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Fitch: BDC Debt Wall Poses Potential Challenges for 2016

October 19, 2015, 07:50 AM
Filed Under: Industry News

For the first time since the financial crisis, business development companies (BDCs) are facing a relatively significant near-term maturity wall, as $1.3 billion of convertible notes and other debt issued by Fitch-rated BDCs in 2011 and 2012 are approaching their maturity dates in 2016. Fitch Ratings believes that options for refinancing are potentially limited, as a variety of issues could pose challenges for the sector.

Many of the issues concerning BDC equity investors, including competitive underwriting conditions, outsized energy exposures, increased valuation marks, potential dividend pressures, and unsustainable asset quality metrics, may also weigh on debt investors, which could make it more challenging for BDCs to economically refinance maturing convertible notes and private placement debt with public market issuance.

Today, about $3.2 billion of institutional bonds remains outstanding across the Fitch-rated universe of BDCs; however, there have not been any issuances since FS Investment Corporation issued $275 million of seven-year notes in April. Apollo Investment Corporation also completed a $350 million transaction in March 2015, which was intended to partially refinance $454 million of borrowings the firm had coming due between October 2015 and September 2016.

Part of the sector's recent absence from the debt capital markets can be explained by what is happening in the equity markets. Many BDCs are currently trading below their net asset value, which generally precludes them from accessing the equity market for growth capital, absent shareholder approval. With constrained equity market access, BDCs are unable to add debt to the capital structure without potentially breaching leverage targets.

Rated BDCs with 2016 maturities include Apollo Investment Corporation ($229 million), Ares Capital Corporation ($805 million), Fifth Street Finance Corp. ($115 million), and BlackRock Capital Investment Corporation ($158 million). All have sufficient borrowing capacity on corporate credit facilities to allow for the refinancing of maturing debt at spreads over LIBOR ranging from 175 bps to 225 bps and maturities ranging from 2018 to 2020. However, corporate credit facilities require a security interest in unencumbered assets, while convertible notes are unsecured, which reduces funding flexibility, in Fitch's opinion.

Additionally, while some BDCs maintain outstanding borrowings on their credit facilities, Fitch generally considers corporate revolvers to be bridge financing for portfolio company investments until longer duration funding can be arranged. A material reduction in borrowing capacity on credit facilities could limit a BDC's operating flexibility and strain its liquidity profile.

The scope of available financing options for BDCs has expanded over the past five years as investors have become more comfortable with the operating model. While pre-crisis BDCs had significant exposure to volatile equity investments and outsized leverage tolerances, post-crisis BDCs have generally been committed to lending higher up the capital structure (in first and second lien positions) and maintaining leverage levels commensurate with the underwriting risk being taken. Leverage targets are in a range of 0.5x-0.75x today, compared with pre-crisis tolerances of 0.8x or more.

In aggregate, Fitch-rated BDCs have issued $675 million in public debt and $322 million in equity year-to-date through Oct. 15, 2015. The pace is well below 2014, when more than $2 billion of debt and $1.5 billion of equity was issued during the year.

Fitch's sector outlook and Rating Outlook for BDCs have been Negative for more than a year, and further signs of reduced financial flexibility or net interest income among rated BDCs would likely further pressure individual ratings.

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