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BDC Preview: Week Of December 10 – December 14, 2018

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Inescapable: We’re going to assume the ups and downs of the major indices – and the corresponding movement in BDC common stock prices – will continue until it doesn’t. Since late August, the turmoil across all asset classes has caused the playbook of BDC fundamentals to be thrown out the window as new low after new low is reached, with a few head fakes along the way. As we write this the Dow Jones index is trading 200 points down in the Monday pre-market, which only means that more of the same is on the cards.  Admittedly, this past week, the BDC sector fared less poorly than the 3 major indices (Dow Jones, NASDAQ and S&P 500), but that could reverse itself this week, whether the broader markets go up or down. All we are sure of is that the BDC sector cannot disentangle itself from whatever direction the markets are headed. Here is the chart showing the price of the UBS Exchange Traded Note with the ticker BDCS – which includes most every BDC player – since August 30, 2018, roughly when the market dramas began, compared to the main indices.

The BDC sector is now down nearly 10% since its 2018 high. If history is any guide – and without any new sector-specific developments – we could readily drop by as much again, or even more. As we ruefully often remind readers – because we were long at the time – BDCS dropped 28% in the summer of 2011 because of what was happening in far-away Greece and what might happen in the equally distant rest of Europe.  Then – one day – the markets decided that enough is enough and start to climb back some or all the way.

Crossing Over: At this point, the BDC sector is still ever so slightly ahead in total return terms in 2018, and still above its lowest level of the year. That could drop into the red in the blink of an eye. We’ll be keeping an eye on the price of BDCS and see if the 52 week lowest level is breached – $18.72. That would just be 2% off the Friday close.

Down Again: In prior editions of the BDC Preview, we’ve discussed the fate of the latest public BDC  – Bain Capital Specialty Finance (BCSF). At November 30, BCSF – after printing a IPO price of $20.05 – traded at $18.40. This last week, the price erosion continued, with BCSF down to $18.00. We’ll be tracking the stock price of BCSF again to see if the slide continues.

All Grown Up: Also on our radar is FS Investment (FSIC), now that the merger with Corporate Capital Trust (CCT) has been approved by both BDCs shareholders on December 3. Formally, FSIC does not become the enlarged and renamed “FS KKR Capital Corp” until December 19. Moreover, there are still regular and special distributions to be paid on December 27 that could affect unusually affect the stock price. Since the vote last Monday there has been little in the way of developments, except for a new shareholder presentation that turned up on the website on December 6. Although the presentation is a 36,000 feet view of the now merged BDC, it’s worth reviewing. Just click here. We’ll be curious to see if the beating FSIC – soon to be FSK – has been taking for months will continue. This past week, the price was relatively flat and did not dip to the 52 week low of $5.90, and closed Friday at $6.05.

For our part, after looking under the hood at the credit portfolios of both FSIC and CCT as of September 30, 2018, we are in no hurry to get on the FSK bandwagon, whether the “train leaves the station” or becomes “oversold” or whatever. We’ll be guided by that other well worn expression: “what you don’t know can hurt you” and there are too many Watch List credits with too many question marks to allow us to do anything but watch and report back. Obviously FSIC is better value at $6.05 than at the $10.75 high of less than 2 years ago, but that’s not comfort enough. We expect the FSK portfolio turnaround is going to take several quarters to effect, and we’ll have many opportunities to evaluate progress made.

New Leaf ?: Also in the sightline is Garrison Capital (GARS), which continues to find new price lows. Admittedly the dividend was paid out last week, but GARS did hit a new intra-day 52 Week Low of $7.16. Since announcing its dividend cut on November 6, 2018, GARS has dropped over 10% in price, with no end yet in sight. Here’s a chart that covers the period since the announcement:

Bad Company: The yield at the latest $0.92 annual payout pace is 12.7%. That’s one of the highest BDC yields out there. We count a dozen BDCs with a 12.00%+ yield. GARS peer group includes other BDCs on investors question mark list such as FSIC, Medley Capital (MCC) and Monroe Capital (MRCC). Our credit review of the September 30, 2018 portfolio was surprisingly positive for a BDC that had just repeatedly stumbled and had to cut its payout for the second time in just over 5 years as a public company. Moreover, GARS appears to have successfully accomplished its strategic repositioning of its business in lower risk debt and borrowers. Again –  to our surprise –  the “risk profile” of the portfolio – when we take a long term, bigger picture look at the probability of default of performing loans – was looking pretty solid as of September 30, 2018. However, both the BDC Reporter and most investors seem to want to see if the Investment Advisor’s credit underwriting holds up as new loans “season”. Management is not unaware of this challenge and in its most recent Investor  Presentation, called out that 86% of all investments on the books were from 2017 and 2018 “vintages”. Will those be very good years – as with wine – or are further misfires going to show up ? That will take till the end of 2019 at the earliest to get a decent answer, but the direction of the stock price may give us a hint as to which way investors are leaning.

Inactive: The problem with hyper-active, downward trending markets (nobody seems to mind a hyper active upward trend) is that there’s very little incentive to push the Buy button when tomorrow that same stock – for no apparent reason and with no additional market moving news – could be available for a lower price. As we reported to our Premium subscribers when compiling our BDC Common Stocks Market Recap, only 10 BDCs are up or even in price over the last 4 weeks and 36 are down. We don’t have the data but we expect that the number of BDC stocks that have risen in price since the August 30 2018 sector high is even lower.

As a partial illustration here is a chart of the price action of some of the more popular BDCs since August 30, 2018. These include Ares Capital (MRCC), TPG Specialty (TSLX), Main Street Capital (MAIN), BlackRock TCP Capital (TCPC), White Horse Finance (WHF) and Goldman Sachs BDC (GSBD).  As you can make out through the jumble of lines, all have dropped in price to varying degrees – and some at times quite sharply before recovering partially.

That’s kept us and many other investors out of the market for weeks.  However, if we get a major, out of control sell-off or some sort of siren calling investors out of their shelters, expect to see a jump in trading volumes and a rebound in many BDC prices, especially amongst the market favorites. Will that happen this week ? Will we re-learn how to buy stocks rather than just sit with our arms crossed frowning at the screen ? Was that dip in late November, that shows in our chart, the bottom ? We shall see.

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