Bad news for mid-sized companies in need of financing: Shares of business development companies have plummeted during the stock market crash and currently trade at 80 percent of their net asset value, says the managing director of Lincoln International, Ronald Kahn, in his peHUB.com column.
While this is devastating for their shareholders, the real concern may be the BDCs' sudden inability to raise additional capital, said Kahn.
Business development companies have been flourishing for the last two years and their continued ability to raise new capital has made them a force in providing financings to middle market companies, he said. With the financing spigot potentially closed, such companies will be unable to deploy capital at the same rate they have been. Plus, with limited resources, they will undoubtedly be more selective and lend to only the best of credits, according to Kahn.
More bad news: The S&P LCD leveraged loan index, a composite of large, liquid below-investment grade loans, has gone to 89 from par. As we saw in 2008, when you can buy a liquid loan on the secondary market yielding 7.5 percent, why would you deploy capital in new deals that only yield 5-6 percent? Hedge funds in particular, also a major provider of capital to middle market companies during the last two years, are well-known for being able to rapidly shift investment strategies in the wake of opportunities. So it should come as no surprise if we see these institutions backing away from the new issue market in favor of more lucrative opportunities in the secondary market, Kahn said.
During the last crisis, many of these hedge funds reaped enormous profits by investing in secondaries - look for them to do so again, said Kahn.
Commercial banks have always been leery of the middle market and usually decide to play in this space only after returns in the large cap market become too thin. With yields on below investment grade debt increasing, and the recent large outflow of capital in high yield funds, it would seem logical that many banks and financing companies now have the ability to revert back to providing capital to larger credits rather than the middle market, he said.