BDC COMMON STOCKS

Week 35

Green Eyed Monster

We imagine that BDC investors must be somewhat envious of investors in the major indices in August.

Everyone suffered early on in the month during what some are apparently calling “Black Monday 2024” but the subsequent recovery has been unequal.

The S&P 500 actually managed to end both this last week, and the month of August 2024, up.

The benchmark S&P 500 closed August with a 2.3% gain for the month. It’s now up 18.4% so far this year and is within 0.4% of the all-time high it set in July.

AP – August 30, 2024

The NASDAQ and the Dow Jones were not quite as robust but nobody was complaining.

Okay-ish

BDC investors, by contrast, had less to cheer about, notwithstanding a 1.1% increase in the price of BDCZ – the exchange-traded note which owns most BDC stocks – and 1.0% if we believe the S&P BDC Index on a price only basis.

Yes, one BDC reached a new 52-week high: Blackstone Secured Lending Fund(BCSF) and the number of BDCs trading at or above Net Asset Value Per Share (NAVPS) did increase to 14 from 13 the week before.

25 of 42 BDCS were unchanged or increased in price on the week, 2 of which went up by more than 3.0% – BCSF and a recovering Hercules Technology Finance (HTGC).

Down

All of this is cold comfort for BDC investors in the context of the full month.

BDCZ still closed out August (1.8%) down and tellingly – according to Seeking Alpha data – 34 of 42 BDCs were in the red over a 1 month period.

Also tellingly – and a reminder of what a cold place the BDC market can be for stocks out of favor – 11 BDCs fell (5%) or more in price, including 4 greater than (10%).

Beaten Up

Battered most has been BlackRock TCP Capital (TCPC), off (16.1%).

Clearly, investors cannot get comfortable that the worst is open for the beleaguered BDC that we wrote about recently.

Here’s an extract from our conclusion which encapsulates that sort of doubt about the outlook for this once high-flying BDC:

Could TCPC turn out to be a credit disaster for its shareholders over the long term? There have been several others over the years – BDCs whose NAVPS was in constant decline and eventually caused their asset manager to pull the plug in some way. (Losses like the ones we’ve experienced surely must represent a reputational embarrassment for BlackRock or is the firm so huge – and TCPC so relatively small – to be invisible? ). We’re not sure at time of writing, based on the data. Although we suspect the worst is over for awhile, there’s no guarantee that two or three years out TCPC’s NAVPS could not be in the middle single digits. These declines are very hard to stop once they get going as has been the case for two and a half years.

BDC Reporter- TCPC: What’s Wrong – August 13,,2024

TCPC has been in price descent for over 3 years now – off (38%). Even now we can’t be sure if the proverbial bottom has been reached.

Metrics-wise, the BDC is trading at a (10%) discount to NAVPS and 5.6x projected 2024 Net Investment Income Per Share (NNIPS). Maybe more useful is the Price To Earnings ratio for 2025 – when the latter is expected to fall (10%) to $1.48. That PE is 6.2x. Low, but not the lowest one has seen.

The current yield is 14.8%, which shouts out that the market expects a dividend cut before long.

We should note, though, that those 2025 projected earnings still exceed the current annual running rate of the dividend at $1.36.

Maybe investors are looking way ahead or don’t even believe that $1.48 estimate? Or, the stock is “over-sold” and set for a bounce?

Word-less

Also taking it on the chin price-wise is TriplePoint Venture Growth (TPVG), which we’ve written about so many times before that there’s nothing new to say, except that both the venture-debt BDC and TCPC are among the 10 BDCs whose credit performance we’ve rated as being BELOW NORMAL.

On Our Minds

Credit is Job 1 where leveraged lending is concerned and the fact that almost a quarter of our BDC coverage universe is underperforming in this regard is a cause for concern.

In the background, the BDC Reporter – leveraging the capabilities of the BDC Credit Reporter – is doubling down on gathering up credit statistics for every BDC to make our “ratings” as quantitative and consistent as possible.

This is a very time consuming process but even at this interim stage we are beginning to worry more than usual about underwriting setbacks at BDCs that were not on our fretting radar a year ago – or even at the beginning of 2024.

To name some names besides the obvious ones like TCPC, TPVG, Horizon Technology Finance (HRZN); OFS Capital (OFS) and Investcorp Credit Management (ICMB) .- all of whom have seen their NAVPS drop by (10%) or more in the last 12 months – there’s Goldman Sachs BDC (GSBD); Oaktree Specialty Lending (OCSL); Great Elm Capital (GECC); Golub Capital (GBDC); Prospect Capital (PSEC); Runway Growth Finance (RWAY) and Portman Ridge Finance (PTMN).

