BDC COMMON STOCKS

Week 49

The Beat Goes On. Sort Of.

As Seeking Alpha reports above, this week the main markets – except the under-loved Dow Jones – continued to surge upwards, breaking records along the way.

However – as we anticipated – the BDC sector did not participate in the general merriment but also did not “fall out of bed”.

BDCZ – the UBS Exchange Traded Note which holds most BDC stocks – fell (0.3%).

The Van EcK BDC exchange traded fund with the ticker BIZD – which also holds most BDC stocks fell (0.4%).

The S&P BDC Index – calculated on a total return basis – was down (0.3%).

Not So Good

If we look at price movements across all 42 BDCs we track 16 were unchanged or in the black but 26 were in the red, reflecting the more dour environment after two weeks of rising prices.

In another sign of some price weakness – and end of year investor adjustments – only 2 BDCs increased by 3.0% or more.

Up

OFS Capital (OFS) rose up from its price depths to increase by 6.0%.

Some speculators will be delighted but anyone who bought the stock at the beginning of the year is down (27%) – the second worse price performance by any BDC.

With a very different backstory, Hercules Capital (HTGC) was the second biggest percentage price gainer: up 3.1%.

For all that, HTGC’s closing price of $19.51 is still well below its summertime high of $21.78. Famously, the air was suddenly let out of the venture-BDC’s stock price shortly thereafter as results failed to match investors over-excited expectations.

After all, at its height HTGC was trading at a price 91% above its current Net Asset Value Per Share (NAVPS).

When you remember that the BDC sector trades at somewhere near 1x book that was a remarkable – and a non-defensible premium.

Even now HTGC trades at a 71% premium, only behind that other famous internally-managed BDC – Main Street Capital (MAIN).

(By the way, 16 BDCs are trading at or above their NAVPS, up from 15 the week before).

Down

6 BDCs dropped (3.0%) or more in price, the biggest number in a month.

Saratoga Investment (SAR) fell by (6.5%), mostly because this week the BDC’s $1.09 per share dividend was paid out.

Special Case

Also down was Prospect Capital (PSEC) – by (5.2%) – a week after the BDC’s stock price moved upwards from its lows.

Not helping was the news on Friday that S&P Global Ratings downgraded the BDC’s debt to “junk status”: BB+.

This action by S&P, though, is akin to closing the stable door after the BDC horse has long ago bolted.

S&P, according to news reports, points to PSEC receiving a higher proportion of its income from Pay-In-Kind (PIK) income than its peers as one of the reasons for the downgrade.

Memory Lane

Not that we’re engaging in a game of we-told-you-so, but we wrote an article over 6 YEARS AGO warning of PSEC’s questionable practices in this area – and in others.

Here’s a little of what we said, but read the full article for our analysis at the time:

From our standpoint … there is no appropriate Target Price for PSEC even at $4.0 given that we know so little about the true credit quality of the portfolio.

Shareholders could wake up one morning and find out some hard truths which could cause the stock price to tank to some unknown depth.

That level of risk is not worth any yield PSEC might currently be paying.

BDC Reporter – Prospect Capital: Differing Views Following The Earnings Release – August 31, 2018

?

According to Bloomberg, S&P also points to higher non-accruals at PSEC than at its peers, which we find confusing.

As of the latest earnings release, PSEC admitted to having only 0.5% of its total assets on non-accrual.

We track every BDC’s performance by this unreliable – but oft used – metric and there are many, many BDCs of all sizes with a higher percentage of non-performing assets at cost and at FMV.

Something’s Happening Here

What S&P did not address – but should give the BDC’s investors pause – is the huge shift in its portfolio positioning going on, as CLO, real estate and “control” leveraged buy-out investments are slated to be turned over in favor of plain vanilla LBOs.

To our minds, this could be a sign of desperation after years of management defending its presence in those same segments.

Tolling?

We find the most disturbing news in the latest S&P report is that PSEC’s infamous preferred stock – already rated BB – has been downgraded another notch to B+.

With the writing on the ratings wall, PSEC has requested that S&P withdraw “the issue rating on the preferred stock”.

This source of capital – according to some critics – has been the main way PSEC has managed to keep paying its cash distributions in recent years, and now has the lowest rating we can remember at a BDC.

As S&P reports, there is $1.6bn of preferred stock outstanding and more issuance planned.

That’s a lot of money that is hanging in the balance.

What we said in 2018 remains relevant today: anyone invested in PSEC “could wake up one morning” to some further bad news.

Where We Are

With just 3 more weeks to go, BDCZ is up a modest 1.9% in price on the year, versus 27.7% for the S&P 500.

That’s not a comparison most BDC investors will be happy with but on a total return basis, BDCs are up 15.4%, thanks to the Fed and those high interest rates.

That’s still well below the S&P 500’s total return of 29.3%, but narrows the gap somewhat.

As has been the case for several weeks now, half the BDC universe is up in price in 2024 and half is in the red.

Going into the final furlong, 21 BDCs are trading within 10% of their 52 week high and 17 within (10%) of their 52 week lows.

As we’ve said too many times before, 2024 is going to be a year which will be remembered fondly or with bitterness by BDC investors depending on what BDC common stocks have been in your portfolio.

Anyone who just owned – and held – the sector as a whole will find themselves somewhere in between but – going by historical return standards – with little to complain about.

Where We’re Going

There’s so much we could say, but we won’t – yet.

In Week 52, which closes out the year except for December 31, we’ll offer up a few predictions for 2025 including our list of which BDCs are the most likely to cut their total payout, or even their regular distribution, next year.

It’s been a few years since the outlook has been so poor. That, and the uncertain economic and fiscal backdrop, makes 2025 already look entirely different than 2024.

Have BDC investors – and BDC prices – already adjusted for what lies ahead or will be seeing an unusually high level of price volatility?

Our guess is that we’ll be seeing an uncomfortably fragile market with all sorts of sector and individual BDC price swings.

That’s interesting for us to write about but will be the hard on the nerves of BDC common stock investors.