BDC COMMON STOCKS

Week 45

Change

Week 45 coincided with the U.S. elections held on Tuesday and whose outcome was known by Wednesday.

The major indices went on a rampage when the results became clear, with the S&P 500 moving up 4.66%; the Dow Jones 4.61% and the NASDAQ 5.41%.

The BDC sector got caught up in the frenzy – but not as much as you might expect.

BDCZ – the exchange traded note which owns most BDC stocks – after two weeks in the red – moved up 1.2% and the S&P BDC Index – on a price only basis – moved up 1.6%.

Ups And Downs

When we look at the price movement of the individual BDCs there was no clean sweep, notwithstanding the sector price increase.

28 BDCs moved up in price, or were unchanged, but 14 were in the red.

We will concede, though, that much price volatility occurred – both upwards and downwards – with 10 BDCs increasing 3.0%, or more, in price and 4 falling (3.0%), or more.

That’s a lot of zig and zagging, brought on – one assumes – both by the animal spirits that followed the election and a slew of new information about BDC performance and prospects as nearly half the universe of public BDCs we cover divulged their IIIQ 2024 results.

Number One

Far and away the biggest winner was TriplePoint Venture Growth (TPVG) – and its long battered shareholders – whose stock price increased nearly 20%.

This was in response to IIIQ 2024 results that included a slightly higher Net Investment Income Per Share (NIIPS) than in the quarter before and a turn up in its Net Asset Value Per Share (NAVPS) after 10 quarters in a row of declines.

Investors may also reassured by the external manager’s commitment to waive a portion of its incentive fee through 2025, if need be, to defend the recently reduced $0.30 per share quarterly distribution.

TPVG closed the week at $7.87 and the running rate yield is 15.2%.

This sounds like stirring stuff but when this move is placed into the context of the last 5 years – as this chart below – shows – we are reminded how much red ink has come before:

Even in 2024 YTD – according to Yahoo Finance – the stock remains (28%) in the red.

Similar Theme

Also involved in what might, or might not be, a “dead cat bounce” was BlackRock TCP Capital (TCPC), which increased 8.25% in price.

Again, the underlying reason was the hope that the worst has passed for the BDC with the famous parent.

In this case, NAVPS continued to drop in the IIIQ 2024 versus the period before, but less so than before.

Also, a special $0.10 dividend was announced, alongside a still unchanged $0.34 regular dividend.

With a price of $8.66 at the Friday close, the regular distribution of $1.36 per annum, amounts to a yield of 15.7%.

Honorable Mention

The last BDC gainer we’ll mention is Saratoga Investment (SAR) which this week kept its quarterly distribution at $0.74 but threw in an unexpected – and previously un-hinted at – $0.35 special.

That helped SAR, whose latest results published a few weeks ago, strongly suggest a corner has been turned, to close at $24.84 – almost a 7% increase on the week.

Setting aside the special, the regular distribution – which seems stable at $2.96 – yields 11.9% – very close to the BDC sector average.

Train Wreck

So much for the most notable winners. This week also saw Prospect Capital (PSEC) announce very poor results for the IIIQ 2024.

The reduction of (25%) in the BDC’s regular distributions – which are paid monthly – received most of the attention, including from us in an article we wrote on Friday.

Just as shockingly, the BDC booked ($100mn) in realized losses and another ($124mn) in unrealized losses. Given that Net Investment Income was $89mn, those are very large losses.

PSEC’s NAVPS fell (7.3%) in 3 months – the worst performance by far of any of the BDCs that have reported. In fact – according to our records – the percentage NAVPS loss is the largest by any BDC in a 3 month period all year.

Unsure

Nor is the BDC Reporter convinced that PSEC’s just-announced plans to re-make itself as a conventional middle market BDC, providing both debt and equity in leveraged buy-outs, is going to pan out.

The initial challenge will be divesting itself over time of CLO; real estate and a few key – but very large – “control investments” at a reasonable price.

Then, the BDC will have to convince both prospective borrowers and investors that it’s a dependable middle market lender on a much bigger scale than they have been of late.

Assessing whether PSEC can keep credit losses at a reasonable level will take many quarters, leaving an aura of uncertainty around the BDC for years to come.

Motive

Why PSEC’s management has chosen this drastic change is hard to tell.

Bloomberg, and others, have been arguing for a long time that the BDC is not generating enough cash from its investment portfolio – loaded with pay-in-kind (PIK) investments – to service its distributions. As a result – the argument goes – the BDC has to rely on raising preferred stock from unsuspecting investors in a classic case of borrowing from Peter to pay Paul.

The reduction in the distribution will take some pressure off but apparently not enough to allow the status quo to continue.

