In June, sister publication Private Debt Investor published a piece entitled BDCs: A market that’s turned ugly fast. Given the enormous pressure on the small and medium-size businesses financed by these vehicles, said a source in the piece, “the second quarter is going to be terrifyingly ugly”. For secondaries firms with a taste for credit, these vehicles could present an opportunity.
First introduced in 1980, business development companies are closed-ended vehicles that lend to small- and mid-sized businesses in the US. They exploded in popularity after the financial crisis, taking on riskier lending opportunities after the withdrawal of the banks. In 2019, BDCs held gross assets of $113 billion, compared with $19 billion in 2009.
Last week, Pantheon’s credit secondaries platform bought a 28 percent equity stake in a $356 million special purpose vehicle, a wholly owned subsidiary of BDC PennantPark Investment Corporation. Pantheon paid $35 million for the stake and has the option to invest an additional $30 million at fair market value over time. It bought the equity from PennantPark, which owns the debt that comprises the rest of the vehicle.
For Pantheon, the deal provided access on a secondary basis to a high-quality portfolio of first lien senior secured loans, as well as the opportunity to invest fresh capital into what many are expecting to be a good vintage for debt. The firm also had some discretion around the composition of the portfolio by risk, price and industry, Secondaries Investor understands.
For PennantPark, the deal brought several benefits. Pantheon’s secondary liquidity injection helped it increase its bitesize for future investments and fund some capital returns to its investors. It also allowed the BDC to derisk its balance sheet. The portfolio was spun into a joint-venture vehicle named PennantPark Senior Loan Fund I. With Pantheon’s approval, PennantPark was able to move a $245 million credit facility off its balance sheet and into the vehicle, “providing a much more robust balance sheet and more flexible capital structure”, wrote analysts from investment bank Raymond James & Associates.
PennantPark has performed fairly well through the covid-19 crisis, having pivoted toward more senior debt during 2019. The Cliffwater BDC Index, which measures the performance of exchange-traded BDCs, plunged nearly 50 percent in March to its lowest level and has since rebounded, suggesting that an extreme need for liquidity among BDCs has passed – at least for now.
Still, there are many BDCs that are struggling to secure debt financing to grow or have highly levered structures that could benefit from this joint venture approach. BDCs are mandated not to exceed a debt-to-equity ratio of 2:1, which is tough to manage at a time of great volatility. All of this opens a window for secondaries capital. In the words of one buyer, we could see a heck of a lot more of this in the future.
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