Renowned as risk takers, they raised cash by selling stock, multiplied the haul with borrowed money, then used it to lend to some of the country's most indebted companies. If all went well, they would profit handsomely.
But right now, the strategy is going badly for many business development companies — key players in the $812 billion private credit market.
Analysts and ratings companies are sounding alarms as a number of the firms — often just called BDCs — rush to shore up their finances or throw lifelines to their borrowers. One of the largest, Golub Capital BDC Inc., is among those raising funds at a time that may significantly dilute existing shareholders. And while the Federal Reserve and federal government announced programs to prop up struggling companies, BDCs may not benefit much. Many companies they finance, owned in part by private equity firms, don't qualify under current rules.
It's a bruising time for the aggressive investment vehicles that swelled in recent years to command $110 billion in assets and just a few months ago were vying to snap up more high-yield credits. BDCs offer another glimpse into what happens when investors juice returns with leverage only to find themselves wrong-footed with the deadly coronavirus pandemic upending commerce and straining the global financial system.
"The BDC sector is among those most affected by this credit shock," analysts at Moody's Investors Service wrote in a report last week, downgrading their outlook for the sector to negative from stable. "BDCs' loan portfolios will decline in value, weakening BDCs' capital positions and increasing their risk of bank covenant non-compliance," potentially leading to defaults on their debt.
In a harbinger of what's to come, Portman Ridge Finance Corp. just watched a company that it's helped finance since 2015 collapse in a matter of weeks.
The borrower, Ravn Air Group, filed for Chapter 11 bankruptcy protection on April 5, citing an eye-popping 80% to 90% drop in passenger revenue. Owned by private equity firms JF Lehman & Co. and W Capital Partners, the operator of flights for three Alaska air carriers said it had sought state and federal aid, and tried to work with lenders, but ran out of cash by the end of March, forcing it to suspend operations and lay off employees. It said it hopes to work out a solution and restart operations.
Portman Ridge had valued its $1.8 million piece of a loan to Ravn Air at almost 100 cents on the dollar at the end of December, SEC filings show.