BDC COMMON STOCKS

Week 15

Quiet Strength

In a 4 day week, the BDC sector moved up modestly in price.

The S&P BDC Index – on a price only basis basis – increased by 0.5%.

(We’re not using BDCZ – the UBS-sponsored exchange traded note which owns most BDC stocks and which we’ve traditionally used to measure sector price performance because this was a dividend paying week, which confuses the numbers).

Looking Good

For BDC investors this was an impressive result, even if the absolute percentage price increase was not much to write home about.

The week’s gain followed a considerable price drop the week before, regardless of which measuring stick we use.

Moreover, the BDC sector was up, while the S&P 500, the Dow Jones 30 and the NASDAQ all moved down on the now well known concerns about higher rates; inflation or “stagflation” and so much more.

More on the differing paths of the major indices and the BDC sector later.

Getting Granular

In these 4 days, two-thirds of BDCs (30 of 45) moved up in price.

Admittedly, there was no mad rush to buy and no BDC stock increased 3.0% or more.

In fact, the highest percentage price gain was achieved by Gladstone Capital (GLAD), up 2.26%.

Mo’ Money

Investors rewarded the BDC for an increase in its regular monthly distribution to $0.0675.

On an annualized basis, this increases GLAD’s payout to $0.8100 from $0.7800 previously, a 3.8% jump.

We can’t say the increase is a great surprise given that GLAD posted Net Investment Income Per Share (NIIPS) of $0.27 in the calendar IVQ 2021 (annualized $1.08); a 35% increase from just 3 months before, and well above the $0.195 quarterly payout.

Something had to give. We wondered if GLAD – like its sister BDC Gladstone Investment (GAIN) might offer up a special distribution.

Sustainable

Management, instead, chose the regular distribution route – albeit with a modest raise – suggesting that the upward trend in earnings registered last quarter was not a one-time matter even though income was boosted primarily by ” a $1.6 million increase in success fees received associated with the exit of Lignetics, Inc. [ a portfolio company]”.

For what it’s worth, the analyst consensus for NIIPS in the calendar IQ 2022 is $0.2000, and $0.8000 for the year.

If correct, this would suggest that GLAD may go from “out-earning” its regular distribution to being slightly behind.

However, given the tendency of analysts to project earnings very conservatively, earnings and pay-outs may just end up matching this year.

At the moment, GLAD seems poised to pay out its higher distribution level in 2022 in three years, and that’s before taking into account the coming impact of higher interest rates on earnings.

Bellwether

The second biggest percentage price gain was by Ares Capital (ARCC), up 2.0%.

Of course, that’s not much of a gain in the bigger scheme of things but given that – far and away – ARCC is the largest player in the sector, we pay attention when its price moves materially – either up or down.

Since paying out its quarterly dividend, ARCC has increased in price from a low of $19.51 in mid-March to a high of $22.11 on Thursday intra-day.

In a month’s time that’s a 13.3% increase for the industry leader, and suggests investors have not given up hope for further price heights for ARCC whose 52 week peak is a price of $23.00, set in February of this year.

Trio

Along these same lines, 3 BDCs actually did post 52 week highs this week.

One of them is another BDC behemoth similar to ARCC – Owl Rock Capital (ORCC).

Also breaking price records were Hercules Capital (HTGC) and PennantPark Floating Rate (PFLT).

Good Sign ?

We find HTGC’s price performance encouraging because there has been much dire news about a much slower pace of IPOs in the technology sector; the fall from grace of NASDAQ and much worrying that the golden age of the sector may be drawing to a close after many record years of capital raising; exits and sky high valuations.

However, the tech slowdown may play right into the hands of venture-debt lenders like HTGC (and several other BDCs with a similar focus) who may find themselves more in demand as alternative sources of growth capital fall away for a while.

To make our point, we offer below the 2022 YTD price chart of HTGC versus the NASDAQ. The former is up 12% and the latter is off (15%):

Flying High-ish

Also a signal of BDC price buoyancy is that the number of BDCs trading within 5% of their 52 week highs increased back to 13, from 11 the week before.