Putting Lipstick On

Our own theory – as mentioned in our Friday article – is that management needs to re-position PSEC to make the portfolio more salable to a third party asset manager down the road.

The idiosyncratic – and clearly flawed approach – management has pursued for years is unlikely to attract any would-be buyers at an attractive price.

Years And Years

In the long run, this re-positioning is a Good Thing in principle.

The execution, though, will remain in question for a long time.

We’ve seen other BDCs recognize that they were headed down a blind alley and drastically change their approach. Out of many examples, we’re thinking most of Apollo Investment (AINV), which changed its name (MidCap Financial) and its ticker (MFIC) and switched from investing in larger, upper middle market deals, often in a second lien position, to a highly diversified pool of middle market loans sponsored by MidCap. That has worked out well but even now the BDC still has assets like its investment in Merx Aviation still on the books left over from its earlier strategy.

MFIC admitted on its latest conference call that the aircraft lessor still represents 6% of its portfolio years after the BDC began the process of removing these sort of assets from their books.

Re-positioning a BDC like PSEC could take 3 to 5 years…

The BDC Reporter will be very interested in what progress is made every quarter going forward.

We may even write a regular feature given both the size of the BDC and the intriguing nature of the challenge PSEC’s management has inflicted on itself.

Where We Are

According to the S&P BDC Index, with only 7 weeks left in the year, the sector is up only 2.3% in price terms this year.

By contrast, the S&P 500 is up 27.2%.

On a total return basis, the BDC sector is up a more encouraging 11.5%, helped by a 1.7% boost this week pushing us into a double digit percentage return.

Like the country, the BDC sector is sharply split – with 20 BDCs trading within 10% of their 52 week lows (including 8 new lows set this week) and 21 trading within 10% of their 52 week highs.

Likewise – and quoting Seeking Alpha data – 22 BDCs are in the black price-wise this year and 20 in the red.

The number of BDCs trading at or above book – a metric that some pundits like to believe reflects the relative vibrancy of the sector – is at 15.

That sits somewhere in the middle between the highest and lowest levels reached in 2024.

Looking Forward

Notwithstanding the burst of energy following the elections, what we’re hearing from the many BDCs that have reported results is very mixed.

On the positive side almost everyone – as they have all year – expects a much higher level of M&A activity in 2025, or even before.

BDCs point to PE sponsors large reserves of dry powder; their need to return capital to shareholders and the effect of lower interest rates (down 75 basis points from their peak) bringing seller and buyer expectations closer together.

For the BDC sector, more M&A means more deals to choose from; more fees and – potentially – wider spreads on loans (if you believe the optimistic outlook we heard on many calls).

Credit conditions are generally seen to be pretty good with a strong economy showing up in most sectors and with borrowers EBITDAs and debt coverage metrics headed higher.

Downside

On the negative side – and as we highlighted going into earnings season – loan spreads are under pressure in every segment of the market, with the (possible) exception of venture debt.

This is not a new phenomenon but with every quarter that passes more and more of the loans booked at superior margins in 2021-2022 are disappearing from BDC books.

We hear a lot of hopeful talk that spreads on new loans will not fall any further, but we’re not betting the farm on that.

Even if spreads remain where they are, the result is 100-200 basis points of yield lost over the Good Old Days of not so long ago.

Some BDCs might receive some pre-payment fees or accelerate OID as a result of repayments at lower spreads but it will be cold consolation.

Unfortunately, private lenders are victims of their own success and are now facing competition from all the capital raised in the last couple of years to invest in this segment of the market.

Adding insult to injury, we even hear some BDCs complaining that a few banks – with their lower cost of capital – have had the audacity to re-capture some of the market share they’d previously given up.

It Happens Every Time

In such an environment of plentiful money the biggest risk is not even the shaving down of BDC loan yields discussed above but the danger of choosing the wrong borrowers from a credit standpoint.

For a while there BDCs had their pick of the very best deals out there.

Now, with refinancing in full swing across the debt markets, BDC managers will have to be very careful where to place their money.

Thankfully, most have a very large built in base of existing borrowers that they know well to choose from but that will not enough to keep BDC portfolios fully invested.

Under conditions like these a large number of weaker credits come to market, which was not the case in 2022-2023 when only the strongest borrowers could find a home.

No Choice

Unfortunately, BDC managers need to maintain or grow their AUM and are under self imposed pressure to book deals even at a time of slim pickings.

It’s very hard to tell from the outside looking in whether a BDC is taking on appropriate amount of risk or not where new transactions are concerned but we’ll keep our eyes peeled.

The loans of 2025 will provide most of the credit challenges of 2027-2028 – another reminder in this weekly recap that this is a very long term business where today’s success can seed the day after tomorrow’s setbacks.

Anyway, with the support of our readers, we hope to be around to chronicle whatever happens in the years to come.