BDC COMMON STOCKS

Week 47

Pointless

We know this is akin to complaining about the weather, but these markets do not seem able to make up their minds.

Donald T gets elected and everyone hits the BUY button only to – shortly after – have second thoughts, sending all the indices down. Then, on getting out of bed this last Monday investors had a third thought and decided all was well – and rallied again.

The Dow Jones – that historic holdover – was up 2.0%, while the NASDAQ and S&P 500 rose 1.7%.

As Wall Street Breakfast – published by Seeking Alpha – reminds us, the S&P is only 0.9% away from its all-time high – a distance that could be covered in a few enthusiastic minutes, if the mood holds.

Not Very Different

The BDC sector has been on a similar, inconsistent path.

This week, BDCZ – the exchange traded which holds only BDC stocks and sometimes serves as our price guide – was up 1.9%. Last week, BDCZ was down and the week before was up.

Anyway, BDCZ closed on Friday at a price of $19.05.

Still since week 39, BDCZ has moved one red cent per share down.

Active

Nonetheless, when we get into the details, there has been a lot of chopping and changing this week within the 42 BDC universe we track.

31 BDCs were up in price and – more interestingly – a relatively high number – 7 – were up 3.0% or more in price and 2 were down by (3.0%) or more.

Here are the 3.0% plus movers:

Place Your Bets

We’re not surprised that Prospect Capital (PSEC) tops the table, moving up 9.3%.

As reported repeatedly on these pages, PSEC has been having a very poor year where all the fundamentals are concerned: earnings and net asset value per share are way down and – to add insult to injury – shareholders have recently endured a (25%) cut in the monthly distribution after completely missing out on the fat years of 2022-2024 when high rates caused most BDCs to increase their distributions.

The BDC’s stock price was close to its all time low – set during Covid – in mid-November, reaching $4.15.

That was nearly a (50%) discount off PSEC’s NAVPS, which itself has dropped (12%) in the last 12 months and (24%) since the end of 2021.

Bad Is Good

This has made PSEC the perfect stock for speculators, convinced that – at least for the moment – the worst has passed.

PSEC encouraged that notion with a press release this week about the sale of one of its multi-family properties from its wholly-owned REIT subsidiary.

Management has promised to re-position the PSEC portfolio and getting out of real estate is part of the plan. Here is what the BDC Reporter wrote on the subject in the BDC Publications News Feed:

BDC Reporter Adds: This is interesting. Prospect Capital (PSEC) has recently announced its intention to re-position its portfolio. That involves – amongst other things – reducing its exposure to real estate. (Why – you might legitimately ask is PSEC involved in real estate within a BDC format not intended for that purpose). So now we get a press release announcing a multifamily property – owned for 4 years – has been sold out of PSEC’s REIT. We don’t know what the dollars involved really are because we’ve been told the investment achieved a “1.7 times cash on cash return”, and $56.7mn was received at the end but we don’t know what the cash income received might have been on the way. Unfortunately, everything PSEC does always leads to further questions. In any case, this sale represents only 0.2% of the REIT’s portfolio and there were dispositions like this one in the ordinary course of business so this does not necessarily a sustained determination to sell off its properties or that this is being done successfully. We’ll need to see several hundred more press releases to be sure.

Moving On

The rest of the BDCs on the 3.0% plus list are a mixed bag.

We can’t help noticing that Main Street Capital (MAIN) – the most popular BDC of all by some metrics – is there.

Once again, MAIN was one of several BDCs reaching a new 52-week high and thus likely to cause more pundits to groan about the BDC’s outsized valuation.

This includes trading at a premium of 77% over book value, even better than that other investor favorite – Hercules Capital (HTGC), which is only at a 64% premium.

Capital Southwest (CSWC) – seen by some investors as a MAIN “mini-me” – was until very recently trading at a similarly wild valuation but a couple of new non-accruals has taken the bloom off that rose.

CSWC trades (14%) below its 52 week high but still 40% above book.

In The News

Both Oaktree Specialty Lending (OCSL) and Golub Capital (GBDC) reported their latest quarterly and fiscal 12 month results this week, here at the tail-end of earnings season.

The BDC Reporter – and the markets – were anxiously awaiting the reveal.

OCSL has been under-performing for several quarters, losing (5%) of its NAVPS in the prior two quarters.

Here is a smidgeon of what we wrote following the IIQ 2024 results:

There was little to cheer about in OCSL’s latest results and no sign that the BDC has turned any sort of corner. Still, there’s no panic showing at the manager and investors appear to be remaining calm even though OCSL’s stock price has dropped (25%) since January of 2022. 

