The high yield spread, as shown by the St. Louis Fed graph below, has improved significantly since it blew out in March’s COVID-19 crash. Thus, the spread is nowhere near the 8%+ peaks (vertical green lines) which have previously marked particularly attractive Business Development Company ‘BDC’ buying points.
Source: St. Louis Fed and Google Finance
Recently, however, the BDC sector has gotten cheaper with price declines carrying the Wells Fargo BDC ETN (BDCS) to an almost oversold position (36 RSI).
Source: Yahoo Finance
The main fear prompting the most recent dip is essentially the same as March’s. Namely that a double dip COVID-19 induced recession could cause numerous debt defaults among the middle market companies that BDC’s lend to.
This in fact might happen this winter, and frankly knowing whether it will is a key risk to all BDCs. Management teams may rate how many of their loans are currently in trouble, but there’s little ability for the analyst to second guess this judgment, nor do the risk ratings say as much about future loan viability as we’d like them to. For this reason, combined with the leveraged nature of BDCs, Cash Flow Kingdom decided to lower its risk rating on just about every BDC name it covered when COVID-19 first hit. We also placed the overall sector on hold, and have been pretty much sitting on the sidelines ever since.
We don’t deny everything will eventually be just fine, in fact we are generally some of the more optimistic people we know regarding the US getting past COVID-19. Further, we acknowledge if we can pick the right firm and time it decently, specific BDCs will end up being quite a bargain. The phrase, “Be Greedy when Others or Fearful” still applies. However, we contend first you need to