BDC FIXED INCOME

New Lows

Thanks to weaker economic data and coronavirus concerns – both separate and inter-linked factors – interest rates headed downwards in the week ended February 21, 2020.

The 10 year Treasury, which we use constantly for its ease of use to illustrate a wider reality, closed the week at a yield of 1.4710%.

The 10 year was at 1.5880% the week before and reached an inta-week low of just 1.4390%, before that slight uptick at the Friday close.

We are fast approaching the lowest rate in the past 5 years – 1.336% – set briefly in July 2016.

What Are You Gonna Do ?

More importantly – but harder to prove – the general market sentiment seems to be accepting that rates can and will go lower at the slightest pretext.

Certainly, for the moment, the notion that the 10 year Treasury may head to 3.5% or even 4.0% – which some pundits were signalling as a veritable certainty less than two years ago – seems more like science fiction than anything else.

Down And Up

As a result, BDC Fixed Income prices are likely to be headed higher, especially as at this time of growing global risk spreads on most credit instruments are – counter intuitively – shrinking.

That seems to be reflected in the BDC Reporter’s weekly median price for the 44 public BDC issues we track.

This week, the median moved to  new high of $25.72 from $25.68 the week before.

That’s not the highest point in the sector’s history, but is getting close.

Popular

More telling is that the number of BDC debt issues trading at or over $26.00 reached a remarkable number of 14.

That’s three more in this category than a week before and five more than a month ago.

Top of the heap is Hercules Capital (HTGC), whose Baby Bond HTXY which matures in 2033 and bears a yield of 6.25%, reached $27.50.

That’s about as high a price we’ve seen for any BDC fixed income instrument as we can remember.

Investors were probably attracted both by the  latest financial performance of the BDC – one of the best in BDC earnings season – and the fact that the debt can’t be redeemed till 10/30/2023.

If we’re going to get lower rates for longer a 5.8% market yield for a BDC issuer with an investment grade rating is like gold dust.

Less Popular

At the bottom of the price table, there were still only three BDC issues trading below $25.00.

As always, the lowest priced remains Medley Capital’s (MCC) Baby Bond with the ticker MCV.

That closed at $23.53.

MCV has been both higher and lower of late but within a narrow range.

It almost goes without saying that there was no progress on anything to do with MCC this week…

Otherwise, the other two sub-par issues were Capitala Finance’s (CPTA) Convertible with the ticker CPTAG and one of the OFS Capital (OFS) Baby Bonds – OFSSI – which often swings below the $25.00 level.

Two Reasons Why

As we’ve said before, the combination of lower rates across the board and a shrunken universe of publicly traded BDC debt – now that Oaktree Specialty Lending (OCSL) is calling in its only two issues in March – is a recipe for higher BDC debt prices.

Unlike the stock market, upward price changes in BDC debt do not come with  major short term moves, but the trend seems to be inexorably upward.

Caveat

That could change if the current funk becomes a global crisis.

Then even investment grade Baby Bonds such as HCXY may not seem a safe enough haven for some investors who’d rather bunker down.

That was the pattern we saw in the last great loss of market confidence late in 2018 and before that in early 2016.

We seem a long way from those days, but we’ve seen overall market sentiment – and there’s now little difference between equities and bonds in this regard – change very quickly.

We’ll be on the lookout for any possible scenario.

If anything notable happens intra-week, the BDC Reporter will make note on our News Feed.

Quieter

After months where there were major developments in BDC Fixed Income every week, very little happened this week that deserves mention.

The only notable item is that almost every BDC that has held a conference call of late has either recently raised new unsecured debt or promises to do so.

Or both.

Inverted

We now count three BDCs that have boasted of raising medium term unsecured debt at rates that compare favorably with often shorter term; restrictions laden secured bank facilities.

New Record ?

With fixed income yields dropping ever more, the day when a BDC will be able to raise debt capital at an interest rate below 3.0% is fast approaching.

We assume Ares Capital (ARCC) will break that record first, but there are other candidates.

The most recent ARCC Baby Bond was priced at a 1.65% spread over the equivalent Treasury.

Just for the record, the 5 year Treasury yield is currently 1.3180%.

Add 1.65% to that and you’ve got investment grade debt at 2.968%…

Right Now

More importantly in the short run, we estimate that three-quarters of public BDCs are likely to borrow unsecured at a sub-5.0% yield, should they choose to do so.

That’s expanding the universe of BDCs that might tap the unsecured market, as the economics become more favorable.

This week Solar Senior Capital (SUNS) hinted that raising unsecured debt might be in its future:

“At December 31, 2019, SUNS’ net leverage was 0.78x compared to 0.80x for the prior quarter. As a reminder, Solar Senior’s target leverage is 1.25x to 1.5x net debt to equity under the reduced asset coverage requirement.

In December of last year, the DBRS Morningstar assigned a long-term issuer rating and a long-term senior debt rating of BBB to the company with a stable trend on both ratings. This rating positions SUNS to diversifying its liability structure”.

The biggest group of potential users are BDCs with existing unsecured debt.

Like many of their own borrowers, these BDCs are going to be in a continual refinancing mode in an understandable effort to cut their cost of debt capital.

That’s going to be necessary because the pressure on income from lower LIBOR is going to continue.

The chart below shows how 1 month LIBOR has moved down in less than two months, since the beginning of 2020:

Momentous

Titanic changes are underway in the financial markets that are going to have broad consequences for the economics and profitability of BDCs of all stripes.

We are only beginning to get an idea of how this will play out, but we’re trying to look ahead to give our readers a heads up.

This is not the best forum for a long term perspective but the developments we mention in passing every week are going to make a big difference to how the industry is managed and funded and to investor returns in both common stock and fixed income securities.

Not every BDC has the same resources to confront the changing environment.

Even amongst those who do there are different strategies being employed.

Not all are likely to be successful.

We’ll seek both to highlight the broad changes going on and how they play out at individual BDCs.