BDC Weekly Assessment: Decrease Vs. Higher Center-Market Cage Match

Welcome to a different installment of our BDC Market Weekly Assessment, the place we focus on market exercise within the Enterprise Growth Firm (“BDC”) sector from each the bottom-up – highlighting particular person information and occasions – in addition to the top-down – offering an summary of the broader market.

We additionally attempt to add some historic context in addition to related themes that look to be driving the market or that buyers should be aware of. This replace covers the interval by the third week of November.

Market Motion

BDCs had one other good week with a complete return of round 1%. It was the best-performing sector throughout the earnings area we observe. A continued rally in shares and good Q3 outcomes are supporting BDCs.

12 months-to-date, BDCs are the second-best performing sector after MLPs.

BDCs have nearly totally recovered from the valuation drop off their latest peak. The common valuation in our protection has moved up above 100%, roughly according to the historic common.

Market Themes

As BDC buyers know, BDCs will not be all the identical. One of many key dimensions through which they fluctuate is the a part of the market they give attention to. Bigger BDCs resembling BXSL, OBDC, ARCC, OCSL and others give attention to the so-called higher middle-market, or firms with EBITDA above roughly $50-100mm, whereas different BDCs resembling CSWC, FDUS, PNNT and others give attention to smaller firms with EBITDA within the $10-50m vary.

A lot of this dynamic is solely because of the dimension of the BDCs – bigger BDCs give attention to bigger firms and smaller BDCs give attention to smaller firms. It is because smaller debtors search for small loans and bigger debtors search for bigger loans. It would not make a lot sense for a bigger BDC to give attention to decrease middle-market firms and vice-versa. A tiny mortgage for a big BDC requires a lot the identical due diligence as a bigger mortgage however most likely would not transfer the needle by way of portfolio allocation. On the identical time a smaller BDC is unlikely to have the ability to stump up the capital to supply a sufficiently big mortgage to a bigger borrower.

What’s fascinating, nevertheless, is that some BDCs additionally attempt to defend their space of the middle-market area. For instance, BXSL (a big BDC specializing in the higher middle-market area) has this chart of their newest quarterly presentation which reveals that bigger firms have a roughly comparable unfold on loans per flip of web leverage however a a lot decrease default charge and a better degree of earnings development.

PNNT, however, reveals that loans to smaller firms have a a lot larger yield on loans (1-1.5% larger on first-lien loans and extra on second-lien loans) and decrease danger within the type of decrease leverage and higher covenants.

These sound like very completely different messages, so what is going on on? One reply is that the definitions don’t fairly line up. PNNT makes use of $50m+ because the higher middle-market whereas BXSL makes use of $100m+.

Two, PNNT makes use of information from the Nationwide Middle For the Center Market and Refinitiv whereas BXSL makes use of the Lincoln Worldwide Personal Market Database.

Three, the metrics do not line up. PNNT is targeted on yield, leverage and covenants for first-lien and second-lien individually whereas BXSL is targeted on unfold per flip of leverage and default charge for the 2 varieties of loans collectively.

All in all, the BDCs are clearly going to cherry decide the numbers that go well with them. A smaller BDC is just not going to be an higher middle-market lender and vice-versa even when the numbers supported that funding case. Aside from the pure mechanics of lending, each components of the middle-market permit for sturdy returns. As an illustration, decrease and core-middle market lenders like FDUS and CSWC have put up very sturdy efficiency numbers as have lots of their higher middle-market counterparts. We are able to additionally discover lenders in each areas that haven’t carried out properly.

Finally, BDCs can do properly in each components of the market so buyers should not essentially give attention to one space simply due to what they see in a BDC presentation. It’d make sense, nevertheless, to think about diversifying a BDC portfolio alongside this dimension simply as buyers diversify their BDC publicity throughout different dimensions resembling portfolio allocation (e.g. first-lien vs. second-lien / fairness and so forth.) and trade sectors.

Market Commentary

Blackstone Secured Lending (BXSL) reported good outcomes for a complete NAV return of 4% throughout the quarter or roughly in the course of the pack thus far this quarter. The NAV rose near 1% because of a excessive degree of retained earnings. Internet earnings did fall, nevertheless that was largely because of a large share issuance that hasn’t but been put to work. Non-accruals remained near zero. BXSL is buying and selling at a valuation of 108% which is 6% above the median BDC and is on the costly facet traditionally.

The Golub BDC (GBDC) had a superb Q3. Internet earnings rose 13% – because of a mix of upper base charges in addition to the corporate’s administration payment discount to 1%.

A base dividend of $0.37 was declared – a 12% improve. The corporate additionally declared a $0.07 supplemental. We gained’t see equally giant dividends and web earnings will increase going ahead because the administration payment lower is non-repeatable. GBDC has now moved to commerce on par with the sector valuation which is fairly uncommon within the final couple of years and is now not a slam dunk allocation because it was again then.

General, BDCs proceed to ship sturdy earnings. If danger urge for food holds up properly, we must always see a bumper This autumn as deal seasonality kicks in and results in a bump in prepayment payment earnings throughout the sector. BDCs resembling ARCC and TSLX (pictured under) might be huge beneficiaries of this dynamic.