BDC Weekly Review: New BDCs Coming To Market

Welcome to another installment of our BDC Market Weekly Review, where we discuss market activity in the Business Development Company (“BDC”) sector from both the bottom-up – highlighting individual news and events – as well as the top-down – providing an overview of the broader market.

We also try to add some historical context as well as relevant themes that look to be driving the market or that investors ought to be mindful of. This update covers the period through the second week of February.

Market Action

BDCs were down around 1% with PSEC leading to the downside on disappointing earnings. Year-to-date, the sector is down marginally despite fairly robust early Q4 earnings and a somewhat more hawkish than expected Fed.

The sector’s valuation is right on top of its historic average of around 102%. We have come off around 3% or so from the recent peak.

Market Themes

Despite the year being barely a month old, we have already seen a flood of BDC IPOs. First is an IPO of an existing, fairly large BDC from Blue Owl (OBDE). The profile looks pretty good – very low non-accruals, 12% net IRR since inception, record high NAV. The price has drifted lower as we would expect since existing shareholders are taking advantage of the liquidity to exit. This is limited to 5% of each investor’s position. Larger lock-up expiries will come over the next year.

Another BDC is one from Palmer Square (PSBD) which launched in 2020. Palmer Square is a boutique credit manager and is better known as a CLO index provider. The NAV has risen since inception and its exposure to first-lien debt is above the BDC average.

Nuveen has a BDC that also dates back to 2020 and which IPO’d in January (NCDL). The allocation is around 86% in first-lien loans with an initial taster management fee at a low 0.75% which will step up to 1% (which would still be one of the lowest in the sector) after 5 quarters. Its NAV has fallen since inception.

Finally, a BDC from Morgan Stanley (MSDL) which also launched in early 2020. The NAV has risen nicely since inception. Its focus is on upper middle-market.

Out of all of these OBDE looks the most compelling to us at the moment.

The overall strength in the BDC market and strong equity market risk sentiment make it a good time to IPO BDCs. It also provides liquidity to investors in what were previously private funds with limited exit opportunities. The timing is also interesting given the Fed’s widely expected pivot to cutting rates which will lead to lower net income across the sector. This doesn’t necessarily mean that insiders are marking the top in the sector but it’s fair to say, as we have earlier, that the Goldilocks period for BDCs is likely coming to an end.

Market Commentary

Ares Capital Corp (ARCC) posted strong results. The NAV rose by 1.3% and the total NAV return for Q4 was 3.9%. Over the past year the stock delivered a 16.1% total NAV return, well above the median of around 10% despite trading only slightly above the average valuation over that time.

Net income rose by 7%, primarily due to a drop in incentive fees and a higher level of repayment fees. As expected, end-of-year seasonality helped support fees though they were not as high as last year’s. The market started to recover in October so perhaps there wasn’t enough time to ink deals.

Non-accruals ticked up slightly to 1.3% – roughly where the sector is and there were net realized gains. ARCC issued a new bond recently to refinance a 2024 maturity and this will slightly decrease net income going forward.

Golub Capital BDC (GBDC) posted good Q4 results. Total NAV return was 3.1% as the NAV rose marginally largely due to retained income. Net income was flat as interest expense rose a bit. The drop in the incentive fee should accrue over Q1 and should boost net income a few cents. Non-accruals remained contained at 1.1% on fair-value and there was a small net realized gain. It remains fairly attractive within the BDC sector.

Stance And Takeaways

On the back of the recent BDC IPO wave we will be adding a couple of these new entrants to our BDC Tool much like we did with BXSL when it IPO’d a few years back. Decent historic returns and shareholder-friendly fee structures make for compelling new holdings in the sector.

As far as our allocation, we recently downsized our position in ARCC near its recent peak – around 3% above the last closing price. There is a good chance the company will issue new shares which should bring its stock down 3-5%, offering a better entry point.