KBRA releases its Business Development Company Ratings Compendium, which looks at results for the quarter ended September 30, 2024. This quarter, KBRA reviewed the financial performance of our rated BDCs in a landscape characterized by ongoing competitive pressures, increasing payment-in-kind (PIK) optionality, declining but still high base interest rates, and the potential for distribution/common dividend cuts. We also evaluated asset quality, noting higher unrealized and realized losses for some BDCs despite consistently low non-accrual rates. In 3Q24, the market environment remained characterized by low transaction volumes, significant capital raises by new private credit vehicles, and a strong broadly syndicated loan (BSL) market supported by an active collateralized loan obligation (CLO) market.

For this Compendium, KBRA separated the financial metrics of its continuously offered non-traded perpetual BDCs (eight publicly rated), given their nascent stage and portfolio composition differences. These BDCs have unseasoned portfolios with minimal or no non-accruals (median 0% at fair value (FV)), a significant proportion of first lien senior secured loans (median about 96%), and a reasonable allocation to more liquid assets, including BSLs with lower yields. They also exhibit relatively low gross leverage, with a median of 0.83x.

KBRA-rated BDCs generally demonstrated stable performance in 3Q24, and KBRA maintains an overall Stable Outlook for 2025, supported by solid credit metrics. This includes comfortable liquidity coverage for near-term maturities, which have either been refinanced or in some cases proactively prefunded. Liquidity and funding structures have benefited from sizable issuances of senior unsecured debt in a favorable market for unsecured debt in 2024. Further, KBRA-rated BDCs are aided by strong access to bank credit facilities, reflecting considerable overall relationships between major banks and large BDC managers. The ability to proactively tap debt markets and enhance bank funding sources bolsters our view of liquidity heading into 2025. Additionally, BDCs are focused on liability management in the high interest rate environment, enhancing funding sources to include middle market CLOs for increased diversification of secured borrowings and hedging newly issued fixed rate debt in anticipation of lower rates. KBRA believes that the rated BDCs can navigate an uncertain environment effectively, driven by strong investment composition, which includes a high proportion of senior secured first lien loans and moderate leverage. Non-accruals remain manageable with room for an increase in the event of a less favorable economic environment.

Key Takeaways

• Increased Use of PIK Interest: In response to competitive pressures, BDCs have increasingly incorporated PIK arrangements in 2024, allowing borrowers to pay interest with more debt in lieu of cash. PIK income remains a relatively small percentage of BDC interest income, and it is unclear whether portfolio companies will incorporate PIK in a declining interest rate environment despite being given the option.
• Dividend Coverage Concerns: Most KBRA-rated BDCs have maintained base dividends despite growing income due to “special” dividends during favorable conditions. However, with declining interest rates and increased competition, dividend coverage ratios may face challenges, particularly for newer BDCs without low-cost fixed rate debt from previous years and investment portfolios with lower-yielding assets. Importantly, coverage of interest expense on rated debt by earnings is expected to remain quite solid.
• Stable Asset Quality: Despite challenging conditions with high base rates, non-accrual rates for KBRA-rated BDCs remain low. The shift to more first lien senior secured loans and conservative underwriting practices have contributed to the stability of asset quality across our rated BDC universe. Lower interest rates should enhance portfolio company metrics.
• Competitive Pressures in the Private Credit Market: Competitive dynamics in the private credit market have led to lower spreads, particularly with the return of the BSL market. BDCs are adapting by enhancing liability management, issuing CLOs and fixed rate debt with interest rate swaps, and renegotiating credit facilities to better manage borrowing costs.
• Outlook Remains Stable but Cautious: The overall Outlook for KBRA-rated BDCs remains Stable, with strong liquidity and manageable leverage. However, there is caution around economic uncertainty with high base rates, inflation, and geopolitical risk. BDCs are focused on adapting to these conditions with appropriate leverage and proactive management of credit risks.

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About KBRA

KBRA is a full-service credit rating agency registered in the U.S., the EU, and the UK, and is designated to provide structured finance ratings in Canada. KBRA’s ratings can be used by investors for regulatory capital purposes in multiple jurisdictions.

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