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BDC Fixed Income Market Recap: Week Ended March 6, 2020

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BDC FIXED INCOME

Holding On

By most any measure, BDC Fixed Income prices are weathering the current market storm relatively well.

In the past two weeks, the S&P 500 has dropped (11.0%) and the BDC sector – as measured by BDCS – by (9.1%). 

By contrast, the median price of the 43 BDC Fixed Income prices we track has dropped just (1.2%).

This week that median price actually moved up slightly from the week before, but we’re not making much of that change in such a short period.

From the BDC Fixed Income highest level in 2020 to this week’s closing, the maximum drop is (1.4%).

Imperfect

Not that the BDC Fixed Income sector is immune to the downward pressure on all asset classes worldwide that is underway.

Only 4 issues are now trading over $26.00 – our designated threshold that suggests unusual market enthusiasm for an instrument that will have to be repaid eventually at $25.00.

Number One

Top of the table is a newcomer to that status – Gladstone Capital’s (GLAD) Baby Bond with the ticker GLADD.

That bond matures in November 2023 and pays out an interest yield of 6.1250% at par, and was trading at $27.00 when the market closed.

Still, GLAD can redeem the debt as early as November of this year so recent or future buyers at this elevated level:  beware.

Ever Higher

As we’ll discuss in a minute, the chances of GLAD and many other BDCs redeeming their publicly traded debt at their earliest possible convenience continues to rise.

At the bottom of the price table, there are 9 issues trading below par.

Still, that’s unchanged from the week before.

Unmoved

Also the traditional laggard on this part of the table – Medley Capital’s (MCC) Baby Bond with the ticker – MCV – even traded a couple of cents higher than the week before.

Even as MCC itself has reached new depths price-wise its debt investors seem unfazed.

Amazing

The most interesting “action” this week and last has been the precipitous drop in the risk-free rate.

As we write this, with the sun going down in Los Angeles and bond traders globally nervously preparing for the Monday open on Wall Street, the 10 year Treasury is being quoted at 0.548%.

The 5 year Treasury – the most appropriate risk-free base for most BDC debt issues these days – is at 0.426%.

Record Levels

Market commentators – and there are a lot of them – seem to believe that whatever the yield is right now we’re headed to zero before too long.

A few weeks ago we predicted that – on paper at least given that the best BDCs can raise unsecured debt as low as a 1.65% premium to the risk free, we could be seeing new placements at just over 2.0%.

More realistically, the bigger BDCs might shortly be coming to market to borrow unsecured – as we’d predicted – under 3.0%.

Of course, that depends on whether the risk-free rate remains in the  cellar for a decent period (very likely) and that the spreads investors demand to be invested in portfolios of leveraged debt do not expand (less likely).

Quiet Place

In the short term we don’t expect much activity for any BDC in the debt capital markets.

The times are just too uncertain for either issuer or investors to rush into anything.

What happens next for new BDC debt issuance will depend largely if the current stock price drop gets followed by a recession or not.

That may take a few weeks to become clear to market participants.

Alternatives

If we skate by the gaping hole of the Next Recession and BDC credit losses remain within expected ranges and the ever complaisant rating groups don’t have a change of heart about their investment grade blessings, some BDC issuers will be sitting pretty and borrowing cheaply.

On the other hand, if we fall into that gaping hole all bets are off and any number of things could happen in the rest of 2020 where capital raising is concerned.

Liquid

Ironically – judging from what we’ve seen in the BDC results very few players NEED to borrow unsecured to meet their target leverage.

After all, the Small Business Credit Availability Act (SBCAA) has been in place for two years now and BDC CFOs have been busy tapping a very generous market for all sorts of borrowings, both secured and unsecured.

Offset

The opportunity lies in reducing borrowing costs at a time when ever lower LIBOR (now at 1.38% for 1 month) are squeezing down BDC profits, and with no immediate end in sight.

As we work our way down to zero or negative interest rates in the U.S. every penny will count for BDC investors as management and incentive fees are not shrinking, nor are other running costs while their top lines are in danger of dropping by (20%) or more.

That loss of income at the top line is being almost completely absorbed by BDC shareholders and is causing fund managers to layer one more and more assets (and thus debt) to stay in the same place.

Small Mercies

The principal saving grace is that ever lower cost of borrowing may help BDC portfolio companies at this increasingly difficult time and delay potential defaults.

Longer term, this incredible drop in risk-free rates (the 10 Year Treasury was at 3.25% just 18 months ago and has now dropped 85% – and that may go to 100%) may cause the public market for BDC unsecured debt to wither away.

Latest

If BDC issuers continue to grab cheap, institutional placed, unsecured borrowings – taking advantage of  relatively short non redemption periods generously granted by investors and their investment bankers over these last few years – our universe of issues will decline.

This week, Capital Southwest (CSWC) which used to have two public Baby Bonds before retiring one entirely with proceeds from an institutional placement, announced its intention to pay-off half of its remaining Baby Bond (CSWCL).

Complex

Ironically, though, the turmoil in the market may buy existing holders of public BDC debt some more time.

Furthermore, if credit concerns begin to arise amongst institutional investors, the public market may get an unexpected revival and BDC issuers will need to “pay up” to borrow.

Anyway, the BDC Fixed Income segment is not going anywhere soon. 

Even if every BDC issuer who could repaid its unsecured debt that’s past the non-redemption date in 2020, that still leaves 17 issues.

In real life, and without assuming either very good or a very bad backdrop, we believe there will still be 25-35 public BDC debt issues out there by year end 2020.

Looking Forward

More immediately, we’re wondering what the next few weeks will bring for BDC Fixed Income prices.

In our BDC Common Stock Market Recap we fretted that BDC shareholders may be too optimistic about the prospects for the sector and prices may yet drop sharply.

Despite those (4%) down days, we’ve not yet witnessed the true panic that grips a market – and the BDC Reporter – when the outlook irremediably darkens.

Should that occur – and it’s our duty to consider such unpalatable possibilities – we worry that BDC debt prices may not maintain the stiff upper lip we’ve witnessed so far.

We remember back in 2018, and even more in 2016, that debt investors – after a long period of being unfazed by the ongoing market downturn – suddenly lost their nerve and began to bail from their positions.

The sell-off in debt never matched what was happening in the common stock arena but was material.

Fluid Situation

Of course, we don’t know yet if this crisis will be short lived or continue and deepen for a long time.

We’ll be keeping a close eye on BDC debt prices intra-week to report back to readers in these Recaps.

For a more timely heads up – if one is required – check out the BDC Reporter’s News Feed on Twitter or the front page of the BDC Reporter’s website.

At the close of every day we’ll be undertaking a mini-recap and tracking what happens to the median price.

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