CLOs 90 Basis Points More Expensive than Middle Market BDC Specialists: Jasper Burch, Specialty Finance Equities Research Analyst at Macquarie Group Limited Interviews with the Wall Street Transcript
67 WALL STREET, New York - December 27, 2012 - 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 special feature 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: Decreased Bank Loan Competition - Low Corporate Credit Default Rate - Consistent BDC Dividend Yield - Stronger Middle Market Loan Origination - BDC Risk/Reward Profile - Private Middle Market Funding
Companies include: Fifth Street Finance Corp. (FSC), Triangle Capital Corporation (TCAP), American Capital, Ltd. (ACAS) and many others
In the following excerpt from the Business Development Companies Report, an expert specialty finance analyst discusses the outlook for the sector for investors:
TWST: What is the environment like for BDCs right now? How are things going overall?
Mr. Burch: I think it's a very attractive environment, especially when you start looking at the overall macro drivers and the part of the cycle where BDCs are. What you have is an environment of lower risk. The U.S. corporate credit space has significantly deleveraged over the past four years. So in an environment of lower risk, defaults are near historic lows under 2.5% for leveraged-loan defaults. The BDCs are probably even better than that in their underlying portfolios, and you have a very strong pricing trend. Now BDCs invest in the middle market, and middle market yields tend to be much stickier than either high yield or leveraged-loan yields. That means that as the broader credit markets have tightened, you have significant tightening in the high-yield space over the last year.
The same thing is happening with a lot of corporate credit. The yields on new investments of the BDCs haven't been nearly as impacted. The reason for that is that they operate in a space where there is a lack of access to efficient capital. What I mean by that is middle market companies - let's say under $100 million EBITDA - don't have the same access to financing as either larger companies or even smaller companies. Historically, on the low end of that range you had community banks that were able to syndicate together and service companies into maybe $15 million to $20 million EBITDA range, and those levels have significantly come down. Also, most banks tend not to like cash flow financing, but tend to like their financing to be secured by hard assets. At the high end of that range, the $100-plus million EBITDA, the ability to access the liquid markets has moved significantly higher up, so it's a much higher larger company size hurdle to access the liquid market. So you have this market - let's say between $20 million and $90 million EBITDA - of companies that just don't have the same access to capital that they historically had.
On top of that, one of the main competitors of the BDCs historically has been CLOs. CLOs are still around. We've had about $42 billion of CLO issuance this year, but they're materially different than they used to be, and the cost of a CLO has gone up significantly. The actual cost of debt on a CLO has gone from probably about LIBOR plus 40 basis points to now it's on a new issuance probably about LIBOR plus 140 basis points or LIBOR plus 130 basis points. So it's about 90 bps more expensive there, and then on the top of that, the amount the equity in the CLO is leveraged has come down. We're now looking at three or four turns of leverage where historical it's been about five turns. So the expansiveness of the CLO financing structure isn't what it used to be, and on top of that you have more CLOs that are ending their reinvestment...
For more of this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
