BDC Common Stocks

Week 19

Never Ending Story

The slump in the BDC sector, which began out of the blue on April 21, 2022, continued and accelerated in the week ended May 13, 2022.

On April 20, 2022 BDCZ – the UBS Exchange Traded Notes which owns most BDC stocks and which we use as a measuring stick for price performance – reached a high of $20.63 intra-day.

That was a 52 week high and the second time in 2022 that the BDC sector – notwithstanding what was happening to the major indices this year – reached a new record level.

Roll forward to this latest Friday the 13th, and BDCZ closed at $18.43 – a (10.7%) drop in about 3 weeks.

That’s “correction” territory.

At its lowest point this week – before a bounce on Friday – BDCZ fell to $18.01 – a (12.7%) drop from highest to lowest.

Downturn

This week alone BDCZ – notwithstanding that Friday reprieve – fell (4.2%).

The S&P BDC Index – calculated on a total return basis – was off by the same percentage.

Supporting Evidence

The havoc in the BDC market is reflected in the individual BDC metrics we review here weekly.

Of the 44 BDCs we track, 42 were down in price.

More tellingly even, 30 of the 42 fell by (3.0%) or more.

Sometimes much more, as this chart shows.

2 BDCs fell more than (10%) in price and 9 others more than (6%):

Mostly Undeserved

We’d say that only one BDC on the list above was there because of poor performance – Great Elm Capital (GECC).

The rest were being sold as part of the general BDC price pull-back that has turned something of a rally – and bright shining exception to the darkness elsewhere in the markets – into a rout.

The Glass Full Or Half Empty Debate

Just how bad this has become in these last few weeks if we look at the metrics might end up being in the eye of the beholder.

The BDC bull might point out that despite all that has happened, the S&P BDC Index on a total return basis is down “only” (5.5%).

By way of contrast, the S&P 500 total return is off (15.7%) – nearly three times worse.

The NASDAQ total return is off (25.2%) in the same period.

Even the S&P High Yield total return index has performed worse: down (10.3%) in 2022, thanks to the impact of higher rate rather than credit concerns.

Both in absolute loss terms and compared to most anything else you might have invested in, the performance of the BDC sector taken as a whole looks tolerable.

Another favorite metric of investors everywhere: the number of BDCs trading at or above book value remains relatively high at 13. That’s down from 20 during the halcyon days of a few weeks ago but we still remember that at the height of the pandemic this particular metric dropped to 0.

Flood Of Red Ink

On the other hand, there is undoubtedly carnage in individual BDC price performance hiding behind those sector numbers.

For example, back on April 1 ,16 BDCs were trading within 5% of their 52 week highs and another 17 between 5%-10%.

That means three quarters of the BDC universe was riding high where prices were concerned.

Six weeks later, and there are no BDCs trading within 5% of the highs and only 5 in the 5%-10% group.

What’s worse, 21 players are priced within 5% of their 52 week lows. Back at the beginning of April there was only 1 name in that category (also GECC by the way).

In the last 4 weeks, no BDC has moved up in price and YTD only 5, meaning that 39 are in the red in 2022.

12 BDCs have seen their price drop by (10%)-(20%) – i.e. correction – and 4 (20%) plus, or “bear” territory.

Entering Irony Territory

All the value destruction that’s occurred in BDC stocks is at variance with the latest results posted by the BDCs, now that IQ 2022 earnings season is drawing to a close.

We’ve collated enough numbers to know that NAV Per Share (NAVPS) – by contrast with the public markets – has barely shifted in the first 3 months of the year.

With 42 BDCs reporting, the average change in NAVPS is only (0.7%), after being up 0.4% in the IVQ 2021.

16 BDCs even managed to show a growth in NAVPS. See the BDC NAV Change Table.

Cheques Are In The Mail

Likewise, the dividend picture – measured as the latest distribution announcement versus the prior period for every BDC – was mostly positive.

We count 11 BDCs announcing higher payouts, 27 unchanged, and only 4 lower. (2 BDCs continue to not pay distributions).

Not Really Bad

Even of the 4 BDCs paying out less to shareholders, in the case of 3 the decrease is either tiny r consists of a lower “special” – a category of distribution subject to fluctuation from period to period, and not necessarily indicative of earnings weakness.

