LPC: Falling loan pricing and repayments weigh on BDC earnings

PennantPark Investment

16/08/2017 15:47

By Leela Parker Deo 
    NEW YORK, Aug 16 (Reuters) - Sliding loan pricing and 
increased repayments are continuing to curb the profitability 
and growth of Business Development Company (BDC) funds that lend 
to private U.S. midsized companies.  
    BDC share prices have been under pressure as investment 
income has fallen, which is raising fears about dividend 
coverage and even dividend cuts, as the funds report results for 
the three-month period ended June 30. An upturn in the rates of 
non-performing loans is also seen as a threat. 
    Of the 67 BDCs that have reported earnings to date, 20% have 
shown an increase in the value of their loan investments from 
when the loan was booked to its fair value today, according to 
BDC Collateral. 
    The sector is trading at an average 7% discount to Net Asset 
Value (NAV), which measures mutual funds' price per share. At 
the beginning of May the sector was trading at book value.  
    "Earnings are still under pressure. It's more of the same. A 
very competitive environment marked by tight spreads, and more 
opportunistic refinancings taking out high-yielding assets. 
Growth continues to be difficult when you are getting repaid 
faster than you can originate deals," said Meghan Neenan, senior 
director at Fitch Ratings. "We do expect to see some dividend 
cuts by the end of the year."  
    The red-hot US leveraged loan market has been repricing 
loans for more than a year, which is hitting BDC's interest 
income and shrinking portfolios or curbing growth as companies 
slash borrowing costs on leveraged loans. The funds are also 
absorbing increased loan repayments which are eroding portfolio 
yields as the proceeds are reinvested into lower-yielding loans. 
    PennantPark Investment Corp's (PNNT) portfolio shrank after 
US$199m of repayments exceeded US$89m of new investments, which 
left the fund with US$103m in cash at quarter-end, Wells Fargo 
BDC analysts said in a report.  
    Capitala Finance Corp (CPTA) deployed a total of US$6.5m in 
the most recent quarter, but had US$49m in repayments, which is 
curbing portfolio growth, Jefferies analysts noted. 
    FS Investment Corp (FSIC) reported that its total 
commitments to direct originations, including unfunded 
commitments, in the second quarter was US$197.1m while the 
investments that it exited, including partial paydowns, totaled 
US$218.3m.  
    FSIC also said that although it declared its third quarter 
dividend unchanged, it expects to cut its dividend by 15% in the 
fourth quarter and the fund's adviser agreed to waive a portion 
of its 1.75% base management fee starting in October. 
    The wall of cash that has flowed into U.S. middle market 
lending strategies in the last 18 months has made leveraged loan 
origination and underwriting significantly more aggressive on 
terms and price. 
    Around US$35bn has been raised for middle market lending in 
2017 so far, compared to US$60bn raised in 2016, according to 
Thomson Reuters LPC data. Nearly two thirds of the money raised 
in 2017 has been allocated to direct lending funds while BDC's 
equity capital makes up less than 5%. Middle market 
Collateralized Loan Obligation funds account for 20% of 2017 
fundraising and mezzanine strategies make up close to 13%.  
     
    HEAD OF THE CLASS 
    Despite an increasingly crowded and competitive field, some 
BDCs are continuing to outperform their peers, which is 
differentiating them from the pack. TPG Specialty Lending Inc 
(TSLX) was praised by analysts for its continued strong yet 
conservative dividend coverage and emphasis on extracting 
prepayment fees when loans are refinanced.  
    TSLX generated an annualized 13% return on equity on 
repayments, Wells Fargo analysts said, noting that "credit 
quality was again pristine   and NAV increasing slightly to 
$16.15/share."  
    Ares Capital Corp's (ARCC) also turned in a strong 
performance in the second quarter. Jefferies analysts said that 
while yield compression drove lower than forecast interest 
income, ARCC remains one of the best positioned BDCs for growth 
based on leverage capacity and existing liquidity.  
    "Ares has seen significant repayments and yet is 
consistently able to generate a significant amount of 
underwriting every quarter showing that scale and deal 
origination capabilities do differentiate platforms," said 
Neenan. 
    With its quarterly results, ARCC also announced the purchase 
of the remaining US$1.6bn in loans in the Senior Secured Loan 
Program which concludes the winding down of a legacy joint 
venture with GE Capital. The resolution provided an immediate 
portfolio yield boost which increases the fund's capacity to 
invest in higher yielding assets and ramp up its replacement-the 
Senior Direct Lending Program-more quickly.  
 
 (Reporting by Leela Parker Deo; Editing By Tessa Walsh) 
 
Keywords: LOANPRICES BDC/