TRLPC: BDCs under pressure in 2016

Fri Feb 19, 2016 9:59am EST
 
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By Leela Parker Deo

NEW YORK Feb 19 (Reuters) - Business development companies (BDCs) are extending losses in 2016 as slumping share prices restrict access to growth capital and the value of some loan investments fall in volatile markets as fears of defaults rise.

BDCs specialize in lending to privately-owned US middle market companies and are closed-end investment funds that raise equity capital from retail and institutional shareholders.

The sector is currently trading at a steep discount to Net Asset Value (NAV), which is making it difficult to raise fresh equity without diluting existing shareholders. With few exceptions, the funds are trading at 75-80% below NAV, which measures mutual funds' price per share.

"It's a big deficit to overcome. The sector is dependent on the equity markets for growth," said Meghan Neenan, senior director and BDC analyst at Fitch Ratings.

The lack of fresh equity capital means that BDCs are less able to take advantage of the higher spreads and tighter leveraged loan structures that are now on offer, after years of investing in aggressively priced and structured deals.

BDCs have gained market share in the last two years alone with other alternative capital providers by investing heavily in borrower-friendly loans as banks pulled back from lending to small and mid-sized companies in the face of heightened regulatory scrutiny on leveraged loans.

Market volatility has pushed spreads on middle market institutional term loans higher to an average of 540bp in the first quarter, the widest level since 563bp in the third quarter of 2012. Spreads were 519bp in the fourth quarter of 2015 and 514bp a year earlier.

In addition to tumbling NAV, BDC analysts are also watching for signs of any deterioration in credit quality, including underperforming loans in a rising default environment.   Continued...