Fitch: Institutional Debt Markets Re-Open to BDCs
CHICAGO--(BUSINESS WIRE)--The institutional debt market appears to have re-opened to business development companies (BDCs) as Ares Capital Corp. (Ares), Fifth Street Finance Corp (FSC) and Prospect Capital Corp (Prospect) issued unsecured notes since early 2013. Fitch Ratings believes this is a positive sign for an industry that was shunned by the institutional unsecured market since the onset of the financial crisis as a result of prior covenant breaches by two large legacy issuers.
Increased unsecured debt issuance would diversify BDCs' funding sources and add additional financial flexibility as a result of increased unencumbered assets.
The BDC industry has expanded dramatically in recent years, and we believe an increase in the size and number of potential issuers should allow institutional investors to differentiate between stronger and weaker players, particularly when market conditions are difficult.
Prospect was the first BDC to complete an institutional deal since the crisis; pricing a 10-year, $250 million offering at 5.875% in March 2013. Ares issued $600 million of five-year notes with a 4.875% coupon in November 2013, then two months later, reopened the deal for a $150 million add-on, at a premium. This speaks to investor appetite for the company's paper. The most recent issuance was FSC's five-year, $250 million offering with a coupon of 4.875% this month.
We expect other BDCs with demonstrated credit discipline and the balance sheet capacity to handle a $250 million deal to access these markets as well.
While the re-opening of the institutional market is at least partially attributable to a search for yield in the low interest rate environment, investors are showing a willingness to lend to the space at a time when leverage limits could double (if proposed legislation is passed by Congress). Although three deals have been completed over the past 18 months, it is still too early to tell how reliable this market will be as a source of debt capital in the future.
Prior to 2007, the industry was comprised of only a handful of registered BDCs. Allied Capital Corporation (Allied) and American Capital, Ltd. (ACAS) were the two largest and demonstrated access to the institutional market. However, the financial crisis led to sizeable portfolio write-downs, causing both Allied and ACAS to trip debt covenants. This led to a protracted period of renegotiation, particularly for ACAS. Rating downgrades forced some investors to sell at a loss, which effectively precluded BDCs from accessing the market until recently.
The BDC industry has grown significantly in recent years as banks, facing tougher capital requirements, have cut back on lending to the middle-market space. Today there are nearly 60 SEC-registered BDCs, which have raised more than $15 billion of cumulative equity capital since 2007.
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.