Business development companies should withstand 2024 economic slowdown, but credit conditions will weaken, Fitch says

By Steve Gelsi

Fitch keeps ratings unchanged heading into 2022, with Ares and Fifth Street retaining their highest scores

Ares Capital Corp. and Sixth Street Specialty Lending Inc. held onto the highest debt ratings among the 21 business development companies covered by Fitch Ratings, amid expectations that the sector will face economic headwinds in 2024, but with no major impact to their balance sheets.

Ares (ARCC) and Sixth Street (TSLX) are both retaining their ratings of BBB/stable, the highest grades among the BDCs in Fitch's universe, which includes mostly publicly traded BDCs and a few private ones.

In her ratings move on Monday, Fitch analyst Chelsea Richardson kept BBB-/positive ratings on three other BDCs and kept 16 at BBB-/stable, with all remaining in the broader BBB category.

Although the 2024 outlook for BDCs is deteriorating due to expected weakening in asset-quality metrics and increased debt-service costs resulting from higher interest rates for borrowers, Fitch expects net investment income and dividend coverage for BDCs to remain relatively strong in the coming year.

While BDCs will be helped by the floating-rate structure of their loan portfolios, Fitch cautioned that BDC earnings are approaching peak levels, and the benefits from higher interest rates could be partially offset by rising nonaccruals or spread compression with their loan portfolios.

BDC portfolio companies are expected to face higher-for-longer interest rates and a challenging funding landscape amid a slowing economy and heightened geopolitical risk.

Fitch also believes that terms for new middle-market deals could deteriorate relative to 2023, given increased competition for private credit deals, continued growth in perpetual nontraded BDCs and other direct lending funds and a potential rebound in the syndicated markets, Richardson said.

"Fitch believes rated BDCs are well positioned to navigate challenging sector dynamics in 2024 and expects financial profile ratios to remain within Fitch's BBB category benchmark ranges," Richardson said. "Manyrated BDCs will benefit from their affiliations with broader investment manager platforms as competition for new deals increases, since these platforms provide access to deal flow, investment resources, risk management and workout capabilities."

Overall, BDCs with ties to larger private-equity firms can improve their access to funding given strong relationships with lenders across the platform, she said.

The three BDCs that kept their BBB-/positive ratings from Fitch are Blackstone Secured Lending Fund (BXSL), Blue Owl Capital Corp. (OBDC) and Golub Capital BDC Inc. (GBDC).

The 16 with BBB-/stable ratings are Bain Capital Specialty Finance Inc. (BCSF), Barings BDC Inc. (BBDC), BlackRock TCP Capital Corp. (TCPC), Blue Owl Capital Corp. II, Blue Owl Capital Corp. III, Blue Owl Technology Finance Corp., Capital Southwest Corp. (CSWC), FS KKR Capital Corp. (FSK), Goldman Sachs BDC Inc. (GSBD), Hercules Capital Inc. (HTGC), Main Street Capital Corp. (MAIN), Morgan Stanley Direct Lending Fund, New Mountain Finance Corp. (NMFC), Oaktree Specialty Lending Corp. (OCSL), Oaktree Strategic Credit Fund and SLR Investment Corp. (SLRC).

-Steve Gelsi

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11-27-23 1227ET

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