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BDC Preview: Week of April 15 – April 19, 2019

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Medley Merger: The week of the three-way Medley Group vote has arrived. On Friday March 19, 2019 the ballots at Medley Capital (MCC); Sierra Income (SIC) and Medley Management (MDLY) will be counted and we’ll know if the three will become one under a newly public SIC banner. Or will we ? The chances of yet another postponement of the vote are high. Although the BDC Reporter noted – just last week – that the SBA has caused MCC to promise to redeem all its $135mn in subordinated debentures in short order, no official word has come to investors by dint of an update of the Proxy. Nor have the disclosures required by the Delaware Chancery Court following a lawsuit regarding this vote been made by the Medley defendants. Nor have shareholders been officially updated on the multiple offers made by third parties in recent weeks and the Board’s reaction to them. Speaking of the Board, MCC has lost two of its “independent” directors. Can a BDC even function – legally speaking – with those positions still unfilled ? We don’t know the answer but we may be about to find out.

Like last week, the absence of any press release or filing from the opponents to the merger remains deafening. Even NexPoint Capital – whose offer to become MCC’s next external manager appears to improve with every new press release – has been quiet for days and days. Also notable by their radio silence are activist FrontFour Capital; would be investment Advisor Marathon Asset Management and Origami Capital – recently eager to acquire MCC’s SBIC portfolio at a discount. There are many more players besides in this Game Of Thrones knock off who are likely to be active behind the scenes, but who’ve not been heard of. No wonder that MCC’s stock price was flat last week. Investors – typically an active bunch – have no idea where this is going, but a great battle between the multiple parties is anticipated that might bring some clarity where now there is only confusion.

Market Prices: As discussed in the premium feature BDC Common Stocks Market Recap this week, BDC common stocks have been going nowhere fast for seven weeks, even as the broader markets have been defying gravity – and the doomsayers – by moving upwards. To our mind, that’s a sign that the BDC rally – which began December 24, 2018 – is in trouble. For the moment, BDC shareholders are pleased to be out of the price turbulence that brought the sector down between the summer of 2018 and Christmas Eve, and can focus on clipping their coupons. As studies – and the Wells Fargo BDC Index – have shown, long term returns from BDC investing come from distributions received rather than upward prices. Nonetheless, we’ll be keeping an eye out for any surge upward of BDC stock prices. We believe that’s the less likely option, but the markets can surprise us. We’ll also be looking for any price weakening. At the moment, only 1 BDC out of 45 is trading within 10% of its 52 week low and 17 are trading at a price above book. If these metrics start to change for the worse, we’ll be concerned. Most likely, though, is that the normally volatile BDC common stock sector will continue to putter along, neither hot nor cold.

Fixed Income Capital Markets Activity: As we’ve noted in our latest BDC Fixed Income Market Recap, we’ve been surprised that more BDC issuers have not come to market in 2019 to date. Listening to the Conference Calls for the past year has made abundantly clear that many players have ambitions to become bigger in terms of assets under management, and that requires access to greater borrowings. With the Fixed Income market close to its best levels of the past two years, we’d have expected more BDC CFOs – and their friends on Wall Street – to be tapping what seems to be a receptive investor base. In fact, over recent years the universe of investors who’ve “discovered” this fixed income niche has expanded, allowing issuers to raise unsecured debt at lower spreads over the risk free rate than before. Plus, the risk free rate – thanks to that bond market miasma that has taken hold since October 1, 2018 (when the ten year Treasury yield peaked at 3.25%) – has dropped back to more “affordable” levels; typically a fillip for issuance. There are 42 public BDC debt issues to choose from currently. Maybe this week the number will increase to 43 ? As soon as we hear anything, look to our Twitter feed and later to these pages.

Credit Update: This week, we’ll continue to monitor BDC portfolio companies for material credit developments. There have been a series of bankruptcies and behind the scenes restructurings going on in 2019. This week  we hope to offer a new table in our Tools section for our Premium subscribers with a database of the the BDC portfolio companies that have walked the bankruptcy plank, or are expected to do so, in the first months of this year. Notwithstanding a still red hot M&A market which has rescued some troubled entities – and given their BDC investors something to cheer about – there continues to be a steady trickle of companies giving up, and seeking court protection. Most are able to find new life with new owners or from debt for equity swaps, but some are being liquidated. In either case, BDCs are at risk of permanently losing capital and a reduction in investment income. We can’t speak to whether the overall credit performance picture is getting better or worse, as we’re still grappling with the data management of tracking 3,000+ BDC portfolio companies on a daily basis !  However, if those early cracks in the U.S. economy that have predicted by so many for so long are going to show up anywhere, the middle market leveraged loan sector – in which the BDCs are the leading players – is the place to look. We don’t expect any one setback to tell the story, but will be looking out for an acceleration in the drip drip of companies getting into trouble.

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