BDC COMMON STOCKS

Week 23

Sweet Or Sour

BDC investors: do you want the good news or the bad news ?

Let’s start with the latter: BDCZ – the UBS Exchange Traded Note which owns most BDC stocks and serves as an indicator of the sector’s price movement – dropped (2.22%) in the week ended June 10, 2022.

The S&P BDC Index on a total return basis was down (2.01%).

35 of the 43 public BDCs we track dropped in price and only 8 increased.

This was the second week in a row of a weaker BDC sector, but continues a trend that began April 21 and has seen BDCZ drop (12.3%) from its highest level on April 20.

Almost Gone

Even the big bounce we had for a few days in late May has been largely – but not completely – erased.

Not A Pretty Picture

At this point, no BDC trades within 5% of its 52 week high (versus 16 just 10 weeks ago) and only 4 are within 5%-10%.

By contrast, 23 BDCs are trading within 5% of their 52 week low.

Less spectacular – but still notable – is the decrease in the number of BDCs trading above net book value per share: 13 versus 17 in early May.

The Few

On a 2022 YTD basis, only 8 BDCs have scratched out a price gain and only 4 when you consider a percentage increase of 3% or more.

For the record these are OFS Capital (OFS), up 14%; Fidus Investment (FDUS) up 8%; newbie Runway Growth Finance (RWAY), up 4% and newly renamed Carlyle Secured Lending (CGBD), up 3%.

Buckets Of Red

Unfortunately, there has been considerable price damage amongst BDC stocks in the red. There are 17 which are down (10%) or more, including 4 off more than (20%) in less than half the year.

Even if we use a longer time frame, the BDC NAV Change Table shows that there are currently more BDCs with a price lower than at the end of 2019 (24) than up (15).

Using Seeking Alpha data, we find that over a 1 year period, only 7 individual BDC stocks are in the black.

In fact, using a BDCZ chart as our guide, the sector has dropped back to a price level previously reached in March 2021 – rolling back nearly 16 months of gain.

With That Said...

Yes, there is good news – of a sort.

The BDC sector continues to outperform the major indices on the way down as a flicker of optimism remains amongst investors.

This week offers a useful illustration.

The S&P 500 dropped (5.1%) this week, the Dow Jones “only” (4.4%) and the NASDAQ (5.6%).

The S&P 500 closed at its lowest level in 14 months and is down (19.2%) for the year.

By contrast – and this is the “good news” – BDCZ is off only (9.8%) in 2022, and (6.8%) on a total return basis according to the S&P BDC Index.

Hanging In There

While the S&P 500 dropped back below to a new low this week, giving up that late May bounce, BDCZ remains nearly 3% above the lowest point reached at the intra-day nadir on May 20.

On Friday June 10 – after the update on inflation was received and all the major indices dropped between (2.7%) and (3.5%), BDCZ fell just (0.7%).

A Good Thing ?

Ironically enough, the suddenly revived speculation that the Fed might accelerate its rate increases – possibly including one or more 75 basis point boosts – would be a big boost for BDC earnings – and soon.

Already, BDC managers have been indicating on their conference calls that the third quarter will see a substantial increase in investment income as loan floors are cleared and 1 and 3 month pricing resets occur.

Even higher rates would only gild the lily of BDC earnings and more than compensate for any loss of income from lower than expected new investment activity.

Eyes Are Open

However, everyone also understands that a sharp increase in borrowing costs will eventually cause financial distress for leveraged companies big and small and effectively guarantee no “soft landing”.

The piper, though, will not get paid till 2023 at the earliest – judging by the current strength of the U.S. economy with only 6 full months left in 2022.

How High Can You Go ?

Moreover, a case can be made that the Fed – despite its long delayed but sincere desire to fight inflation – would pull back from continuing to raise rates in 2023, if the likely result was to be an avalanche of bankruptcies.

Defensible

We realize that we’re now speculating about the unknowable so we’ll stop and return to our main point – which is supported by the data – that BDC sector prices have remained more resilient than those of the major indices – a rare state of affairs.

This is neatly illustrated by this chart of BDCZ and the 3 major indices for all of 2022. As you see, the phenomenon has been in effect all year:

Looking Forward

As we’ve said before – given that the much threatened recession is still many months away – we remain in the early innings of a stock market downturn that began – going by the price charts – somewhere between November 2021 and January 2022.

The BDC sector itself did not turn irremediably down till – as we’ve seen – April 21, 2022, overcoming 3 brief pullbacks along the way.

Highly Unlikely

There is simply too much uncertainty ahead to expect that the markets might return to their prior heights, leaving the last few months just an investor’s bad dream.

Where this ends we do not know.

If History Is Our Guide

Based on prior experience, though, we’d surmise that if investors begin to panic about a recession, whatever relative strength BDC stocks have shown by comparison with the broader markets will evaporate.

That’s what happened in March 2020 when fears about the potential devastating impact of the pandemic took hold.

Towards the bottom, every BDC was trading at new lows and no BDC had a price above net book value per share.

One dark day – and only for a moment – BDCZ traded at $7.11 a share – (55%) lower than Friday’s close.

Every BDC stock was down – regardless of strategy, leverage or reassuring words from management – and by huge percentages.

Even well heeled investor favorites like Ares Capital (ARCC) dropped by more than (50%) in a matter of weeks.

So Far So Good

By contrast, what we’ve seen so far is an orderly retreat by the BDC sector.

There’s no guarantee that will continue.

Plausible

On the other hand, there’s no certainty we’ll get panic selling either.

Maybe the outlook will gradually improve without great drama.

In that case, the BDC sector will be well positioned and could yet – thanks to the revival of animal spirits and those likely higher earnings – find its way to new price heights.

Our target price for BDCZ – which admittedly sounds like science fiction right now – is $23.8, 32% up…

Defining Times

What a difference in outcomes the next few months could bring !

As we’ve said before, the BDC investors who get this right thanks to their keen insights – or crystal ball – have the opportunity to make an outsized total return – something which happens only a few times in a decade.

On the other hand, get your positioning wrong and the (6.8%) 2022 YTD total return loss that the S&P BDC index has calculated through June 10 will seem like small change.