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Bonds News

Dividend cuts loom over BDC market as pandemic extends

NEW YORK, April 16 (LPC) - Business development companies (BDC) feeling the squeeze from the economic shutdown caused by the coronavirus pandemic are likely to pass that pressure onto shareholders over the next two quarters through dividend cuts.

BDCs, which invest in small and mid-sized businesses, make distribution payments to shareholders quarterly. Dividends are one reason investors add BDCs to their portfolio, and slashing payouts removes that incentive.

Golub Capital BDC has cut its dividend to US$0.29 per share from US$0.33 per share. Gladstone Capital Corp also cut its quarterly dividend to US$0.195 per share from US$0.21. Main Street Capital Corp has recommended halting its twice-a-year supplemental dividend.

The BDCs cited in press statements that their financial decisions reflect the impact of the coronavirus pandemic on market conditions and the vehicles’ holdings.

Market analysts expect this to be a harbinger of a broader market trend.

Spokespeople from Golub Capital BDC and Main Street Capital Corp declined to comment. Spokespeople for Gladstone Capital Corp did not respond to a request for comment.

REVENUE SQUEEZE

With entire sectors of the US economy shutting down, non-accruals, or non-performing loans within the BDCs, will spike as cashflows get hampered, further hurting earnings and thus dividend payouts.

Whether BDCs realize losses or keep non-performing loans in the portfolio hoping struggling companies would turn around, will thus require a delicate balancing act.

The main question for managing non-performing loans “is whether non-accruals is a tool to shore up liquidity in portfolio companies and get it performing again or using it as a way to delay the inevitable and recognize the loss,” said Meghan Neenan, managing director and North American head of non-bank financial institutions at Fitch.

“With non-accruals there is no income being generated by the asset and no revenue flowing to the BDC, which therefore is going to leak in the dividend coverage,” Neenan said.

Before the public health crisis, non-accruals had ticked up to 3.4% of public BDC portfolios in the fourth quarter from 3.2% in the third quarter, according to BDC Collateral data.

The increase in non-accruals is likely to hike up leverage levels, which averaged 1.05 times in the fourth quarter of 2019, up from 1.03 and 0.99 times in the third and second quarters for all public BDCs, according to data from BDC Collateral.

“It’s prudent for lots of BDCs to cut dividends this quarter and cut deep enough you don’t have to do it again. But that is asking BDCs to determine what earnings are going to be once this is all over, and that is going to be very hard to estimate,” said Robert Dodd, an analyst at Raymond James.

Because the coronavirus crisis has resulted in a widespread shutdown of the US economy, even positions in the companies that operate in non-cyclical sectors are likely to be impacted. BDCs are expected to mark down positions even in good assets, such as healthcare companies, which have been historically favored by BDCs.

“There are a lot of good businesses out there that can’t get to their customers, which will likely translate into higher defaults,” said Mitchel Penn, an analyst at Janney. “The higher number of defaults could push many to cut dividends or raise capital.”

PORTFOLIO MARKDOWNS

A BDC’s ability to pay dividends may be further impacted by portfolio markdowns, which can cause liquidity issues.

The current market volatility makes markdowns imminent. Each quarter a BDC values the assets in its portfolios based on its performance and the capacity of the company to repay its debt. An asset is marked down if that company is underperforming.

Golub Capital BDC saw “significant” unrealized valuation deterioration, Chief Executive Officer David Golub said in its earnings estimate.

Golub and Bain Capital Specialty Finance are both looking to shore up liquidity through equity offerings, according to US Securities and Exchange Commission filings. The equity offerings are expected to be dilutive to their existing shareholders.

To pay down debt, the BDCs will sell stock at a discount to net asset value (NAV) per share.

A BDC conducting an offering at a discount to NAV per share indicates potential liquidity concerns, said Casey Alexander, a BDC analyst at Compass Point, a financial research firm. He does not cover Golub or Bain specifically.

The discounts likely signal there are problem spots in their portfolios, he said, which may be “resulting in an extraordinary need for an equity infusion.”

Apollo Global Management’s BDC halted its share buyback program in mid-March, which is used to boost its trading price. The firm made the move partially to guard against markdowns, one fund manager said, as stopping its repurchase program will keep more cash on the balance sheet.

Spokespeople for Bain and Apollo declined to comment. (Reporting by David Brooke and Andrew Hedlund. Editing by Michelle Sierra and Kristen Haunss.)

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