That’s not the highest number we’ve seen this year, but does suggest investors have not abandoned the field as yet.

Moreover, 19 of the 45 BDCs we track (soon to be 44 as Newtek Business Services – NEWT – prepares to change its status) are priced at or above net book value per share.

That’s very close to the highest number in this popular category we’ve seen all year.

Bed Has Been Made

At this stage, in the great debate amongst BDC investors whether it’s better to join the rest of the market in pulling back in the face of a multitude of risks or holding fast to reap the benefit of higher interest rates and strong fundamentals, the preference is clear.

This is clearly reflected in the 2022 YTD price of BDCZ and the three major indices, which shows the wide gap between them, and which may grow even wider:

Coming Up

BDC earnings season for the quarter ended March 31, 2022 will shortly be upon us, heavily concentrated in the first two weeks of May, but beginning April 26, 2022 with ARCC’s results.

We believe BDC investors are looking beyond the upcoming results, which should be weaker than in the IVQ 2021, both in terms of earnings per share and Net Asset Value Per Share (NAVPS) – the two lodestars of performance.

Low ST Expectations

The BDC Reporter reviewed the analyst consensus for EPS (typically based on NIIPS or an adjusted version thereof) of 43 players and found only 9 BDCs were expected to show better results in the first quarter of this year versus the last quarter of 2021.

As we’ve explained previously, slower than usual leveraged buy-out activity may weigh on investment income and slightly higher short term rates impact most BDCs borrowing costs without an offsetting gain of income due to the “floors” arranged with borrowers.

High LT Expectations

Yet, those same analysts in their full year projections – whether calendar or fiscal – projected 25 BDCs would post higher EPS in the full period.

Analysts must be expecting both transaction volume to increase and the likely 0.50% rise in the Fed Funds rate in May, followed by (possibly) another in June to set the stage for BDCs to see their pricing reach above their floors, resulting in higher revenues and net investment income.

BDC Reporter Projections

For our part – at this stage – we project 22 BDCs will be paying out higher distributions in 2022 than in 2021 and only 6 a lower payout.

Those projections were made even without figuring in potentially higher interest rates.

A very preliminary estimate of how much EPS and dividends could rise by year end 2022 if the Fed remains hawkish where rate increases are concerned is 10-15% by the end of the year.

Both Sides Now

However, there are a myriad factors that could keep either EPS or dividends from taking full advantage of the higher rate environment including a rise in credit losses (not on the horizon yet, but not out of the question); managerial decisions to de-leverage in the face of the current environment; BDCs deciding to maintain more earnings on the balance sheet in preparation for future periods and much else besides.

The table is set for BDCs to earn even more than we anticipated just a few months ago, but there is no clear-cut certainty that will happen as the year plays out.

Elephant In The Next Room

Furthermore – as we’ve also discussed previously – BDC investors will be worrying as much as anyone else – if not more – that the very same rate increases which will benefit their bottom lines in 2022 will bring on a recession in 2023.

Looking at the relative levels of all the markets, the “recession is coming” scenario remains a minority view.

Sentiment, though, can turn on a dime and all the high hopes of BDC investors for a windfall from higher rates could yet turn into a rush for the exits.

Memories

Being old and wizened, we do remember that BDC dividends peaked in 2008 even as the Great Recession was taking hold.

Ironically – but tellingly – ARCC’s quarterly dividend was at its highest level of $0.42 for the last time in March of 2009 when the BDC’s stock price had dropped by 85% from its pre-recession high and has only just returned to the same level a few weeks ago thirteen years later…

Prices Matter

As a result, what happens to BDC prices in the next few weeks will tell us a good deal more about investors animal spirits than earnings reported and dividend paid out.

Judging by everything we’ve covered above, the mood amongst BDC investors is cautiously optimistic, but what happens in the broader economic and geopolitical sphere could trump everything.

2022 could yet match or exceed 2021 where performance is concerned or remind us of the dar days of March 2020..

We stand by to cover the outcome either way.