BDC COMMON STOCKS

Week 27

Going Strong

If you’ve been at the beach – or in our case in London – you may need a quick update on how the major indices fared in this holiday-shortened week.

The S&P 500 “kicked off the second half of 2024 with its best weekly performance since late April”, climbing 2.0%, while the NASDAQ did even better, increasing by 3.5%. Even the Dow Jones – often the odd index out – went up 0.7%.

In a word, the markets are hot.

Well Enough

BDCZ – the BDC Exchange Traded Note which owns most of the BDC public stocks and serves as one of our sector price guides – did not keep up with the the major indices, dropping (0.4%).

However, better reflective of the sector’s performance was the change in the S&P BDC Index – calculated on a total return basis, including both price changes and dividends received.

This is a period when many BDCs are paying out both regular and “special” dividends, which lifted the index by 1.8%.

Other Metrics

Most of the other price data belied the BDCZ drop.

For a second week in a row, there were 28 individual BDC stock prices in the black (increased or unchanged) and 14 in the red.

Getting High

Impressively, 5 BDCs reached new 52 week highs.

These were the usual suspects – well performing players who’ve been episodically reaching new price heights – whether of the 52 week or all-time variety of late.

Amongst the most noticed was Main Street Capital (MAIN)- which as recently as last Friday – set a new lifetime price of $52.30 intra-day.

Here’s a stock price chart dating back to 2007 for this long popular which is worth its 1,000 words:

Joined At The Hip

MAIN is neck-and-neck with Hercules Capital (HTGC) – a very different BDC – but which also touched that all-time price record on Friday:

These are BDCs which have been around for a very long time by this sector’s standards and which have faced down a long list of macro and micro challenges over the years.

Lessons Learned

These two charts are a reminder that if you pick the right BDCs you have the prospect of getting both a stock price increase over the long-term and a regular – and an increasing stream of dividends.

That’s a very intriguing proposition for the buy-and-hold investor.

We’d also say the spiky shape of the charts demonstrates how volatile BDC prices can be – even for the most beloved, NAV-growing players.

Hope?

For anyone who feels MAIN or HTGC are “too expensive” – a very personal and imprecise term – just be patient.

The chances are good that sometime in the next year or two – or next week – their stock price could be much lower.

For example, less than 2 years ago – as the fear of a U.S. recession and a stock market collapse reached a pointless peak – HTGC could have been purchased at a (45%) lower price than today.

Where We Are

Getting back to here and now, the sector metrics suggest the BDC rally rolls on – despite a brief stutter in June.

BDCZ reached its own 52-week price high at the end of June 2024 and remains only (0.4%) off that peak, trading a smidge beneath the highs reached in 2020 (before the pandemic wrought the biggest percentage price drop in BDC history) and in 2022 (when EVERYONE was certain that U.S. recession was coming and would far outweigh the greater income BDCs might derive from higher interest rates).

As we’ve noted before, BDCZ over its near-10 year lifetime traded materially higher than 2020,2022 or today back in 2017.

This is also the case if we look at the lifetime chart of one of other BDC price guides: the only sector exchange traded fund, whose ticker is BIZD:

Not Fair

We’ve noted before that BDCZ and BIZD are currently paying out a higher level of distributions that in 2017 yet are trading a good (20%) below the highs of 7 years ago.

Obviously, the macro and rate environments were sharply different back then and this time we’ve got the almost certain impact of lower interest rates ahead to contend with.

There may also be technical factors at work such as how the indices are constructed as they are frequently re-balanced so comparing 2017’s BDC apple with 2024’s orange might mislead.

Debate

Nonetheless – a BDC bull might argue that the component BDCs in the sector are bigger and more stable than was the case in 2017 – boosted by years of raising gobs of unsecured debt on favorable terms and increasingly investing in first lien positions.

Most BDCs are sitting on record levels of undistributed income which should mitigate for years to come a potential secular decrease in earnings.

