Investors are losing interest in BDCs, suggesting wider sentiment dip
by Olivia Fishlow
Business development companies are generally seen as a proxy for the $1.7 trillion private credit market. Now, their struggles are indicating a weakening industry.
Investors are losing interest in BDCs, which hold private debt investments, in light of growing concern around credit quality and the Federal Reserve’s rate cut last month. Because most direct loans are floating-rate, the rate cut has led some managers to scale back distributions as their borrowers will pay less on their debt. Competition from banks is also leading firms to tighten pricing to win borrowers, bringing yields down further.
Shares of many publicly-traded BDC funds have dropped since the start of the year. Blackstone Secured Lending Fund is down around 21% year-to-date with Blue Owl Capital Corp. dropping 19% and Ares Capital Corp. dipping roughly 12%, according to data compiled by Bloomberg.
Jonathan Lamm, chief financial officer of the Blue Owl BDCs, said the firm is “completely flummoxed” by the BDC selloffs, noting the stock price does not reflect the strong credit performance of the fund.
“We think that we are mispriced from a sector perspective,” he said in an interview. “The only reason that the sector should be trading off like this is if there is a massive amount of credit defaults coming, which we see no evidence of.”
Some BDCs are already shrinking payouts to investors, eyeing future rate cuts. Blackstone Inc.’s non-traded business development company, Blackstone Private Credit Fund, said last month it was reducing its dividend by around 9% to 20 cents per share.
It is the first time that the $75 billion vehicle — the largest BDC in the industry — has ever cut its dividend.
The dividend cut seemed to be based on “market- and rate-related predictions, rather than credit issues in the portfolio,” according to Chelsea Richardson, a senior director at Fitch Ratings.
A spokesperson for Blackstone said that the action reflects the floating rate nature of BCRED’s portfolio, while noting the fund’s credit quality remains strong. A representative for Ares declined to comment.
At the end of September, Oaktree Strategic Credit Fund, another non-traded BDC, cut its dividend by roughly 10%, to 18 cents per share. And prior to the Fed’s cut, Golub Capital Private Credit Fund lowered its dividend by around 15%, landing near 19 cents.
Representatives for Oaktree and Golub did not respond to requests for comment.
Stress Indicators
Other BDCs are expected to cut too. Across 32 of such funds rated by Fitch, average dividend coverage is hovering at around 105%, according to Richardson. If that falls below 100%, it means that the fund is paying out more than it’s earning.
Many are looking at how future rate cuts will impact BDC dividends, since the promise of such payouts is a central appeal of the structure. When the Fed first started its rate-hike cycle, many of these vehicles boosted payouts with extra dividends on top of their base distributions, measures designed to pass along the benefit of higher floating-rate income to investors.
Mike Petro, the portfolio manager of Putnam Investments’ BDC strategies, analyzed the impact of rate cuts on their portfolio. He forecasts a further 75 basis point reduction would result in an 8.5% cut on average to the total BDC dividends from its peak. Petro cautioned that for the broader BDC market, the decline would likely be higher.
“Broadly, it is a message from the market forecasting more dividend cuts and some credit issues,” Petro said. He noted that the median BDC is trading at around 80% of net-asset value.
To be sure, lower rates make it cheaper for private credit funds to borrow money, which they need to dole out more investments. It’ll also relieve some pressure on companies struggling with higher leverage.
“As rates went up, their dividends went up, and as rates and spreads go down, you’ll see distribution cuts,” said Larry Herman, a managing director at Raymond James & Associates. There’s been a “decline in sentiment” partly driven by expectations of future cuts, he said.
Some market participants have also started to worry about private credit’s exposure to software companies, which could be upended by artificial intelligence. Technology accounts for around 23% of the Cliffwater Direct Lending Index, a benchmark that tracks the performance of middle-market private loans in the US.
Other signals of stress are flashing too, with the percentage of PIK in BDC portfolios, a tool to defer paying cash-interest, continuing to rise. Plus, implosions are happening elsewhere in leveraged-credit markets.
Investors are seeing more risk in BDC debt compared with similar lending peers, including banks, regional banks and indexes that measure financial institutions, according to a report from JPMorgan Chase & Co.
BDCs have boomed into a half-trillion dollar market, with total assets up 33% in the second quarter compared to the same period last year, JPMorgan said.
But investors increasingly have more options to invest in private credit. Asset managers are launching interval funds that allow investors to cash out periodically. These vehicles can also wrap up more than standard corporate loans, which many private credit firms are looking to diversify away from.
“So goes the performance of the BDC funds, so goes the performance of the investment manager’s broader direct lending strategy,” said Meghan Neenan, a managing director at Fitch, adding that assets sitting in BDCs make up about half of total direct lending volume.
Deals
- Private credit firms are weighing up providing a debt package worth around £1.3 billion to finance a potential take-private deal for JTC Plc
- CVC Capital Partners is in talks with private credit lenders to finance a dividend recapitalization of Swiss software business WebPros
- Goldman Sachs Group Inc. is selling a significant risk transfer tied to a portfolio of about $5 billion of corporate loans
Fundraising
- CVC’s credit unit has amassed a €10.4 billion pool of capital for its latest push into European direct lending
- Southeast Asia-focused alternative investment manager Indies Capital Partners Pte. has raised over $300 million for its fourth private credit fund
Job Moves
- Ares Management Corp.’s partner and head of strategy Eric Vimont is leaving the firm, after expanding in Asia via several key acquisitions
- Blackstone hired Apurva Shah for a top role in its private credit and insurance business in India as the alternative asset manager seeks to capture the country’s rising demand for credit
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