BDC Weekly Review: Next Recession Is Likely To Be Very Different

Jul. 17, 2022 6:48 AM ETBXSL, SAR30 Comments


  • We take a look at the action in BDCs through the first full week of July and highlight some of the key themes we are watching.
  • BDCs had a good week, supported by a recovery in credit assets as well as a rise in short-term interest rates.
  • The next recession, if it comes, is likely to be quite different from some of the more recent ones, making it difficult to translate BDC performance across recessionary periods.
  • This week we added to BXSL as the stock dipped on its last lock-up expiration.
  • I do much more than just articles at Systematic Income: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Business And Finance Concept Of A Bull Market Trend High Quality


This article was first released to Systematic Income subscribers and free trials on July 9.

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 first full week of July.

Be sure to check out our other Weeklies - covering the CEF as well as the preferreds/baby bond markets for perspectives across the broader income space. Also, have a look at our primer of the BDC sector, with a focus on how it compares to credit CEFs.

Market Action

It was a good week for BDCs as credit assets continued to recover from their June swoon. Only two BDCs are down so far in July: the underperformer FCRD as well as BXSL which fell on its last lock-up expiration and which we discuss in more detail below.

Year-to-date most of the sector remains in the red, however, the total year-to-date return has clawed back into single-digits.

BDC YTD return

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The sector continues to steadily dig itself out of its hole as shown below.

BDC Index

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The sector valuation stands at 93% which is well below its historic average though this is biased lower by the fact that Q2 NAVs should fall i.e. valuation on the likely Q2 NAVs are a few percentage points above their current level.

Average BDC valuation

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Market Themes

A recession sometime next year is becoming the base case for many analysts and investors. One way in which we evaluated allocating to BDCs with a view to recession is to see which ones have remained more resilient over recessionary episodes.

However, one obvious challenge with this approach is that recessions aren't all the same. Some recessions are less damaging to the corporate sector and others more so. And some companies can sail through certain kinds of recessions and go bust in others. As they say on the tin - "past performance is no guarantee of future results".

Let's quickly review some of the recent recessions.

COVID (2020) - this was by far the shortest recession in the modern period as a partial closure of the economy was bridged by historic fiscal and monetary stimulus. The corporate sector managed through with little aggregate disruption though some sectors such as retail and hospitality were strongly impacted.

Energy shock (2015) - not technically a recession. About a quarter of the energy and natural resources sector went bust due to a plunge in oil prices, driven by booming US oil production. The damage was largely localized in the energy space with limited fallout to other sectors.

GFC (2008) - the subprime mortgage crisis which spilled over into the financial sector and then to Main Street, lasting a relatively long time of 18 months.

Dotcom (2001) - was relatively brief and shallow driven by the collapse of a speculative bubble in Tech companies.

The next recession is unlikely to be driven by a blow-up in a single sector such as the 2015 period. If anything, the Energy sector might outperform if energy prices remain elevated. We are also unlikely to see the kind of financial market chaos that we saw during the GFC as banks are in much better health. We are also less likely to see the kind of fiscal support we saw during the COVID period and much less support from the Fed as it will be constrained by inflation. Overall, it seems like the next recession could be a relatively shallow one, given the relative health of the household and corporate sectors but it could be extended as the Fed will be unable to push rates back lower as quickly as it has in the past.

So while we shouldn't necessarily expect BDCs to repeat their performance over the next one, we can have some confidence in the fact that underwriting quality and company support should still contribute to differentiated performance. This is why a glance at how various BDCs fared through previous periods is still advisable when making an allocation in the current environment.


Systematic Income BDC Tool

Market Commentary

Saratoga Investment Corp. (SAR) showed a 2.5% net realized / unrealized change impact to the NAV for the quarter ending in May. It's a good canary in the coalmine as it reports a month earlier than nearly all other BDCs.

The only thing to keep in mind is that in May high-yield bond credit spreads closed around 4.2% and they finished June at 5.9%. Publicly traded bond valuations don't directly translate to private loan valuations, however, the ratios should be roughly comparable. It's probably fair to pencil in something like a 3-4% drop in the sector average NAV drop over Q2 if we use SAR as a baseline.

Saratoga Investment NAV per share


Stance And Takeaways

This week we saw a 9% peak-to-trough fall in the price of Blackstone Secured Lending (BXSL) as the final lock-up expired. The stock has since recovered about half the drop. We took the fall as an opportunity to add to the stock in our Income Portfolios. As of this writing BXSL is trading at an 88% valuation - or 5% below the sector average. In our view, this is appealing in the context of the company's track record and low fee structure and the stock carries our "Buy" rating at the moment.

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This article was written by

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Income investing across BDCs, CEFs, ETFs, preferreds, baby bonds and more.

At Systematic Income our aim is to build robust Income Portfolios with mid-to-high single digit yields and provide investors with unique Interactive Tools to cut through the wealth of different investment options across BDCs, CEFs, ETFs, mutual funds, preferred stocks and more. Join us on our Marketplace service Systematic Income.

Disclosure: I/we have a beneficial long position in the shares of BXSL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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