BDC FIXED INCOME

Amazing

The most remarkable period in the short – and previously stable and uneventful life of the BDC Fixed Income sector – took another turn in the week ended March 27, 2020.

At an even faster pace than BDC common stocks, BDC debt prices – using the median number – jumped up 16.80%.

Readers of the BDC Common Stock Market Recap will know those securities moved up 14.45% this week.

That gain in the price of BDC debt followed the prior week’s unmatched (28.3%) drop.

For two – or arguably three – weeks now BDC debt and common stock prices have been moving largely in tandem, completely at variance with most of the former’s eight year history.

Deep Breath

So where are we  ?

Like last week, every single BDC remains at a price below par and in a wide range of $15.31-$23.91.

Last week – for sake of comparison – the range was $12.40-$22.00.

In all but one case – we checked – this week’s prices were higher than last week’s, some by a lot, others by a little.

Exceptional

The only exception was a Prospect Capital (PSEC) Baby Bond with the ticker PBC, which matures in 2029.

PBC dropped from $20.58 to $19.90 this week.

Maybe investors – concerned about the BDC’s viability over the long term – worried about the longer maturity than its two other Baby Bonds with earlier maturity dates.

Offer They Could Refuse

For the record, the PSEC Baby Bond maturing in 2024 with the ticker PBB which the BDC generously offered to take off holders hands at $17.00 a share ended at $19.14.

As we reported during the week, the tender offer has now closed and only $0.654mn of debt was redeemed by nervous debt holders.

Debt buybacks at a discount are not unknown in BDC history, serving to boost book value; reduce future obligations, etc.

However, the speed at which PSEC made the offer and the un-generous price (in retrospect) did not sit well with most PBB debt holders.

PSEC shareholders – one supposes – should have cheered the gambit but a permanent or temporary waiver of the highest fee structure  in the BDc complex will be more “shareholder friendly”.

So Much To Cover

But we digress…

At the top of the BDC issues where price are concerned are the usual names:

Tops was Ares Capital (ARCC), whose Baby Bond (AFC) was inherited from Allied Capital and which does not mature till long after the BDC Reporter is no more (2047).

That was followed by one of Hercules Capital’s (HTGC) many unsecured borrowings, with the ticker HCXZ and a 2025 maturity.

Unexpected

Third was – a little more surprisingly – one of THL Credit’s (TCRD) Baby Bonds with the ticker TCRW, maturing in 2023.

Just a few days ago, TCRD was amongst the ranks of BDCs that investors seemed to doubt their very survival in their current form as its stock dropped to $1.56.

There’s been no news or announcement out of TCRD – now managed by First Eagle Investment Management LLC – that might explain the renewed confidence.

Even the stock price has not increased that much, reaching $2.940 – still in the question mark zone by the BDC Reporter’s arbitrary standard of any BDC under $3.0 a share.

Lowest Of The Low

Down at the bottom of the table and priced in the mid-teens are one of Medley’s Capital’s (MCC) Baby Bonds with the ticker MCV.

Just above is Capitala Finance’s (CPTA) Convertible due in 2022 with the symbol CPTAG.

Finally, there’s Investcorp Credit Management’s (ICMB), inherited from CM Finance when the BDC management contract was sold and which has the ticker CMFNL.

Metrics

Overall – using the median price – BDC Fixed Income is trading (20.0%) off par and (22.4%) off the level at February 21 – the last Friday before the current apocalypse began.

That compares with a (41.4%) drop where BDC stocks are concerned, using slightly different but comparable methodologies.

As Anybody Else

The BDC Reporter – which has been covering and investing in BDC Fixed Income ever since the first issues were launched in 2012 – is surprised, bothered and bewildered by how much debt prices have dropped.

Based on the 2016 and 2018 experiences, we expected the median price to drop below par by (5%-10%) at times of market dislocation, and a wide spectrum of prices.

That remained the case till two weeks ago.

Defenestration

In the past fortnight, though, the BDC Fixed Income playbook has been thrown out the window –  and then repreatedly jumped on with hobnailed boots.

With the benefit of hindsight during this week-end pause – and based on what we’ve seen in terms of “dislocation” in the bond market generally where all the old rules have not held up – we have explanations.

Gimme

As mentioned last week, we surmise – and have real life examples to draw from – investors were raising cash and sold everything that was not nailed down , and some that was.

Margin calls had to be covered; bills had to be paid and mental stress from watching securities drop relentlessly in value had to be reduced.

Fear Of Failure

In some cases – maybe more than we had counted on before the crisis began – investors may also have begun to worry about getting repaid in full and on time on these debt obligations of the BDCs.

On one or two occasions in the past when the specter of issuer bankruptcy arose, BDC investors have not been shy to run for the sidelines until the situation was clarified.

No BDC has yet ever filed for bankruptcy so investors ended up making a round trip in the debt involved as the chart of Medallion Financial’s Baby Bond MFINL shows:

(BTW, we’ve cut off the chart just before the crisis. Today MFINL – with MFIN no longer a BDC – trades at $20.40).

Bold Words

Last week, we went on the record as believing that “the chances of even one BDC failing to repay its unsecured debt still seems extremely low”.

