BDC COMMON STOCKS

Week 2

Neutral

This was a flat week.

This week, our traditional measuring stick for BDC sector price performance – BDCZ – is not useful because of a just-received quarterly dividend.

On paper BDCZ – the UBS-sponsored exchange-traded note that owns most BDC stocks – fell (2.3%), but adjusting for the $0.4400 per share distribution the drop was only( 0.1%).

The S&P BDC Index, calculated on a price basis, was down (0.2%) and (0.1%) on a total return calculation.

Furthermore, the number of BDC stocks up in price during the week was exactly equal to the number down.

One BDC was up 3.0% or more, and one was down (3.0%) or more.

Details

The former was micro-BDC PhenixFin (PFX), which has been having quite a recovery of late.

The latter was Saratoga Investment (SAR), the first BDC to report its IVQ 2023 results – albeit through November.

As our readers will know – and discussed in all our 3 publications – things did not go well for the lower-middle market-focused BDC.

Recurring earnings per share were lower than the prior quarter; net asset value per share dropped by a sizeable (3.6%); a new non-accrual was added in the period and there was some tussling between management and an analyst on the earnings conference call.

For the BDC Reporter’s article on the subject, click here.

Over at the BDC Credit Reporter, we updated our database, including one new underperformer from SAR’s 57 portfolio entities. This was ETU Holdings, with a 3 rating on our 5-point scale. We also downgraded Zollege PBC to the lowest rating – CCR 5 – following its non-payment of interest due and despaired that already non-performing Pepper Palace will recover, following another unrealized write-down this quarter.

To be fair, though, SAR’s overall credit metrics – although worse this quarter – remain within “normal” boundaries.

That may explain why the BDC’s stock price – as shown below – dropped by about (10%), then flattened out in the rest of the week:

SAR ended up (9.1%) down for the week – a notable reverse.

By the way, at BDC Best Ideas we wrestled with whether SAR was a BUY following this price drop, and at a time when bargains are hard to find with 32 BDCs trading within 10% of their 52-week highs, including 2 which set new price records this week.

BDC Best Ideas Promo

Busy

There was much other BDC news during the week, though none with as much impact as SAR’s unexpectedly weak showing.

A glance at the BDC Publications News Feed, which is contained in the Subscriber Tools section of the website but is available to all readers, will show how busy things have been.

Debt Issuance

Two very different BDCs – Sixth Street Specialty Lending (TSLX) and Main Street Capital (MAIN) – both tapped the institutional unsecured debt market for substantial amounts.

For the past few weeks, both the public and private debt markets have thrown their gates wide open for BDCs seeking to raise fixed-rate, 5-year debt.

Yield-wise, we were most impressed by the 6.1250% TSLX negotiated with its new note holders, and its BBB+ rating to boot.

To state the obvious, the interest rate tide has turned where medium maturity fixed-rate borrowings are concerned even if the Fed continues to hang tough at 5.25%-5.50%.

Both markets and borrowers are looking ahead.

Venturing Out

We also heard from Runway Finance (RWAY); Horizon Technology Finance (HRZN) and Trinity Capital (TRIN) about their level of new investment activity – and repayments – in the just completed IVQ 2023.

Notwithstanding the once-in-a-generation recessionary conditions in the venture ecosphere, these BDCs have all kept busy.

That’s in contrast to SAR – for example – which initiated no new borrower relationships.

First Hit

Finally – and importantly – the BDC Credit Reporter at the end of the week identified the first material bankruptcy of a BDC-financed company in 2024.

That’s Nexii Building Products and the two venture BDCs involved – HRZN and TRIN – are at risk of material losses of capital and are already not receiving interest income on their loans – on non-accrual since December 1, 2023.

The reverse was important enough to require HRZN to make an official filing about the situation.

HRZN’s stock price has been shooting up of late, as this 1-year chart shows.

One has to wonder if Nexii’s problems will have any impact on HRZN’s upward price trajectory which has occurred even as its number of companies on non-accrual have grown (now to 4) and its NAVPS dropped (9.2%) in 2023 YTD – second worst of any BDC.

Paying Out

Both Gladstone Capital (GLAD) and Gladstone Investment (GAIN) announced January 2024 dividends this week. No needles moved as the amounts paid out were unchanged from prior periods.

GAIN, though, will have to distribute a great deal more in “special” distributions to match an excellent 2023. The BDC paid out $2.44 last year. At the one-month annualized 2024 pace, GAIN Is going to be ($1.48) a share short.

GLAD – by contrast – seems to be on a path to paying out more in 2024 than 2023. Last year, the total payout came to $0.91 per share, and the current $0.0825 monthly dividend annualizes to $0.9900. (BDC Best Ideas is projecting $1.0200 per share this year).

By the way, both BDCs are trading at close to their 52-week highs.

Going Forward

BDC prices may have been flat this week, but there’s no doubt that the fever hasn’t broken where the rally is concerned.

That’s a little surprising given SAR’s dissapointing performance and the recent downgrade of 10 BDCs by an analyst, but we’ve long ago given up trying to figure out what the “market is telling us”.

What we can offer is that IVQ 2023 BDC earnings season is beginning in earnest at the end of January, and many investors will be looking for clues about the future in those results.

Debated

Then there’s the continuing uncertainty about when and by how much the Fed is going to cut rates. This week when we saw the relatively strong CPI readings a cut in March – which we’ve not been projecting – seemed increasingly unlikely.

That’s good for BDCs, their earnings and distributions.

However, the weak producer index – down (0.1%) – has reinvigorated this endless debate. The 10 year Treasury yield dropped to 3.9500% by the Friday close, and the futures market now rates the odds of a spring 2024 cut in the Fed funds rate at 76%, from 70% days before.

To our mind – and most everyone else’s – a 0.25% rate cut in March would signal Chairman Powell and Co. have deep-seated concerns about the direction of the economy (i.e. some sort of slowdown). If so, the BDCs will have to contend with slightly lower income and a much larger sense of dread. This long-winded rally we’re in is not pricing in a recession of any sort. We’d argue BDCs are in a good position to handle even a mild to modest slowdown but we doubt investors will wait around to find out.

One Opinion Amongst Many

Our base case in BDC Best Ideas – where we think about these things every day – is that rate cuts will not come to June and won’t amount to more than (0.5%) or so by year’s end.

We admit, though, Best Ideas is in the minority.

Let’s see what happens because there’s a wide divergence between what the markets believe the course of interest rates will take and what the Fed is signaling.