BDC COMMON STOCKS

Week 38

Better

After two weeks in the red, the BDC sector returned to the black for the third week of September.

BDCZ – the UBS Exchange Traded Note which owns most every sector stock and which we use to measure price performance – was up 0.77%.

BDCZ closed at $19.65.

The Wilshire BDC Index Total Return – which uses a different methodology and includes dividends as well as price change – increased 0.45%.

Mixed

Less impressive were some of the other metrics we peruse weekly – and sometimes daily.

First, only 17 of the 41 individual public BDCs we track went up in price, while 22 were down and 2 were unchanged.

Second, of the BDCs in the black only 2 increased by 3.0% or more, while 5 dropped by (3.0%) plus.

Third, the number of BDCs trading above book value – a stat much favored by some investors – dropped to 13 from 15 the week before and 20 at the end of August.

On The Other Hand…

Still, if the month of September – famous for being difficult – had ended on Friday, BDCZ would still have been (ever so slightly) in the black: 0.2%.

Furthermore, this week we saw two more BDCs reach new 52 week highs.

Deal Doing

One was Barings BDC (BBDC), which reached a new high of $11.15, and closed Friday at $10.50.

This late-in-the-day price boost followed the Mass Mutual-supported BDC’s announcement of its intention to acquire non-traded Sierra Income.

BBDC’s advisor was by no means guaranteed a positive response from the market about this transaction.

After all, Sierra Income was managed – and poorly – by now bankrupt Medley Management/Medley LLC.

Not A Pretty Sight

As we discussed in an article intra-week, the $630mn Sierra Income investment portfolio – which used to be nearly 70% larger just a few years ago – is riddled with underperforming and non performing companies.

That’s even after the BDC booked all sorts of realized losses in the last many quarters.

By its own admission, a quarter of the remaining portfolio is not performing to plan, including 11 companies with one or more instrument on non accrual.

BBDC, though, with its now patented promise that its parent will absorb excess losses over a ten year period that might come out of the Sierra portfolio, quieted the most obvious area of concern that investors might have.

Risk averse as we are, the BDC Reporter also appreciated that the acquisition will be mostly funded with new BBDC shares issued to Sierra shareholders, rather than”leveraging up” the buyer’s balance sheet.

Worth Watching

If BBDC can successfully pull the Sierra Income transaction off – which promises higher NAV Per Share, Net Investment Income and dividend – they will have bought two pigs in a poke (including MVC Capital) and turned them into silk purses.

The proof of that pudding should be clear by late 2022 when most of the Sierra Income portfolio should have been turned over and replaced with the unusual mix coming out of the Barings platform.

Also, by the end of next year, we should see how BBDC resolves most of the credit sore spots at Sierra.

Already on the conference call BBDC held to discuss the acquisition, we couldn’t help feeling that management was offering some pretty heavy hints that substantial progress has been made in the month since BBDC and Sierra agreed on the book value of the portfolio.

Also, the Sierra Income story – and this is also true of former sister BDC PhenixFin (PFX), which used to be Medley Capital – is a reminder that BDCs can take quite a licking and keep on ticking.

Hanging In There

Despite years of poor management – and being used as pawns by insiders in a game of self enrichment that went nowhere – both Sierra and PFX’s shareholders retain at least some value.

For what it’s worth – and despite some very poor managers over the past twenty years  making some misguided decisions where numerous BDCs are concerned (we can count ten players without even trying) – the sector has never suffered a BDC bankruptcy.

Increasingly of late – and this gives us hope that the future will be different than the past – the incompetent advisors and BDCs with unworkable models have been weeded out.

We won’t pretend the remaining BDCs –  and their advisors –  all have the “right stuff” and that there won’t be future Medley Capital and Sierra Income-like casualties in the future, but the number is diminishing fast.

By our count – and we may be being unfair to s0me BDCs in the midst of being truly “turned around” – there are only eight  problematic BDCs left that might not be with us in their current form in a few years.

Eight might seem high out of forty one but as a percentage of the total public BDC portfolio assets, they represent only 3% – by our count – as these are typically smaller players.

Comeback

Anyway, also reaching a new 52 week high was OFS Capital (OFS), a BDC which was left almost for dead by the market at the beginning of the pandemic in 2020.

Between February and March OFS dropped (71%) in price.

Since then – and sticking to the BDC resilience theme – OFS’s stock price has more than tripled.

At its 52 week high, OFS traded within 10% of its price just before the pandemic, even though its quarterly distribution remains (30%) below the amount paid in the IQ 2020.

Looking Forward

The broader markets – as we briefly discuss every day in our BDC Daily Updates – remains jumpy, as you’d expect after this very long rally.

As always, the BDC sector does not operate in a vacuum and what happens to market sentiment more broadly will impact BDC prices.

Nonetheless – as we’ve said before even as prices were in the red – we don’t see any catalyst that will cause a bear market, or even a correction, where BDCs are concerned.

Transactions like the one being undertaken by BBDC only enhance value in a sector where the vast majority of players are headed in the right direction.

Furthermore, this week we had two optimistic calls by Oppenheimer about Golub Capital (GBDC) – discussed on these pages – and Capital Southwest (CSWC), which we heard about on Friday.

Two thumbs up (from one analyst) by themselves are a guarantee of nothing, but we get the impression from the stable price conditions we’ve been discussing since May that neither analysts nor investors are ready to turn their backs on the BDC sector as yet.

If they should – even for a brief period – we’re more likely to see “bargain hunters” appearing than a broad price roll-back, even though this rally has brought many BDC stocks to record multiples of expected earnings.

We doubt that the BDC Reporter is the only party out there whose noted the positive BDC outlook for distributions; general NAV increases and constantly improving balance sheets.