UPDATE: Prospect Capital Corporation said it would not change its leverage capacity in a 6 April SEC filing, citing new industry regulations from Standard & Poor’s. The ratings agency had put Prospect on a negative credit watch following its decision to up possibly up its leverage.
Multiple business development companies have taken the first steps to allow the usage of additional leverage, following the passage of a new law doubling the amount these mid-market lending vehicles can statutorily borrow.
The boards of directors for FS Investment Corporation and Prospect Capital Corporation have approved measures letting their respective companies take on additional debt if they so choose. The Small Business Credit Availability Act, which was tacked onto a $1.3 trillion spending bill last month, increases the debt-to-equity ratio allowed under law for BDCs from 1:1 to 2:1. President Donald Trump signed the bill into law on 23 March.
FSIC and Prospect, neither of which could be reached for comment, disclosed the developments in regulatory documents filed with the Securities and Exchange Commission. The new ratios for the two BDCs will kick in come March of next year. FSIC currently is levered at 0.75x, while that figure for Prospect is 0.59x.
Under the new law, a BDC must seek approval from its board of directors or shareholders to increase its leverage limit. If the managers seek board approval, they have a one-year wait time before the 1:1 ratio can be surpassed. If the company seeks shareholder approval, however, it would be able to exceed the 1:1 limit starting the day after shareholders approve the measure.
“I think all BDCs will approve the leverage capabilities so they have the ability to utilise it. It’s going to depend on the specific BDC on whether it goes above 1:1. They’re going to have be able to access additional debt,” said KBW managing director and BDC analyst Ryan Lynch.
To tap that extra capital, he noted, the companies will need to amend their loan documents, most of which have a 1:1 debt-to-equity ratio limit, or tap the unsecured debt markets. It will likely take several years before any BDCs get “meaningfully above” a 1:1 debt-to-equity ratio, he added.
Additionally, Ares Capital Corporation has recommended that it be allowed to incur additional debt to invest in another portion of the mid-market that was “previously not economic” for the largest BDC, chief executive Kipp deVeer said in a statement.
Ares declined to comment beyond the release.
The BDC’s management hasn’t decided whether it will seek board approval or shareholder approval, according to a source familiar with the situation. Ares is currently levered at 0.68x.
Another upshot to the increase of leverage levels could be a larger return on equity for BDCs, possibly from a median of 7 percent up to 8-9 percent, according to a Wells Fargo research note. The note, penned by Jonathan Bock, Finian O’Shea and Joseph Mazzoli, cites the ability of BDCs to invest at in lower-risk, lower-yielding investments as a reason for the potentially higher ROE.