The Zacks SBIC & Commercial Finance industry will continue to bear the brunt of higher prepayments as interest rates rise. This is likely to keep hurting the industry players’ profitability to some extent.
Yet, higher interest rates, favorable regulatory changes and decent demand for personalized financing solutions are expected to keep supporting the industry in the coming days. Solid asset quality continues to act as a major tailwind. Hence, a few industry players like Golub Capital BDC, Inc. GBDC, BlackRock TCP Capital Corp. TCPC and Horizon Technology Finance Corporation HRZN are likely to gain from these favorable developments.
About the Industry
The Zacks SBIC & Commercial Finance industry comprises companies that provide finance to small and mid-sized privately held developing firms. These firms are typically underserved by traditional banks and other lenders. Additionally, firms suffering from financial distress are the primary target clients of these lenders. The industry players provide customized financing solutions, ranging from senior-debt instruments to equity capital. This financing is provided for a change of ownership transactions, strategic buyouts, recapitalizations and growth initiatives in partnership with business owners, management teams and financial sponsors, among others. Some of the other products offered by the industry participants are mezzanine loans that typically pay high-interest rates and could be converted into equity in the target firm.
3 Major Factors Shaping the Future of SBIC & Commercial Finance Industry
Rising Rates: The Federal Reserve aggressively raised interest rates last year. Though the central bank is expected to pause further hikes as inflation continues to cool down, the interest rates are likely to remain high in the near term. While rising rates led to a spike in prepayments and refinancing before interest rates climb further, higher rates will keep benefiting SBIC & Commercial Finance industry players. The demand for products and services offered by these companies is likely to keep growing amid the challenging macroeconomic backdrop. Thus, the industry players are expected to witness a decent improvement in revenues going forward.
Solid Asset Quality: Following the COVID-19 outbreak and a subsequent halt in business activities in 2020, the majority of sectors wherein SBIC & Commercial Finance companies provide loans were hit hard. This raised fears of a deterioration of asset quality for industry players. But the support from the administration in the form of stimulus packages, extensive vaccination drives and the re-opening of businesses supported economic growth and prevented a substantial rise in delinquency rates for the industry players. Even now, the industry players are not expected to witness much deterioration in credit quality though high inflation still remains a major near-term headwind.
Regulatory Changes: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helped these companies to reduce portfolio risks by investing in higher capital structures without foregoing current returns. Thus, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Zacks Industry Rank Indicates Bright Prospects
The Zacks SBIC & Commercial Finance industry is a 36-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #74, which places it in the top 29% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of an encouraging earnings outlook for the constituent companies in aggregate. Looking at aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s bottom-line growth potential. Over the past year, the industry’s earnings estimates for the current year have been revised 21.1% upward.
So, we are presenting a few stocks that are well-positioned to outperform the market based on a strong earnings outlook. Before that, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks SBIC & Commercial Finance industry has underperformed both the S&P 500 composite and its own sector over the past year.
The stocks in this industry have collectively lost 7.6% over this period, while the Zacks S&P 500 composite gained 4.5% and the Zacks Finance sector declined 1.6%.
One-Year Price Performance
Industry's Current Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing loan providers because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.82X. The highest level of 1.03X, lowest of 0.41X and a median of 0.90X have been recorded by the industry over the past five years. Also, the industry is trading at a significant discount compared with the market at large, as evident from the trailing 12-month P/TB for the S&P 500 composite of 10.31X, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a low P/TB ratio, comparing SBIC & commercial loan providers with the S&P 500 may not make sense to many investors. However, a comparison of the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TB of 4.44X is also way above the Zacks SBIC & Commercial Finance industry’s ratio, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
3 SBIC & Commercial Finance Stocks to Bet on
Golub Capital: This Zacks Rank #2 (Buy) stock makes investments mainly in one stop (a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans) and other senior secured loans of middle-market companies. Based in New York, the company invests roughly $10-$75 million of capital.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Following the acquisition of Golub Capital Investment Corporation in September 2019, Golub Capital became one of the largest externally managed, publicly-traded business development companies in the United States in terms of assets. The deal continues to support the company’s financials.
As of Mar 31, 2023, Golub Capital had total investments (fair value) of $5.49 billion in 333 portfolio companies and a net asset value (NAV) per share of $14.73. As of the same date, the company had cash, cash equivalents and foreign currencies of $87.5 million and restricted cash, cash equivalents and foreign currencies of $50.2 million. Further, at March 2023-end, GBDC had $3.1 billion in outstanding debt.
The company’s shares have lost 9.7% over the past year. The Zacks Consensus Estimate for earnings has been unchanged at $1.60 for fiscal 2023 over the past month. GBDC has a market cap of $2.2 billion.
Price and Consensus: GBDC
BlackRock TCP: This is a specialty finance company that is mainly focused on direct lending to middle-market companies and small businesses. Carrying a Zacks Rank #2, TCPC lends largely to companies with solid market positions, strong regional or national footprints, differentiated products and services and sustainable competitive advantages.
As of Mar 31, 2023, BlackRock TCP had total investments (fair value) of $1.7 billion (in 143 portfolio companies), total assets of $17.9 billion and a NAV of $13 per share.
BlackRock TCP has been witnessing growth in total investment income over the last few years. The company is expected to continue witnessing a rise in investment income in the quarters ahead, given the regulatory changes and rising demand for customized financing. Also, its investment commitments to new and existing portfolio companies have been steadily rising.
As of Mar 31, 2023, TCPC had debt of $10.2 billion and cash and cash equivalents of $987 million.
BlackRock TCP has a market cap of $608.3 million. Over the year, the company’s shares have plunged 21.1%. The Zacks Consensus Estimate for earnings has been revised 6.7% upward to $1.74 for 2023 over the past 30 days.
Price and Consensus: TCPC
Horizon Technology Finance: Headquartered in Farmington, CT, HRZN is a specialty finance company that provides capital in the form of secured loans to venture capital-backed firms in the technology, life science, healthcare information and services and sustainability industries.
Despite the tough macroeconomic scenario, Horizon Technology Finance is expected to continue witnessing the growing demand for customized financing from private equity firms and venture capitalists. The company maintains a robust balance sheet position. Driven by the rise in the demand for customized financing and a robust deal pipeline, total new commitments are expected to keep increasing.
As of Mar 31, 2023, HRZN had $112.3 million in liquidity, comprising $43.5 million in cash and money market funds, and $68.8 million in funds available under existing credit facility commitments. As of the same date, the company's net debt-to-equity leverage ratio was 124%, above the 120% targeted leverage.
The fair value of Horizon Technology Finance’s total investment portfolio was $724 million billion as of Mar 31, 2023. Net asset value was $11.34 per share on the same date.
Horizon Technology Finance has a market cap of $333.3. Shares of this Zacks Rank #1 company have declined 2.6% over the past year. The Zacks Consensus Estimate for 2023 earnings has been revised 3.7% north to $1.69 over the past month.
Price and Consensus: HRZN
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