BSL - BSL: Floating Rate Fund 10% Yield And 10% Discount (Rating Upgrade)

2024-01-05 23:31:38 ET

Summary

• Blackstone Senior Floating Rate 2027 Term Fund is a leveraged loan CEF.
• BSL has a wide discount to net asset value but a stable NAV performance that compares favorably with 'golden standards' in the leveraged loan space which trade flat to NAV.
• The fund's dividend yield is fully covered, and the collateral pool is well-diversified.
• BSL should benefit from a higher rates environment for longer, with current economic data suggesting the Fed will not cut Fed Funds anytime soon.

Thesis

With the jobs report just out , and non-farm payrolls rising more than expected, treasury yields are yet again rising. The labor market continues to be more resilient than expected, and without a high unemployment rate the Fed has absolutely no reason to cut rates. The economy seems to be humming along, with no recession in sight, although economic leading indicators have been deteriorating in the past year. How does this translate into an investment thesis? Well, a goldilocks economy for longer will translate into floating rate assets yielding attractive dividend yields for much longer than expected. As yields collapsed in the past two months, many analysts were hurrying-up to call upon the demise of floating rate assets. Not so fast.

Something needs to break in the economy for the Fed to start lowering rates. It is as simple as that. If unemployment stays low, PMIs stay above 50 and the economy is moving along at a healthy GDP growth rate, there is no incentive for the Fed to stimulate said economy via monetary policy. Blackstone Senior Floating Rate 2027 Term Fund ( BSL ) is an ideal fund to take advantage of such an environment. We covered this name before here , where we were warning investors they should be cognizant of the term maturity for the CEF in 2027. We are still a long ways away, and what matters now is the outlook for the fund and its return in the next twelve months. We believe default rates will stay low in the leveraged loan space and rates will stay higher for longer, which will provide a total return in excess of 10% for this name in the upcoming year. With its large -10% discount, which is at the bottom of its historic range, the CEF could produce even a greater upside.

Very wide discount for a term fund

BSL's current discount to net asset value sits towards the bottom of its historic range:

We can see the CEF having a -10% to 0% range for its discount to NAV. This in itself is a bit surprising given the Blackstone family name which usually commands a premium. Blackstone actually changed the CEF name back in February 2023 to reflect the term structure for the fund, but that did not have an impact on the discount. All else equal, the discount will narrow on its own as we approach the CEF's term maturity.

Adequate NAV performance

The CEF's NAV has been stable in the past 18 months after the initial drop in asset prices due to higher rates:

Leveraged loans are an asset class which is well known for their low standard deviation. That feature is reflected in the CEF's NAV performance which does not see-saw, but has shown substantial resiliency in the past year. The fund compares very favorably on that metric with 'golden standards' in the leveraged loan CEF space, namely Invesco Senior Income Trust ( VVR ) and Apollo Tactical Income Fund ( AIF ):

The fund distributes what it makes

With a floating rate asset base, the CEF's dividend yield is fully covered, with the fund distributing what it makes:

That was one of the main concerns voiced by analysts predicting lower rates. Lower Fed Funds would translate into a lower SOFR rate (with a 1 month to 3 months lag), which in turn would translate into lower CEF distributions down the road. We do not think that is the case until late Q3 2024. Please note that leveraged loans reset off 1- or 3-months SOFR, and a sudden change in Fed Funds takes time to percolate to SOFR rates. It does not happens instantaneously for the underlying collateral since rates are not reset daily on the floating rate loans, but fixings happen throughout time.

Defaults are set to rise, but only modestly

As per Fitch Ratings, default rates for leveraged loans are set to rise :

Fitch Ratings-New York-04 December 2023: Fitch Ratings is forecasting corporate high yield ((HY)) and leveraged loan ((LL)) default rates to rise in 2024 from 2023 levels before declining in 2025. We expect 2024 default rates of 3.5%-4.0% for leveraged loans, and 5.0%-5.5% for HY, up from 2023 default forecasts of 3.0%-3.5%, and 2025 default rates to range from 2.0%-3.0% across both markets. On an issuer count basis, we forecast 3.5%-4.0% for leveraged loans and 4.5%-5.0% for HY in 2024.

Higher default rate expectations for 2024 reflect growing macroeconomic headwinds, including the impact of higher-for-longer interest rates and a sharp slowdown in the U.S. economy, as growth is expected to decelerate meaningfully in response to tighter monetary policy and its impact on consumer spending.

However, please note the expected increase is very modest, and to be more specific Fitch anticipates only a 1.5% rise in defaults for leveraged loans, default level which is currently at 2%:

Default rates have been creeping up in 2023, but they are still very low by historic standards. Please note that the leveraged loan asset class overall is very resilient especially when high recovery rates are factored in (leveraged loans are usually senior secured in the capital structure).

The collateral pool is granular

The fund does a good job in building a well-diversified granular portfolio:

No single name represents more than 1% of the collateral, with any individual default having a marginal impact on the CEF after recoveries are factored in. In the leveraged loan space historic recoveries run close to 70%, which means that even if PetVet Care Centers were to default tomorrow, the impact to the CEF would only be 0.3% (the name has a 1% weighting, and after subtracting expected recovery of 0.7% we get the -0.3% fund impact).

From a ratings standpoint the CEF does not take excessive risks to generate the dividend yield:

The fund has a low bucket for CCC names, which amount to only 7% of the collateral. A retail investor should only be worried when CCC concentrations exceed 12% of a fund's collateral pool.

Conclusion

BSL is a leveraged loan CEF. The fund distributes what it makes and has a NAV performance which closely tracks the golden standards in the leveraged loan space (the VVR and AIF funds). The CEF trades at a very wide -10% discount to NAV, which is towards the bottom of its historic range, and a surprise for a CEF from the BlackRock family. With economic data coming in stronger than expected, we feel the Fed will have rates higher for longer than people expect, which will benefit floating rate funds like BSL. We are a buyer for this under the radar CEF with a larger than normal discount to NAV.

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