In fact, two of the four – Sixth Street Specialty Lending (TSLX) and Fidus Investment (FDUS) – are projected to grow EPS in the quarters ahead, according to the analysts covering them.

At the end of the day, only 1 BDC – troubled GECC, which has just reached a new 52 week and all time low price this week – is materially cutting its payments to shareholders.

GECC’s total market capitalization is only 0.1% of the BDC sector as a whole.

The Elephant

Credit results – admittedly still being assembled and dissected by the BDC Reporter – confirm that most BDCs boast relatively clean sheets where non performing and underperforming assets are concerned.

At least 16 BDCs have no non performing borrowers at all.

Only 5 BDCs for whom we have completed the data are showing underperforming assets greater than 15% of their total portfolio.

Not Much New

With a recession looming in 2023 – according to the plurality of economists/soothsayers – we’d say only a handful are already under credit strains – sometimes many years old.

This last quarter has not evidenced much pick-up in new strained companies or non accruals.

Through A Glass Darkly

This means that if the market is right – judging by the price changes we’ve seen of late – that BDC net asset values are likely to see a (10%) or greater drop, the losses must come mostly from portfolio companies currently performing normally and – presumably – valued at par as of the IQ 2022.

Has the market called this right or are the price drops of recent days evidence of investor over-reaction to the doom and gloom affecting all markets everywhere ?

To find out, you’ll have to go away to your proverbial island until the end of 2023 or thereabouts before finding out how this turns out.

For Those Who Remain

In the interim – and adding to the complexity of the situation – it’s clear that BDC earnings and distributions are much more likely to move upward in 2022 than anything else.

On every conference call – with different degrees of conviction and each with different numbers – BDC managers have been indicating that higher rates are already beginning to contribute incrementally to IIQ earnings, with more to come in the second half of the year.

(With less of a drumbeat, we’re also hearing that lending activity is picking back up after a quiet first quarter, and there’s even hope that spreads might widen on new loans).

The Beat Should Go On

Unless BDCs greatly pullback AUM or start to be impacted by new non-performing loans in the next 3 quarters – neither of which we expect – this phenomenon of higher profits will bleed into early 2023 as well, as each rate rise from the Fed will boost net earnings.

If BDC prices stay down – or go even lower – we may see double digit average BDC dividend yields.

Already well known large cap players like Carlyle Secured Lending (CGBD) is yielding 11.4%; BlackRock Capital (BKCC) at 10.1% and Hercules Capital (HTGC) is at 12.6%.

Temptation Island

Will investors worried about a recession on the distant horizon be able to stay away from the highest distributions and yields in recent BDC history in the here and now ?

We believe that in the long run investor concerns about the prospective ravages of a recession trump all other considerations – including juicy distributions and seemingly trouble-light balance sheets.

Sooner or later, the psychosis of fear brought on by the uncertainty that occurs as more and more portfolio companies shift from the performing to the underperforming column will cause many investors to flee – in some cases just to the sidelines.

Not So Simple

However, that does not mean that in the short term the increasingly attractive values popping up throughout the BDC sector may not bring some investors back in.

We saw an example of this as recently as Friday May 13, with BDCZ up 1.65% on the day and 39 of 44 BDCs in the black, including 5 moving up more than 3.0%.

Whether that’s a “dead cat bounce” or the beginning of a trend will depend less on what happens in the BDC sector in the next few weeks – where the die is mostly cast and expectations set for a few more weeks – but in the broader environment as to the direction of short and long term rates; inflation; GDP growth; Ukraine, etc.

If Only…

If we could properly evaluate how those imponderables might work out in the weeks and months ahead, we’d be a good deal richer and a frequent guest on CNBC, but we can’t.

No Predestination

We will say, though, that there’s nothing pre-determined about how BDC investors will act in the short term, and this could yet go in directions that neither the BDC Reporter, or our readers , could have imagined in recent weeks as every day seemed to bring BDC prices to new lows.

BDCZ is at a one year low price-wise (or was on Thursday). We’ll be curious to see if that proves a short term bottom or not.