BDC COMMON STOCKS

Week 31

Trust

Once in a while we feel compelled to set aside all the metrics that normally guide us and listen to our gut feelings.

That’s what we did back in Week 28 when we concluded the BDC Common Stocks Market Recap with this suspicion:

Shortly Thereafter...

This week we got that “price drop” in spades.

The (4.3%) fall in the price of BDCZ – the exchange traded note which owns most of the BDC stocks – and the (4.5%) fall in the S&P BDC Index – calculated on a “total return” basis – was the worst drawdown we’ve experienced since Silicon Valley Bank went belly up in the spring of 2023.

We have to go all the way back to October 2022, when the BDC sector was reaching its lowest point since the war in Ukraine began and the Fed promised to massively raise rates, for something similar.

Deja Worry

This time, the fears are similar: apparently the most recent unemployment numbers and a host of other metrics that investors – and their enablers in the financial press – gravitate to at times like these are promising a shrinking economy ahead.

As all our readers will know – especially those holding technology stocks – asset prices fell on all fronts.

Overall, $2.9 trillion in value was wiped out in the major markets accordsing to one report.

The NASDAQ 100 dropped (3.1%) on the week, and the S&P 500 and Dow Jones fell (2.1%.

Hyperbole Day

Those numbers don’t tell the full story as the bulk of the damage occurred Thursday and Friday causing headline writers to reach for their Thesauruses.

There were plenty of references to markets “falling sharply”, “plummeting“; plunging, and so on.

By The Numbers

In our bailiwick, not one BDC managed to increase in price on Friday. (2 did stand pat price-wise).

For the week, 40 BDCs were in the red, including a whopping 31 down (3%) or more.

Inside that (3%) plus group, 6 BDCs were down (7%) or more.

The First Shall Be Last

Ironically – but not surprisingly – the biggest percentage price drop was at Hercules Capital (HTGC).

The venture BDC had seen its stock price rocket up of late, setting the stage for a classic “profit taking” by investors.

Thanks to a (12.2%) price drop HTGC has fallen back to the level the stock reached at the beginning of April.

Still, HTGC trades even now at a huge premium of 65% over its net book value per share – a level most BDCs can only dream of.

Beat Up

The second Biggest Loser was Oaktree Specialty Lending (OCSL), which dropped (10.3%) following a IIQ 2024 earnings release that saw its NAVPS fall (2.8%) and questions being raised about the sustainability of its dividend.

As this chart shows, since the beginning of 2024 “bargain hunters” have 7 times – in percentages large and small – hiked up OCSL’s price on the anticipation that Oaktree can turn around its prtoblem BDC

Every time those brave souls have been disappointed.

BDC investing is hard when you don’t know in advance that a BDC is going to more credit troubles just when you expected the opposite:

As of June 30, 2024, there were eight investments on non-accrual status, which represented 5.7% and 3.7% of the debt portfolio at cost and fair value, respectively. That’s up from five investments on non-accrual status in the prior quarter, which represented 4.3% and 2.4% of the debt portfolio at cost and fair value, respectively.

OCSL – Earnings Press Release – August 1, 2024

On Our Minds

We asked ourselves back on July 18th – even as OCSL reached its then 52-week low whether further depths might be plumbed:

To date – despite reaching today’s 52 week low – one could argue investors have not punished the stock very much.

OCSL is trading at a still high-ish 7.8x multiple of its projected fiscal year ANIIPS and at a not-so-dramatic (5%) discount to net book value.

This suggests the market is taking a measured approach to the BDC’s challenges.

The question everyone must be asking themselves is whether this tempered approach will subsist if losses continue to mount and NAVPS drops even more.

OCSL’s IIQ 2024 results – especially on the credit side – will need to be watched carefully.

BDC Reporter- Oaktree Specialty Lending: New 52-Week Low- July 18, 2024

We got our answer this week with the (10%) drop as the BDC’s unfortunate shareholders received a double body blow from poor quarterly results and the impact of the market pullback.

As of Friday, OCSL is one of the sector’s worst price performers over a 1 week, 1 month, 6 month and YTD period.

The stock closed at $16.51 and was valued at 7.3x projected 2024 earnings and a (9%) discount to book.

