Drumroll, please!
With distributions few and far between in 2023, LPs are becoming more selective with their capital. It stands to reason, then, that investment performance and manager track records will be facing greater scrutiny than ever before. As such, new ways to compare and assess this data will be in high demand.

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Fitch: BDCs face recessionary bumps but have a cushion
Fitch Ratings, in a credit market commentary, discusses where business development companies stand, with Q2 numbers now in the books. The commentary says that earnings for the remainder of 2023 should be in line with expectations despite challenges from economic conditions.

Fitch expects a recession either in Q4 or in Q1 2024. Given differences in underwriting standards and portfolio risk profiles, this will have varying consequences across the BDC sector. But recent earnings may provide a cushion for bumps on the road ahead.

Interest coverage ratios have fallen for some of the underlying portfolio company borrowers. As an example, Ares Capital’s weighted average interest coverage ratio declined to 1.6x in Q2 from 2.4x YoY. Such a fall could put pressure on cash earnings. Relatedly, Fitch expects an uptick in amendment activity and payment-in-kind interest going forward.

As to the cushioning for such expected bumps: numbers vary greatly across the sector. As Fitch points out, Hercules Capital posted net investment income growth of 88.6 percent, year-over-year, for the second quarter 2023. The NII figure for Ares Capital, on the other hand, was 39.5 percent.

Several issuers have increased their base dividends due to excess earnings from the increased interest rates of recent quarters. Eleven of the 20 rated issuers announced dividend increases as part of their Q2 2023 earnings results.

It is likewise becoming more common for BDCs to include supplemental dividends based on excess earnings. Fitch expects that the spread of this policy will stabilise base dividends through cycles.

Essentials