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BDC Fixed Income Market Recap: Week Ended October 30, 2020

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BDC FIXED INCOME

Minor Slip

In the worst week for securities from a price standpoint in many months, BDC Fixed Income fared pretty well.

While BDC common stocks – as discussed in the Common Stock Market Recap – fell (4.6%); and the S&P 500 (5.6%) – the median price in this segment was off only (0.1%).

From the highest point of three weeks ago, BDC common stocks are down over (10%) but BDC Fixed Income is off but (0.4%).

Assessment

Admittedly, there has been some damage from the recent bout of doubt in the markets.

The number of BDCs trading at or above $25.00 has dropped back to 16 from 19 the week before.

The highest security’s price fell to $26.07 from a closing of $26.40 the week before.

(The Baby Bond in question on both occasions was one of Hercules Capital’s (HTGC), with the ticker HCXY).

Otherwise, though, there was little change where pricing is concerned.

Down Below

The number of Fixed Income issues trading in the nether regions beneath $22.50 (“correction mode” or worse) remained at three.

Tha meant the bulk of BDC debt issues remain priced between 90% and 100% of par, as has been the case for months.

Same Old

The three underperforming exceptions to the rules were exactly the same as last week and the week before:

Two Baby Bonds of Great Elm (GECC) and one of the three unsecured debt issues of OFS Capital (OFS).

The lowest price reached was $21.16 by GECCN, admittedly noticeably lower than the $21.75 price the debt closed at the week before.

So there is slippage in the BDC Fixed Income sector, but nothing dramatic as yet.

Nothing New

We’ve seen these patterns before:

Common stocks drop across the board but BDC public debt holds its own.

At first.

Then, as panic begins to grip the broader investing community, debt prices start to drop moderately, but still shocking participants unused to such moves.

That’s what happened in December 2016 and in the first couple of weeks of the Coronavirus crisis.

In regards to the former, investor confidence returned around Christmas and all securities – including BDC debt – moved up sharply for the next several months.

Different Path

Of course, as readers will remember, that was not the case in March of this year.

In fact, investors began a desperate search for liquidity, which included selling all and everything of value, which included BDC unsecured debt.

By the third week of March – as we remember all too well – the median price of BDC Fixed Income was trading at (32%) off par, and every individual issue was below par.

So much for those investment grade ratings that so many BDC issuers boast of and – in most – cases – a long history of almost unchanged price levels.

You Must Remember This

We’re not there yet this time, but we do remember that the shift from a light jog in the general direction of the exit to a mad scramble can happen very quickly.

You wake up and get the impression that every holder of every instrument has placed a “For Sale” sign on their computer terminal.

Then as now, this panic selling has far less to do with BDC fundamentals but with market psychology and the need to get liquid, both for defensive and speculative purposes.

Speaking of Fundamentals

This week we had a first glimpse at the latest results with all 6 BDCs reporting being Baby Bond issuers.

In all cases, the financial performance of the players involved was GOOD (5) or FAIR (1) in the latest period.

The only BDC to get a FAIR – rather than a GOOD rating – was Oxford Square (OXSQ), but that was due to liquidity concerns rather than anything else.

See the BDC Performance Table.

To Their Credit

From a credit standpoint the reporting BDCs mostly improved for a second quarter in a row.

That was reflected in higher NAV Per Share for everyone except Stellus Capital Investment (SCM).

(However, that drop in net assets had more to do with the need to pay out an unusually high amount of distributions in the period than anything to do with credit quality).

See the BDC NAV Change Table for the quarter-to-quarter changes in NAV Per Share and over the longer term.

Best In Class

Arguably, the BDC that posted the most improved credit performance was the one with the most Baby Bonds outstanding in this half dozen group: Fidus Investment (FDUS).

Following a first quarter 2020 where management became highly concerned about multiple portfolio companies, the mood has greatly improved.

The given value of underperforming assets has dropped from $166mn to $97mn this quarter, or just 13.5% of portfolio assets.

Unexpected

Interestingly, the top 3 BDCs in terms of percentage of underperforming assets operate principally in the lower middle market which many expected – including FDUS – to be a disaster zone due to the pandemic.

Overall, though, the market appears to have been satisfied with the performance of all the reporting BDCs.

We checked the prices of all the public unsecured debt of the 10 issues involved and none materially changed after the IIIQ results were announced.

Next !

We reviewed the BDC Earnings Calendar to evaluate what’s coming up.

Nineteen BDCs will be inundating the BDC Reporter with IIIQ results on this coming historic week, eight of which are BDC public debt issuers.

As always, we’ll be most focused on the weaker players, but will be keeping an eye on everyone involved.

Which Way ?

In the “weaker” category coming up to bat this week are Capitala Finance (CPTA), whose stock price continues to drop to record low levels – always a worrying sign for debt holders as well.

We’ll be interested to hear what management’s plans are now the BDC has no secured financing and with its two unsecured debt issues (besides SBIC debentures) less than 18 months away from maturity.

Unable or unwilling to raise secured debt, can CPTA’s management access new unsecured debt to repay CPTAL and CPTAG or will assets have to be sold to repay debt holders ?

Been There

We’ve seen in the case of Medley Capital (MCC) what happens when these questions get answered, even if only partially.

MCC’s Baby Bond with the ticker MCX, which is being redeemed in November, has jumped up in price to trade above par after being in a $21-$24 price range in preceding weeks.

[Investors are less certain of what will happen to the remaining Baby Bond – MCV – which closed this week at $24.00 but has been as low as $12.36 ]

Watch List

We’ll also be curious to see how First Eagle Alternative Credit (FCRD) – with its new name and ticker symbol – will be contending with long standing credit challenges.

The BDC’s two Baby Bonds inherited from the days of TH Lee’s tenure – FCRW and FCRZ – are trading close to par.

That may not continue if the BDC cannot demonstrate – once and for all – that it’s credit difficulties are under control and diminishing.

Last time we counted FCRD had $148mn in underperforming assets, nearly half the entire portfolio and equal to three quarters of net book value.

Despite a new manager; an injection of capital; a redrafted senior secured loan agreement and high hopes FCRD – and its debt and common stockholders – are not in the clear as yet.

The common stock trades at a (51%) discount to June 30, 2020 book value…

Strapped In

The week ahead will be a busy and eventful one, both on the bigger stage and in BDC-land.

This may prove to be the third time since the segment emerged in 2012 that investors therein are tested.

In the first two instances (2016 and earlier in 2020) BDC debt prices bounced back almost all the way relatively quickly and without any bankruptcies or defaults along the way.

If we should get another period of high drama we still expect any across the board price drop to be short lived, unless the very fabric of the country gets called into question for an extended period.

More likely, though, that the public BDC market quietly chugs along as before.

Even the BDCs we worry the most about are much more likely than not to carry on and meet all obligations to their debt holders.

The BDC Reporter will continue to trust but verify.

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