It’s been a year since US business development companies won a major victory – possibly ushering in the biggest change in the industry’s history – and became able to take on additional debt.
As a refresher, the enactment of the Small Business Credit Availability Act in March allowed BDCs to increase their leverage profile to a 2:1 debt-to-equity ratio, up from 1:1, subject to several factors.
There are two ways BDC management can assume the ability to take on the additional debt: a board vote or a shareholder vote. Those that win approval via the former route must wait a year before they can access the new debt, while those that take the latter option can tap it immediately.
Another (likely) step in the implementation process is to win over BDC lenders’ consent to alter their credit facilities covenants, many of which would not let the borrowers go above the old 1:1 maximum.
Paying for leverage
One potential sticking point was how BDC management teams would charge fees on their additional levered capital.
“Some managers have fairly attractive fee schedules and I expect will use the leverage change to enhance shareholder value,” Cliffwater’s Steve Nesbitt told PDI shortly after the legislation passed. “Those that do not are going to have difficulty executing on a larger leveraged strategy. They’ll either get blowback from their investors, or they will start selling at deeper discounts.”
One common remedy is to maintain the firm’s base management fees – most of which are charged on levered funds in addition to equity – on assets financed up to the 1:1 level and cut that figure to 1 percent on assets above it.
“Some managers have fairly attractive fee schedules and I expect will use the leverage change to enhance shareholder value.”
Steve Nesbitt, Cliffwater
BDCs that have done so include those backed by Ares Management, Solar Capital, The Carlyle Group, and Oaktree Capital Management. The FS Investments- and KKR-backed vehicle will do the same if its shareholders give it permission to expand its borrowing capacity. Apollo Global Management’s BDC permanently cut its management fee of 2 percent to 1.5 percent on all assets financed up to the 1:1 ratio. Above that threshold, the management fee is 1 percent.
PDI takes a look at the 10 largest public BDCs by total assets as of 31 December 2018 to discover what they have done.
Ares Capital Corporation
Total assets: $12.9bn
The industry’s largest player approved the extra leverage via a board vote in June 2018 and will be able to up its leverage profile on 21 June.
It has set a new target leverage range of between 0.95x and 1.25x. ARCC plans to use a “modest amount of incremental leverage” to continue executing its current strategy.
The firm believes it could achieve an increase of up to 20 percent on its annual core earnings per share. ARCC also played a pivotal role in pushing for the legislation, spending $2.32 million out of the at least $8.23 million in lobbying costs that BDCs disbursed overall.
FS KKR Capital Corporation
Total assets: $7.11bn
FS Investments, which merged with KKR’s Corporate Capital Trust late last year, won board approval shortly after the SBCAA was signed into law. The firm recanted, though, after S&P puts its credit rating on negative watch, thus signalling that the mid-market lender could be stripped of its investment-grade status. The firm also helped finance the SBCAA’s passage, contributing $3 million to the effort. The BDC has decided, however, that it will seek shareholder approval for additional leverage at its annual stockholder meeting in June.
Prospect Capital Corporation
Total assets: $5.97bn
Prospect was one of the first BDCs to vote to increase its borrowing availability via a board vote, but it too walked back on the decision after S&P put it on negative watch. The firm received an investment-grade rating from Moody’s earlier this year. Management indicated on the earnings call for the firm’s fiscal second quarter, ending on 31 December 2018, that there were no plans to revisit extra leverage capacity.
Main Street Capital Corporation
Total assets: $2.55bn
Main Street is one of the few BDCs that has chosen not to pursue the extra leverage capacity. On its first-quarter 2018 earnings call, the firm alluded to S&P’s bearish stance on the hike in borrowing capacity and noted it would like to maintain its investment-grade
rating. The firm spent $390,000 in lobbying for the legislation.
Golub Capital BDC will be number four on the list if a merger with Golub Capital Investment Corporation, one of its private BDCs is completed. The merged entity would have pro forma assets of $3.5 billion, as of 30 September. Due to the US government shutdown at the beginning of the year, the merger has been delayed. Golub Capital BDC won approval from shareholders in February to tap the extra borrowing room. Management has said it does not plan on deviating from the current strategy, but the firm will benefit from the ensuing flexibility. The merger had not closed at the time of writing.
New Mountain Finance Corporation
Total assets: $2.45bn
New Mountain was one of the firms that sought approval from its board and its shareholders, and won them both. Earlier this year, the firm was at the upper end of its target leverage range. As a result, in February it conducted an equity offering that raised $59.3 million.
Apollo Investment Corporation
Total assets: $2.38bn
Apollo spent $2.25 million lobbying Congress on the legislation and was one of the first to take action. The extra capacity took effect in April after a board vote last year. The BDC will use it to invest in lower-risk assets.
The firm has set its new leverage range between 1.25x and 1.4x. Management said in May 2018 that doing so could provide it with an additional $1 billion in assets.
PennantPark Floating Rate Capital/
PennantPark Investment Corporation
Total assets: $2.24bn
PennantPark Floating Rate won approval from the board in 2018 and was able to access the additional leverage in early April. The new target level leverage is between 1.4x and 1.7x. PennantPark Investment secured the go-ahead from its stockholders to tap the extra borrowing capacity in February and can access it immediately. That BDC’s new leverage target is 1.1x-1.5x.
Solar Capital/Solar Senior Capital
Total assets: $2.14bn
Solar and Solar Senior won approval from their respective boards in August and from their shareholder bases in October. Solar now has a target leverage range of between 0.9x and 1.25x, while for Solar Senior that scale is 1.25x-1.5x.
The extra leverage and a new private fund that the firm held a final close on in October have increased its hold size substantially to $200 million, according to a source familiar with the situation. The extra leverage will allow Solar Senior to expand its commercial finance businesses.
Oaktree Specialty Lending Corporation/
Oaktree Strategic Income Corporation
Total assets: $2.12bn
Oaktree Specialty Lending is one of the late-comers. The firm’s board approved the measure in February and does not plan to seek shareholder approval. Oaktree Strategic Income, however, secured approval from its shareholders in July to access the extra leverage. It has set a new leverage target range of 1.2x-1.6x.
Total assets: $2.08bn
The Carlyle Group-backed BDC received approval from its board and shareholders in April and June, respectively, to up its leverage. The target range is now 1x-1.4x, management said on the fourth-quarter earnings call in February. The firm spent $60,000 on lobbying for the legislation.