However, even proponents of the bill said further revisions are
necessary for the U.S. Senate to green-light the bill, while some
critics caution that raising the leverage limit would create
Members of the U.S. House Financial Services Committee voted 31 to
26 to adopt an amended version of the "Small Business Credit
Availability Act," which proposes to raise the leverage limit to 2:1
from 1:1. Discussions are ongoing to make additional tweaks that
address investor protection concerns raised by Democrats.
"If a deal is struck with Democrats that accommodates demands for
investor protections, the bill will get broad bipartisan support in
the House and greatly increase the chances for passage in the
Senate," said Brett Palmer, president of the Small Business Investor
BDCs are a specialized type of closed-end investment fund. The BDC
industry has expanded steadily since the credit crisis, taking an
increased share of the middle market lending pie, and is widely seen
as playing a key role in fueling economic growth for small
As traditional lenders face increased capital constraints and
tighter lending guidelines under new regulatory requirements, BDCs
have stepped in as alternative capital providers.
For investors, the model is compelling: steady, robust returns at
relatively low leverage levels.
While there is much consensus within the BDC community that the
framework governing BDCs needs to be revised and modernized to ease
capital formation, there is significant debate as to the merits of
raising the leverage threshold.
The debate centers on how best to enable the industry to grow in
order to expand borrower access to needed financing, while also
managing credit risk and shareholder returns.
Critics from within the industry caution that increasing leverage
under the current proposal adds more risk without differentiating
between BDC models. Increased defaults could hamstring the ability
to attract capital in the public equity markets or in the unsecured
[to top of second column]
"The BDC structure is a way for retail investors to access the asset
class, while enjoying the safety of the 1:1 model. All it will take
is one blow up to result in the retail bid bowing out," said Alex
Frank, CFO of Fifth Street Management, an alternative asset manager
and the SEC-registered investment adviser to two public BDCs, Fifth
Street Finance <FSC.O> and Fifth Street Senior Floating Rate Corp <FSFR.O>.
"The sector is still in the relatively early stages and still
growing. I don't see the need to change the leverage cap at all, but
if so, differentiation based on risk is needed."
There are other possible implications, as well, namely how the
rating agencies would treat additional leverage. The leverage cap,
which is low relative to other lending entities, is seen as one of
the major underpinnings of investment grade BDC ratings.
"Fitch likes the 1:1 leverage cap, but a change won't trigger any
automatic downgrades. We would have to assess BDC by BDC and how
each would use the excess capacity" said Meghan Neenan, senior
director at Fitch. "Would they take advantage or not, if so what
would it be used for?"
Of course, BDCs would not be required to bump up leverage to 2:1 and
market participants said prudent BDCs would likely maintain a
cushion as they do today under the current limit, but others would
take on more capacity.
"Some BDCs would certainly increase leverage, and others may need to
follow suit in order to compete," said Frank.
The increase would be good for BDCs, but bad for the market, said a
lender at another BDC shop. It would incent more BDCs to pop up, but
it could make for more aggressive, sloppy lending.
(Editing by Jon Methven)
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