BDC Reporter muses on meaning of Prospect's large deal

Prospect Capital's (PSEC +0.9%) sizable $210M lending deal announced this morning and 9 booked deals over $100M in the last year suggest it and many of its larger brethren are competing for larger borrowers who don't fit the mold of the larger syndicated loan market BDCs typically play in, writes Nicholas Marshi.

On the good side, these "story credits" allow Prospect and other BDCs to charge higher rates and fees than are available in the "dirt cheap" syndicated loan market. And Prospect (and others) have become so big that typical middle market deals aren't enough to move the needle on their portfolios anymore.

Ideally, though, no individual loan would represent more than a tiny fraction of the portfolio, so while "big fish" deals allow for good earnings and maintenance of the distribution today, Marshi worries about the impact of the blow-up of an individual company or of wider credit issues when the next economic downturn hits.

Other large players today: Ares Capital (ARCC +0.8%), FS Investment (FSIC), American Capital (ACAS +1.4%), Apollo Investment (AINV +0.4%), Main Street Capital (MAIN +0.1%).


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Comments (15)
  • drewmeister7777
    , contributor
    Comments (11) | Send Message
    So who has taken on the mantle of the mid market deals that Prospect seems to be moving out of?
    18 Aug 2014, 11:38 AM Reply Like
  • Nicholas Marshi
    , contributor
    Comments (573) | Send Message
    The middle market is smaller in dollar size than the large cap market but with many more borrowers and more opaque reporting and less sophisticated financial management. As a result there is no one lending champion in the middle market. I'd be surprised if any one lender has more than 1%-2% of the market of deals with an EBITDA under $50mn. There are many BDCs involved, regional banks, some finance companies most people have never heard of (after all no branches to notice), some foreign banks and some specialized private funds. BDCs do predominate. Guessing here I'd say 30-35 of the 40 BDCs we track are in the middle market, as defined above.
    18 Aug 2014, 11:55 AM Reply Like
  • Nicholas Marshi
    , contributor
    Comments (573) | Send Message
    By the way, while I appreciate Seeking Alpha featuring my musings I would point out that the main concern I ended with in my morning post is that the uncertainty that comes from having large loans in portfolio when the Next Recession hits may cause very high volatility in BDC stock prices even before we find out if concerns are warranted or not. BDC investors, despite much reporting from the companies, invest relatively blindly and many do not want to wait around when conditions worsen, and tend to sell first and ask questions later. Investors will have to be prepared for BDCs they own to potentially drop by 25%-50% even if they perform adequately. Hard to prove till it happens but I point you to recent BDC volatility on garden variety bad news. Look at KCAP, HTGC, FULL, FDUS etc. in the last year. Drawdowns can go as high as 25% on higher dividends and no bad debts. What happens when non performing loans jump to 5%-10% of total assets, as they can.
    18 Aug 2014, 12:05 PM Reply Like
  • user1969
    , contributor
    Comments (30) | Send Message
    Your probably right Nicholas.
    But on the other hand you'll see the stock market also drop 25% - 50% when the next recession comes.
    Just about all stocks across the board will get hit if there is a recession.
    18 Aug 2014, 01:19 PM Reply Like
  • nodhannum
    , contributor
    Comments (32) | Send Message
    So let me get this straight. There is risk in, I am glad there is no risk in non dividend Mo-Mo stocks that yield nothing but speculation. If the BDCs go down and still pay decent dividends then I pick up what doing DRIPS...more shares.
    18 Aug 2014, 01:54 PM Reply Like
  • DHL-2
    , contributor
    Comments (528) | Send Message
    You are worried about the next recession? We haven't fully come out of this one yet into a boom. I'm more worried about the increase in interest rates and the impact it will have on BDCs
    22 Aug 2014, 09:22 PM Reply Like
  • Tda
    , contributor
    Comments (125) | Send Message
    Nicholas, your points are well taken. BDCs are not for the timid, the risk averse, or those who fear volatility. Nevertheless, long investors in BDCs as well as *all* other equities would do well to have stop-loss orders in place in the event of the Next Recession (or worse). Geopolitical turmoil has been on the upswing and even a rumor can upset our profitable apple carts.
    The bull market has been great, but the "writing on the wall" by sensible chart watchers is growing every day. Sure, I'd rather not leave money on the table while the party's still going, but that's preferable to a sudden and substantial loss. I'm hanging in there with PSEC and AINV for now.
    18 Aug 2014, 12:30 PM Reply Like
  • Teriee
    , contributor
    Comments (109) | Send Message
    18 Aug 2014, 06:13 PM Reply Like
  • koolsool
    , contributor
    Comments (493) | Send Message
    Since I have been following BDCs, the extreme share price drops on bad news or short sellers attacks or another financial crisis have been buying opportunities to add to or establish a position. I agree with the comment that ALL stocks go down together during recession. The value of non-dividend paying stocks is way less than the ones that pay income while they move. And it may take way longer for non-dividend stocks to recover because there is no reason to own them in a down market.
    18 Aug 2014, 02:51 PM Reply Like
  • lewni
    , contributor
    Comments (6) | Send Message
    TDA never put a fixed stop loss in place as you can be taken out by the market makers. Much better to use a mental stop loss to protect yourself and then sell when you hit it.
    18 Aug 2014, 04:40 PM Reply Like
  • Tda
    , contributor
    Comments (125) | Send Message
    lewni, thanks for the suggestion, but how does that work? Should bottom-end price alerts be placed on each stock, then when they occur, take a look to see whether it's a visible downward trend or a random (or manipulated) down spike?
    Seems like an excellent idea but please verify its correctness. Thanks!


