(Bloomberg) — Investors are demanding higher risk premiums to own the debt of business development companies, reflecting their anxiety around private credit exposure, according to Barclays Plc.
A broad-based index of the debt shows spreads climbing 80 basis points to 260 basis points this year, reaching “rarefied territory,” strategists including Corry Short wrote on March 17. Unsecured bonds of BDCs have also “meaningfully” underperformed collateralized loan obligations — an asset class that offers the best point of comparison, according to the bank.
“CLOs are reasonable comps for BDCs because both own corporate loan assets financed with debt and equity obtained through the capital markets,” the strategists wrote. “Our view, therefore, is the pricing of those instruments should resemble each other.”
But since January, spreads on broadly syndicated loan CLOs have widened about 20 basis points, compared to nearly 75 basis points for unsecured BDC debt. That difference is “justified” due to the lack of collateral or lower-quality assets backing BDCs, the strategists said. They also point out that BDCs have higher exposure to the troubled software sector — 20% on average — compared to about 12% for CLOs. An uptick in redemptions from some BDCs has contributed to wider spreads this year too, they noted.
BDCs usually sell shares to retail investors and use that money to buy portfolios of corporate loans issued by small and mid-size companies. The vehicles also raise cash by issuing bonds and other debt to institutional investors. The premium on that debt represents additional interest that investors charge on top of base interest rates.
Spreads on BDC unsecureds have surpassed other parts of the investment-grade bond market, as well as some parts of the high-yield market, according to Barclays. The rest of the investment-grade index has widened by just 15 basis points to 92 basis points this year, it said.
At the same time, Barclays acknowledges that its analysis doesn’t take into account the regulatory constraints imposed on BDC leverage. Key structural differences also persist between BDCs and CLOs despite efforts to show an “apples-to-apples” comparison, the bank said.
And despite the substantial widening in spreads, Barclays notes that the probability of a BDC defaulting on its unsecured debt is “very low today,” thanks to their access to liquidity and leverage-to-asset coverage metrics.
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