| NEW YORK, March 29
NEW YORK, March 29 The performance of Business
Development Companies (BDCs) is diverging into ‘haves’ and ‘have
nots’ as some platforms continue to raise capital and others
struggle to perform as conditions in US middle market lending
BDCs are specialized closed end investment funds that lend
to US private mid-sized companies. They include publicly traded
vehicles, whose shares are listed on an exchange, and private
unlisted, or non-traded, platforms.
In early 2016, the share prices of BDCs were trading at a
25-30% discount to Net Asset Value (NAV), which measures mutual
funds’ price per share. The discount made it difficult to raise
fresh equity capital without diluting shareholders.
Although the share prices of publicly traded BDCs have
rallied dramatically in the last year along with the wider
equity market, performance across the sector remains mixed.
Despite falling yields and excess demand for middle market
loans broadly, growing funds with access to equity capital that
can deploy that capital into top tier deals have a competitive
advantage over their peers, analysts said.
“We do expect to see opportunistic equity issuance, but the
question is can BDCs deploy the proceeds into accretive deals?
Can they cover dividends without having to invest further down
the risk spectrum?” one analyst said.
More than half of BDCs are now trading at NAV or above, but
individual share prices reveal a wide disparity between the
strongest and weakest performers. Shares of the top performing
funds are trading at comfortable premiums to book value, but
among the weakest performers, shares are at significant
Hercules Capital (HTGC) is trading at a 1.43 premium to NAV,
Golub Capital BDC Inc (GBDC) at a 1.22 premium and TPG Specialty
Lending Inc (TSLX) at a 1.24 premium. At the other end, Garrison
Capital Inc (GARS) is at a 0.77 discount to NAV, KCAP Financial
Inc (KCAP) is at a 0.76 discount and Fifth Street Finance Corp
(FSC) is at a 0.62 discount.
“We continue to recommend BDCs that we consider the 'haves'
meaning they have the ability to sustain or increase their
current dividend levels, while they also have the liquidity,
debt capacity and/or valuations in excess of NAV to support
growth,” said equity analysts at Jefferies in a March 15
research note. The analysts are favorable on Ares Capital Corp
(ARCC), Hercules Capital (HTGC) and Triangle Capital Corp
TO RAISE OR NOT TO RAISE
BDCs’ inability to raise equity in 2016 left some funds
scrambling for capital and unable to take advantage of more
favorable yields early last year. More funds are currently able
to raise equity, which will provide increased funds for
investment in 2017.
Seventeen funds are trading above book value and several
have already issued equity this year, including GBDC, which
priced a public offering of 1.75m shares of common stock at
US$19.03 per share. Including GBDC, at least four BDCs have
issued approximately US$280m of equity in 2017 so far.
But BDCs are now operating in a tougher borrower-friendly
market and are facing the perennial dilemma that the best time
to raise equity is not necessarily the best time for BDCs to
invest in low-priced loans.
Insatiable investor demand for private credit has pushed
yields dramatically lower in 2017. Yields on middle market
institutional term loans have fallen to 6.16% in the first
quarter so far compared to 7.33% in the first quarter of last
New money loans have been in short supply in 2017 and BDCs,
direct lenders and alternative debt capital providers are
competing aggressively for investment opportunities. Sponsored
new money volume stands at just US$9.72bn as the end of the
first quarter approaches, roughly 20% lower than the 4Q16 tally.
Successive refinancings are expected this year as issuers
seek to secure lower spreads, putting added pressure on
portfolio yields and potentially making it difficult for some
BDCs to meet dividend payments to shareholders as they struggle
to replace double digit-yielding paper that is refinanced out of
the portfolio, a second analyst said.
Even if BDCs are able to raise equity, having sufficient
scale and relationships to get a first look at the best deals is
also important, as well as a conservative fee structure, he
“The ability to invest that capital at sustainable yields is
essential as well as being positioned to absorb a drop in
interest income,” the analyst said.
Developments in the underwriting environment for middle
market loans is likely to drive the amount of BDC equity
issuance this year as the funds struggle to balance growth
prospects, intense competition and earnings pressure.
(Reporting by Leela Parker Deo; Editing by Tessa Walsh)