BDC COMMON STOCKS

Week 46

A Little Strange

The week ended November 15 – just days after a momentous election – was a peculiar one.

For the major indices, the euphoria of a future with less regulation and ever higher spending had quickly passed.

The NASDAQ was down, the Dow Jones was down, the S&P 500 – recently at a record high – was down. Even the Footsie in old Blighty was down.

The BDC sector – as measured by the percentage price change of BDCZ, the exchange traded note which owns nothing but public BDC stocks – barely moved: dropping (0.1%).

Unexpected

This suggests not much of anything was happening to the component individual BDC stocks, but that was not the case.

20 BDCs increased in price and 22 decreased but – more to our point – 4 increased in price by 3.0% or more and 6 fell by (3.0%) or more.

That’s nearly a quarter of the BDC universe on the move in one direction or another, suggesting investors are still busy re-pricing risk and opportunity in the wake of the election and BDC earnings season.

Top Four

The winners are listed below – drawn from a Seeking Alpha table – and consist mostly of smaller BDCs, each with their own tale to tell:

The Last Shall Be First

Leading the pack – and with portfolio assets of only $190mn, the amount Ares Capital (ARCC) might devote to a single loan – was Investcorp Credit Management BDC (ICMB).

That collective sigh you heard was from the BDC’s shareholders, accustomed – as the chart below shows – to an ever falling stock price and mediocre results.

Setting The Scene

In the IIQ 2024, the BDC managed to post recurring earnings of only $0.09 per share.

Net Asset Value Per Share (NAVPS) dropped (5.1%) – the fifth worst performance by that standard in the quarter.

Shareholders worried that the $0.12 a quarter dividend – recently reduced from $0.15 – might get chopped.

To The Good News

Now, let’s jump forward to November 12.

Recurring earnings jumped up to $0.16 a share – a 78% increase – and if that wasn’t enough – NAVPS increased by 6.5% – the best performance we’ve seen to date in the IIIQ 2024. The dividend of $0.12 remained unchanged, and will be paid on December 20 to holders of record.

The One

Almost all this improvement, though, hinged on one portfolio company: Klein Hersh, LLC.

The first lien loan to this company had been on non-accrual since the IIIQ 2023 and – at its lowest point – was valued (64%) below cost.

By some financial magic we don’t fully understand, the loan has been extended from 2027 to 2032; the par amount increased by a couple of million dollars and – most of all – the value increased and the interest returned to accruing status. That included “$0.5 million [which] represents the reinstatement of previously recorded paydowns for interest received from Klein Hersh LLC, while it was on non-accrual status”. 

Two-thirds of ICMB’s NAVPS increase in the quarter came from the higher valuation of Klein Hersh.

Does this present a turning point for a BDC that over the last 5 years – before this latest bright spot – had seen its NAVPS drop by over (50%) and its dividend by a like percentage ?

Flailing

Not terribly unexpectedly, the worst performing BDC in terms of percentage price decrease was another tiny player: Oxford Square Capital (OXSQ).

Like ICMB, OXSQ has been a long falling knife. The difference is that this quarter the BDC’s fundamentals continued to descend while ICMB got a Klein Hersh reprieve.

In the IIIQ 2024, Net Investment Income Per Share (NIIPS) dropped from $0.13 in the quarter ended June 2024, to $0.10.

NAVPS also fell – by (3.3%).

Over the past 5 years, OXSQ has seen this critical metrics decrease by (57%) and its monthly distribution by a similar percentage.

This week OXSQ – along with 4 other BDCs – reached a new 52 week low of $2.67.

We can’t help wondering how long the BDC can keep on paying out $0.0350 a month/$0.4200 a year in distributions.

Given the weird economics of CLOs – the principal revenue source of the BDC – it’s very hard to tell, but the 15.7% yield at which OXSQ is trading does suggest the market believes “not long”.

WHERE WE ARE

Way Behind

2024 is coming close to its finish line with the S&P BDC Index on a price only basis up 2.2% and 11.6% on a total return basis.

As we woefully point out nearly every week, even the higher of those numbers trails far behind the S&P 500’s performance, which is 24.6% when all dividends are figured in.

Going by Seeking Alpha data, 20 BDCs are in the black YTD, led by everyone’s favorite Main Street Capital (MAIN) – up 22%.

Miracle?

In second place is the turnaround story of 2024, Monroe Capital (MRCC), up 16%. Just by maintaining its regular distribution at $0.25 a quarter and keeping its NAVPS erosion to (2%) in 2024, MRCC has defied its nay-sayers and caused a rebound in its stock price.

From its lowest point in November 2023, MRCC is up 22% in price.

