(The following statement was released by the rating agency)
NEW YORK, January 07 (Fitch) Proposed regulation to increase
development companies' (BDC) maximum leverage level (legislation
won't likely result in immediate or sector-wide rating changes,
Fitch Ratings. However, Fitch generally views the potential
leverage increase as
a negative for credit quality.
The manner in which individual managers utilize a potential
increase relative to the seniority and liquidity of their
determine which BDCs might be exposed to negative rating
pressure. This could
increase rating differentiation amongst Fitch-rated BDCs, which
centered in the 'BBB' rating category.
Under the proposed legislation, asset coverage requirements for
decline to 150% of debt from 200% of debt, effectively allowing
BDCs to increase
debt to equity leverage to 2.0x from 1.0x. While the legislation
ongoing, the bill has passed the subcommittee and could go to
the House of
Representatives for a vote as early as the first half of 2014.
Supporters of the
bill argue that the higher leverage limit would increase the
lending to the middle market, an activity that banks have pulled
back from due
to regulatory capital limitations. Supporters also view a
leverage increase as a
means to increase portfolio credit quality, seniority, and
liquidity, all while
improving equity returns.
Fitch believes ratings for BDCs are capped at the 'BBB' rating
category due to
the relative illiquidity of BDC's assets, the market value
sensitivity of the
BDC structure, dependence on the capital markets to fund
portfolio growth, and a
limited ability to retain capital due to dividend requirements.
A key factor
underpinning this rating view is the current leverage limit of
contributes to stronger recovery prospects for debt holders,
even if portfolio
investments are exited at a meaningful discount.
Absent a corresponding increase in leverage, an increase in the
leverage limit would increase a BDC's asset coverage cushion.
This could better
mitigate the illiquidity of BDCs' assets and the mandatory
in the BDC structure. However, during a prolonged period of
economic stress, a
more rapid deleveraging and/or sale of assets may be more
advantageous from a
debt holders' perspective, although that would likely be
accompanied by reduced
While asset coverage cushions would immediately increase at the
time the bill is
passed, Fitch expects cushions would decrease over time as BDCs
leverage. For example, BDCs may elect to invest in more senior
as middle-market asset-backed loans (ABL) and bank loans. These
yields relative to current BDC investments, but when accompanied
leverage allow for comparable levered equity returns. It is not
feasible for a BDC to invest meaningfully in ABLs and bank loans
now given that
these types of investments cannot generate returns above BDCs'
While ABL and bank loans may generally exhibit increased asset
relative to current BDC investments, this differential may be
limited in a
The use of incremental leverage will vary by company, with some
aggressive than others, which could differentiate ratings among
BDCs. BDCs with a senior secured investment focus could feel
pressure to raise
internal leverage targets if competition is running at higher
and earning higher returns for shareholders. The use of
simply to increase equity returns by levering up riskier assets
recovery prospects would negatively pressure ratings.
Before any additional leverage could be added, BDCs would need
to amend their
bank credit facilities. Currently, all Fitch-rated BDCs use
revolvers for working capital needs and/or longer-term
financing, and the
majority of these credit facilities have a 200% asset coverage
order to take leverage above 1.0x, the banks would need to amend
coverage covenant to 150%. If banks agree to the amendment, this
ultimately be a governor of how much additional leverage BDCs
given advance rates on different asset classes.
Katherine (Kate) Hughes
Associate Director - Financial Institutions
70 West Madison Street
Chicago, IL 60602
+1 212 908-0560
One State Street Plaza
New York, NY 10004
Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549,
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch
Wire credit market
commentary page. The original article, which may include
hyperlinks to companies
and current ratings, can be accessed at www.fitchratings.com.
expressed are those of Fitch Ratings.
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