BDC Market Update:
The following table is from yesterday’s article showing the stock performance of BDCs over the last two months with only a handful in positive territory and the average BDC down around 5%. BDC prices have been under pressure, most likely related to the overall market and economy and I believe this has driven a flight to safety for BDC investors that has been more of a hold safety and sell the others. As I have mentioned in previous newsletters, I have been waiting for a general BDC pullback to reposition my investments after selling most of my Tier 2 and Tier 3 BDCs to reinvest in Tier 1 BDCs this quarter. NMFC, MAIN, PFLT and FSIC are all considered Tier 1 and mostly related to dividend coverage and discussed at the end of this newsletter.
BDCs tend to overreact to interest rate and general economic news. I still believe this round is related to the economy and general market as well as small caps (BDCs invest in private micro micro caps). I have not noticed anything significant about the trading volumes so I do not believe this pullback is related to institutional selling. My personal strategy has been to sell ‘lower quality’ BDCs and buy ‘higher quality’ on the pullbacks such as this. I define quality as higher dividend coverage, growing NAV per share, less need to reach for yield, less portfolio growth, less share issuances, higher quality assets with a focus on first lien secured during a frothy environment, etc. I also pay a premium for internally managed or lower operating costs as well as SBIC leverage abilities.
At this point I have started to buy certain BDCs but mostly waiting for a bottom. The chart below shows BDCs at the lowest level in the last 12 months and down about 12% since the highs before the issues related to being dropped from the indices.
Obviously BDCs will bounce back at some point and for now investors should enjoy the yield on current holdings and be ready to buy when there are signs of strength. Investors should be less concern about news related to interest rates unless it is associated to the overall health of the economy which is much more important to BDC fundamentals.
I will not discuss pricing in this newsletter since it is covered in my recent (linked above) and upcoming articles. The following table shows the current multiples:
Upcoming Articles & Reports:
I have put together the following chart to help readers understand how the various ongoing series of articles on Seeking Alpha tie together with my process of evaluating BDCs. Some of these are ‘premium reports’ but most of the information used comes from the public articles linked on the “BDC Risk Profiles”, “Articles by BDC” and “General BDC Research” pages.
Currently I am focused on pricing and risk profiles both of which are related and drive the overall rankings.
Dividend Coverage Tiers:
These tiers take into account the following three categories of dividend coverage:
- Historical – Six quarters of actual dividend coverage using core NII.
- Projected – Simple average of my base, best and worst case projections.
- Optimal Leverage – Simple average of the stable and lower yield analysis of an apples-to-apples comparison with similar amounts of leverage but using the current cost structure for each company.
The following are the general tier descriptions:
- Tier 1: BDCs that can cover dividends even with a worst case scenario and also have the ability to cover dividends with much lower portfolio yields.
- Tier 2: BDCs that are more likely to cover dividends during a worst case scenario and with lower portfolio yields.
- Tier 3: BDCs that may not be able to cover dividends in a worst case scenario and/or lower portfolio yields.
- Tier 4: BDCs that may not be able to cover dividends in a base case scenario and/or stable yields and would most likely have larger issues with lower portfolio yields.