Business development companies have billions of dollars of loans on their books that are at risk of further erosion in value, according to a new BDC watchlist. And that’s on top of the billions of dollars’ worth of loans that already aren’t being paid.
The total fair value of these at-risk loans, according to first-quarter filings with the Securities and Exchange Commission, comes to $5.7 billion, according to 9fin, an AI-based information platform for global debt markets. That represents a decline of $1.2 billion, or 17 percent off the par value of the loans.
London-based 9fin found that there are 468 individual loan positions across 157 public and non-listed BDCs that have experienced “material value erosion in the most recent quarter and are at risk of further declines or stress.” The platform tracks quarter-over-quarter declines in the fair value marks, which are largely determined by managers themselves, to identify credits with a negative trend in valuation. An at-risk loan is one that has fallen below 90 percent of par, which 9fin said is most exposed to further deterioration.
“Given the scale of the asset class, and the recent questions around creditworthiness, the industry needs better visibility into where risk is concentrated,” says Josie Shillito, global head of private credit at 9fin.
These at-risk loans represent 1.9 percent of the industry’s $305.2 billion in BDC loan volume, as measured by NAV, at the end of the quarter. The watchlist does not include loans already on non-accrual status as of the first quarter. 9fin said those bad loans amount to 2 percent of BDC loan volume, for a total of nearly 4 percent of troubled, or potentially troubled loans in BDC portfolios.
Peter Benson, lead BDC analyst at 9fin, called the 4 percent figure a “meaningful” number.
That number also could understate the scope of the problem, given that the analysis largely relies on the “fair value” of loans reported by BDC managers, instead of loans that are trading in the market. Benson said that about three quarters of a portfolio’s private loans are valued by the BDC managers themselves, rather than by an independent valuation expert.
“Whether or not they’re marking them correctly, I can’t say,” noted Benson.
Shillito acknowledged that “there is a big information asymmetry in private credit. It's not a liquid market.” Whatever distress does exist is “not easily findable, traceable, or organized. This is one metric by which it can be measured. And the reason we can measure it is because they're forced to publicly disclose it.”
The firm gathered data filed with the SEC by public, private, and non-listed BDCs because all are governed by the Investment Company Act of 1940, which requires them to make such disclosures.
The data firm also reached out to every BDC it included on the list. “We gave them a chance to comment on every credit that we included in the report. About a third of the firms got back to us in some way and declined to comment. About two thirds didn’t.”
After hearing from some of the BDCs, it removed revolvers from the analysis “because those can fluctuate wildly depending on how they're drawn on a fair value basis quarter over quarter,” said Hunter. When possible, it also removed broadly syndicated positions or liquid positions because they are also marked to market, whereas a private credit’s value is largely at the discretion of the manager.
Hunter acknowledged that syndicated loans are still an important part of the BDC universe. “They are supposedly being used to manage liquidity,” he said. And “in a time where there is a liquidity crunch, it's still important that they're now down in value because you're still going to sell them at a loss and still take a loss for your investors.”
The analysis also found that a handful of at-risk loans are held within multiple BDC portfolios.
