LPC: BDC sector splitting into 'haves' and 'have nots'

BCP Investment

29/03/2017 19:36

By Leela Parker Deo 
    NEW YORK, March 29 (Reuters) - 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 
remain challenging. 
    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 
discounts. 
    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 
(TCAP).  
     
    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 
year. 
    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 
added. 
    "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) 
 ((Leela.Parker@thomsonreuters.com)) 
 
Keywords: BDC SPLITS/