After a colossally “brutal” period in the beginning of the COVID-19 outbreak last year, a recent report from Kroll Bond Rating Agency noted that business development corporations mostly rebounded by year-end 2020 to bring a sense of renewed optimism into the alternative-lending space.
“Underwriting volumes that dried up in 2Q 2020 rebounded quickly in the second half of year, while bond spreads tightened close to pre-COVID levels,” the KBRA report stated, “and a large percentage of non-accruals either resolved themselves or were restructured, refinanced or amended.”
KBRA, at year-end 2020, held stable outlooks to eight of 12 publicly traded BDCs it tracks.
That stood in stark contrast to March 2020, when mark-to-market portfolio valuation declines had ranged between approximately -3% and -10%, according to KBRA – noting that mainly reflected credit spread widening in March.
“COVID was a massive shock to the system,” said Chris Flynn, president of First Eagle Alternative Credit, which operates First Eagle Alternative Capital BDC (Nasdaq: FCRD) . “You run sensitivities, you run stress tests, you run different scenarios, and you figure out how many different standard deviations away from the mean. COVID was pretty dramatic.”
Because a majority of BDCs had adequate credit lines to cover unfunded commitments, BDCs were able to weather much of the early tumult of COVID-19’s impact, KBRA’s report noted. By the start of the fourth quarter, many were able to increasingly add unsecured debt to their balance sheets and raise $3.5 billion in debt capital markets since the start of the fourth quarter, according to KBRA.
“If you think about a bank’s operations historically, if there’s stress to the system or if a credit underperforms, then the workout team come in,” said Flynn. “They are focused on minimizing liquidity, because they need to reduce exposure, which basically cuts off the life of the business. That traditionally resulted in bankruptcies and defaults.”
By contrast, many of First Eagle’s BDC clients were buoyed by the firm’s prudent underwriting that limited so-called “tier one” exposure to companies that were potentially impacted by the pandemic.
“So, I feel that if this was a test run to find out whether alternative credit is here to stay, and if it is a better alternative to the historic way these businesses were financed with commercial banks, then I would say the industry passed with flying colors.”
