BDC COMMON STOCKS

Week 36

Not Too Bad

Much damage has been augured for the stock market in September – mostly because the average monthly return of the S&P over time is (0.7%).

After this first – holiday abbreviated week – those dark omens appear to have some validity where the major indices are concerned: the Dow index was down (0.8%), the S&P 500 (1.3%), and the NASDAQ retreated (1.9%)– largely on bad news out of Apple.

Interest rates – always a factor these days – moved up during the week based on strong non-manufacturing ISM data.

This economy – like a doughty, much-pummelled prizefighter – just won’t hit the deck.

The BDC sector was not immune to the month’s bad vibes – with BDCZ – the exchange-traded note that owns most BDC stocks and which serves as a price indicator – falling (0.9%).

That’s the fourth week in the red out of five.

The total return BDC S&P Index was off (0.9%) as well.

By Contrast

Still, this was relatively small beer, with 18 BDCs increasing in price and 24 decreasing.

Only 2 BDCs were down (3.0%) or more. When the sector is really dropping that number has been as high as 34 this year.

The number of BDCs trading at or above book value remained unchanged for a remarkable 6th week in a row.

There was even a new 52-week high achieved. This was by Bain Capital Specialty Finance (BCSF), breaking its own records set the week before.

The number of BDC stocks trading within 10% of their 52-week highs increased to 22 from 21 the week before.

(Admittedly, though, the number just 0%-5% off the peak dropped from 11 to 7).

Flying High-ish

Going by our end-of-week closing prices for BIZD, the sector is only (1.3%) off the high of $18.31 set on August 4, 2023.

For the year, BDCZ remains up a robust 8.1%, and the total return S&P BDC Index clocks in at an 18.1% gain – better than the S&P 500 over the same period.

At this point, 34 BDCs out of 42 are up in price in 2023 – including 16 by a double-digit percentage.

If this is the sort of damage the September curse is going to inflict, most BDC investors will be delighted.

However, we recognize that there are 3 more weeks to go, so we won’t poke the bear.

News Recap

Far and away the biggest story of the week is that after years of”will they? won’t they” worthy of a rom-com BlackRock Investment Capital (BKCC) and BlackRock TCP Capital (TCPC) have agreed to merge.

As we said when first writing about the combination, this is far from the first such move by an asset manager with more than one public or private BDC in its stables.

Oaktree has been down this path, as have Golub, Goldman Sachs, and FS Investments-KKR.

This might not be the last either, as we wonder what PennantPark; Blue Owl; Blackstone, and others might do. Golub itself might even have another go.

Rationale

For the managers involved these combinations have a host of benefits including bulking up their assets under management in one entity, which saves on expenses and time spent.

Where the private BDCs are concerned, being acquired by an already public sister fund provides liquidity for shareholders who might have been locked up for years.

The super-sized BDCs become more relevant in their market segment and should benefit from lower financing expenses and greater trading volume, which itself attracts new investors.

Clever Move

More subtly – on some occasions – this is an opportunity to drop a BDC with an imperfect path into its brethren in the hope that the market will forgive and forget its prior transgressions.

That’s the case with BKCC whose history as a public company was marked by a huge drop in its net book value and stock price, not to mention a greatly lowered dividend.

Only in recent years – around the time BlackRock acquired Tennenbaum – has the BKCC ship been righted – a process that has taken a very long time and included long periods when management – to their credit – provided much financial support in the form of fee waivers.

In a few years, BKCC will be forgotten – its assets repaid, sold, or written off – and the TCPC narrative – which is a better story – will prevail.

Over at our sister publication – BDC Best Ideas – we’ve already opined on whether TCPC is a BUY, SELL or HOLD and what our initial expectations are.

BDC BEST IDEAS

Now We Know

Also in the news, this week – right at the end – was Prospect Capital (PSEC), whose 10-K was finally published after much delay.

Inquiring minds were mostly interested to hear how PSEC would handle the financial collapse and possible liquidation of PGX Holdings – a controversial “credit repair” company in trouble with the authorities. Here’s some of what we found in the 10-K on this subject:

PGX experienced a significant change in value during the current period. Leading into March 2023, PGX was undergoing a litigation process commenced by the Consumer Financial Protection Bureau regarding the legality of PGX’s billing practices when using telemarketing to acquire new business. Due to recent rulings issued by the courts in these legal proceedings, PGX determined it needed to move away from a telemarketing model to an online model to attract new customers. As a result of this material change to PGX’s business model (which will take time to develop) and other impacts from the court rulings, PGX filed for Chapter 11 bankruptcy protection in the District of Delaware in June 2023 and continues to navigate the on-going legal proceedings. Due to these factors, the value of our investment in PGX decreased.

Prospect Capital – 10-K For Fiscal Year Ended June 2023

One Of Many

As the 10K showed in detail, PSEC booked nearly half a billion dollars in realized losses during its fiscal year, with PGX accounting for 61%. The PGX loss was 6x the amount of any other write-down.

Uncertain

There’s more.

PSEC has chosen to maintain a value of $75mn for PGX as of June 30, 2023, presumably on the belief that the business can radically transform itself as mentioned above.

We don’t have access to the latest information but as an interested outside observer that prospect (no pun intended) seems highly unlikely. However, we’ve been wrong before so we’ll have to just wait and see what the next valuations bring.

Tough Times

In any case, and looking beyond PGX, PSEC has just booked its worst year where realized and unrealized losses are concerned in a long history dating back to 2006 when its name was Prospect Energy.

Those losses exceeded – and by a significant margin – all net investment income earned in the fiscal year.

The BDC’s NAV Per Share (NAVPS) has dropped (15%) in the past 5 quarters and at a time when most of its peers have maintained or increased their NAVPS.

Walking Away

The market has long ago cottoned on to the BDC’s credit deterioration. Since peaking at $9.25 a share in June 2021, PSEC has dropped (35%) in price to $5.99 on Friday – just above its 52-week low.

A Mystery

Given that management has not admitted that there is anything wrong – even though many of its “control” investments have been written down along with PGX – and has not increased its dividend where almost every other BDC has – it’s hard to say whether PSEC can or will be “turned around”.

As has been the case for years, management continues to make “idiosyncratic” investment choices, including doubling down on PGX as recently as December 2022 and investing in a host of asset categories that other BDCs eschew. Not helping is that management continues to charge the highest management fee in the public BDC space – twice the level of peers like GBDC.

Unsolicited Advice

Maybe it’s time for PSEC’s management and Board to look around for a buyer. This remains a very favorable time for private credit and there are many potential acquirers with the capacity to take on an underperforming BDC with $7.7bn in portfolio assets.