BDC COMMON STOCKS

Week 41

Head Fake

October began with much promise for BDC investors, following a devastating September.

After the first two days of the month, BDCZ – the exchange traded note which owns most BDC stocks as serves as an unofficial price guide – was up 7.5%.

We’re sure, though, that everyone was asking themselves if this was just a technical bounce after markets generally – and the BDC sector included – had reached new YTD lows.

The final answer is not yet in, but BDC prices began to decelerate from day three and by Friday gave up 55% of the their advance.

BDCZ closed at $16.04, up 3.35%.

Wider World

What happened to BDC stocks – as usual – was similar to the action in the broader markets.

The S&P 500 also started out the week/month with record breaking increases, but lost steam in the last 3 days.

The S&P index ended up ahead – but only by 1.5%, after having dropped (12.3%) in the prior 3 weeks combined.

Feline Analogy

All this suggests an infamous “dead cat bounce” more than anything else.

From a BDC perspective, we noticed a huge volume of shares traded on Monday and Tuesday, but no follow up in the days that followed.

For example, Ares Capital (ARCC) typically trades 2.7mn shares a day.

On Monday, 5.6mn shares exchanged hands and 3.5mn on Tuesday, but by mid-week volume was below the average. On Friday ARCC volume was just 1.5mn shares, three quarters less than Monday.

Weekly Metrics

Still, if it’s any consolation, 34 BDCs did increase in price over the week, the latter days slump notwithstanding.

Of those, 15 increased by more than 3.0%, while only 2 BDCs fell more than (3.0%).

The week before – when investors were in panic mode – 35 BDCs dropped by (3.0%) plus.

Leader

Far and away the biggest price mover was the price of First Eagle Alternative Credit (FCRD), which jumped 38% on the news that Crescent Capital BDC (CCAP) intends to acquire the beleaguered BDC.

CCAP, by contrast, saw its stock price drop (10%) this week, as the market appears to feel the would-be buyer has been too generous.

Biggie

Whether that’s right or wrong, this was a major news story from a BDC perspective and for a number of reasons:

First, the acquisition will continue the gradual reduction in the number of public BDCs in our coverage universe.

This reflects the strength – rather than the weakness – of the public BDC sector as buyers continue to pick off weaker players in an attempt to bulk up assets under management and improve trading liquidity.

CCAP – since last year – has been owned/backed by insurance giant Sun Life.

Clearly, even in the midst of a difficult period for the BDC sector – BDCZ is (just) in “bear market” territory – there are groups with deep pockets looking down the road.

Going And Coming

At the same time, this is the second time a leading asset manager has walked away from the BDC.

TH Lee, which was the external manager and founder (2009) of what was initially THL Credit Inc sold its $17bn AUM credit management business to First Eagle Asset Management in 2019.

This included the right to manage the BDC.

No Cavalry

With the benefit of hindsight, one could say that First Eagle did not do much to change the BDC’s trajectory – already much troubled – when coming on as the new external manager.

One letter of the ticker symbol was changed from TCRD to FCRD; a dollop of capital was invested and generous fee waivers offered up.

However, the senior management team was not significantly altered, and the BDC continued to be hampered by multiple long standing credit hotspots, some of which remain.

Saving Grace

Still, there was an attempt to re-position FCRD into a more diversified and “safer” portfolio, principally in first lien senior secured loans and that’s what CCAP is probably looking to going forward.

Given that CCAP’s portfolio is far larger than FCRD’s – and most of the latter’s portfolio companies are now performing normally anyway – there does not seem to be much of a danger to the buyer going forward.

Unfortunately for the BDC Reporter, the news of the would-be acquisition occurred while our website was crashing, and we were offline.

We hope to offer a fuller analysis of CCAP’s apparently over-generous offer before long.

Back To The Week That Was

Unchanged is the number of BDCs trading at or above net book value. Those rare birds still amount to 4, four-fifths less than a few weeks ago.

As of Friday, there were no BDCs trading even within 10% of their 52 week highs and 39 were within 10% of their 52 week lows.

Investors may take some cold comfort from the fact that the number of BDCs reaching new 52 week lows this week was 2, and that “only” 25 BDCs are within (5%) of the lowest price versus 35 last week.

Where We Are

As has been the case – albeit to varying degrees – the BDC sector’s fortunes continued to be attached to those of the broader indices.

Where the S&P 500, NASDAQ and Dow go, the BDC sector will follow.

As everyone knows those major indices are in the basement right now – close to their lows – with the the Dow off (19%); the S&P 500 down (23%) and NASDAQ (32%).

No Joy

Moreover – the mood is grim and susceptible to further slumping every time another negative headline pops up.

“It’s always darkest before the dawn” and the investing environment is inky dark right now.

For the BDC sector – down (16%) on a total return basis and (23%) on a price basis, using data from the S&P BDC Index for both numbers – that leaves investors only a few percentage points over the lowest level of 2022. That nadir was reached on September 29, beating out the prior record in mid-June.

No BDC – except for FCRD – trades in the black on a year-to-date basis and the sector’s average stock price to net book value per share is at 0.78.

As the BDC NAV Change Table shows, only 3 BDCs are still trading at a stock price higher than they did in 2019.

Dichotomy

Confusingly for investors, though, the outlook for future BDC earnings and distributions continues to be strong.

This week we received Saratoga Investment’s (SAR) latest quarterly earnings; Capital Southwest (CSWC) shared preliminary EPS and NAV Per Share results for the IIIQ 2022; Stellus Capital (SCM) announced IVQ 2022 distributions and Runway Growth (RWAY) issued a press release about its recent investment activity.

In none of these instances was there any suggestion of the extreme weakness being telegraphed by the level of BDC prices, which affects every player without exception.

Higher Yield

We estimate that the average yield for the BDC sector is 12.2% – and with the possible exception of Great Elm (GECC) – we expect every BDC out there to maintain or increase their distributions in what remains of 2022 and into the first half of 2023.

Not Too Bad

There has been a pick-up in defaults and bankruptcies in the leveraged finance arena, but – as we try and show in the BDC Daily News Feed – most of the companies in trouble are not financed by BDCs. On the rare occasion that they are, the amounts at risk are very modest and prospective losses even lower.

From what we can tell from the public record, there should not be any material uptick in non performing assets on BDC books in the IIIQ 2022 results shortly to be announced and even in the IVQ 2022.

Too Far ?

BDC stocks seem “oversold” by all the metrics one typically uses and even if one assumes a sharp increase in troubled assets before this economic period is over.

However, we may have to wait many more months to find out if we are right given the unending gloom up ahead.

As of Friday, more selling – and potentially a new YTD low for BDC stock prices looked more likely than any other scenario, but we’ll admit to having been fooled before by the short term direction of the markets.