March 22, 2019 / 5:05 PM / a month ago

BDCs rebound in 2019 after year-end slump

NEW YORK, March 22 (LPC) - Business Development Company (BDC) share prices are rebounding after hitting a near three-year low in December and are outperforming the S&P/LSTA leveraged loan index as well as the S&P 500.

The Wells Fargo BDC Index has returned 14.34% so far this year through Thursday's close, compared to 4.2% for the S&P/LSTA leveraged loan index and 13.8% for the S&P 500.

Nearly 95% of BDCs have seen since December an improvement in share price to Net Asset Value (NAV), a measure of a company’s assets minus liabilities on a per share basis, according to data from LPC, a unit of Refinitiv.

The positive performance of BDCs, which invest in the debt of small and medium-sized companies, is due to low portfolio valuations after credit spreads widened in a volatile December amid a market selloff.

“Investors largely looked past the decline in book values this quarter given the market backdrop in 4Q18,” said Ryan Lynch, an analyst at Keefe, Bruyette & Woods.

Monroe Capital Corp (MRCC) said its NAV per share decreased to US$12.66 per share as of December 31 from US$12.95 per share at September 30.

“This decrease was primarily as a result of unrealized mark-to-market valuation adjustments,” said Aaron Peck, chief investment officer and chief financial officer of MRCC, in a fourth quarter earnings call on March 6.

“There was significant short-term widening of credit spreads at the end of December. This widening of spreads caused valuations to decline temporarily for most of the positions in our portfolio. We estimate that nearly half of our per share NAV decline in the quarter occurred as a result of the widening of spreads,” he added.

BDC book values declined in varying degrees across the board for publicly traded BDCs, but the shares of listed vehicles have also rebounded as their portfolios recovered from fourth quarter hits.

Funds that registered the biggest gain in share price to NAV since December include MRCC, KCAP Financial Inc (KCAP), FS KKR Capital Corp (FSK) and Bain Capital Specialty Finance Inc (BCSF).

Earnings front

BDCs have recently reported results for the fourth quarter of 2018, which saw a pricing correction in the primary US leveraged loan market after secondary loan prices tumbled.

“Overall, it was a mixed quarter and tough to gauge given the volatility/credit market sell-off we saw in 4Q18, which largely reversed in 1Q19,” Lynch said.

Rising Libor and wider spreads helped BDCs portfolio yields, although this benefit was also offset by higher funding costs from variable rate bank facilities. Dividend coverage was solid, as many funds have reset quarterly dividends paid to shareholders in recent years, and net investment income was steady, analysts said.

TPG Specialty Lending Inc (TSLX) reported net investment income of U$0.67 per share, its strongest quarterly level since inception, which resulted in a full-year net investment income per share of US$2.25, the firm said on its earnings call.

BCSF posted results for its first quarter as a publicly traded BDC with net investment income of US$19.8m or US$0.41 per share for the fourth quarter of 2018, compared to US$4.8m or US$0.19 per share for the quarter ended December 31, 2017.

“For the most part BDCs benefitted from rates going up and spreads widening modestly. But with the Fed likely to stabilize rates this year, rising rates won’t provide as much upside in 2019,” said Meghan Neenan, a managing director at Fitch Ratings.

The Federal Reserve kept interest rates unchanged and signaled that it would not hike rates in 2019 on Wednesday.

BDCs returns do not yet reflect changes to rules passed a year ago that allows higher leverage and ultimately more loans to mid-sized companies.

BDCs can seek board or shareholder approval to increase leverage to a ratio of 2:1 total debt to equity from a previous cap of 1:1.

“We are starting to see leverage move above 1x,” Neenan said. “Ultimately it depends on the portfolio mix and what happens with spreads, but with increased leverage you should see a bit of better [return on equity]. It will be incremental, not transformational.”

Reporting by Leela Parker Deo Editing by Tessa Walsh

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