Not Good Enough.

BDC COMMON STOCKS

Week 12

By The Numbers

For the week, the BDC sector – as measured by the exchange-traded note with the ticker BDCZ which owns most of the relevant stocks – was up 0.2%.

BDCZ went from $18.99 on Friday March 15 to $19.02 on March 22.

As is often the case this year, BDCZ was eclipsed by the major indices, who proved much more newsworthy.

The S&P 500 had its best performance over a week in 2024 and was up 2.3%. The Dow Jones increased 2.0% and NASDAQ jumped 2.9%.

All the Sturm und Drang of the week before about one higher-than-expected inflation report melted away when the Fed – and Chairman Powell in his prepared remarks following the regular conclave – appeared ever-closer to beginning the long anticipated first interest rate cut.

Just not now.

For the year-to-date, BDCZ is up a measly 0.3%. To contrast, the S&P has moved up 9.7%.

You can hear BDC investors sighing from here.

Consolation?

The metrics are a little less dismal if you consider the S&P BDC Index calculated on a “total return” basis.

In twelve weeks, the mix of price change and dividends received, has caused the index to increase by 3.2%.

If it’s any consolation – and you believe this year’s BDC “total return” will neatly match the first 12 weeks – the annualized 2024 return comes to 13.9%.

Worrying

Unfortunately, even the BDC sector’s relatively lackluster overall performance seems to overstate its performance this week – and in 2024 – when we look at the totality of the metrics.

For example, this week 5 BDCs out of the 42 we track (BlackRock Capital Investment – BKCC – has been removed due to its merger into BlackRock TCP Capital – TCPC) dropped (3.0%) or more in price.

None increased by 3.0% or more even as the sector overall was anemically in the black.

Furthermore – picking through the data points we gather every week – we note that 24 BDCs have dropped in price in 2024 over their level at the end of 2023, more than the 18 that are in the black.

Also, the number of BDCs trading within 5% of their 52-week highs peaked at 23 at the end of January this year.

This week there were only 13 who could make that boast.

In the first week of the new year, when optimism reigned supreme, there were 18 BDCs priced at or above net book value per share. This week, there were 15.

Yes, we had a BDC reach a new 52-week high this week – Blue Owl Capital (OBDC) – but we also had a rarity of late – a new 52-week low: TriplePoint Venture Growth (TPVG).

Flagging

The BDC come-back that began in September 2022 – when the sector reached its nadir – is faltering – again.

We say again because over the year and a half of an upward trend for BDCZ – which saw the ETN increase as much as 18% at the height on January 2, 2024 – there have been 4 distinct periods of softness.

The biggest price drop – nearly (11%) – came about due to the failure of SVB Financial and the fear that the financial system would teleport back to the conditions of the GFC.

The Fed and the Treasury – and the general strength in the rest of the banking system – made sure that would not happen.

Then in the autumn of last year, the markets – against all the evidence – worried that long-term interest rates would be headed upward as the U.S. government would be unable to fund its budget dedicit.

Of course, the deficit grows ever larger but the markets have changed their minds again.

The latest crisis of confidence seems to have been about whether inflation is truly under control but the worry has not lasted long.

Lower For Longer

Harder to pinpoint, but a possible factor holding BDC prices back, is the very obvious impact lower rates – when they finally occur – will have on BDC income, earnings and distributions.

The BDC Reporter – going by the analyst earnings estimates and the dividend projections of our sister publication BDC Best Ideas – has repeatedly pointed out that 2024 should still be an excellent year where profits and payouts are concerned.

We’re not likely to see a lower interest rate induced material earnings drop till the fourth quarter at the earliest.

Moreover, the huge reserves of undistributed income most BDCs have collected during the last two “fat” years should keep dividend payouts stable well into 2025.

However, markets are famously looking into the future and even the distant prospect of lower distributions may be causing profit taking and looking elsewhere for profitable capital deployment.

Not So Good

Unfortunately – going by the results of the latest BDC warnings season which only awaits Logan Ridge Finance’s (LRFC 10-K filing to be call completed – investors may also be disappointed by how some individual players performed.

The BDC Reporter rated 11 BDCs as underperforming overall in the IVQ 2023 in our Quarterly Performance Table.

Of those companies, 9 also showed up amongst the 11 BDCs with the biggest price decrease in 2024.

Taken Aback

Investors are not in a forgiving mood – and – to our surprise – we found there were more BDC underperformers where fundamentals are concerned than we expected in the latest full quarter.

Was that an anomaly or the beginning of an ever greater dispersion of financial results amongst our 42 BDCs after two years of that higher interest rate tide lifting all boats?

Of course, all the BDC managers are putting on a brave face – both those who deserve to and those who don’t. Rare is the asset management group which will take responsibility for unusually high investment losses.

Gold Standard

Maintaining a “stable NAV” or even achieving an increase over the long term is the stated goal of every BDC manager.

All BDCs are subject to having some of their portfolio companies underperform and a few move to non-accrual and ultimately to be written off. That’s the nature of leveraged lending, even in a relatively strong economy like the one we’re in. The erosion of earnings power and capital that follows can be offset by equity gains elsewhere; selling new shares at a premium or buying back shares at a discount (occasionally both in the same quarter!) and by retaining profits. (This does not purport to be an exhaustive list).

As the BDC NAV Change Table – which we’ve just spiffed up for ease of use – shows, 15 BDCs have managed to increase their NAVPS over the last 5 years. (In some cases, though, these are newer BDCs with a shorter history). Another 8 have seen their NAVPS drop less than (10%) in 5 years, which given the high level of earnings BDCs pays out, ensures a still bounteous “total return”.

Caught somewhere in-between are the 10 BDCs whose NAVPS has dropped (10%-20%) over 5 years and then there are the 9 BDCs whose NAVPS loss is in excess of (20%), including 7 who are down by (30%) or more.

These have been the “falling knives” of the last half decade, each with their own backstory and all who have their proponents claiming that past is not prolog.

Bounce Back

For example, Great Elm Capital (GECC) has seen its NAVPS drop (82%) since 2018 and its dividend reduced by (75%). However, a new manager, strategy and (dilutive) capital has caused its NAVPS to increase by 16% in 2023. Not coincidentally, GECC’s stock price has jumped up 13% in the last 12 months after a vertiginous (84%) drop previously.

Key Question

More important than who has failed to maintain a stable NAV in the past is who won’t in the future.

Unfortunately, the most recent data suggests there are plenty of candidates.

The BDC Best Ideas undertook a BDC-by-BDC credit review – using data in the BDC Credit Table (also spiffed up of late) and NAV Change Table, as well as leaning on the research undertaken by the BDC Credit Reporter – and concluded that more than a fourth of the players are performing BELOW NORMAL.

BELOW NORMAL means an increased likelihood of credit losses; shrinking equity base and fast declimning NAVPS.

There are many of the usual suspects on the BELOW NORMAL list – BDCs that have long struggled to pull themselves together.

There are also, though, some new names who previously had managed to keep a clean sheet.

None of this is written in stone. Credit turnarounds are possible. Moreover, we’d be the first to admit that even though we relied on quantitative metrics to come up with our 11 names there’s an element of subjectivity involved.

We hope our readers will do their own homework.

However, if we’re right and a quarter or more of the BDC universe – including some very big and famous names – continue to perform poorly from a credit standpoint – this will undoubtedly weigh on individual and sector prices going forward.

The coming IQ 2024 BDC results – not that far off – will weigh heavily on what might happen to BDC prices.