Business Development Companies Sell Baby Bonds
September 6, 2017
By Tim McPartland
Two business development companies (BDCs) have sold new baby bonds with identical coupons of 6.125%.
When we saw these new issues were going to be sold, we were quite excited, as neither company is investment grade and we thought that we might get some new issues with a 7% coupon. Our excitement turned to disappointment when pricing was announced.
KCAP Financial (NASDAQ: KCAP) came public in late 2006 at an offering price of $15 a share and now trades at a measly $3.42 a share. Its shares have been as high as $11 in 2012, but it has slid dramatically since that time.
KCAP carries a current common share yield of more than 14%. While I haven’t done a deep dive on the company’s financials, there is no chance whatsoever that we will own a bond from this issuer in the foreseeable future.
Harvest Capital Credit Corporation (NASDAQ: HCAP) has been somewhat more successful than KCAP. But in the most recent quarter, ended June 30, Harvest Capital announced a $4.1 million write-down on assets as a loan was totally written off. This is a sizable write-down for a BDC with just $137 million in assets. Anytime you are lending money at an average interest rate of more than 14%, you can be certain that virtually all loans are made to very risky smaller companies and there will be times when large write-downs are taken. The baby bonds being issued by HCAP are relatively safe until we enter the next recession, but the coupon is so stingy that we simply won’t buy. HCAP will use the proceeds of this issue to call the HCAPL 7% baby bonds, which are currently outstanding.
If there is anything good about these bonds, it is that they are being issued by BDCs, which are closed-end funds. Thus, they are covered by the Investment Company Act of 1940 and must maintain at least 200% asset coverage on their senior securities (bonds and preferred stock). Additionally, both of these issues mature in 2022. That timing is a positive, as we prefer shorter duration instruments at this time.
The KCAP baby bonds are now trading and are in the range of $25.05 to $25.25, while the HCAP bonds are now trading in the $25.25 to $25.35 area. These prices again prove that even junky companies can issue debt at a level once reserved for investment-grade issuers and yield-starved investors will eat them up.
Tim McPartland is a private investor with over 45 years of investment experience. His analysis, research and writing is devoted to the hunt for income producing securities of all types, but in particular specializing in preferred stocks, exchange traded debt and Master Limited Partnerships.