MAIN - BDC Weekly Review: A Mixed Picture On Q2 Commitments

2023-07-28 22:01:54 ET

Summary

• We take a look at the action in business development companies through the third week of July and highlight some of the key themes we are watching.
• BDCs continued their rally with a 1% gain on the week as the sector valuation breached 100% and nearly converged with the historic average.
• A number of BDCs have reported their Q2 commitments - a metric that is loosely indicative of net income going forward.
• Jefferies is setting up a non-traded BDC.

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 third week of July.

Market Action

BDCs had another strong week - extending the rally into the second half of July. The sector is up around 5% so far in the month.

BDCs have enjoyed a strong 17% rally off the May lows in total return terms.

The average valuation of BDCs (in our coverage) has now topped 100% and is just shy of its long-term average.

Market Themes

Over the last couple of weeks a number of BDCs have released their commitment numbers for Q2. Although these metrics don't tell us a whole lot, they can provide a few clues about the performance of individual companies and the broader sector, specifically with regard to net income.

For instance, a relatively high level of commitments is more likely to be indicative of higher net income. This is due to elevated prepayments (and prepayment fees), a potentially higher level of leverage and an increased amount of portfolio turnover at wider credit spreads versus the likely comparatively lower spreads of current loans in the portfolios.

So far the results we have seen from a handful of BDCs are somewhat mixed. Golub Capital ( GBDC ) said it originated $111m in new commitments, down from $157m the previous quarter. This is the lowest quarter in a while - even in 2022 commitments averaged around $300m a quarter. This is likely a function of a slowdown in repayments. Otherwise, BDCs would be maxing out their lending as everyone keeps talking about how it’s the best lending environment in a long while.

Main Street Capital ( MAIN ) said that there were $176m of new commitments in Q2 - well above the $12.9m figure the previous quarter. Fundings ran at $148m - up from $44m in Q1. About a third of that was one chunky loan for $45m to a cyber security firm. With relatively wide private debt credit spreads and a lender-friendly environment, it’s clearly a good time to be making new loans.

Horizon Technology Finance Corp ( HRZN ) chimed in and said it originated $53m of new loans in Q2 up from $47m. This is relative to $28m of repayments. Not clear if there were any sales but this suggests that HRZN is adding exposure at a time when rates on new loans are pretty attractive. This should boost their leverage and likely net income so there is a natural limit to how much they can do this.

So far the picture from commitments is mixed. GBDC has a history of being cautious so their relatively low level of commitments possibly speaks to their risk-averse profile. This will likely limit the boost to net income from additional lending. On the other hand, a robust level of commitments at both HRZN and MAIN suggests tailwinds to net income and, possibly, relative stability in the NAV. If the NAV were falling off a cliff, it would mechanically raise leverage, which would leave little room for new additional lending.

Market Commentary

Private credit remains hot. Jefferies is throwing its hat in the BDC ring and setting up a new BDC. The core of the capital base is a $625m anchor investment from the Abu Dhabi Investment Authority. Jefferies Credit Partners is a relatively small manager with AUM of around $10bn as of 2021.

The BDC will have $1.7bn of investable capital which would make it on the larger side in the sector. It will focus on first-lien senior secured loans to private equity sponsored US companies, targeting upper middle-market borrowers that have more than $75 million of EBITDA.

Unfortunately, this will be a private / non-traded BDC so it will not be accessible to retail investors. Jefferies is better known as a boutique investment bank so it will be interesting to see how they do managing the BDC.

A robust level of commitments at both HRZN and MAIN also speaks to a likely relative stability in the NAV. If the NAV were falling off a cliff, it would mechanically raise leverage, which would leave little room for new additional lending.

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