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BDC Preview: Week of January 28 – February 1, 2019

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Markets: As always, the BDC Reporter – and everyone else – will be keeping an eye on the markets after five weeks of rallying. We’re not yet at the December 3, 2018 level of 2,535 on the Wells Fargo Index which we set last week as a useful target, but have inched closer after the 0.9%  increase last week. That left us at 2,519 (2,496 the week before) and almost fully recovered from the December bloodbath. As we’ve discussed at greater length in the BDC Common Stocks Market Recap progress going forward is going to be harder to come by and other forms of non-investment grade debt are already leveling out. On the other hand, if January 2019 looks anything like February 2016 – the last time we had a sudden pull-back out of a seemingly clear blue sky – the price trend will remain upward with only very modest bumps along the way.  That rally lasted over a year.

BDC Fixed Income prices will also be in our sights. That segment has bounced back to exactly par – at least by using the median price of the 41 public securities we track. BDC debt hovers somewhere between its best levels of 2017 – before the risk free rate and the Fed Funds rate started to really ratchet up and the pits of last December when investors were selling everything off and bringing prices to record lows. With the government re-opening, and if there is some sort of agreement with China that might avert tariffs, will confidence seep back into the markets, pushing up rates and putting a brake on any further improvement in BDC fixed income prices ? Or will market confidence slip and every other prediction relate to a coming world-wide recession ? Then the risk-free rate will drop but so – most likely – will BDC debt prices. BDC Fixed Income holders are probably hoping for some slow growth, muddling along economy scenario which will keep prices close to where they are or a little better.

Medley Capital Merger: There have been a number of twists and turns in this proposed merger. Last week Medley Capital (MCC) was out lobbying shareholders with a new presentation arguing for a FOR vote on the proposed tripartite merger with Sierra Income and Medley Management (MDLY). Dissident shareholder – and the most active of the 4 different groups opposed to the merger – FrontFour Capital Group (“FrontFour”) used the opportunity to counter MCC’s arguments, but not much new was said by either side. Even the MCC stock price did not do much, moving from $2.95 to $2.99. However, there was breaking news on Sunday January 27, 2019, which we’ve already written about on the BDC Reporter: Institutional Shareholder Services (ISS) brushed off FrontFour’s arguments against the merger and – according to MCC – came out in favor of a FOR vote. This week we’ll be interested to see what FrontFour says in response, and whether we’ll get the full ISS rationale for supporting what must be – at the very least – a controversial decision given MCC’s rocky history as a BDC and the multiple conflicts of interest of the management. Equally intriguing will be the reaction of the market – as reflected in the MCC stock price.

Earnings: Some readers may believe we’ve “buried the lead” by mentioning the first week of BDC earnings season third in our Preview, and they might be right. If we’ve counted correctly- and readers can look up the BDC Earnings Calendar in our Tools section – there are 10 different earnings releases coming this week. We don’t expect anything particularly special out of any of the BDCs reporting, but several names are still grappling with portfolio turnarounds (AINV, PNNT, OCSL) , which means anything can happen. Also, Gladstone Investment (GAIN) is coming off a September 2018 quarter where adjusted Net Investment Income Per Share dropped sharply. That was a one-off said management which can point with some cause to a couple of major equity realizations since quarter end and new loans booked that should – this quarter or next – return GAIN to its former state or better. After all, management just recently hiked its regular distribution… We’re optimistic for GAIN but when you have 12 companies in a 32 company portfolio on the BDC Reporter’s Watch List (one third of those already on non-accrual), a little anxiety is warranted.  High flyers like Capital Southwest (CSWC) should report strong results. The main wild card there, though, is what value is ascribed to its largest portfolio investment – and biggest equity stake – Media Recovery Inc.

SBCAA:  Just as important as hearing about how BDCs performed in the fourth quarter of 2018 will be learning what their intentions are regarding the Small Business Credit Availability Act (SBCAA) and the higher leverage allowed. All but one of the ten BDCs about to report results have adopted the new regulations, mostly by Board of Director fiat. That means many more quarters will pass before these BDCs max out their assets under management and borrowings. Investors, though, will be gaining some further insights – both from what they’ve done on their balance sheet and from what is said on their Conference Calls.  A little is known about each BDCs intentions but with so many moving parts involved and such a long time frame between when the SBCAA was first enacted and its full implementation much more needs to be filled in. Hopefully analysts and others will ask the hard questions necessary about the additional risks being added and whether the additional income likely to be booked will “trickle down” to the shareholders.

All the above will be grist for the BDC Reporter’s nill and we expect to be kept very busy in the month ahead as the BDC sector closes the books on 2018; as well as completes two major change of ownership transactions (MCC and KCAP Financial) and seeks to push up assets under management across the board – almost all financed with more debt.

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