Fitch Sees Valuation Challenges Ahead for BDCs

Fitch Ratings in a news release said it expects BDCs to struggle to mark their portfolios to fair market value on a quarterly basis. The ratings firm said BDCs can expect a challenge in meeting this valuation requirement in light of falling asset prices resulting from the global coronavirus pandemic. “Portfolio marks, on their own, are not necessarily indicative of the ultimate credit performance of individual loans, but unrealized write-downs can pressure credit facility covenants, including asset coverage requirements and minimum equity levels, all of which can have negative rating implications,” Fitch wrote. The company conducts testing of BDCs’ sensitivity to valuation declines and the resulting effects on asset coverage and related covenants. For the current analysis, Fitch took 11 rated BDC portfolios and applied various valuation stresses to assess the impact on their asset coverage ratios. Fitch found that all 11 BDCs maintained asset coverage cushions in excess of minimum regulatory requirements and lender covenants under portfolio stresses of 5% and 10%. However, when the hypothetical valuation stress increased to 15%, one firm breached its asset coverage cushion; and when the portfolio stress increased to 20%, several of the firms breached their asset coverage cushions. Still, Fitch wrote, BDCs can take steps to seek to mitigate this potential, “including redeploying portfolio cash flows (from interest and principal repayments) into debt repayment, limiting new origination activity and cutting dividends.”