The continuation of low oil prices alone should not meaningfully
pressure business development companies (BDCs), says Fitch Ratings in a
new report.
Fitch's latest stress tests of BDCs focus on leverage ratios under
downside scenarios to energy-related investments broadly, and oil & gas
exposures specifically. The tests include a partial writedown of oil &
gas-related investments, a partial writedown of all energy and
energy-related industrials (including metals and mining, rubber and
plastics, solar, and others), and a total write-off of all oil &
gas-related investments. The tests are independent of any specific oil
price levels or time frames.
Under each stress scenario, the overall effect on leverage ratios was
modest across 10 Fitch-rated BDCs. In the case of a partial oil & gas
investment writedown, the average BDC leverage ratio increased 2 bps, to
0.66x from 0.64x. The stress test on energy and energy-related
industrials raised leverage 4 bps, to 0.68x. And a total write-off of
oil-related investments brought average leverage up 10 bps, to 0.74x.
Notably, the starting point for average leverage, 0.64x as of September
2015, was materially higher than the beginning of the oil-price downturn
in third-quarter 2014, when average leverage was just 0.54x for the
rated universe. BDCs are required to maintain asset coverage ratios of
200% of capital in order to comply with the Investment Company Act of
1940 (and borrowing covenants), which limits their debt/equity ratios to
under 1.0x. Thus, the leverage cushion has declined year over year.
BDCs did recognize losses on energy-related exposures in 2015. Rated BDC
oil & gas investments had an average fair value that represented 84.9%
of cost at Sept. 30, 2015. Fitch believes additional realized and
unrealized losses will be recognized in 2016, given the magnitude of
price declines and the length of time at such levels. Additionally, oil
price hedges will provide less protection to portfolio companies in
2016, as some portion of remaining hedges are likely to roll off.
Individual BDCs with higher exposures include Apollo Investment
Corporation and PennantPark Investment Corporation, which had 15.6% and
12% of their portfolios, respectively, in oil & gas investments at Sept.
30, 2015, according to Fitch's calculations. Leverage ratios for these
two firms are the most impacted from an oil & gas write-off scenario,
with both experiencing an increase in leverage above 1.0x.
In spite of the results of the stress tests, a number of other industry
challenges, including competition, declining asset yields, unsustainable
asset quality, increased leverage, an inability to access the equity
markets, and expanded investment strategies continue to support Fitch's
negative sector outlook for BDCs.
Four of 10 Fitch-rated BDCs have negative rating outlooks. Further
rating pressure is possible should oil prices remain depressed near
current levels of $30 per barrel for a long period. In Fitch's view, oil
prices have yet to find a sustainable equilibrium. Our base expectation
for oil prices in 2016 is $45 per barrel.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article can be accessed at www.fitchratings.com.
All opinions expressed are those of Fitch Ratings.
BDC Energy Stress: Drilling into the Details (BDCs with Higher Leverage
Most Exposed to Additional Markdowns)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=876592
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