Over the past few years, we’ve seen BDCs combine through joint ventures and M&A, resulting in larger entities with total assets far surpassing $5 billion. Firms continue to write larger cheques; in recent months, Owl Rock Capital Partners and Golub Capital, which both oversee large BDCs, each underwrote unitranche loans of more than $1 billion, stealing the thunder from syndicated markets.
We caught up with Eversheds Sutherland executive partner and BDC guru Cynthia Krus to see if that trend will hold in the coming year and what else 2020 might have in store for BDCs.
Private Debt Investor: What do you anticipate in 2020 for BDCs?
Cynthia Krus: I think you’re still going to be looking at consolidation, bigger is better in today’s marketplace. I think that almost all of the transactions that have been announced in the past year have reflected that. More AUM allows BDCs to do a larger variety of transactions, which allows them to do even larger size loans, and smaller BDCs can’t survive.
In addition, the institutionalisation of the BDC industry is also expected to continue. The typical BDC used to be a standalone fund. However, today BDCs are generally part of a platform of funds. Many BDCs have increased the size of the loans they make, and as a result of the need to diversify their portfolios, have sought to increase AUM. As a result, the depth and breadth of the industry will create even bigger players in the market.
What will the driving factor behind this consolidation be?
In addition to the search for greater AUM, some of the managers who have not performed as well as the industry will seek an exit through acquisition of their BDCs or assignment of their advisory contract. That will still be a component of these consolidation transactions.
Will the fundraising boom for private BDCs continue?
BDCs are a very flexible vehicle that allow smart asset managers to customise structures to fit their client bases. I think that the private BDC allows asset managers to ramp up a portfolio and build that vehicle into a viable publicly listed vehicle or alternatively provide a permanent private capital vehicle.
With the interest of institutional investors and in the wealth management channels, I expect to continue to see an appetite for the private BDC model. I believe you will see more of this in the future. Also, some of the BDCs that have raised private funds will go into exit mode soon. There are five or six out there that are coming up on their exit timeframe. Their success will give even more indications of how many more private BDCs we will see.
What do you anticipate seeing for the IPO market?
There certainly are going to be more BDCs or similar funds out there that have the ability to go public. However, the pace will depend on the overall market conditions. In today’s market, a BDC with $500 million to $1 billion in total assets is generally needed to be a viable IPO candidate. This is a lot larger than what it used to be.
In addition to size, a manager needs a “track record” or strategy to differentiate itself from the other managers. Without a significant size and well-defined strategy, it is very difficult to have a successful IPO of a BDC.
Are BDC portfolios well positioned for a downturn?
I do think the industry is the best prepared that I’ve seen it. BDCs now have more institutional support than in the past and managers that are still around took away valuable lessons from the 2008/2009 downturn. I do think they are in a pretty good place for the upcoming year since the portfolios are valued on a quarterly basis. The focus on valuations and methodology over the past couple of years has put BDCs in a good position.
Managers are also looking at their teams and seeing if they need more resources to proactively manage troubled situations or the best way to work through issues that may come along. I think managers are being smart about it.
BDCs are very resilient because they can invest at any level of the capital structure. They can move up and down the capital stack as the market warrants.
Also, as a result of 2008, I think managers have been more prudent about dividends and making sure they are able to meet those expectations, even if the market becomes more challenging.
What will the institutional investor appetite be for the vehicles?
I honestly think it’s like letting the genie out of the bottle – once people become familiar with the BDC structure, people will find a way to use the model. It reflects a greater shift or focus on the middle market as an economic engine. The middle market is a very attractive place to be lending or investing. From retail investors to high-net-worth individuals who don’t have another way of getting into this [private credit] channel, they will continue looking at BDCs. If an investor is looking for yield, this is one of the ways of satisfying that appetite.
Are BDCs a must-have for managers?
I definitely think that alternative assets are becoming mainstream. Managers are going to need some type of alternative in their portfolio of funds. The likelihood that a BDC is the alternative today is higher than ever. I think managers are much more creative when assessing alternative products and how such products fit into their portfolios’ strategy.
We ask firms who are interested in forming a BDC, why do they want to manage a BDC? Who is their target investor base? What are they planning to invest in? What type of vehicle would fit best for that investment strategy? Not the other way around. Because of the flexibility and resilience of the BDC, I think that BDCs are going to continue to grow and become a bigger slice of the market.