The 1:1 leverage limitation set by existing statutes was too restrictive and may have forced business development companies (BDCs) to invest in high yielding debt to make the returns that investors seek. Increasing leverage can help. With twice as much leverage now available, it is possible for BDCs to focus on higher credit quality and lower yielding assets to achieve equity returns of around 9% - 12%. But, is this what BDCs want to do? Directors will have to plan on effective communications with shareholders, lenders and ratings agencies to gain their approval. Today, BDCs on average have less than 1.00x leverage. This is yet another opportunity for further distinction among BDCs as they make these decisions.
Existing statutes let BDCs borrow at a limit of a 1:1 debt-to-equity ratio. The new provision increases that ratio to 2:1. Both the House of Representatives and Senate had passed similar legislation before, though they were part of different legislative packages. Ratings agency Fitch Ratings said on Monday that the change will not involve sector-wide alterations to an individual manager’s credit ratings, but any move by a BDC to up its leverage would be viewed as “negative for its ratings”. The firm’s portfolio would also be taken into account, with more exposure to senior investments viewed more favorably.