BDC COMMON STOCKS

Week 42

Different Paths

After a strong rebound the week before, the BDC sector had several choppy days through October 14, 2022.

Using the S&P BDC index on a price only basis, the sector ended up 0.78%.

On a total return basis – also using the S&P BDC index – the gain was 0.8%.

As happens occasionally, the BDC sector performed better than the major indices.

For example, the S&P 500 was (1.55%) and the NASDAQ (3.1%).

Details

29 individual BDCs moved up in price, 1 was unchanged and 13 were down.

As always these days, there was much individual price volatility, with 9 increasing by 3% or more and 3 decreasing by (3%) or more.

Nonetheless…

Notwithstanding the last two weeks positive numbers for the BDC sector over a 1 month period all but one BDC is in the red.

If we look at 50 day and 200 day moving averages only 1 BDC is in the black, and that’s First Eagle Alternative Credit (FCRD) boosted in price by Crescent Capital’s (CCAP) purchase/merger offer.

If we look back to the end of 2021, no BDC is showing an increase in price in 2022.

More Metrics

As the week before, only 4 BDCs are trading above their net book value per share.

No BDC is trading within 10% of their 52 week high, and 14 are priced within (5% of their 52 week low and 25 within (5%-10%) – virtually every player.

With just 10 weeks to go in the year, and using the S&P BDC index again, the sector is down (22%) YTD in price terms and (15%) on a total return basis.

From its highest high in April of this year, the BDC sector – going by price only and still using S&P’s data – is down (24%).

The main comfort BDC investors can take in this desolate price landscape is that they have performed better than the S&P 500 (25%) and the NASDAQ (26%) on price performance but not as well as the Dow Jones 30 (19%).

Going Forward

Looming up ahead just two weeks away is the beginning of BDC earnings season.

We’ve had a hint here or there from some of the sector’s denizens about what to expect from the 42 BDCs that have still to tell us how third quarter 2022 performance played out.

Moreover, we’ve been keeping track of what various financial publications have been saying about investment activity in the different layers of the leveraged loan market.

Front Line News

One of our favorite resources is Kelly Thompson’s publication Direct Lending Deals – recently bought by Krolls’s – which provides its subscribers with daily updates of new loans booked, many of which relate to the BDC sector.

The message we get is that new loan activity – although not at the frenetic pace of 2021 – was strong across all segments in the June-September 2022 period.

This week, Main Street (MAIN) undertook its regular quarterly preview of recent activity in its so called “private loan portfolio” and the numbers suggested the BDC has been busier than a one armed paper hanger.

The large cap borrowers are clearly turning to direct lenders – such as some of the larger BDCs – instead of the syndicated loan market or the high yield market.

Sponsors and lenders are still booking corporate add-ons and new platforms even as everybody claims to being more picky and sticking with only the best choices available.

Not Quiet

Judging from what we’ve heard from Horizon Technology Finance (HRZN) and some of its peers, the venture debt market is also busy.

There are 5 BDCs whose main focus is venture debt lending, with assets under management of $5bn, and there are several other BDCs with a secondary focus.

Sticking Around

Notwithstanding all the above, most BDCs have been projecting on their most recent conference calls that they’re not expecting much in the way of repayments of existing loans .

This all suggests that we expect to see BDC assets under management at cost increase for many players and – possibly – for the sector as a whole.

That – without even getting into the impact of higher rates (a subject we’ve beaten to death) – should support recurring BDC income in the quarter and into 2023.

Dipping ?

Harder to handicap is what will happen to BDC asset valuations.

We’re guessing that the IIIQ will not look all that much different than the IIQ.

Most BDCs should report lower asset valuations, but nothing dramatic.

This will show up in growing, but still modest, increases in investment write-downs (“unrealized losses).

Small Losses

There should not be any unusual level of realized losses and – also important – no gut wrenching increase in the number of non performing loans.

So far, BDC lenders have been very fortunate in that very few of the companies that have been filing for bankruptcy of late – and there has been an uptick recently – have been on their books.

Even then, losses incurred or likely to be booked have been very modest.

Not Perfect

Unfortunately, the BDC Reporter is beginning to notice a pick-up in the number of underperforming companies in BDC portfolios.

These companies are still paying their interest, and most are not even in technical default.

We expect to see further deterioration of this kind in the third quarter, but the day of reckoning involved is still some time off and subject still to whatever the Fed and the economy has in store.

Or, in other words, it’s too early to tell when realized losses might peak.

Low Hopes

Judging by BDC prices, investors are expecting that every BDC will be taking quite a credit beating in 2023, which will greatly reduce book value and income.

At the moment, the sector is trading at a (22%) discount to net book value overall.

Most BDCs are trading at Price to 2022 earnings multiples in the high single digits and we calculate the average yield for the 41 BDCs that are paying out distributions is 12.1%.

Out Of Whack

The BDC Reporter – looking at the data rather than at the VIX – continues to believe that BDC earnings and dividend performance – both in the IIIQ 2022 and in 2023 – will be much better than the current prices suggest.

In fact, we project BDC earnings and distributions by the time 2023 is done will be higher than in 2022 and 2021.

We also don’t expect – recession or not – for any more than a handful of BDCs to cut their distributions next year.

Are we right or disastrously wrong ?

You’re going to have to keep reading for more than a year to find out.