BDC COMMON STOCKS

Week 25

Losing Altitude

Portentously – but possibly prophetically – last week we warned that a downward shift might be occurring in BDC sector prices, brought on by the PROSPECT of lower interest rates somewhere in the second half of 2024.

This week, BDCZ – the exchange traded note which owns most of the public BDC stocks – increased 0.1%, after declining (1.4%) the week before.

However, that’s a false positive and the rest of the data we mull over every week does suggest the bloom is off the BDC rose where prices are concerned.

For example, two other sector price indicators we use – the BDC ETF with the ticker BIZD and the S&P BDC Index – calculated on a price basis – gave different results in this holiday shortened week.

The former did not change, going from a price of $17.00 to $17.00. The latter fell (0.2%).

Admittedly, that’s not much of a downwards shift.

Clearer

However, the individual BDC data paints a more worrisome picture.

26 BDCs dropped in price and 16 increased – the second week in a row of a majority of the BDCs being in the red.

Also for a second week in a row, 5 BDCs dropped (3.0%) or more and onlyone increased by more than 3.0%.

Very noticeably, the number of BDCs whose price was at or above their net book value per share dropped from a multi-year record of 22 a fortnight ago to 17 this Friday.

That’s its lowest level since Week 14.

Charging Ahead

This is happening as the major indices – and especially the S&P 500 – continue to motor along.

At the end of May, the S&P BDC Index – calculated on a total return basis – was a nose ahead of the S&P 500, which we remember celebrating at the time.

Just 3 weeks later – like a marathon runner hitting a “wall” – the BDC total return is down at 9.5% and the S&P 500 – also on a total basis that includes dividends – is up 15.4%.

BDC investors have gone from nose-to-nose with the S&P 500 to falling far behind.

In 3 weeks…

Less

Also off are the number of BDCs trading within 0%-5% of their 52 week highs: dropping from 15 to 12.

Interestingly – and yet another sign of a shift underway – the number of BDCs trading within 0%-5% of their 52 week lows has gone from zero at the end of May 2024 to 6 as of now.

Worst

This week , 2 BDCs reached new lows in this category: OFS Capital (OFS) and TriplePoint Venture Growth (TPVG).

The former has gone (26%) down from its 52 week high in price terms and trades at an (18%) discount to book.

The latter has seen a (35%) drop from 52 week high to low and is trading at an (8%) discount to book.

TPVG – viewed over its entire history – seems to be in the worst shape, trading at its lowest levels ever, with the exception for a brief period during the early days of the 2020 pandemic, as this chart illustrates:

The venture-debt BDC’s price-to-expected 2024 earnings is down to 4.9x, way below the BDC average of 8.4x as calculated by BDC Best Ideas.

Its current yield is 19.3%!

Is that punishment enough for what was once a very promising BDC, whose price has now tumbled (57%) since late 2021?

Ironically since 2021, TPVG has actually increased its annual dividend payout by 11% but investors – are they are wont to do – are looking forward and do not seem to like what they see.

What’s Coming Next?

We wish we knew…

This could be a short-term price pullback – a very familiar phenomenon where all stock prices are concerned – or the early innings of something more severe.

Maybe those forward-thinking BDC investors believe – not unreasonably given market expectations – that the BDC sector has reached “peak” earnings now that interest rates are set to decline and are taking their profits and moving on.

Some other investors might be reading some of the dark headlines in the financial press about private credit’s potential credit problems and deciding that caution is the better part of valor.

Or – maybe – the never-ending rally in the other indices is drawing capital away from the BDCs after a long upward run.

Pretty Darn Good

All we can say – more than one-third of our way through a detailed review of every public BDC found on these pages – is that BDC fundamentals remain strong in all the categories we analyze: earnings; net book value; credit; liquidity and distributions.

As is always the case, there are exceptions to the rule and wide variations between even the more successful BDCs but there are no signs of sector-wide incipient disaster.

Prospects

Instead, the BDC sector continues to attract large amounts of new capital – both in the form of equity and debt – being raised by BDCs across the spectrum and in all segments of the market.

One day we’ll get a revival in M&A both in LBOs and in the venture sector, which will provide another fillip to BDC assets under management; earnings (more loan volumes, higher fees) and realized equity gains.

Everything Is Relative

Moreover – and more controversially – as interest rates drop and yields in all asset classes decrease, we expect – as spelled out in BDC Best Ideas – that BDC investments will gain in popularity.

Yes, BDC distributions might drop (10%)-(20%) in the years ahead but if high yield bonds, REITs and dividend paying stocks drop even more, investors might decide that less is more where BDCs are concerned.

Let’s check back in 2027 or 2028 to see if that investment theory paid off.

Focus

In the short term, though, we’ll be watching to see if the (3.2%) decrease in the S&P BDC Index on a price only basis that began June 4, 2024 will continue and officially put an end to the sector’s long running rally.

It’s been some time since BDC investors faced a down market and could cause some shareholders sleepless nights.