GSBD

As an example, here’s what we wrote about GSBD this week in the BDC Credit Reporter after reviewing one of its troubled companies:

There’s no way to sugarcoat this: GSBD had an awful IIQ 2024 where credit performance was concerned and this may have lasting consequences. First, the BDC booked ($38mn) in net realized losses, led by ($26mn) on the restructuring of Thrasio. There were 3 other write-offs as well. Seconds, the BDC booked ($93mn) in net unrealized losses, which amounts to (1.5%) of GSBD’s equity at par. The total ($121mn) in losses amounts to about two quarters of Net Investment Income. No wonder that the BDC’s Net Asset Value Per Share (NAVPS) fell (6.0%) in the last 3 months, the second worst performance of the 40 BDCs that have reported this metric.

At the moment, the BDC admits to having 10 non-accruals amongst its 155 portfolio companies. The value of those non-accruals comes to $111mn at FMV, or 3.4% of the portfolio. More worryingly, we calculate that non-performing loans account for 7.8% of all debt outstanding.

BDC Credit Reporter – Wine.com LLC: IIQ 2024 Update – August 28, 2024

OCSL

OCSL has been underperforming for some time, but we were hoping for some sort of recovery this quarter which did not occur.

This is an extract from an article we wrote recently about this BDC with the famous manager- Oaktree Capital:

…The news that the number of non-accruals on the books has increased from 5 to 8 and that non-performing assets at cost amount to 5.2% of the portfolio (5.7% of the debt alone) is discouraging. We’ve been rating OCSL’s credit performance as being BELOW NORMAL for some time and this only adds to our concern that underwriting is not up to snuff. Management argues that this is not a problem with the Oaktree platform, which is fair enough. These problems are said to be “idiosyncratic” but after how much time and how many failures does one concede that a new approach might be necessary? The sudden commitment by management to boosting its share of first lien loans in the portfolio may be a quiet admission that too much systemic risk was being booked…

BDC Reporter – Oaktree Specialty Lending: IIQ 2024 Performance Review

GECC

By contrast, tiny GECC seemed to be in full successful turnaround mode till this quarter, with new management; new capital and a new strategy.

However, the IIQ 2024 saw the BDC take a step back with its NAVPS falling (4.1%), as described by management on their conference call:

 The reduction was primarily due to illiquid Level 3 investments on non-accrual in 2 portfolio companies, which adversely affected NAV by approximately $0.40 per share in the quarter. 

GECC- IIQ 2024 Conference Call

GBDC

GBDC, whose credit track record has been almost pristine till now, helped by a policy of booking a highly diversified portfolio – was sullied in the IIQ 2024 by a major write-down, which management addressed straight on:

The headline is that GBDC’s quarter ended June 30 was great in part and disappointing in part…So what was the disappointing part? GBDC had negative outcomes in 2 credits, Imperial Optical and Pluralsight, and this led to meaningful write-downs on both of them. Now we’re very proud of our long track record of low defaults and low credit losses, but we’re not perfect. In this quarter, GBDC saw $0.17 per share of net realized and unrealized losses adjusted for the merger, primarily from these 2 credits.

David Golub -CEO – GBDC – IIQ 2024 Conference Call

PSEC

PSEC is much in the news these days but nobody has been saying much about the huge realized losses booked in its fiscal year ended June 2024.

The latest annual loss is equal – give or take a few million dollars – to all Net Investment Income achieved in the period and substantially more than total distributions paid out to shareholders.

That’s a headline buried in the latest drama on PSEC’s conference call, which we discussed last week.

RWAY

Less clear-cut but still worth considering is the credit performance of RWAY, which remains NORMAL overall, but did attract our attention recently.

The BDC’s own rating system has 35% of its portfolio by FMV “underperforming”, up substantially from prior years.

As we concede in our article, this might – or might not – be important but is one more example of why we’re harping on BDC credit performance.

Here We Go

Let’s get the caveats out there, and there are several.

First, most BDCs are exhibiting “normal” credit performance – a modest number of watch list companies/assets; a low level of permanent losses and non-accruals not materially impacting earnings.

There are even a handful of BDCs with what we rate as performing ABOVE AVERAGE, typically showing an increase in NAVPS; very few non-accruals and little in the way of losses.

Second, some of the BDCs that we’ve mentioned as under-performing of late might have just had a couple of bad quarters and could be back on a righteous path in the rest of 2024.

(GECC very explicitly made that argument on its IIQ 2024 conference call and the BDC Credit Reporter’s research suggests that several of the BDCs mentioned have a brighter credit outlook looking forward than looking back).

Third, most of the BDCs with a poor credit track record of late are not (yet) sinkholes that promise to swallow up shareholder returns over the long term.

The BDCs- and their owners – are still benefiting from the extra high earnings of the last few years brought to them by the Fed’s high interest rate policies.

Sticking

Anyway, we remain “constructive” on the future of the BDC sector – even as note this apparent slippage in credit quality amongst a quarter or so of the participants.

Part of the problem might be that we’ve all gotten use to the very lender-friendly environment of the past few years and have to adjust back to a more “normal” level of credit distress.

After all folks, the bread and butter of BDC activity is higher risk lending to non-investment grade companies – the epitome of a business where you cannot make an omelet without breaking eggs.