BDC COMMON STOCKS

Week 47

Inflection Point ?

As America was having its annual late November rendez vous with turkey and extended family, a new market catalyst suddenly appeared.

As everyone knows by now a new Covid threat was identified and – very quickly named the Omicron variant.

The markets were only half awake on Friday and the news situation was fluid but the major indices still dropped between (2.23%) and (2.53%).

Back in 2020 several months passed between the first Covid stories and tens of thousands were infected before the markets reacted with what proved to be the mother of all pullbacks.

Now – with not one case in the U.S. of the Omicron infection – the hatches are being battened.

“Fool me once” etc.

Impacted

Of course, the BDC sector dropped (1.1%) on Friday.

By the way, we’re using the price of the UBS sponsored exchange traded note with the ticker BDCZ.

The Van Eck sponsored exchange traded fund with the ticker BIZD, which also owns most BDC stocks, fell (1.2%).

Almost All

On Friday alone 39 of 45 BDCs we track fell in price.

For the week, BDCZ is down a non-dramatic (0.81%), with 10 BDCs in the black or unchanged and 35 in the red.

The number of BDCs trading within 5% of their 52 week high fell from 24 to 17.

Likewise, BDCs trading at or above net book value per share fell from 21 to 17.

Still, over the whole week 10 BDCs still managed to increase in price, even though 35 did drop.

Above Notwithstanding

However, if the markets continue to “swoon“, all the data points we’ve been reviewing daily and weekly at the BDC Reporter could become meaningless.

We really don’t pretend to know what the week ahead brings. Even if investors remain resilient initially that does not mean when new information comes in that we couldn’t have a further – and more sustained – sell-off.

Investors of all stripes – including those in BDC stocks – will have to make some difficult decisions many months into this long winded rally.

For the moment, the BDC sector has fallen back only (3%) off its highest price (BDCZ) and less than that (Wilshire BDC index) on a total return basis.

Unfortunately that also means the BDC sector has a long way to POTENTIALLY fall.

Like A Rock

The good news in all this – if we look hard – is that the BDC sector’s fundamentals are stronger at the moment than at any time in recent memory and certainly better than in February 2020.

On a macro level, with LIBOR already at rock bottom levels (under 0.1% for the 1 month period) and most every BDC protected by interest rate floors on their floating rate loans, the sector does not face the sudden decrease in income that accompanied the 2020 crisis.

Credit conditions – as much discussed on these pages and elsewhere – are mostly better than those at the beginning of 2020.

BDC capital structures – with only a few exceptions – have benefited from months of a historic “Great Refinancing” that has brought in huge amount of medium term unsecured debt capital at very attractive yields and with little in the way of covenants that might trip anyone up.

Liquidity – as well – is in very good shape, in most every case, to fund any commitments made to existing borrowers.

If we do get a new Covid crisis of some sort, we expect investment activity will decelerate very fast, but most BDCs should have the capital to meet any investment opportunity that might present itself.

While BDCs asset value – and net asset values – could drop very fast after 6 quarters of headed upwards – earnings should not be materially impacted in the early stage of a new Covid-crisis.

Retain or Payout

What could happen to dividend payouts will vary by BDC.

We saw in 2020 a huge variance in how different BDC managers responded to the crisis: some preemptively hoarding earnings while others just kept on keeping on. Undoubtedly that would reoccur.

Follower

What is (almost) certain is that if the major markets buckle and drop by any gut wrenching percentage (10%, 20%, 30 % 40 % ?) is that BDC stock prices will match or exceed them.

Notwithstanding all the good sector fundamentals, this has always been an industry where investors shoot and ask questions later.

Nobody knows what credit losses might be early in any kind of crisis so why risk staying around to find out ? seems to be the mantra.

Nothing New Under The Sun

The BDC Reporter has been through the Great Recession (2007-2009) ; the European Financial Crisis (2011); the dramatic drop in the oil price (2014- February 2016) and the Covid pandemic (2020).

Like earthquakes in Japan or drenching rains in the summer in England, these price drops are part of the landscape.

For investors the extreme price volatility the BDC sector represents both threat and opportunity.

If Only...

For example, if you’d bought Ares Capital (ARCC) at its nadir in 2019 and sold 1 year later you’d have enjoyed a 350% price gain.

One year after the European crisis your price gain would have been 35% and 1 year after the Covid low point 114%.

On the other hand, if you’d bought ARCC at its pre-Great Recession high and sold just before the price turned back up – as some nervous investors are prone to do – you’d have lost (85%) of your principal in two years. No amount of dividends collected while this was happening could soften that blow.

Time Is Of The Essence

Both on the way down and on the way up most of the change in price happens in a very short period.

Using ARCC again as our case in point, the BDC’s price bottomed out at $7.90 on March 19, 2020. By April 17, the stock price reached a intra-day price 60% higher.

We may or may not be facing – less than two years after the last one – a new crisis, but BDC investors will need to be thinking about their game plan which should best include if and when to fold ’em, but also if and when to get back in the game.

The BDC sector is not going anywhere. In fact, in the years ahead we expect AUM and market capitalizations to rise substantially.

In the short term, though, much of anything can happen.