Thursday, August 11, 2016

Looking Through The Rearview Mirror

I read last week that FINRA has launched an investigation into non-traded business development companies (BDCs).  FINRA is late to this issue, like about three years too late.  Non-traded BDC sales are down a staggering 63% through the first seven months of 2016 compared to the same period in 2015.  The drop can be attributed, in part, to the closing of Franklin Square's FSIC III and CNL's Corporate Capital Trust, two of the top selling non-traded BDCs, and the tepid reception of their respective follow-on offerings.  The decline in sales is also related to the lower NAVs reported by many BDCs over the past year and a half, which served to spook clients and financial advisors.  Non-traded BDCs are required to value their portfolios quarterly, or more frequently if their NAVs move outside pricing bands, and non-traded BDCs have shown they are not immune to market forces.

The drop in oil prices that started in the second half of 2014 was felt across high yield markets, and therefore by non-traded BDCs.  The oil and gas sector is heavily represented in the high yield debt sector, and the graph I presented my previous post illustrates how correlated oil prices and the high yield markets were until earlier this year.

BDCs are a structure, not an asset class.  Most non-BDCs operate in the large non-bank financing market, primarily making a variety of loans to small and medium sized companies.  Companies that borrow from BDCs and other non-bank lenders are generally growing companies that do not have banking relationships or cannot get bank financing, and therefore do not have investment grade credit ratings, if they have a rating at all.  This is a high yield market and comes with all the risk of high yield investing.

I have seen various numbers related to the size of the non-bank capital market, but the smallest figure I have seen is $1 trillion and the largest over $50 trillion.  This is a legitimate market that is not going away anytime soon.  Non-traded BDCs are a small part of this huge market.

No comments: