NEW YORK--(BUSINESS WIRE)--The sector and credit outlooks for U.S. business development companies (BDCs) are negative for 2015, according to Fitch Ratings' 2015 BDC Outlook report published today. Competitive underwriting conditions, unsustainable asset quality metrics, and a notable shift in risk appetite, for some issuers, are among the factors that will pressure certain BDC ratings over the next year, according to Fitch.
Middle market underwriting conditions remain fiercely competitive, reflected by tighter yield spreads, higher leverage, and weaker covenant packages. These competitive dynamics make it more difficult for lenders to find attractive deals, resulting in a steady decline in portfolio yields and heightened pressure on dividend coverage. This trend has been slowed only by an expanded risk appetite and, to a lesser extent, more diligent sourcing of transactions.
The expanded risk appetite of BDCs is exemplified by higher balance sheet leverage, expansion into new industry verticals, such as aircraft leasing and venture lending, the introduction of senior secured loan programs, which are levered funds that are managed off-balance sheet, and movement down the investment capital structure. While Fitch believes these strategies may provide higher returns, they may also significantly alter BDCs' risk profiles.
BDC are generally well positioned to benefit from an eventual increase in rates. Fitch notes, however, that the benefit from spread expansion could be offset by asset quality deterioration, if underlying portfolio company borrowers are unable to service their increased interest requirements.
Low interest rates have generally masked underlying portfolio issues in recent years, given the relative ease of refinancing. Fitch expects some asset quality deterioration in 2015, but performance across the industry may vary significantly resulting in potential rating differentiation.
On a positive note, Fitch believes BDC funding profiles have improved meaningfully in recent years, with increased unsecured debt issuance and extended funding durations to better match assets and liabilities. Debt maturities are modest for the industry until 2016.
Rating activity on issuers in Fitch's BDC portfolio was negative in 2014, and Fitch believes there is potential for some further negative rating actions at the issuer level in 2015.
The full report '2015 Outlook: Business Development Companies' is available at 'www.fitchratings.com.'
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research: 2015 Outlook: Business Development Companies (Riding the Low Rate Wave May Leave BDCs Soaked)