67 WALL STREET, New York - December 28, 2011 - The Wall Street Transcript has just published its Business Development Companies Report offering a timely review of the sector to serious investors and industry executives. This Business Development Companies report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
Topics covered: BDC Risk/Reward Profile - Higher Dividend Yields - Private Middle Market Funding - Business Development Companies Historical Overview
Companies include: Allied Capital (AFC); American Capital (ACAS); Apollo Investment Corp. (AINV); Ares Capital (ARCC); GE (GE); Harris & Harris Group (TINY); New Mountain Finance (NMFC); PennantPark (PNNT); Saratoga Investment Corp. (SAR); Solar (SLRC); Triangle Capital Corp. (TCAP).
In the following brief excerpt from the Business Development Companies report, industry experts discuss the outlook for the sector and for investors.
John Stilmar joined SunTrust Robinson Humphrey as a Director of financial services research in October 2008. He has more than five years of experience in sell-side research, where he has demonstrated expertise in various consumer and commercial finance lenders. Mr. Stilmar has been recognized by several external constituents such as Institutional Investor for excellence in his categories. Before research, he spent six years at Capital One Financial Corp. in various capacities, mostly in treasury and structured finance. He graduated from the University of Richmond's The Robins School of Business with a dual concentration in finance and marketing.
TWST: What is it about BDCs that make them a unique lending structure?
Mr. Stilmar: The BDC is really nothing more than a structure. It has certain rules, most notably cap on leverage of debt to equity one to one. This makes the structure very defensive and with other stipulations on types of companies allows managers to remain focused on providing capital to private middle market businesses. In return for these restrictions, the BDC pays out 90% of its earnings and is not subject to corporate taxes. These are just the structural components of a BDC, but what makes the BDC successful is the style, track record and platform of the manager. Choosing the right manager in this space is critically important as doing so adds to the uniqueness of a platform.
TWST: How are BDCs doing?
Mr. Stilmar: Let's look at this in two ways: one, the stock performance, and two, the underlying business. If we look at Ares, ticker ARCC, and look at August being the time period in which we really started seeing the acceleration of the dissent of the equity market and compared the stock performance to the KBW Bank Index called the BKX, which is broadly used as a proxy for financial performance, Ares has outperformed the BKX pretty materially. Not all BDCs can say that, but this serves as a strong data point that investors will support good managers in a defensive structure like the BDC. I am not hiding from the fact that it is a financial, and that with global uncertainty financials are facing increasing selling pressure in the face of this uncertainty.Absent this conversation turning to a discourse on capital markets, let's talk about the business.
Currently, capital markets are very fickle and liquidity for smaller companies remains more in question as pricing and terms for debt capital remains a high variable as the lenders are trying to price credit in a world that seems to change every day. This is where a good manager with capital in a BDC can be an oasis for borrowers and provide an opportunity for investors. Since the end of June, pricing has widened, and the quality of loans that BDCs are seeing is improving in terms or covenants and structure. This is really exciting for those with capital. So on one hand the volatility creates a great opportunity. All the signs are pointing to a market that allows BDCs to capitalize. The big wild card that I don't want to hide from in our conversation is that market uncertainty and associated global growth concerns can lead to businesses having credit issues. Given these loans are to private and smaller companies that one might see in the public debt markets, there is a rational concern that these companies can experience greater credit risk. We would be delusional to believe that if this slowdown becomes worse, that BDCs will be completely immune from losses.
However, there are several items that you need to keep in mind that keep us comfortable with this risk. Generally, the prior downturn came from massive deleveraging and a void of liquidity. In the middle markets, product structures have remained relatively defensive, so I feel better about the quality of the loans on the book. Furthermore, the last downturn gave us - or shall I say lenders - a window into how their respective borrowers behaved in a recession, a benefit of perspective not available in last downturn. I think this has helped managers make more informed loans as the downside scenario for company performance can be measured. Finally, BDCs make loans to these companies. That means there generally is 30% to 60% of either equity of junior debt capital to act as a credit cushion. A low growth or minimal growth environment is still just fine for a BDC. Credit as cash flows from business should still be ample to cover the borrowed amount. For these reasons I remain optimistic for the future but are not blind to environment that we are in.
TWST: Should BDCs be looked at as investment vehicles to be included in a portfolio right now?
Mr. Stilmar: I think so, but I must say that there are risk and return considerations. I think the business development companies for the most part have all the ingredients that provide for safety, although you are going to have to do some research to select the best company and the best manager. Company specifics are crucial to that decision, but I think as a structure it has a lot of very positive dynamics. I think we have talked about them earlier. I won't tell you my opinions on all of them, but I do think that over time choosing the right BDC makes all the difference in the world. If we looked at shareholders that invested in ARCC in 2008 or 2009 versus shareholders that invested in Allied Capital, a BDC that Ares eventually bought, Allied as Ares saved Allied from a distress situation. I think the return proposition will be starkly evident.
The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This Business Development Companies report is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
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