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New BDC Structure Adds to Competitive U.S. Middle-Market Landscape, Fitch Ratings

June 10, 2022, 07:49 AM
Filed Under: Industry News

Business development companies (BDCs) have periodically evolved since their creation in the late 1980s, with the advent of perpetual non-traded BDCs being the most recent example, Fitch Ratings says. Continuous fundraising in perpetual non-traded vehicles has increased lender demand for credit in an already competitive market, and their structural differences relative to publicly traded BDCs could affect portfolio valuation volatility, liquidity management and funding profiles. Still, perpetual non-traded BDCs potentially can achieve investment-grade ratings, provided additional risks are sufficiently mitigated.

Perpetual BDCs continually raise capital via distribution partners, primarily reaching accredited retail investors. Monthly capital inflows need to be deployed relatively quickly so that excess cash does not negatively affect returns. Some perpetual non-traded BDCs temporarily invest these funds in more liquid, broadly syndicated loans (BSLs) before redirecting the capital into traditional middle-market opportunities as they arise. BSL valuations tend to be more volatile, particularly in periods of market disruption, and can inflate leverage ratios for BDCs relatively quickly, as they mark their portfolios to market quarterly.

With no public market liquidity for shareholders in non-traded vehicles, perpetual BDCs have been offering quarterly tenders, subject to size limits and board approval. Available liquidity and leverage capacity must be carefully managed to meet redemption submissions from investors, which can vary significantly over time. While boards can opt out of the tenders in any given quarter, gating redemption requests can negatively affect future fundraising.

Fitch looks for investment-grade BDCs to have at least 35% of their total debt be unsecured. The rapid scaling of perpetual BDCs has resulted in increased demand for unsecured funding. While market access for BDCs has improved in recent years, reaching record levels in 2021, issuance requirements could outstrip investor supply, particularly during periods of market dislocations.

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