- $1.2 billion in new capital in Q3
- Investors are seeking yield
- Ares, American Capital stand out
Much of the recent activity is being driven by low interest rates, propelled by the Federal Reserve’s third round of quantitative easing, which is expected to keep rates depressed through mid-1015. For BDCs, which invest in privately-owned businesses, the recent drop in longer-term rates has provided an opportunity to build up their balance sheets, expanding their capacity.
“QE 3 has unlocked some activity, as investors are looking for yield, and BDCs can certainly offer that,” said Arthur H. Penn, the CEO and chairman of New York BDC PennantPark Investment Corp., which raised $97.4 million of equity through a supplemental stock offering in September.
During the third quarter, BDCs as a group raised $1.2 billion of new equity capital, making that the strongest quarter for fundraising since 2007, analysts at Stifel Nicolaus & Co. Inc. reported this month. The irony, as analysts Greg Mason and Troy Ward pointed out in their report, is that the best time for BDCs to raise money (dilutive to their clients, because equity raises reduce the value of existing shares) is also often the worst time to put capital to work.
“When the equity and credit markets become frothy this is typically the best time for BDCs to raise equity capital because the stocks are at peak valuations and the lowest dividend yields (low cost of equity); however, during this time the credit markets are usually peaking as well and competition for new loans to businesses becomes extremely competitive and typically is a time when BDCs should pull back, be more disciplined and put less capital to work,” Mason and Ward wrote in their note to clients.
One of the most aggressive players in the recent market climate, with surging stock prices and falling interest rates, has been Ares Capital Corp., the BDC affiliate of Los Angeles-based Ares Management LLC.
At the end of August, Ares Capital raised $427.4 million in equity by issuing nearly 26 million new shares of stock, followed in September by a public offering of $175 million in senior unsecured notes and a $200 million private placement in October of convertible senior notes.
While other BDCs have been issuing a variety of equity and debt vehicles to raise capital, one that has taken something of a different course is American Capital Ltd of Bethesda, Md., which seized the opportunity while rivals were raising capital to instead repurchase $125.0 million of its common stock during the third quarter, under a capital plan that it launched in September 2011. The company also refinanced $600 million of debt through a new four-year term loan facility.
American Capital was battered probably as badly as any BDC by the credit crisis; it responded by closing several offices, eliminating certain functions and a restructuring of its portfolio. The company has made progress: In June, Fitch Ratings raised its outlook on American Capital to “positive” from “stable.”
Under American Capital’s share repurchase and dividend policy, the money may be used for repurchases if ACAS common stock is trading at a discount to the net asset value of its portfolio or for the payment of cash dividends if at a premium to NAV.
“Though the improved portfolio performance is expected to continue with economic recovery, we believe that the low interest rate environment and global cues remain a headwind,” Zacks Investment Research wrote in a September report on American Capital; the agency maintains a “neutral” recommendation on the stock.
Regardless of broader market conditions, investors seem to take solace in a BDC sector that is “comfortably in equilibrium,” said James K. Hunt, CEO and CIO of THL Credit, the BDC affiliate of the Boston buyout shop Thomas H. Lee Partners LP. THL Credit itself raised $74.7 million through a stock offering in September. “In the world’s search for yield, we clearly have a product that is attractive to shareholders.”