The US House of Representatives passed legislation on Thursday that could double the debt-to-equity leverage ratios allowed for business development companies.
The House approved the Financial Choice Act in a 233-186 vote, with Republican members nearly unanimous in supporting the legislation and Democrats united in opposition, according to the congressional record.
The bill moves on to the Republican-controlled Senate for a vote now. A final bill hashing out the differences in each house’s draft must the House and Senate before heading to President Donald Trump’s desk.
The FCA increases the BDC leverage limit – which Congress set at a 1:1 ratio decades ago – to 2:1, in addition to rolling back regulations of the financial industry from the 2010 Dodd-Frank Act. The legislation would also abolish the Volcker Rule, which limits the types of firms that can sponsor a private equity-style fund.
Boosting leverage to 2:1 will have a “profound positive impact for BDCs”, Manuel Henriquez, chairman and chief executive at Hercules Capital, told Private Debt Investor in April.
Doubling the debt-to-equity ratio could allow BDCs to extend credit at lower costs, while still fulfilling their shareholder’s expected return of 10-12 percent, he added.
This increased leverage could help each BDC be a better “economic engine to the US economy and in providing growth capital to small and medium business to stimulate economic growth,” Henriquez said.
A group of well-known institutional investors including The California Public Employees’ Retirement System and the New York State Teachers’ Retirement System had opposed the FCA because the bill would undercut shareholder rights, like control on executive pay, and allow special interests to block financial law enforcement.
For BDCs, increased leverage could widen the gulf between firms that have a low cost of capital and those that do not, as PDI argued. Firms that pay a premium for capital already may have to pay even more for the additional leverage, while firms that borrow at low rates could see total interest expense increase nominally by comparison.
The FCA is moving through the halls of Congress as BDC performance has continued its upward trend recently.
The average BDC market price has spiked more than 21.24 percent over the 12 months ending 8 June, while net asset value per share has jumped by 10.22 percent over the same period, according to the Cliffwater BDC Index. Over a three-year period BDC market prices have increased by 17.63 percent and NAV has gone up 21.16 percent.