With the analyst community projecting 2025’s NIIPS will come to $1.02 (from $1.13 in 2024), the BDC – which closed at $8.23 – or a price to expected earnings multiple of 8.1x.

That makes MRCC not super-cheap anymore but the BDC may yet find its way to new heights.

The current yield is 12.1%, suggesting investors believe that the payout is sustainable for some time yet.

Trouble Proof

In third place in the table is Barings BDC (BBDC) – up 16%.

There were all sort of overblown worries earlier that the departure of some professionals from the firm to join a newly established would-be rival would cause the BDC irreparable damage.

We can see from BBDC’s steady results that has not happened and investors who once let BBDC’s stock price drop to $6.96 a share have bid it up 42% to close at $9.95.

Just another reminder is that every BDC’s story is unique and subject to massive swings in sentiment.

Case In Point

We made that case this week when discussing the long history of Gladstone Capital (GLAD) – one of 3 BDCs to reach a new 52 week high, along with MAIN and another BDC in turnaround: FS-KKR Capital (FSK).

These huge changes in price and performance are what make BDC investing so interesting, but also so gut wrenching for investors trying to foresee what might happen next.

It’s also one of the reasons we write the BDC Reporter – to chronicle the changing fortunes of all these BDCs, from the minnows to the whales.

LOOKING FORWARD

On The Calendar

Third quarter BDC earnings season is not over yet and players like Oaktree Specialty (OCSL) could still roil the market, along with PennantPark Investment (PNNT); PennantPark Floating Rate (PFLT) and Golub Capital (GBDC).

(We’re especially unsure about which way things will go with OCSL and GBDC – both large BDCs).

Writing Is The On The Wall

However, the basic themes that will dominate the conversation in the months ahead are becoming clear from the many BDCs we’ve already heard from.

Here are the top three – in our opinion – and you’ll see them reflected in next quarter’s – and next year’s – earnings estimates and the questions the analysts will be asking:

1. Spread compression. To some degree or another, virtually every BDC has complained/commented about spread compression on new loans. BDCs focused on the lower middle market and so-called “core middle market” like to point out that competition is not as ruthless in their segment as for the upper middle market, but it’s happening across the board. The strain has been so bad that some BDC managers are even arguing that a bottom has been reached and a widening of spreads may be coming. We’re not holding our breath, but even more than reductions in the SOFR rate thanks to the Fed, this factor is impacting BDC earnings both in the short and long term.
2. Credit weakness: The IIIQ 2024 has not been terrible where credit is concerned. Many of the big credit disasters of earlier in the year (think Pluralsight, Thrasio, etc) have been “fixed”, losses booked and everyone has moved on. However, more than twice as many BDCs have reported lower NAVPS in this quarter than higher. From analyst comments, we sense that they feel – in a general sense – that credit quality in BDC portfolios is eroding. This will redouble efforts to determine if that trend is continuing when we discuss IVQ 2024 results in February of next year. There is no general panic as yet – nor should there be – but these things can change.
3. Wither Rates?: One day we think we all know what’s going to happen to the Fed Funds rate – the most important ingredient in a BDC’s P&L. Then we don’t. In the last few days, the Trump victory has caused the markets to re-think their expectation that we’ll get a rate cut in December of this year and that next year will see many more, reaching an aggregate of 1.0% or more. This wreaks havoc with investors and analysts modeling of BDC results. We can’t help feeling that the recent uptick in the BDC sector is due to firming expectations about interest rates. If Chairman Powell is “in no hurry” to lower rates, then maybe the rest of us shouldn’t be so sure that BDC income will fall as much as previously expected. Back and forth this will go in the months ahead till a definite trend is established. Fasten your seatbelts, there’s going to be a lot of discussion.

Watchtower

We’ll be keeping an eye on the broader markets – both stocks and bonds – to see if confidence builds or slips.

In the case of the latter – which must have seemed well nigh impossible when the election results were first revealed – we’ll start to sweat a little.

Credit is typically one of the first segments from which investors bail when the big R is mentioned.

That other bugbear – inflation – may keep rates high (yay!) but also poses a challenge for the many borrowers without the pricing power to “pass on” their higher cost.

Beware What You Wish For

We’ve had a wonderful mix in recent quarters of a growing economy; solid employment; inflation coming down and below average credit strains.

As in a game of Jenga, start taking away one or two or three of those blocks and the BDC sector could be in for a rough patch.

We are living in interesting times – said to be a curse – but this will keep the BDC Reporter on its toes both before and after the rapidly approaching year-end.

This is no time – Thanksgiving dinners and Christmas shopping notwithstanding – to take one’s eye off the ball.