BDCs win leverage cap increase after US$1.3trn budget signed

NEW YORK, March 23 (LPC) - Business Development Companies (BDCs) will gain access to additional capital to lend to small and mid-sized businesses after language to increase the maximum leverage allowed by the funds was added to a US$1.3trn government spending bill President Trump signed into law on Friday.

The BDC language will permit the funds to employ leverage up to two times total debt to equity, meaning they will be able to borrow up to two dollars for every dollar of assets the fund owns and thus make more loans to the businesses in which they invest. Until now leverage for BDCs was capped at a ratio of 1:1 total debt to equity. The industry has been seeking change on this front for more than five years.

The omnibus spending bill needed to pass by midnight Friday to fund government operations and federal agencies through September. The US House of Representative passed the bill Thursday, advancing it to the Senate, which voted for the bill early Friday morning. Trump signed the bill later in the afternoon, but not before threatening to veto the budget and shut down the federal government.

The addition of the BDC language on Wednesday, which had in recent months garnered significant bipartisan support in both houses of Congress, and its hard won victory on Friday are widely seen by proponents as a win that will modernize the BDC industry and provide more growth capital to small and mid-sized companies. Legislative efforts to raise the leverage limit first began in 2012 and gained traction in late 2013.

Middle market businesses, often defined as companies with between US$10m and US$1bn in annual revenues, are a major driver of the US economy.

The use of additional leverage will permit BDCs to pursue higher quality deals with less associated credit risk, while still generating competitive returns for their investors, market participants and analysts said.

The possibility of accessing more capital comes at a welcome time for the BDC sector. In a highly competitive middle market lending environment, the sector has faced headwinds.

Some BDCs have struggled to grow or meet quarterly dividends as new entrants and record levels of fundraising for middle market direct lending and private credit strategies have put tremendous pressure on borrowing rates and portfolio yields.

Still, not all BDCs will necessarily have access to the full 2:1 leverage or opt to maximize leverage. Under the current 1:1 cap, BDCs, on average, utilize 0.71x leverage, according to a Wednesday report by analysts Ryan Lynch and Paul Johnson at Keefe, Bruyette & Woods.

Certain BDCs stand to benefit more than others depending on a range of factors, including the percentage of first-lien investments, track record, portfolio size/platform, investment grade rating, and current leverage utilized, the report said.

The KBW analysts wrote in the report that they expect the biggest beneficiaries to be Ares Capital Corp (ARCC), TCG BDC (CGBD), FS Investment Corp (FSIC), Golub Capital BDC Inc (GBDC), PennantPark Floating Rate Capital (PFLT) and TCP Capital Corp (TCPC).

Proposed legislation to increase the leverage cap was put back on the table late last year after the US House Financial Services Committee in November voted 58-2 to adopt H.R. 4267, the Small Business Credit Availability Act.

The language added to the government spending bill mirrors the House bill as well as S. 2324, the Small Business Credit Availability Act, which earned overwhelming bipartisan support in the Senate, including 6 Republican and 12 Democrat cosponsors, the Small Business Investor Alliance said in a release on Thursday. (Reporting by Leela Parker Deo Editing by Jon Methven)