We’ve been right so far, but given that we are only week away from our fearless prognostication, we’re not planning on landing on any aircraft carrier yet and unfurling our “Mission Accomplished” banner.

Questionable

If stock prices tell us anything – and if you accept a $3.0 and below price as an indicator of shareholder concern about BDc sustainability – there are still 7 players whose future is doubted;

Here are the ticker symbol, in order from lowest to highest price under $3.00:

MCC, GARS, ICMB, BKCC,OXSQ, PNNT and TCRD.

From a BDC public debt investor standpoint only 5 of the above are relevant as GARS and BKCC have no traded debt.

Nervously

During the past week, whenever we’ve had a minute to get away from the front lines, we’ve been revisiting the balance sheets and portfolios of most of the 5 BDCs in these nether regions.

We’ve been checking our assumptions and the math involved to determine what likelihood there is that we’re wrong and one of these BDCs might fail in the months ahead.

Nor is it only a matter of a BDC failing – which could occur if a liquidity crisis were to occur and no rescue financing was available – but whether in a orderly-enough liquidation scenario the debt holders will get repaid in full.

(Sorry BDC shareholders, we’re not considering your interests here).

Unbreakable…

So far, we stand by our confidence in BDC debt even if some issues managed to test our resolve by dropping in value by two-thirds at the height of the drama.

The rush up in BDC debt prices – even amongst the “weaker” BDCs this week seemed to validate our confidence.

For example, CPTAG increased 58% this week from its lowest price !

Once Upon A Time

If these were normal conditions we’d expect a gradual increase in BDC debt prices back to par and beyond over the next few weeks as the economy and markets recovered their confidence.

As you’ve heard too many times of late, though, these are unprecedented conditions, with uncertainty at every turn.

Buzz Off

Furthermore – as we’ve expounded on at different times and in different ways – the U.S. Government appears to be deliberately uninterested in helping non-investment grade companies.

Help – such as it is – has been firehosed at large cap, investment grade companies and at the huge number of smaller companies – virtually none of which are in the BDC or leveraged finance market.

Yet, it’s right there in the “middle class” of American business that the risk is the highest – principally due to the debt which every company in this huge segment carries.

Amalgamate the debt in the leveraged loan and high yield markets in the U.S. and assume a nominal 30% of investor equity beneath that – and setting aside any bank debt these borrowers might  carry – and the enterprise value in play is in excess of $3 trillion.

Universal

From what we’ve read from multiple data sources and from our own review of BDC portfolios in these new conditions, most every non-investment grade company out there is at risk of under-performance and default.

Moody’s, Fitch and S&P are as busy as they’ve ever been downgrading the companies that they cover, and are far from finished.

Here’s an article that gives you some of what we’ve been reading.

Test Case

For our part, when we looked down a small BDC’s portfolio, updating our database with the latest news and prices, we found 22 of 24 portfolio companies fit our definition of under-performing.

8 new names were added to the under-performer list since the coronavirus crisis began.

Best Case

Now, if the U.S. economy pulls back from the brink and manages to avoid a new Great Depression and “just” contends with a couple of negative quarters of GDP and most everything goes back to something akin to normal by the end of the summer, many newly under-performing companies will move back to performing status.

Some new monies will be borrowed; fees paid;  earnings losses booked etc, but most of the companies will reverse direction.

Shareholders – whether public or PE groups or private individuals – are going to take a huge hit when all Covid-19 losses are added up, whatever programs the government puts in place now or in the future.

However, most of these companies will continue to pay their lenders who, in turn, will service their own lenders, including BDC Fixed Income debt.

Not So Good Case

Our concern grows, though, if the global economic and financial system cannot meet this incredible  challenge.

Then, pretty much anything can happen and some/several/many BDCs will risk not continuing in their current form and the sector’s first bankruptcies could occur.

Some may say the BDC Reporter should be talking up the industry at this difficult time but no amount of happy talk will make a difference should we head down that untrodden, dark path.

Guesswork

This may explain why some BDC debt investors have fled the scene and not yet returned.

The odds of a major scale economic and financial disintegration is small but cannot be fully discounted yet.

We are in a strange land without a reliable compass.

Half Full Or Half Empty ?

Caution is warranted yet at the same time – and for a second week – the buying opportunities in the BDC Fixed Income space are incredible for those who dare to buy at some of these prices.

Buy CPTAG today and in two years you’ll be able to book – if all goes well – a 60% capital gain and earn a 9.21% yield while you’re waiting.

Not Alone

There are many opportunities like that.

We count 20 debt issues trading below $20.00, and thus prospectively capable of generating a capital gain of at least 25%. 

After years of BDC investors happy to eke out a total return of 6.0% per annum, the contrast couldn’t be any more shocking.

Trying Time

However, with one eye on what’s happening in our hospitals and in the economy, will BDC debt investors dare ?

Or are even better prices coming this way as the crisis continues,  but one assumes all will be well in the end ?

Every investor will have a different reaction – as we’ve seen in the past month – and that volatility of sentiment is likely to continue some time longer.

You’ve still got time to pull the trigger or shelter in place.