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BDCs weigh U.S. rescue they want yet may not be able to accept

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Business development companies are trying to figure out how they might be able to take advantage of lifelines thrown by regulators to mid-sized companies battered by the coronavirus.

The investment vehicles, which make up a $110 billion corner of the private credit market, have come under pressure in recent weeks with the cash-strapped middle-market firms they lend to drawing on credit lines as Covid-19 shutters businesses.

There’s little clarity on how accessible the Federal Reserve’s Main Street Lending Program -- which will dole out as much as $600 billion in loans to small firms -- will be. The loans may be out of the reach of BDC portfolio companies if their debt levels exceed specified limits.

In addition, loans available under the Paycheck Protection Program -- that can be written off completely down the road if used for certain things like paying workers -- won’t be available to some borrowers that are owned by private equity.

The Fed is accepting feedback through Thursday on the Main Street program. One area of uncertainty is whether it will take into account earnings adjustments, which have become the norm in private debt. If they do, that could potentially eliminate even more borrowers from getting support.

“It’s going to help, but the devil’s in the details,” said Mark Emrich, a managing director at valuation firm Murray Devine & Co. There are several material questions that need to be answered for BDCs. “As I talk to others in the market, the questions that come up are how are they defining Ebitda?” Emrich said. “What about addbacks? How strict are they going to be? Where does the loan sit in the capital structure?”

But even if the loans are within reach, there’s doubts about whether borrowers will want to sign up for them. The four-year loans, which have attractive interest rates of between 2.5% to 4% above the Secured Overnight Financing Rate, also come with hefty restrictions, said James Kaplan, a partner at law firm Quarles & Brady.

“It’s a trade-off,” Kaplan said. “You want the loan but it does limit your business activity, including restrictions on worker compensation, stock repurchases and dividends.”

SEC Action

The Securities and Exchange Commission, which last week approved long-awaited rules that make it easier for BDCs to raise capital, has also stepped in with measures that could help BDCs, and which at least one firm has already chosen to grab.

Under a new order, BDCs can calculate asset coverage ratios -- which essentially cap debt to equity ratios at 2 to 1 for the majority of lenders -- using the value of their portfolios as of Dec. 31. That essentially removes the negative impact of the coronavirus on portfolios and means BDCs can make additional investments in existing portfolio companies just when they need it.

Prospect Capital Corp., with $5.4 billion in assets, said Monday it will use the exemption to give it additional flexibility to support companies during the economic disruption caused by the virus. A request for comment wasn’t returned.

BDCs, which must elect to operate under the order and win board approval to do so, would have limits on new investments. “It’s really targeted for BDCs that need to issue senior securities and offer liquidity to existing portfolios,” said Brian Hirshberg, a member of the capital markets practice at law firm Mayer Brown.

The SEC’s move is regarded by some as a recognition of the increasing importance of BDCs in the $812 billion private credit market. Despite the headwinds the industry is facing, including potential declining asset values and profitability, some players are well-positioned to take advantage of the disruption -- without relying on outside help.

“There are those that are fully capitalized and are lending and are not relying on these programs to make new investments or support their current portfolio companies,” said Cynthia Krus, executive partner at Eversheds Sutherland, who advises the lenders. “They’re still open for business.”

Bloomberg News
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