LevFin Insights —BDCs: Long-awaited BDC Bill inked today as part of bigger spending bill passed by Congress and signed by Trump
The long-awaited BDC reform bill that has been making the rounds since 2012 has finally been inked as part of a larger $1.3 trillion spending bill that was approved by Congress this morning and signed by President Trump this afternoon.
The bill — which was wrapped into the larger spending package — does two main things for BDCs: it expands their lending capacity through the use of greater leverage, and makes forming a BDC easier by streamlining SEC filing requirements.
The leverage limitation will go to 2:1 from the current 1:1 ratio, upon shareholder or director approval. This gives BDCs the opportunity to compete more easily on syndicated loans and upmarket credits by maintaining returns despite thinner pricing on these deals. Additionally, the ability to book larger —higher quality— assets should reduce default risk.
While all BDCs will benefit from a greater leverage cushion, the biggest upside will go to the large, diversified managers with strong track records, origination platforms and limited losses. These BDCs potentially could see lower costs of debt despite a more leveraged balance sheet.
“We see improved risk-adjusted returns as similar ROEs are generated on safer collateral,” Wells Fargo’s Jonathan Bock stated in a research note to investors this morning. He said the cost of debt is more likely to move closer to L+150 from L+225 for a higher leveraged BDC with lower yielding / lower risk assets — similar to that of AAA middle market CLO notes. “A lower yielding asset level strategy would likely be attractive for investors who are more risk averse and additional leverage would still drive strong ROE,” he stated.
Other BDCs may see borrowing costs rise as credit markets look for better compensation against more leveraged balance sheets.
“BDCs may have to rely on higher cost, unsecured debt in order to push leverage significantly above 1:1.,” Keefe Bruyette & Woods analyst Ryan Lynch noted in a March 21 research report. Rating agencies may only allow select BDCs to move above 1:1 or may not be comfortable with a BDC running above some to-be-determined threshold below the 2:1 regulatory maximum. Lynch cites PNNT as an example where its rating agency does not want the BDC to go above 0.8x leverage, despite the current 1:1 regulatory limit.
More broadly, the bill injects more capital into a loan market already competing ferociously for assets and awash with issuer-friendly terms.
Public BDCs have total assets of about $59 billion. KBW estimates total assets could increase by $8 billion to $25 billion, depending how much additional leverage is utilized, for a 14% to 42% increase in AUM across the space.
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