We discussed the IIIQ 2024 results in the BDC Publications News Feed this week, and as you’ll see we had mixed feelings after reviewing the press release:

BDC Best Ideas Adds: Given that Oaktree Specialty (OCSL) is reporting both quarterly and annual results, this is a numbers soup. We can simplify matters by saying recurring earnings (Adjusted NIIPS) were in line with analyst expectations (1 cent off) and the same as the prior quarter. Admittedly, this was achieved thanks to much waiving of fees by the external manager – a “shareholder friendly” move but one that underlines the weakness of OCSL’s profitability. Likewise, the BDC paid out an expected dividend of $0.55 in the IVQ, same as in the IIIQ and $2.09 for all of 2024. Best Ideas had projected a payout of $2.20 – just within the 5% margin of error we’ve given ourselves. However, we’ve adjusted the Expected Return model to reflect the actual 2024 payout. Unfortunately, despite “fixing” some non-performing investments OCSL has stumbled into some new ones – the press release is a little vague. That means credit performance is modestly worse and the BDC’s NAVPS has dropped (0.5%) in the quarter and (5.5%) for the year, even higher than the (2.0%) erosion we were expecting. Both credit performance and NAVPS are below our expectations. We may have to revisit our projections for 2025 because of this. The analysts are projecting ANIIPS will fall to $2.20 next year, which seems on the high side. We’ve been projecting a dividend payout of $2.00 per share, which also seems optimistic.

Material

Subsequently, at our sister publication – the BDC Credit Reporter – we had a longer look at both the new non-accruals and the rest of the portfolio.

Unfortunately, we found that the new non-performers had relatively large dollars of exposure attached even after this quarter’s unrealized write-downs.

Typically – given that credit values tend to head more down than up as time goes by – we worry that OCSL might have further trouble to contend with ahead.

Un-enthusiastic

We were not the only ones worrying.

J.P Morgan’s Melissa Wendel downgraded OCSL from a Buy to a Neutral rating, as reported by Seeking Alpha.

Wedel is less optimistic on NII next fiscal year, due to “lower earnings power as a function of lower expected base rates and tighter spreads,” he wrote in a note to clients.

In all, “we expect mgmt will evaluate potential fee waivers on a quarter by quarter basis,” she said. “However, we view a re-rating of shares as unlikely without better line of sight to NAV stability and full dividend coverage through NII.”

Investors, though, seem unconcerned, pushing up OCSL’s slightly since the earnings were released and those words of warning mooted.

What The Future Holds

The analysts expect OCSL’s Adjusted Net Investment Income Per Share (ANIIPS) to drop from $2.23 in the just ended FY 2024 to $1.96 in FY 2025 – a (12%) drop.

That’s likely to mean the $2.09 per share paid out in calendar 2024 will fall in calendar 2025.

As we write this OCSL trades at 8.1x FY 2025’s earnings and a modest (12%) discount to NAVPS, despite seeing nearly a fifth of its net book value disappear since 2021 , and (8%) in the last 12 months.

The Big Squeeze

Just as much as credit, the BDC Reporter is concerned that management’s understandable attempt to limit credit distress by adding more first lien loans – and less second lien – will push down OCSL’s portfolio yield more than at other BDCs affected by lower rates.

The external manager is already waiving fees to ensure earnings “cover” the dividend, but can this last more than a quarter or two?

OCSL remains on our list of BDCs that deserve special attention.

The Other One

GBDC – till very recently – had a very steady credit and earnings record.

Like MAIN, HTGC and CSWC, the BDC has a cadre of loyal investors that have traditionally kept its stock price riding high – well above book.

However, in the IIQ 2024, GBDC by its own account had some “disappointment” to report on the credit side with two portfolio companies causing losses, including the now infamous Pluralsight implosion.

GBDC, though, merged with a sister non-traded BDC in the quarter avoiding any obvious impact from these reverses on its book value.

The market, though, has been well aware and kept GBDC’s stock price well off its highs at a time when many other popular BDCs have been doing well.

Not Clear

Anyway, the IIIQ 2024 results did not provide any definitive answers as to whether GBDC is “bacK, or at the beginning of a credit deterioration path.

Management conceded that credit performance remained less than ideal:

We talked last quarter about how GBDC had negative outcomes on loans to Pluralsight and Imperial Optical. During the September 30 quarter, we worked through a restructuring of Pluralsight as well as one other longtime nonaccrual credit and you can see this reflected in realized losses that are in this quarter’s P&L. …

During the September 30 quarter, we also took some fair value markdowns on several other companies that are underperforming. The quantum of net realized and unrealized losses, it improved quarter-over-quarter, but it was again higher than our version of normal.