This is not the place for price prognostication about individual BDCs but we can state the obvious: OCSL still has plenty of room to move up or down.

Where We Are

We could go on for pages and pages about individual BDCs given there was so much activity this week, but we only have so much space.

Instead, let’s look at where the BDC sector stands after this maelstrom (there’s another good word that doesn’t get used enough).

BDCZ is off (2.4%) in 2024 – quite a fall from a 6.4% peak a few weeks ago.

Also in retreat is the S&P BDC Index – which includes dividends received. That peaked in our weekly numbers at a gain of 12.7% but is now back to 6.5%.

The number of BDCs trading at or above net book value per share has dramatically fallen from 22 in June to 13 – a (40%) drop.

Likewise, the number of BDCs trading within 5% of their 52 week highs was at 24 in June and just 4 as of Friday.

Fantastic Four

If you’re interested, the BDCs “holding on to what they got” are Barings BDC (BBDC); Bain Capital Specialty Finance (BCSF); PhenixFin (PFX) and our newest public BDC denizen Palmer Square (PSBD).

In what is a good sign of sorts, the number of BDCs trading within (5%) of their 52 week lows remains manageable at 8. That’s twice the number of last week but only 1 higher than the record for the year in this sad category.

There has been nothing like this number of BDCs scraping the price bottom since the spring of 2023. (Blame SVB for that one).

Damage

For much of 2024 the BDC sector – whether we counted just price or “total return” – was giving the S&P 500 a run for its money where price performance was concerned.

That began to shift early in June and now the S&P 500 – despite all the plummeting of this week – is still up 12% for the year and BDC investors can only remember fondly the way things were only weeks ago.

However, there are 5 individual BDCs whose stock price has increased more than the S&P 500 this year and another 5 – when all the dividends are counted – might be ahead – or very close – on a total return basis.

At the other end of the spectrum, 3 BDCs are down (15%) or more in price this year and their distributions will be nowhere near sufficient to avoid them being loss makers.

The BDCs involved are OFS, TriplePoint Venture Growth (TPVG) and Oaktree Specialty Lending (OCSL).

Three quarters of individual BDCs – on a total return basis – are still in the black to varying degrees.

BDC investors may be in shock after Friday’s drama but most are still doing alright and are 52% up since the sector reached rock bottom in the autumn of 2022.

Looking Forward

Sorry. We asked our “gut” what happens next but no answer was forthcoming so we no idea whether Friday’s stock price massacre – part of a broader pullback than began in early June – will continue next week.

Certainly, we worry that the market might punish more than usual any BDC that reports unsatisfactory results in this category.

There are at least 26 BDCs on the docket in the next 5 market days and not all will have good news to offer.

The combination of the words “recession” and “lower than previously anticipated interest rate reductions” are all that many investors need to hear to hit the Sell button.

Market momentum may well be against anyone long BDC stocks but – as we always say – we’ve been surprised before.

Final Word

The “good news” we have to offer is that in the 10 BDC conference calls we’ve listened to of late there is no visible sign of a general slowdown in business and economic performance.

There’s no sign of broad-based drop in portfolio company revenues or EBITDA and no rising request for waivers and amendments to existing loan agreements.

Private equity sponsors are not pulling back but rather getting going on investing more.

Credit results – with a few exceptions like OCSL – remain amongst the best we’ve ever seen.

Maybe the BDCs are hiding a bunch of tired, zombie companies from all of us with over-generous valuations and sleight of financial hand but we have no evidence thereof.

Liquidity is plentiful with almost every BDC raising some combination of new equity and unsecured debt and many negotiating better terms on their secured financings from banks happy to oblige.

If we’re going to get a recession in 2024 that will upend the economy and the BDC sector, it’s going to come out of a clear blue sky taking every pin striped analyst, investment banker and BDC manager by surprise.

Will the market – which famously got the recession call completely wrong two years ago in a parody of “Waiting For Godot” get it right this time?

But What Do We Know

We’ll stick our neck out for that one and argue that the answer is No.

Check back with us at year-end and let’s see where things stand.

Till when we’ll be reading more BDC earnings disclosures than is healthy for us and keeping an open mind.