10.12.That’s quite a jump in the staid world of leveraged lending for a BDC that has been around since 2002 !

In recent quarters, GLAD’s performance and stock price have levelled off.

This quarter the BDC will have to contend with reporting the recent bankruptcy of one of its largest portfolio companies – Francis Drilling Fluids. We delved into the subject for Premium subscribers back on October 16, 2018. Following GAIN reporting a new non accrual loan and lower earnings, GLAD shareholders will be worrying about a repeat.

GAIN – another Gladstone company whose fundamentals have been improving in recent years – has seen its stock price drop as much as (20%) in recent weeks on the back of lower expectations and credit issues.


Last week, WhiteHorse Finance (WHF) came to market with a new Baby Bond, not so long after redeeming an earlier iteration.

This week, we expect GECC might issue another unsecured debt instrument, as discussed previously.

Moreover, there are numerous other BDCs circling, most of them interested in raising debt to take advantage of the higher leverage limits allowed under the Small Business Credit Availability Act (SBCAA). We count 33 BDCs that are in some stage of adopting the new rules, and only 2 that have explicitly said they will not make any change to their status.

This is keeping many BDCs busy renegotiating and expanding secured debt facilities. However secured debt can take these ambitious lenders only so far. Further unsecured debt issuances – both by existing issuers (there are 27 BDCs which have publicly traded debt outstanding) and newbies are in the cards.

We’ll see if any new capital markets activity gets announced this week and on what terms.

With the risk free rate trending upwards, BDC CFOs may be telling themselves that sooner is better.

Shareholders should be asking themselves – and doing the math is not very difficult – how much of the higher investment income generated from new debt-financed loan assets will make its way down to the bottom line and into their pockets.

Often, our calculations suggest that most of the INCREMENTAL income inuring to shareholders is lower than what ends up in compensation paid to external managers.

Nonetheless – as we’ve been predicting in our Weekly Market Recaps to subscribers for some time now – the BDC Reporter believes the size of the BDC Fixed Income segment – and the number of issues outstanding – could grow hugely in the months ahead.

This week is only the first of many opportunities for BDCs to tap the still very accommodative public markets.

We are less certain that institutional debt investors – looking at those pro-forma high leverage ratios and worrying about looser credit standards and the “end of the cycle” are quite as enthusiastic as the public.

The proof – as they say – will be in the pudding in the next few quarters as we see who will be financing the ambitious leverage plans of the BDC sector.

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