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Prices of listed BDCs tumble as falling rates and bankruptcies spook investors
by Lisa Fu
The business development company, a once overlooked vehicle for middle market direct lending in the US, has spent the past few years riding the wave of private credit interest and favourable interest rates. But as rates come down and investors worry about credit quality, publicly traded BDCs have seen share prices decline.
The expectation of a lower interest rate environment, coupled with fears stoked by recent high-profile bankruptcies, including that of auto parts company First Brands, have spooked investors in listed BDCs.
The S&P BDC Index fell nearly 15% from the start of September to its lowest point in October. Many BDCs are now trading for less than the value of their assets, which could force some to rein in their lending.
BDCs emerged in the 1980s to support small, Main Street borrowers, while giving individual investors exposure to assets traditionally reserved for institutions. A BDC boom over the past decade has driven the universe to 166 BDCs, listed and unlisted, representing more than USD 503bn in assets as of 18 August, according to the LSTA’s most recent BDC quarterly report.
“It’s really been institutionalised in the last, let’s call it 10 years, by a number of quality managers including ourselves,” said Matt Stewart, managing director and head of BDC strategy at Blue Owl.
S&P BDC Index
Source: S&P Dow Jones Indices
Rising interest rates following the pandemic onset, from 2022 onwards, put wind in the sails of BDCs. BDC portfolios filled with floating rate loans produced more interest income, which translated into attractive dividends for investors.
But with the Federal Reserve on a path to lower rates — though perhaps paused for the rest of the year — that tailwind has flipped into a headwind.
“BDC shares began to sell off around the middle of September at the same time the Fed began to cut interest rates,” said Mickey Schleien, an analyst at Clear Street. Investors are likely concerned about the sustainability of payouts, he said.
Investors may also have felt anxious over potential issues in direct lending markets following the bankruptcy of First Brands.
Several BDCs saw higher short interest in September, said Larry Herman, a managing director at Raymond James.
“I think that exacerbated the decline in BDC shares, but I think there was a misunderstanding about direct lender involvement in First Brands,” said Schleien. The market seems to have since digested that BDCs had little exposure and shares have rebounded — but not recovered.
Long-term depressed share prices could be problematic for BDCs that want to raise equity to deploy into new loans, said Schleien. When its shares trade below book value, a BDC cannot issue new equity to fund fresh direct lending.
BDCs are trading at an average discount to net asset value of around 15%, he added. Vehicles without an adequate equity buffer could turn to debt but would face leverage restrictions.
“BDCs do have growth potential through equity, but we’re not relying on raising new equity to invest in new assets,” said Stewart. The firm has around USD 17bn in equity between its two listed BDCs and has kept leverage relatively low.
Optimists say BDC share prices could recover, despite expected lower rates, if investors temper their dividend expectations. After all, listed BDCs still offer juicier yields than many other asset classes.
“The outlook for listed BDCs will hinge on the Fed’s rate path, investor expectations for dividends and the resilience of underlying credit performance,” said Herman. “Ultimately, it comes down to how effectively management communicates its dividend strategy.”
Investors will take comfort if credit quality is maintained. This, said Schleien, was the case so far, as BDCs have generally managed to limit troubled credits and support borrowers.
“I think investors will continue to see... the high, steady dividend yield that BDCs offer,” Stewart said. “As a result, I think you’ll see that discount narrow and trading prices improve.”
