BDC COMMON STOCKS

Week 17

Recycling

We’re forced to recycle last week much of last week’s verbiage when discussing this most recent BDC sector price performance.

Admittedly, in the week ended April 28, 2023, BDCZ – the exchange-traded note which owns most of the BDC stocks and serves as one of our price guides – moved up modestly by 1.0% after dipping (0.2%) the week before.

(The S&P BDC Index moved up 0.9% as well).

Watching

However, the wait-and-see mode we noted before continued for another week.

26 BDCs went up in price, 16 went down this week, but only 4 moved more than 3% in either direction – 2 up and 2 down.

The number of BDCs trading at a price above net book value per share was unchanged at 9.

Both Ends

BKCC and MRCC both dropped by more than (3.0%) and GAIN and CGBD increased by more than 3.0%.

Exception

Only one BDC now trades within 5-10% of its 52-week high: SCM.

No BDC can be found within 5% of its 52-week high.

Scraping The Bottom

At the bottom of this table, though, 4 BDCs reached new 52-week lows this week.

These were BCSF, BBDC, BKCC, and PNNT.

Maybe this was pre-earnings season positioning, just in case IQ 2023 results disappoint.

A Little Research

We checked the analyst earnings consensus for the IQ 2023 and compare the numbers expected against the IVQ 2022 actual and found that CGBD and PNNT are expected to post increased profits; BKCC should be unchanged and BBDC to drop.

Even BBDC’s quarter-over-quarter earnings decrease is only due to the fact that in the IVQ 2022 profits were boosted by no incentive bonus being charged – a state of affairs not expected this quarter.

Over at BDC Best Ideas, all 4 BDCs just mentioned are expected to increase their annual dividend payout to shareholders, but we don’t make quarter-by-quarter projections.

In The News

The biggest news of the week was that Ares Capital (ARCC) reported its results well ahead of everyone else.

Although “Core EPS” – management’s favorite measure of recurring profitability – dropped (10%) from the prior quarter and the quarterly “regular” distribution was unchanged for a third quarter in a row, ARCC’s results met our expectations.

As we explained at much greater length in a BDC Reporter article, management made some deliberate, conservative choices that temporarily muted earnings and distributions this quarter versus IVQ 2022 and IQ 2023 analyst expectations.

This left ARCC with more capital – thanks to issuing new shares both in a secondary and through its At The Market (“ATM”) program – and with lower leverage and more investment capacity.

Given these uncertain times, this is a Good Thing even if one of the results is that shareholders are – once again – not receiving their full due in terms of earnings distributed even as the external manager is compensated in full.

In time, as capital retained is deployed into a very lender-friendly market and ARCC takes advantage of some portion of its $4.9bn of liquidity, the result is likely to record profits.

In 2021 and 2022, ARCC booked Core EPS of $2.0200 per share.

Currently, the analysts are expecting $2.3400 for 2023 as a whole – a 16% increase.

Like Smaug

BDC Best Ideas is even more sanguine, projecting ARCC will increase its total shareholder payout by 23% this year over last.

However, that projection depends on management releasing some of the profits accumulating in its vaults.

On its most recent conference call, ARCC’s CFO reminded listeners of just how much the manager is holding back:

 Our current estimate of undistributed taxable income sometimes referred to as our spillover. At year-end 2022 is $650 million or approximately $1.19 per share.

This 2022 spillover level is nearly 2.5x greater than our current regular quarterly dividend rate.

We continue to believe that having a healthy level of spillover income is beneficial to the long-term stability of our dividend. We will continue to monitor our undistributed earnings and balance these levels against prudent capital management considerations.

Ares Capital IQ 2023 Earnings Conference Call – April 25, 2023

The bold type is ours, but the numbers speak for themselves.

Credit

Also reassuring at a time when the “nattering nabobs of negativism” – to quote the late Spiro Agnew – are warning of a recession and rate-fueled crisis on our doorstep, was ARCC’s credit performance.

We’ll review the subject in greater detail when we undertake our Credit Recap for the week.

Here we’ll just say that all the key credit performance metrics remain well below their historical averages and way off the levels of prior crises.

This does not preclude greater deterioration in the future that might materially change the BDC’s performance but is still encouraging to see.

Paying Up

If ARCC is sitting on its profits, Capital Southwest (CSWC) is more willing to share.

As discussed in a full-length article, the internally-managed BDC announced an increase in its regular distribution for the calendar IIQ 2023 and maintained an unchanged “supplemental” dividend.

Meh

Neither ARCC’s results nor CSWC’s increased payout seemed to impress investors all that much, as both seemed to perform within expectations.

The former’s price increased by 1.5% on the week and the latter dropped by (0.5%).

ARCC’s stock price closed the week (13%) off its 52-week high and CSWC’s (23%) off.

On the other hand, CSWC continues to be priced at a premium to net book value but ARCC has dropped (1%) below…

Looking Forward

The next two weeks are going to be loaded with BDC IQ 2023 results.

See the BDC Earnings Calendar for the schedule, which we’re updating in preparation for the onslaught ahead.

Notwithstanding ARCC’s performance, we expect to see higher earnings both on a year-to-year comparable basis and by comparison with the IVQ 2022.

Given the uncertainty about interest rates and potential credit losses, dividends announced might be lower than they could be, as BDC managers hold back a little longer to see how this year and the next might go.

Holding On

The biggest surprise might be – given the early indications we’ve received from ARCC, CSWC, and MAIN – that BDCs’ NAV Per Share could remain relatively stable as should credit performance.

We expect realized losses will be up, and there should be another quarter of increased unrealized depreciation of BDC portfolios but much of that will be offset by retained earnings; share repurchases, and the occasional equity gain.

In the IVQ 2022, the average NAV Per Share in the public BDC sector dropped only (2.3%), with a quarter of the BDC universe actually in the black.

We expect NAV Per Share in IQ 2023 to end up in a not-dissimilar (2%-4%) drop.

Unknowable

What is harder to determine is what will happen to BDC stock prices in the wake of the seeming crash of First Republic Bank.

Admittedly, both the financial sector and the markets in general, have watched with nonchalance the very rapid decline in the bank’s fortunes throughout the week.

Afterthoughts

We can’t help wondering, though, if everyone with a deposit in or a shareholder of any U.S. bank that is not one of the Top 6 will not start asking themselves some hard questions.

If a well-known and apparently well-run bank (setting aside asset-liability management) like First Republic can disappear under the waves so quickly and completely why take the risk with your own institution?

The U.S. Government and the Fed, with their obsession of not being seen to help the banks, may blow up the banking system as we’ve known it.

Collateral Damage

Admittedly, this does not directly affect the BDC sector -which might even benefit down the road.

However, if we do get Part II of a banking crisis that involves dozens or hundreds of institutions (Part I being the SVB and Signature Bank failures), it’s hard to imagine that BDC prices would be unaffected.

Part I caused a (10%) drop in BDC prices, from which the sector has not yet recovered.

Part II could be worse.

However, a lot of shoes will have to drop for our worst fears to be realized, which we hope won’t happen.