BDC COMMON STOCKS

Week 7

Divergent

For another week the major indices and BDC sector prices moved in opposite directions.

This week, the main markets were in the red, and BDCs were back in the black.

The S&P 500 and Nasdaq 100 both halted their five-week winning streak on Friday, prompted by two inflation reports that were hotter than expected, giving fuel to concerns the Federal Reserve might delay interest rate cuts.

Business Insider – February 16, 2024

BDCZ – the exchange-traded note that owns only BDC stocks – increased 2.2%.

The ETN broke a two-week losing streak, which saw its price drop (3.5%) during which time the S&P 500 moved up 2.8%.

Metrics

37 out of the 43 BDCs we track were unchanged or up in price – the largest number this year.

Of these 9 were up 3.0% or more.

At the other end of the spectrum, the maximum price drop was only (2.6%).

Sidebar

That Biggest Loser was Investcorp Credit Management BDC (ICMB), which published its IVQ 2023 earnings press only to retract it the next day, warning investors to pay no attention to the numbers. This was followed by the non-filing of the BDC’s 10-Q and the apparent dismissal – and immediate replacement – of the CFO.

Investors and shareholders of the BDC – whose stock price has been in perpetual decline for the past decade – were not much fazed by this drama given that modest price drop.

Inquiring minds at the BDC Reporter, though, would like to know more given this unprecedented series of events.

More Metrics

With this week’s mini-price surge, the BDC sector is back in rally mode after losing the plot for a fortnight.

There are 17 BDCs trading or above net book value per share (NAVPS) and we calculate that the average price to net book value is 96%.

Furthermore, we recorded 4 new 52-week highs by BXSL, GBDC, HTGC, and MFIC.

We’ve not yet heard this earnings season from BXSL and MFIC, but both GBDC and HTGC reported excellent results and broke various earnings records in 2023.

Speaking of records – 33 BDCs are trading within 10% of their 52-week highs (16 within 5% and 17 within 5%-10%) – the most this year.

By contrast, there is only languishing in the BDC cellar – i.e. within 10% of its 52-week low. No, it’s not ICMB but Monroe Capital (MRCC) – another BDC on a long price descent. This one has lasted 7 years:

GPS

As of Friday, February 16, 2024, BDCZ is down (0.5%) in 2024 but is up 21.6% since the sector reached rock bottom in this most recent cycle on September 30, 2022.

The S&P BDC “total return” – which includes distributions received – is up 2.2% this year and 45.4% since the 2022 nadir.

High Hopes

BDCZ will need to climb 26.3% to reach its highest point since the ETN was launched in 2015.

That apex was reached in March 2017.

A more modest goal is to match the heights reached both in 2020 just before Covid raised its ugly head and in March 2022, at the end of the last cycle – snuffed out by the Fed’s rate hike journey.

BDCZ will need to increase by 9%.

Plausible?

Going by the numbers alone, BDCZ has a good chance to match its price heights of 2020 and 2022.

Let’s do a little math to show why:

In the 4 quarters running up to the pandemic, BDCZ paid out $1.724 in distributions on a per-share basis.

Likewise, in the 4 quarters ending in the spring of 2022, the aggregate dividends came to $1.507.

In these last 4 quarters – buoyed by higher rates, relatively low losses, and greater market share – BDCZ has paid out $1.745.

The peak price to payout multiple in 2020 was 11.9x ($20.54 /$1.724) and in 2022 was 13.7x ($20.60/$1.507).

This time around, BDCZ has peaked at $19.38, which implies a multiple of 11.1x and 10.8x at the Friday closing price.

If we to have perfect multiple symmetries with 2020 and 2022, BDCZ could yet reach $20.77 and $23.91 respectively.

The ETN will have a harder time matching the 2017 all-time high of $23.85, but – for the record – in the 4 quarters leading up to that record-breaking price level, BDCZ paid out $1.825 per share. That makes for a 13.1x price to distributions multiple.

If we apply that multiple to BDCZ’s most recent 4 dividends, we get a pro-forma highest price of $22.86 – lower than in 2017 but 21% higher than today.

A Bear And A Bull Discuss

A bear might say: “Interest rates and decreased competition from the syndicated markets and the regional banks have temporarily boosted BDC earnings – and thus their distributions. Both factors are changing and everyone can see the writing on the wall”.

A bull might answer: “Interest rates will be dropping – and with them BDC earnings, but from everything we’ve heard this week and last, that is unlikely to happen till the summer. Even then the rates will be lowered only marginally. There are likely two – or even three – further quarterly distributions ahead at levels equal or better than anything we’ve seen in this cycle”.

The bull – a garrulous animal – might go on to say: “Many BDCs have stored up a great deal of investment firepower (i.e. are not leveraged up to their target levels) in recent months and have withheld unusually high levels of earnings to distribute in the future. Moreover, the expected pick-up in M&A activity that will accompany lower rates should see fee income balloon at many BDCs, offsetting some of the income lost to lower rates”.

The bear – as always happens in these situations will just throw up his paws and say: “Anyway, there’s going to be a recession in 2024 and you know what that means…”

We’ll leave this endless – and fruitless – debate at this point by reminding ourselves – and our readers – that we have no idea who is right – if anyone.

Solid

However, after reviewing in great detail, the IVQ 2023 results of 13 BDCs, we continue to believe that the sector’s fundamentals remain very strong in almost all cases.

7 BDCs posted recurring earnings above expectations, 3 in-line, and only 3 below (SAR, OCSL, and PSEC).

8 BDCs managed to report higher NAVPS than in IIIQ 2023.

There have been very few non-accruals reported so far, except by OCSL, which was the exception to the rule with 4.

Several non-performing companies got back to performing status as BDCs “fixed” them through bankruptcies and restructurings.

Yes, realized losses and lower income have ensued but the amounts involved have been small.

Most importantly of all, given what we’ve been discussing, no BDC reduced their quarterly distribution and three announced an increase.

If the BDC sector is going to face the much-promised recession (bank crisis? war in the Middle East? consumer tapped out?) they have never been better prepared or in better financial shape.