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BDC Fixed Income Market Recap: Week Ended February 28, 2020

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BDC FIXED INCOME

Breakout

For months, the median BDC Fixed Income price level has gone virtually unchanged, leaving the BDC Reporter to provide color commentary on changes of a fraction of a percent.

Now, though, we are in entirely new territory.

The BDC median price on the 44 public BDC issues we track has dropped to $25.28, down from $25.72 the week before when markets were treating Covid-19 as a far away Chinese problem.

That’s a (1.7%) drop in the median price for the week.

That’s a substantial move by BDC Fixed Income standards, but laughably little compared to the (12.13%) drop in BDC common stocks.

Support

Our other regular metrics also illustrate that this was an unusual week for publicly traded unsecured BDC debt.

As of Friday February 28, 2020 there are only two issues trading at or above the arbitrary $26.00 level we’ve set to measure price enthusiasm.

The week before the number in this category was fourteen.

Likewise, at the bottom of the table, the number of issues trading below par tripled from 3 to 9.

Familiar

Admittedly, most of the BDC issues in the nether levels have been there before – or very close – prior to the meltdown.

As you’d imagine the issues include one the two Medley Capital (MCC) Baby Bonds: MCV.

Also there are Capitala Finance’s (CPTAL) Convertible and Baby Bond: CPTAG and CPTAL.

Then there are two Great Elm (GECC) bonds (out of three): GECCM and GECCN.

Insights

You can see all the prices for all the BDC debt – whether under $25.00 or not – on the BDC Fixed Income Table that we’ve updated for the week.

There’s other very interesting data in the Fixed Income Table.

For example, we can see that currently only 7 issues are trading above their year end 2019 level.

Compare that with the current price versus 2018 where those numbers are inverted: 37 higher and 7 down.

Year-t0-date those 44 issues are trading (1.44%) lower than at the end of last year.

Although we’ve not been running that number weekly, we’d guess ALL that drop in 2020 versus y/e 2019 happened in the last 5 business days.

Calm

There’s clearly been no abject panic amongst BDC debt holders as yet, but it’s not been business-as-usual either.

Volume activity – judging by a quick look at some of the more popular issues – seems to have been three times normal levels.

Presumably,  buyers of BDC debt were happy to grab slightly lower prices as interest rates dropped towards a 50 year low (according to one headline that caught our eye).

Normally that would cause BDC debt prices to jump, not decrease as has happened, so some buyers must have been licking their lips.

Big Spread

Overall, BDC public debt yields – as before – are just over 6.0% on average.

With most BDCs with 5 year or shorter maturities, that a 5.11% premium to the equivalent risk free rate.

We compare that BDC yield – which includes many issues that have received a BBB rating and compare that against “regular” BBB bonds.

Those are currently yielding – according to Bank Of America – just 2.86%.

BDC buyers with open checkbooks were getting a bargain by those standards.

Looking Forward

Based on the 8 years we’ve spent tracking the BDC unsecured market on a daily basis – we were investors right off the bat – we wonder if the measured calm will continue.

As we wrote about in the BDC Common Stock Market Recap, there is a huge degree of uncertainty about the evolving Covid-19 story and its impact on the global economy.

In the past investors – even in debt – have not been able to handle the question marks involved and have tended to push prices down.

Analysis

For our purposes, we’ve revisited how investors in the grandaddy of BDC public debt – Ares Capital’s (ARCC) 2047 Baby Bond have acted in two prior crises.

Those were in early 2016 and in late 2018.

In both cases the market began to worry about a possible recession brewing and the miasma lasted for several months before prices moved up again.

AFC – in those instances – saw its price drop (4.5%-5.0%) at the maximum before recovering.

Arguably this crisis could be as bad or worse than its two predecessors, so we wouldn’t be surprised if AFC – and the rest of the BDC Fixed Income universe – followed suit, if calm is not restored.

In fact AFC – which was trading at very lofty levels – dropped (4.2%) this week alone.

That other high flyer, the Hercules Capital (HTGC) Baby Bond with the ticker HCXY was trading at $27.50 a week ago, but closed on Friday at $26.66.

That’s an above average (3.1%) drop as well, suggesting there was some profit taking involved as well.

Tapping

Our unsubstantiated view has always been that some investors sell some or all their Baby Bond positions even if they have no fundamental concern to raise cash.

After all, there were very few asset classes registering such undiminished prices as BDC Fixed Income last week.

Should overall market confidence weaken, an increasing need for cash to meet margin calls and to position for any turnaround – as well as some growing concerns about BDC fundamentals – can cause an accelerated price drop.

If the all-clear sounds – and we appear to have avoided a recession for the nth time – prices are likely to recover and possibly exceed the high levels of just over a week ago.

If not, though, there is reason to be concerned – or excited if you’re a buyer – that we may be closer to the beginning than the end of BDC debt weakness.

News Worthy

In a week when most market participants were glued to what was happening in the markets, there was one material – and not surprising – development.

MVC Capital (MVC), which has one public Baby Bond with the ticker MVCD, announced its intention to redeem a portion of the debt.

MVCD has a nominal maturity of 11/30/2022, yields 6.25% but has passed its non-redemption date.

MVC has received proceeds from a major investment being repaid. See the BDC Reporter’s most recent Summary Results article, which discusses the subject.

The BDC might have decided to cut its interest cost by getting rid of a portion of its relatively expensive debt, and may be eyeing using secured debt finance in the future.

Or, MVC may be back with a new, lower cost unsecured debt issue in the near term.

Based on what its peers have been able to borrow at – and taking into account a more “normal” portfolio of yielding loan assets, we assume MVC might be able to borrow at 5.00-5.75% in the public market.

We’ll stick our neck out and suggest a private placement of unsecured debt is not yet attainable.

If we turn out to be wrong, any public BDC is a candidate for the private debt market with only a couple of exceptions we won’t name.

However, as we mentioned in our BDC Common Stocks Market Recap article, the new environment brought on by the virus makes all prior assumptions about what can be done or not invalid for a time.

Where We Stand

Leveraged finance – including the BDC sector – is at a crossroads.

With the Fed apparently poised to lower rates and yields reaching record low levels lenders are able to borrow at incredibly low costs of capital.

Issuers who can access the BDC Fixed Income market at the bottom will boast cut-rate yields never seen before.

As we’ve said before, yields under 3.0% for some of the top players are in sight and – shortly – every BDC may be able to borrow unsecured at a rate competitive or  better than their secured debt.

While revolver financings can increase in yield very quickly (in 1 month or 3 month periods) should LIBOR later rise, fixed income can be locked away for 5 years or more.

That’s the opportunity brewing for BDC CFOs, some of the canniest in their profession.

On the other hand, should the Covid-19 crisis  continue and expand, the capital markets for new debt could close down and/or spreads required by investors greatly increase.

If what follows is a recession, even the need for capital will shrink as the supply of loans slows almost to a halt and many players focus on “cleaning up” their existing portfolio.

We now live in uncertain times and the BDC Reporter – and most everyone else – cannot tell which road we’ll be headed down.

Instead, we’ll just promise to report back weekly and provide our assessment of what’s just happened and reposition the GPS as to where we might be going.

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