BDCs for Rising Interest Rates in 2017

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BDC stocks for rising interest ratesRatings agency Fitch put out a note about which business development companies (BDCs) would gain from rising interest rates. Remember, BDCs typically make floating-rate loans to middle market companies, so rising interest rates theoretically lead to higher earnings for these BDCs. It’s all about the Fed, and how rate hikes affect LIBOR.

Fitch: BDCs for higher rates

Fitch believes that Golub Capital BDC (GBDC), FS Investment (FSIC), Ares Capital (ARCC), Hercules Capital (HTGC), and TCP Capital (TCPC) would gain the most from rising interest rates.

The accompanying table for their analysis is embedded below.

In the last year, Golub, Medley Capital (MCC), Ares Capital, TPG Specialty Lending (TSLX), and New Mountain Finance (NMFC) have seen experienced higher earnings from rising interest rates.

Note that Fitch only included the 18 largest BDCs in its analysis, or the largest third of BDCs. These are the BDCs that are most likely to have a corporate credit rating, or be on the cusp of receiving one.

More to it with BDCs

Net investment income is just one metric that analysts use to find BDCs that are worth investing in. We point out that higher interest rates may impact BDC’s portfolios in ways that do not appear in net investment income.

Higher rates could:

  • Result in higher defaults as indebted companies struggle to pay higher interest rates on their borrowings.
  • Cause capital losses from BDCs’ equity investments, which are inherently worth less in a rising rate environment.
  • Cause problems for BDCs which invest in highly-levered CLO equity.
  • Result in only temporarily higher earnings for BDCs. Eventually, BDCs will have to roll over their fixed-rate debt, so their net interest margins will eventually contract as BDCs’ borrowings reprice.

There’s always more to any story, but investors who want to capitalize on rising interest rates might want to start shopping from BDCs on Fitch’s list.

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