BDC Credit Recap: Week Ended July 7, 2023
Week 27
Introduction
As we'll discuss in greater detail below, another week has passed with little in the way of negative credit developments at BDC-financed underperforming companies. At the same time, in the broader non-investment grade company universe, the trend of defaults and bankruptcies continues to increase. Some of the metrics, at first glance, even bear a resemblance to conditions during the GFC. Yet, prices for leveraged loans, high-yield bonds, and the BDC sector are improving...
Bankruptcies
Undoubtedly, Chapter 11 filings are sharply up in 2023 against the 2022 level. Epiq Bankruptcy - "the leading provider of U.S. bankruptcy filing data" - says
"The 2,973 total commercial Chapter 11 bankruptcies filed during the first six months of 2023 represented a 68 percent increase over the 1,766 filed during the same period in 2022"
Record Reaching
This chart from Clearbrook provides a longer historical context, dating back to 2006. As you can see, 2023 bankruptcy levels are neck and neck with the pace in early 2020 and not that far behind the 2008-2010 Great Recession level.
Debt Mountain
We have only just begun - as the Carpenters might say - because the Fed is not done raising rates as more and more debt needs to get refinanced. S&P Global is quoted as projecting that "U.S. companies with speculative credit ratings... need to refinance around $354 billion of debts by end-2024, then a further $813 billion in 2025". Adding insult to injury, the CLO market - which historically has provided much of the financing for these companies - is "drying up", as one author dramatically claims.
Undeterred
However, most market participants are far from panicking. In fact, both the high-yield and private debt markets are perking up from depressed issuance levels. According to Clearbrook - quoting Pitchbook - "since the beginning of the year, companies such as American Airlines and Six Flags have issued $91B in speculative bonds, a 35% increase from a year ago". KBRA's Direct Lending publication indicates a steady stream of new deal activity is underway in the private debt arena (which includes BDCs), albeit below historical levels. The price of BKLN - the ETF for the largest senior loans - is in rally mode and has been since May 25, 2023, and is not far off a 2023 high.
Reason Why
As we suggested last week, the complaisant attitude of the markets appears to be a mix of wanting to capture the highest yields available on floating rate loans and on bonds seen in over a decade and the sense that while bankruptcies/defaults are rising they remain "manageable". For example, "Speculative grade default rates are sitting at 3.07%" as of June. That's much higher than the low point of 1.2% achieved early in 2022 but "well below the level of 4.5% prior to the pandemic." Yahoo Finance darkly warns that "one in 25 U.S. companies will default by March 2024", but that's not an alarming number to industry pros and more a reversion to the mean. After recoveries are figured in, the net losses are modest when compared with the 5% or greater increase in loan yields.
BDC-Financed Company Bankruptcies: For a third week, there were no bankruptcies to speak of. (There continued to be plenty of bankruptcies of non-BDC financed companies, including the Tattooed Chef Inc ; Alpine Summit Energy Partners; PeerStreet; MediaMath, and others besides).
Upgrades or Downgrades: The BDC Credit Reporter did not upgrade or downgrade any of the underperforming companies in its database during the week. As of July 7, 2023, there are 132 companies that are deemed "Important Underperformers" - rated CCR 4 or CCR 5 on our 5-point scale and with an aggregate FMV of $5mn plus.
Other Notable Developments: The only notable story of the week was the auction of Buy Buy Baby, the supposed jewel in the crown of Bed Bath & Beyond's assets. A company called Dream On Me had offered $15.5mn for the company's IP assets, but Bed Bath had hoped a buyer would emerge for some or all of Buy Buy Baby's locations. That did not happen, and the auction is now ended.
The sum of Bed Bath & Beyond's parts does not seem to be adding up to very much, leaving the BDC Credit Reporter concerned about how its only public BDC lender might fare once all the bills are settled, as we noted last week. The failure to sell Buy Buy Baby for more than a pittance only adds to our concern.
CONCLUSION
We continue to be a little surprised by this now 3-week let up in bankruptcies or defaults at BDC-financed companies. This is at variance with what is happening in the broader non-investment grade company market and is at cross purposes with the relatively large number of BDC borrowers reported to be on the brink. Given the short time period involved, we won't draw any conclusions as yet.