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Outlook Mixed on End of Leverage Cap for BDCs

March 27, 2018, 07:41 AM
Filed Under: Regulatory News

A last-minute inclusion to a massive spending package passed by Congress last week and signed by President Donald Trump on Friday will allow investment companies controlled by private-equity firms to borrow more money and increase their lending. But whether that's a good thing depends on who you ask. 

The revision, known as The Small Business Credit Availability Act, was part of the Consolidated Appropriations Act of 2018, the omnibus government funding measure that earmarks money for federal agencies. The bill eases rules for business development companies (BDCs), which provide capital for startups.

According to Bloomberg the measure allows BDCs to borrow $2 for every $1 of assets they own, eliminating an existing cap that restricts leverage to a 1-to-1 ratio of debt to equity.

“Unfortunately, in recent years, we have seen banks cut back on lending to small and mid-sized businesses, making BDCs an even more important resource to our job creators,” said Rep. Steve Stivers (R-OH), who sponsored the measure. “I am proud we were able to pass this legislation to make it easier for BDCs to provide financing to these businesses so they can continue to create jobs in our communities.”

The bipartisan Small Business Credit Availability Act modernizes the regulatory framework for BDCs, improving access to capital for growing small and mid-size American businesses. As a result, BDCs will be brought in line with the same prudent and safe rules already established by Congress and regulators for other 1934 Act public reporting companies.

"We are pleased to see policymakers modernize the regulatory framework for business development companies. The IPA, our members in the portfolio diversifying investments (PDI) industry and  small and mid-size American businesses have been advocating for these long overdue common sense bipartisan updates for years," said Tony Chereso, president and CEO of the Investment Program Association (IPA). He went on to add, "The real winners here are America's small and mid-size businesses that will have access to additional growth capital resulting in meaningful domestic investments and job creation.  Further, individual investors will have more investment choices."

Not everyone sees the changes as a win. Fitch Ratings said believes the previous regulatory leverage limit of 1.0x contributed to stronger recovery prospects for debt holders, even when portfolio investments were exited at meaningful discounts. Average leverage for the rated peer group was 0.65x as of Dec. 31, 2017. 

"The potential for negative ratings pressure for BDCs from increased leverage depends upon how individual managers utilize the relaxed leverage guidelines relative to their portfolio risk profile in regards to asset seniority, issuer credit strength and secondary market asset liquidity," Fitch noted. "The use of incremental leverage will vary by company, with some being more aggressive versus peers, which could differentiate ratings among Fitch-rated BDCs. Ratings for BDCs currently range between 'BBB' and 'BB+', constrained by the relative illiquidity of BDCs' assets, the market value sensitivity of the BDC structure, the dependence on capital markets to fund portfolio growth and a limited ability to retain capital due to dividend distribution requirements."

BDCs play an important role in funding small and mid-sized U.S. companies that may not have access to traditional sources of capital. They also provide individuals with investment opportunities in private companies historically available only to institutional and wealthy investors, through a highly transparent structure subject to oversight by the U.S. Securities and Exchange Commission, states and other regulators. Individual investors will see important benefits from these reforms, including having more of their dollars put to work in their desired investments. The result is increased potential for investment returns critical to people's long-term financial goals and retirements savings.

"Congress created BDCs in 1980 to encourage the establishment of public vehicles to increase the flow of capital to small, growing U.S. businesses. Now the industry is better positioned to continue delivering on that mandate," said Mr. Chereso.

Rep. Stivers was joined by U.S. Reps. Tom Emmer (R-MN), Randy Hultgren (R-IL), and Brad Sherman (D-CA) in introducing H.R. 4267 on Nov. 7, 2017. U.S. Sens. Dean Heller (R-NV) and Joe Manchin (D-WV) on Jan. 18 introduced the companion bill, S. 2324, in the Senate, with U.S. Sens. Thom Tillis (R-NC) and Mike Rounds (R-SD) as among the bill’s cosponsors.

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