Fitch: Lending Slowdown Is Reversing BDCs' Growth
30 May 2015 - 3:55AM
Business Wire
As underwriting conditions remain relatively competitive, the
slowdown in growth is positive, yet is also a result of multiple
challenges to the industry. As leverage levels have trended higher
in recent years, BDCs have grown, but with little improvement in
portfolio yields. The high growth has raised our concern regarding
eventual deterioration in asset quality metrics, which contributes
to Fitch's negative outlook on the sector.
An important factor behind the recent loan slowdown is BDCs'
constrained access to equity markets, a key source of capital to
fund balance sheet growth. Such access is hampered when BDCs' share
prices trade at discounts to net asset values (NAVs), as has been
the case in recent quarters. Equity price discounts have been
driven by a combination of concerns about the sustainability of
current dividend levels, energy exposures, asset quality,
off-balance sheet leverage, external manager conflicts, and share
illiquidity following index removals in first-half 2014. At May 28,
2015, six of eight Fitch-rated BDCs that are publicly traded were
trading at a discount to NAV, with an average discount for the
eight BDCs of 4.9%. Fitch rates a ninth BDC, although it is not
publicly traded.
Over the near-term, another factor that will continue to hamper
BDC loan growth in our view is leverage, which has risen to the
high end of management targets and have reduced cushions against
the 1.0x debt/equity limit under the 40 Act for some BDCs. Average
leverage for the peer group was 0.63x at March 31, 2015, down 1 bp
in the quarter, but up from 0.57x at year-end 2012.
The very high growth rates of BDCs over the past four years have
been driven by the availability of low cost debt funding, rising
equity markets (which had helped BDC share prices, until last
year), a market pullback by banks, the exit of many hedge funds and
a rebuild of the CLO market. These factors contributed to the 2013
and 2014 vintage years being somewhat overheated, and will likely
introduce asset quality issues for BDCs down the road, in our
view.
A chart of loan origination and repayment changes for
Fitch-rated BDCs back to 2012 can be found
https://www.fitchratings.com/web_content/images/fw/fw-chart-20150529.htm.
The bars show that first quarter 2015 loan originations dropped 47%
versus first-quarter 2014 across nine Fitch-rated BDCs. It was the
lowest level since first-quarter 2012 and the first net negative
quarter since at least 2011. This quarter's drop is on the heels of
the same group's combined loan originations growing 14% in 2014,
and 21% compounded annual growth over the last three-year
period.
Fitch expects incremental portfolio contraction at some BDCs
seeking to reduce leverage or fund stock repurchases to appease
shareholders, given depressed valuations.
One counterweight to the current conditions in our view is the
relatively positive macroeconomic picture in the US that likely
limits the risk of rapid deterioration of asset quality across the
portfolio. The implementation of leveraged lending guidance on the
banks and the uncertain future of GE Capital's sponsored finance
business are two examples of potential market opportunities for
BDCs.
Fitch believes that strong equity and debt market access may
provide competitive advantages to those BDCs with such access,
while those constrained may be more focused on optimizing earnings
to close NAV discounts, which could potentially bring higher
risk.
The above article originally appeared as a post on the Fitch
Wire credit market commentary page. The original article can be
accessed at www.fitchratings.com. All opinions expressed are those
of Fitch Ratings.
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Fitch RatingsAndrew FinneranAssociate DirectorFinancial
Institutions+1 212-908-0840orMatthew Noll, CFASenior
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