BDC Market Snapshot: Week Ended March 24, 2023
Two weeks after the BDC sector dropped in price by (10%), investors gathered their courage and pushed prices up. As we covered in our sister publication - the BDC Reporter - most individual BDC stocks (36 of 42) increased in price and the sector overall moved up 2.0%. However, plenty of uncertainties remain about the strength and direction of the financial system - most neatly encapsulated by a continuing drop in the 10-year Treasury, down (16%) since March 2, 2023.
A Little Less
For our part, we continued to update the Expected Return Table BDC-by-BDC, taking into account the huge amount of research we've undertaken at the BDC Reporter and BDC Credit Reporter following the just-completed IVQ 2022 earnings releases. This week, Oxford Square Capital (OXSQ) reported its numbers, which we'll discuss in a minute. However, we also reviewed and updated several other BDC names. Our goal is to ensure all our projections in the Expected Return Table are up-to-date and reflect our most current knowledge. We're almost there, with only Logan Ridge Finance (LRFC) left to update.
We're also busy writing as many BDC Updates as possible - even if our projections have not changed - to provide the "color" behind our numbers. We should be fully up to date in that regard within a couple of weeks, allowing a reader to visit the Expected Return Table to see our payout predictions and stock valuation and read the latest update. Then it's up to the reader to decide whether they have enough confidence in our projections and in themselves to plunk money down at this difficult time.
As religiously as we can, the Expected Return Table updates the latest analyst earnings consensus for 2023 - whether the fiscal or calendar year. We've noticed, though, that some BDCs are now getting EPS predictions for 2024. So we've added a new column to the Expected Return Table showing what the consensus looks like. We've noticed already that in almost every case the analysts are being cautious about next year and predicting lower EPS than in 2023. We assume their models are assuming lower reference rates out of the Fed.
Note, though, that our own dividend projections from 2023 to 2024 do not anticipate such a drop-off. We believe that many BDCs will squirrel away excess earnings this year in order to maintain their payouts in 2024 and beyond. Even if the Fed does end up cutting rates in the second half of the year - as the market believes but Chairman Powell denies - we still expect the BDC sector's payouts in both 2023 and 2024 to reach record levels.
Back To The Elephant
With another week gone in 2023, we still don't see the signs of the credit crisis that some have been predicting since 2022. We'll concede - as the BDC Credit Reporter's Credit Table shows - the value of underperforming assets and the number of non-accruals began to pick up in the IVQ 2022. The BDC Credit Reporter's daily research into underperforming BDC-financed companies is also showing more stress and a likely increase in realized losses this year versus last. (We're in the middle of constructing for the BDC Credit Reporter's subscribers a worksheet that projects out the likely realized losses in 2023 for every BDC, based on what we know about the most troubled companies). However, the level of losses appears to be well within normal, manageable levels which were assumed when we projected out BDC distributions. This is also consistent with what the analysts and rating agencies are predicting about loan and bond losses - higher but nowhere near GFC levels.
Exception To The Rule
With that said, we were very disappointed - from a credit standpoint - by the BDC Reporter's just-completed review of OXSQ's latest results. The idiosyncratic BDC, which invests both in CLO equity stakes and leveraged loans, has seen its net book value per share drop by (25%) in a year - the worst performance of any public BDC. Most of all, though, we're worried that almost every leveraged loan on OXSQ's books is underperforming. At the moment the number of non-performers remains stable but that could change soon. Projecting the impact of these falling knife stocks is very hard, but we've reduced OXSQ's dividend projections by half between now and 2027. Even that may not be enough.
Setting aside OXSQ and - probably - Great Elm Capital (GECC) and PhenixFin (PFX) which we don't cover anymore - the prospects for BDC earnings and distributions continue to be strong both in the short term and long term. The much-discussed likely pullback of regional banks from the lending scene and the capital gap left by the loss of Silicon Valley Bank in venture lending (which is unlikely to be fully filled by its new owner - First Citizens) should only serve to accelerate the BDC sector's growing market share. As importantly, less competition means continuing wider spreads and better terms on new loans and juicier amendment fees and concessions when existing borrowers reach out for help.
Likewise, BDC valuations - as shown in the Expected Return Table, where we calculate the price to expected earnings multiples - remain very low by historic standards. Very roughly, we believe the sector as a group is trading 40% below its historic highs, even as payouts to shareholders are at record levels and headed higher. (That credit elephant in the room is having quite an effect). The good news and the bad news is that the uncertainty that makes for these rich opportunities should be with us for many months yet to come. There should be continuing chances to pick up "bargains" for some time but confirmation that this was not all "fool's gold" could also be far off - well into 2024 or even 2025.