    By the way, unlike many on this forum, I've only been managing my own investments for three years, so I have a lot to learn. They were professionally managed before but I wasn't satisfied with the lackluster results. So now, it's the guy in the mirror.
    19 Aug 2014, 08:41 AM Reply Like
  • 276C
    , contributor
    Comments (433) | Send Message
    Set stops about 20% down. You'll mostly avoid the sweeps and keep those Divies coming
    2 Jan 2015, 12:13 AM Reply Like
  • Big Al45
    , contributor
    Comments (207) | Send Message
    Nicholas, thanks for your analysis. BDCs are financial stocks and the market price for financial stocks is highly cyclical. A "buy and hold" strategy for ANY financial stock has downside risks.


    What sets BDCs apart from the average regional bank, however, is 1) the lack of supervision by a regulator and 2) the excessive amount of fees that BDC management skims from net operating income. This makes starting/managing a BDC very attractive to an Executive suite sociopath.


    To my mind, the management team's competence and honesty are most important criteria in determining whether a particular BDC is a risky investment or not. And its almost impossible to evaluate those criteria from reading 10Qs & Ks.


    BDC investors should remember the fates of ALD, ACAS, PCAP, and MCGC during the last recession and not become "fanboys" for any particular BDC stock. At some point in a future recession, all BDCS will be a strong sell. And only the well managed ones will recover enough to reach or exceed their current NAV and market prices.


    Only time will tell if PSEC is one of the well managed ones or not. IMO, they're growing too fast and making too many large, concentrated investments and seem to be headed down the same road as ACAS. They'll probably survive the next recession (thanks to the leverage constraints) and the executives will keep on making multi million dollar salaries, but the dividend will end and the NAV (and stock price) will be cut in half.


    If were long PSEC, I would be listening very carefully to the quarterly conference call and looking for signs of management sociopathy.
    18 Aug 2014, 05:46 PM Reply Like
  • critterlitter
    , contributor
    Comments (419) | Send Message
    If you're not ready to cash in due to financial needs or getting ready to take a more conservative role due to retirement, then riding out a storm of recession and BUYING MORE can be a golden opportunity. Recessions don't last forever, anymore than bull markets do, and therefore, there is light at the end of the tunnel and gold at the end of the rainbow. It's just a matter if one has the finances and cahoonas to stay in, and even ADD to what some would call carnage. But one's carnage is another's carnival. After all --- what should one be doing when everyone else is selling ??? It ain't a one- or two-year strategy --- it's a three- to five-year journey...


    18 Aug 2014, 09:00 PM Reply Like
  • 13302632
    , contributor
    Comments (1779) | Send Message
    These are senior secured 1st lien notes. With these larger deals, I assume above average due diligence is executed. I would think rather than increasing risk this kind of deal could/would decrease risk. There is less competition in the space so it is possible to get better terms as well. I would think a basket of these larger deals for some core holdings would stand the largest capitalized BDC's in good stead.
    19 Aug 2014, 08:14 AM Reply Like
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