BDC COMMON STOCKS

Week 5

You Go Your Way

For a change there was a wide divergence between the performance of the major indices – especially the S&P 500 and the NASDAQ – and the performance price-wise of the BDC sector.

As noted above, the main markets were mostly down over the last 5 days while the BDC sector – as reflected in BIZD – its only exchange traded fund which owns most BDC stocks – moved up 1.4%.

The S&P BDC Index – both on a price and “total return” basis – also moved up 1.4%.

Digging In

When we look at the individual performance of BDC stock prices, the upward direction seems even more pronounced.

This week we added MSC Income Fund (MSIF) to our coverage universe following its IPO. For our two recent articles about the newbie, click here and here.

This brings our coverage universe to 46, but Logan Ridge Finance (LRFC) will shortly be absorbed into Portman Ridge (PTMN) – which we discussed in the BDC Publications news feed – so we’ll lose a “Ridge” and be back to 45 BDCs before long.

Metrics

Anyway, of the 46 BDCs, 37 were up in price and 9 in the red.

Of the BDCs in the black, 4 were up 3.0% or more.

The more impressive statistic is that 11 BDCs reached new 52-week highs.

19 BDCs are trading at or above their net book value per share, up from 17 the week before but one of those is MSIF.

Good Times

All this – and the fact that BIZD is up 5.3% since December 31, 2024 – are all confirmation – if one is needed – that the BDC sector is in “rally mode” in 2025.

In fact, BDC investors are doing twice as well as those holding the S&P 500.

This happens at time but in recent years we tend to be the hare and the S&P 500 the tortoise and you know how that story ends.

Our Thoughts

We’re guessing that the BDC sector is attracting fresh investor capital in the new year and everyone is drawing the same conclusion that we’ve been mooting – that interest rates won’t be moving downward much or at all in the months and years ahead.

This will allow BDCs to earn a decent yield on their loans while not swo long ago the consensus was that we would be shortly back to a much lower yield regime.

It’s also true that spreads and yields in other non-investment grade debt instruments – such as high yield bonds – are not very attractive right now so BDCs might be attracting yield investors looking for a higher current return.

At the moment, the average yield on BDC stocks for 2025 is just over 11%, according to BDC Best Ideas which calculates the likely yield for 41 public BDCs (soon to be 42 with the advent of MSIF).

Cold Water

This is all delightful for anyone long the BDC sector (but not so good for those wanting to “get in”) but we can’t help adding our regular warning that there are headwinds building as well.

We’ll keep this short because it’s been brought up by us in virtually every article:

Competition for new loans has been compressing spreads for over a year now and that’s gradually – but inexorably – reducing BDC profitability.

This is happening as BDC borrowing costs – unbelievably low in many cases due to the widespread issuance of unsecured notes at bargain yields during the “zero interest” years – are nudging up as many of those notes come to maturity.

Finally – and very hard to quantify because the impact varies so much between BDCs – credit losses continue to erode BDC capital.

This not being offset as much as BDCs might like with equity gains in their portfolio because the M&A environment remains turgid because of those same high interest rates.

2025 is going to be a challenging year for BDC earnings but you’d never know from the price action in January.

Ripped From The Headlines

There also seems to be some complacency amongst investors about the dangers lurking in the current macro environment where tariffs and mass deportations are concerned.

Maybe investors believe the thousands of non-investment grade companies which BDCs finance (as many as 7,000) won’t be negatively impacted by these forces.

We’re not so optimistic but will concede that a few quarters will be needed for damage to show up.

Think of the company importing most of its products from one of the targeted foreign countries (which may end up being the whole globe) which very suddenly sees its costs increase by 25%.

Most will not be able to find an alternative supplier and certainly not without paying more.

Let’s not also forget how many companies rely on low cost labor and how higher costs or the inability to find workers already impacted many sectors such as healthcare in the last couple of years.

When you combine lower margins and/or higher payroll costs with highly leveraged companies already groaning under a debt burden that is not declining trouble is likely to ensue.

Blowing Every Which Way

Moreover, we get the impression that this tariff on- tariff off situation and the long process of deporting millions of workers/consumers will make corporate planning very difficult.

It’s often said that investors hate uncertainty but so do most operating companies.

Relationships with suppliers and customers take years to develop and those could – in many cases – be constantly roiled by shifting policies out of Washington D.C.

Doesn’t Take Much

The sad truth for leveraged borrowers is that only a modest reduction in their profitability and cash flow – as we’ve seen on multiple occasions – can cause them to default on their debt.

Whatever your political leanings this is a time to worry and listen carefully to what the BDC managers will dare to tell us from the frontlines in the quarters ahead, even as early as the IQ or IIQ of 2025.

You don’t undo the 75 year old global world order of free trade – with average U.S. tariffs of 2% historically – and deport some of your most critical low wage work force without breaking some eggs.

And to those who say this will bring employment back to the U.S. we ask you to look at the very robust U.S. employment numbers and let us know from where employers will find workers for these jobs – some of which have not been done stateside in a generation?

Coming Up

In the short term, though, we’ll be hearing from the BDCs what their performance in the IVQ 2024 looked like – which seems like an age away.

Starting next week, BDC earnings season begins and will last for several weeks.

The BDC Reporter will do its best to keep up with the avalanche of information that will be headed our way.

As always, we will undertake a triage process and focus our writings on those BDCs that either out-perform or under-perform earnings, book value , credit or dividend expectations.

Anyone interested in knowing what those expectations are should subscribe to BDC Best Ideas which tracks what the analysts are projecting for earnings and offers our own estimate of what might happen to those other key elements of BDC performance.

The Expected Return Table in BDC Best Ideas identifies what we suppose should happen for every BDC.

It’s the variation from these expectations that typically cause BDC stock prices to move up or down and which wil be the main focus of our analysis, even as we continue to keep the Subscriber Tools such as the BDC NAV Change Table current.