The initial discussion around the increase in leverage that business development companies have been allowed has centred around market effects: what it will mean for covenants and terms, how BDCs will use it in their portfolios, and the like.
Now the discussion has shifted to corporate governance. The statute Congress approved on March 23 – the Small Business Credit Availability Act – lets BDCs opt to increase their leverage levels via a vote by the board of directors or shareholders from a 1:1 debt-to-equity ratio to 2:1.
An incentive to ask shareholders for approval is that the BDC can access the additional borrowing capacity the day after they approve the measure, whereas if a board signs off on the added leverage, the BDC must wait a year.
On this important issue, shareholders deserve a say in the matter.
Any movement in leverage will affect both the management and incentive fees, increasing them as BDCs – many of which charge management fees on gross assets – borrow more. The timing of the issue is opportune: Why not poll equity investors on the leverage issue at annual meetings currently being held, saving time and money associated with a special shareholder meeting?
Some have done so. Monroe Capital Corporation and Stellus Capital Investment Corporation both filed proxies with the Securities and Exchange Commission asking shareholders to vote in favour of the matter. The boards for both BDCs have approved a measure allowing them to increase leverage capacity. Some firms, though, have moved ahead without a shareholder vote.
In candid conversations, market analysts, observers and managers have all voiced support for holding shareholder votes, most in no uncertain terms.
“The storm is visible on the horizon,” one person said, noting that credit managers emerged as winners in the Small Business Credit Availability Act. “You can use more leverage and have a wonderful impact on management fee income.”
Legally, BDCs are required to ask their shareholders for approval to issue stock below net asset value per share. Why shouldn’t the same philosophy be applied to upping a BDC’s leverage capacities?
“Incorporation of shareholders into this leverage discussion may create a compelling opportunity to drive further support for the business strategy and leverage efforts,” write the Wells Fargo Securities’ BDC analysts in their quarterly BDC scorecard. “Managers/boards may be surprised as to the level of support they’ll receive.”
Credit managers are constantly talking about differentiation, and much of the time those talking points revolve around offering numerous product sets, accessing niche parts of the market and other matters relating to investing activities. Adoption of the new leverage guidelines presents a chance for managers to differentiate themselves through corporate governance.
Unlike closed-ended funds, the shareholders of publicly traded BDCs are free to exit their positions at any time, or more bluntly put: BDC investors can walk away if they are dissatisfied with a given manager. It’s therefore incumbent on managers to win the go-ahead from shareholders when making a change as significant as boosting leverage capacity.
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