Many of the mediocre BDC players of 2017 have been acquired and rejigged and overall credit conditions – much to everyone’s surprise – are relatively favorable.

All this – a Bull might say – could propel BDCZ/BIZD to an even higher level in 2024.

Claws Out

Nonetheless – and the stock price performance of BDCZ and BIZD notwithstanding – there are plenty of Bears warning that a peak has been reached and the future will be bleaker, even as half of all BDCs are trading at or above their net book value per share. Here are two examples: here and here.

Then there’s the cold water being poured on Private Credit generally by the likes of JP Morgan’s Jamie Dimon,even while his institution seeks to carve itself a bigger role in what used to be their bread and butter business.

Besides lower interest rates, the hand wringers point to greater competition amongst lenders for new deals impacting loan spreads and thus overall portfolio yields. As usual, many commentators assume the economy will be weaker going forward and that will impact credit quality in a meaningful – and unpleasant – way. Finally, the Bears point to the high prices we’re enjoying and say all upside is fully priced in.

We’re the BDC Reporter and not the BDC Fortune Teller (we do our crystal ball gazing, though, in BDC Best Ideas) so we’re not going to take sides on this critical – but unknowable issue.

A Few Cents Worth

However, we do have a few words to say, which will likely only add to the complexity of this subject.

First, there is no one BDC sector. Conditions, competition, pricing, terms vary widely from one sector of the lending market to another. Gladstone Capital (GLAD) and Ares Capital (ARCC) – to use just two examples – serve very different borrowers and in a widely different ways.

BDCs now operate in every nook and cranny of the corporate lending market but most of the discussion amongst the Bears relates to the leveraged loans for the largest – PE financed – borrowers.

The “BDC sector” is so much more than the LBOs you read about occasionally in Bloomberg.

Even within segments where BDCs are competing head-to-head, performance varies widely for a series of reasons: different strategic approaches; availability of capital; historic performance and just that ineffable but vital factor: how good they are at credit underwriting.

We can guarantee you that if we do have that weaker economy and those higher credit losses – a not unreasonable argument if only because we seem due – there will be a huge difference in losses between BDCs that will ultimately be incurred.

Some BDCs will take it on the chin while others will only take a glancing blow. No generalizations are useful here.

Don’t Look Back

Finally – although we could go on for hours on this subject – the playbook of 2007-2009 where BDCs are concerned is no longer useful today, although many investors pull it out whenever a crisis looms.

Back then there were far fewer BDCs and even the top players were heavily invested in high risk junior capital investments and were saddled with the classic lender mismatch of short-term borrowings funding long-term assets – a perennial recipe for trouble.

No wonder a host of BDCs reduced or suspended their distributions during the GFC and almost everyone’s stock price fell out of bed.

Vive La Difference

The BDCs of today bear very little resemblance to those of 2007-2009.

Much has been learned by the BDC managers who came through that imbroglio and we’ve also had the decamping of the banks from leveraged lending which has allowed BDCs to grab loan assets they could not dream of owning previously.

Moreover, thanks to the flexibility of the BDC structure, their managers can take a long-term view when hard times come a-knocking.

Some loans will be permanently liquidated but many others will be re-purposed and re-structured and – one fine day years down the road – be sold back in the form of equity or repaid.

Taking a snapshot of BDC values at the depth of any recession will not provide an accurate picture of what they’ll be worth once the economy revives.

Yet, that’s what many Bears are likely to do based on what happened in the GFC.

We’ll go so far as to argue that if we face the same macro conditions as during the GFC in the future, the negative impact on the BDCs capital; earnings and dividends will be a small fraction of what occurred before.

Some Things Never Change

With all that said, we’d never argue that BDC prices could not drop sharply in the future and at any time.

This is a sector where sentiment trumps everything else – for a time.

The Bears could both be right but ultimately proven wrong.

Settle In

That process, though, can take a very long time to play out- say 2-3 years.

We expect to be here chronicling whatever happens as we’ve been doing every week for over a decade.