KBRA releases its Business Development Company Ratings Compendium, which looks at results for the quarter ended December 31, 2023, and offers a review of perpetual continuously offered non-traded BDCs as well as recent industry developments. In this quarter’s Compendium, KBRA examines the BDC sector’s funding sources, highlighting that the use of traditional bank revolving credit facilities continues to decline due to constraints on bank balance sheets and the pending Basel 3 Endgame proposal.

The performance of KBRA-rated BDCs remained stable in 4Q23 with solid credit metrics, including comfortable liquidity considering near-term maturities, low non-accruals, and appropriate leverage overall. KBRA will be monitoring BDC’s non-accrual rates and other signs of portfolio stress, as most underlying borrowers only began to experience the full impact of rate hikes in late 2023. KBRA’s Outlook for our portfolio of rated BDCs remains generally Stable, reflecting our view that KBRA-rated BDCs can successfully manage through a more uncertain environment in 2024.

Key Takeaways

• As BDCs continue to increase their market share in direct lending, they continue to diversify and broaden their funding mixes away from traditional revolving bank credit facilities, tapping the senior unsecured debt markets, issuing collateralized loan obligations (CLO), and establishing special-purpose vehicle (SPV) asset facilities.
• BDC net investment income (NII) continues to benefit from higher rates; however, we are cautious as fixed rate debt raised in 2020 and 2021 matures and becomes refinanced at higher rates. In addition, with the Federal Reserve’s expectation of reducing base rates in 2024, BDCs may experience margin pressure.
• For 2023, the majority of KBRA-rated BDCs had negative net fundings, reflecting low mergers and acquisitions (M&A) activity and buyout transaction volumes coupled with the sector’s prudent leverage metrics. Growth was targeted toward perpetual-life BDCs that raised mostly retail capital and newly formed BDCs that raised significant institutional capital in 2023.
• While credit quality in general remains benign—with KBRA’s rated universe of BDCs having a 4Q23 median non-accrual rate of 0.5% and 1% at fair value (FV) and cost, respectively, compared to 0.6% and 1.3% at 3Q23—several BDCs added at least one portfolio company to non-accruals in 4Q23. KBRA continues to monitor additional warning signals, and we have not seen material changes in quarter-over-quarter (QoQ) payment-in-kind (PIK) metrics and internal ratings, nor are we aware of material increases in amendments and waivers. That said, KBRA remains cautious given the high interest rate environment and a potential economic slowdown, which could continue to pressure interest coverage and lead to a further increase in non-accruals in 2024.
• Liquidity remains solid, with many BDCs issuing senior unsecured debt in 4Q23 and 1Q24, anticipating short-term debt maturities as well as boosting their financial flexibility should markets become disrupted in the latter half of the year.
• KBRA-rated BDCs’ balance sheets remain solid with modest leverage, a high percentage of first-lien senior secured loans to less cyclical industries, and low non-accruals.

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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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