GBDC Conference Call

Better

On the other hand, earnings and distributions remained robust. Regarding the latter, GBDC’s calendar 2024 payout came to $1.93 per share, way above the $1.51 in 2023.

That’s partly thanks to special dividends paid out when merging with its sister BDC as well as the result of a new, more liberal payout policy.

Valuation Talk

In 2025, though, BDC Best Ideas projects the payout will drop by (10%) and in fiscal 2025 the analysts expect recurring earnings to drop (5%).

As of Friday, GBDC’s stock traded at a slight discount to book and 9.7x projected FY 2025’s earnings.

GBDC’s stock price will need to climb 16% before returning to its 52 week high and is (36%) behind its all-time high.

The BDC has some way to go to return to its glory days before Covid:

Where We Are

With every passing week, we are ever more aware that “like sands through the hourglass”, 2024 is coming to a close.

Yet, even with only 5 weeks left, it’s not yet clear if 2024 – for BDC investors – will be memorable or not.

At this point, the data is very mixed.

BDCZ, for example, just broke into positive territory for the year: 0.4% up.

Ever since the summer when the major indices shot off to new records, BDCZ has languished – typically in the red.

(BTW, we have no S&P BDC Index numbers to share this week because the site we use is doswn for maintenance).

As to the individual BDCs we track, 22 are up and 20 are down – hardly a mandate.

Undoubtedly, some BDCs have enjoyed almost untrammeled success in 2024, both in terms of fundamentals and price performance.

Top of mind are MAIN, Gladstone Capital (GLAD); Barings BDC (BBDC); Blackstone Secured Lending (BXSL); ARCC; Fidus Investment (FDUS); Logan Ridge Finance(LRFC) and even micro BDC, PhenixFin (PFX).

Most of these BDCs are among the 15 you will find in the BDC NAV Change Table that have increased their NAVPS in 2024.

GLAD is up 10.2% – a percentage so high we had to go to the BDC’s 10-Qs to check ourselves.

FDUS continues to book both recurring income and realized gains.

MAIN, HTGC and ARCC have all recorded all-time price highs and many other records this year.

New-on-the-scene BXSL has barely put a foot wrong all year.

LRFC has translated one successful sale of an equity investment to higher distributions and a rocketing stock price.

BBDC – left for dead by some because of the loss of some of its personnel – has proven all the doubters wrong and stuck to its idiosyncratic approach.

We should probably also mention one of the top turnaround stories of the year Monroe Capital (MRCC), who by “hanging in there” , has greatly helped its stock price.

Both Sides

On the other hand, one cannot forget that where fundamentals are concerned BlackRock TCP (TCPC); OCSL; OFS Capital (OFS); Horizon Technology Finance (HRZN); TriplePoint Venture Growth (TPVG); Goldman Sachs BDC (GSBD); Portman Ridge (PTMN) and – of course – PSEC, have had a miserable time.

The worst performer in NAVPS terms is TCPC and that has caused the departure of the CEO but little – as far as we can tell – of new thinking from the external manager.

TCPC’s stock is on the rebound right now but the future remains obscure.

The credit setbacks seen at HRZN and TPVG have been numerous and painful to note and a useful reminder of how dangerous venture debt lending can be if you pick the wrong horses to back.

GSBD, OCSL and OFS have been a bad credit streak all year. However, the new year does not guarantee that things will get better. Ditto for PTMN.

Summed Up

All in all, this has been a sweet and sour year. Most of the winners were the ones we would have expected but amongst the “losers” there are several surprising names.

If you held the right cards, 2024 – likely the peak year for earnings and distributions for a generation – will likely be remembered as a very good year.

However, just drawing one or two of the many under-performers could ruin an investor’s mood.

If you were unlucky enough to draw – TCPC, OFS, TPVG, HRZN and OCSL – your median price loss would be (25%) at this point and even generous distributions would not keep you from a total return loss.

Looking Forward

We’re going to keep our crystal ball in the attic till we hear from the last 3 BDCs to report their results.

However, we do see some strong themes developing for 2025 that will affect the sector generally.

Some those themes are a little worrisome (warning: British under-statement) for BDC fundamentals and makes the outlook for 2025 more problematic than what we were expecting for the current year.

BDC investors are mostly in a festive mood but that may change as some hard truths emerge in the months ahead.

On the other hand – as a very, very long term observer – we have no doubt that most of the BDC managers are thinking hard about how to proceed and will be able to navigate around the shoals ahead.