Business development companies may be in danger of breaching their own debt contracts as rocky markets cause the value of their credit portfolios to drop.
BlackRock Capital Investment Corp. and New Mountain Finance Corp. are two BDCs that are being monitored by Fitch Ratings for potential downgrades, according to reports published by the ratings agency this week. “They’re the most exposed” to stress in the markets out of the BDCs covered by the credit rater, Fitch analyst Meghan Neenan said by phone.
Fitch does not cover Apollo Global Management’s BDC, which on Thursday announced that it has seen “increased funding requests from some of our existing borrowers.” The BDC, Apollo Investment Corp., told its shareholders in a letter that “we believe we have the liquidity to meet these contractual requests.”
Shares of BDCs, which lend to companies in the middle market, have recently tanked on concern the coronavirus pandemic will sharply erode cash flows of the companies in their portfolios, according to Neenan. She said a drop in the value of their holdings can lead to a rise in leverage that pushes BDCs into a technical default with their own lenders. The extent of the stress they’ve endured in the recent market turmoil will be clearer after releasing their first quarter valuations.
“The asset value is going to come down,” said Neenan. “What we don’t know is by how much.”
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Valuations will likely be marked down less than the steep price drop seen with broadly syndicated loans, which trade more frequently, according to Neenan. In a recent memo to clients, Oaktree Capital Management’s Howard Marks said that tumbling bond and loan indexes had “brought substantial losses to holders,” with senior loans falling 15 percent from February 19 through March 18 to about 81.6 cents on the dollar.
“The middle market will be down considerably less,” Neenan predicted. BDCs don’t actively trade their loans, she said, explaining their valuations are marked to models instead of market.
Still, Fitch sees reason for concern, as the recent widening of credit spreads will likely drive markdowns.
BlackRock Capital Investment Corp. is on “negative” watch as its “minimum shareholders’ equity covenant on its revolving credit facility agreement may not be sufficient to account for portfolio valuation declines resulting from credit spread widening associated with the global coronavirus pandemic,” according to a Fitch report on March 25. The BDC’s “cushion to its asset coverage requirement could also fall meaningfully with valuation marks,” Fitch said.
New Mountain Finance Corp. is also on “negative” watch, with Fitch citing concerns over its asset coverage cushion in a separate March 25 report. Shares of the BDC have been trading at a “significant discount to its net asset value,” Fitch said, hindering its ability to issue public equity in the near term to add to the cushion.
BlackRock did not immediately provide comment on the performance concerns of its BDC, while an investor relations representative for New Mountain did not immediately respond to an email and phone call seeking comment.
Shares of New Mountain’s BDC were down 45 percent this year through March 25. BlackRock Capital Investment Corp. and Apollo Investment Corp. have each dropped about 56 percent over the same period.
While shares of all three BDCs jumped Thursday as the stock market rallied, Neenan said that investors had been signaling increased concern about the underlying holdings of BDCs generally. They probably have drawn on their credit lines in recent weeks to help companies in their portfolios “shore up liquidity given the economic uncertainty,” according to Fitch.
Apollo’s BDC sought to reassure its shareholders in the letter it released Thursday — despite aircraft leasing company Merx Aviation Finance representing 12 percent of its portfolio based on fair value at the end of last year. While Covid-19, the disease caused by the coronavirus, has had a direct impact on the aviation sector, the BDC said Merx was in “a position to weather the current challenges.”
“We are in continuous dialog with our portfolio companies regarding their liquidity needs,” Apollo Investment Corp. told shareholders. “We believe we have sufficient capital to meet these needs.”