Evening Brief – 04.02.24
BDCs to the Rescue
The utilization of traditional bank revolving credit facilities is continuing to fall due to bank balance sheet constraints and the pending Basel 3 Endgame proposal, which is expected to impose more stringent capital requirements on banks according to KBRA research.
The global credit rating agency released its BDC Ratings Compendium, which examined outcomes for the fourth quarter of 2023 and provides an overview of perpetual continuously offered non-traded business development companies (BDCs) as well as recent market trends.
As BDCs expand their direct lending market share, they diversify and broaden their funding mix away from traditional revolving bank credit facilities, tapping senior unsecured debt markets, issuing collateralized loan obligations (CLOs), and establishing special-purpose vehicle (SPV) asset facilities, KBRA noted.
BDC net investment income (NII) continues to benefit from higher interest rates; nevertheless, KBRA remains cautious as fixed-rate debt issued in 2020 and 2021 matures and is refinanced at higher rates. In addition, with the Federal Reserve likely to lower interest rates, BDCs may face margin pressure.
In 2023, the majority of KBRA-rated BDCs had negative net fundings, suggesting low M&A activity and buyout transaction volumes combined with the sector’s cautious leverage measures. Growth was aimed at perpetual-life BDCs that raised primarily retail capital and newly formed BDCs that raised considerable institutional capital.
KBRA stated that liquidity “remains solid,” with many BDCs issuing senior unsecured debt in the fourth quarter of 2023 and the first quarter of 2024, anticipating short-term debt maturities and increasing their financial flexibility if markets get disrupted in the second half of the year.
KBRA-rated BDCs’ balance sheets “remain solid” as well, with modest leverage, a high share of first-lien senior secured loans to less cyclical industries, and low non-accruals.
BDCs have expanded significantly during the last five years, filling a void by providing critical loans to middle-market companies that were formerly primarily backed by banks. As a result, KBRA anticipates a further shift to private credit.
Private credit is estimated at roughly $1.7 trillion, with about $800 billion consisting of direct lending as of the fourth quarter of 2023, up from $830 billion and $322 billion, respectively, as of the same period in 2019, according to Fed data and Preqin cited by KBRA. BDCs had total investments of $281 billion as of December 31, 2023, according to SOLVE Advantage, which represents 35% of the direct lending market, KBRA noted.