Higher interest rates, among other macroeconomic factors, may imply weakness for some high-yield assets. However, some analysts see higher-quality business development companies (BDCs) holding steady in this challenging environment. The VanEck BDC Income ETF (BIZD ), the original exchange traded fund dedicated to BDCs, is already proving its mettle with a 2.40% year-to-date gain. That comes with the benefit of a tempting 30-day SEC yield of 10.98%.
While high interest rates pressure credit quality metrics for BDCs, Fitch Ratings says the outlook for the BDCs in its coverage universe, which includes some BIZD components, is “stable.”
“We expect rated BDCs can withstand modest deterioration in financial profile ratios while maintaining metrics at appropriate levels for ratings,” said Chelsea Richardson, Senior Director.
The $566.2 million BIZD, which turned 10 years old in February, is home to 25 BDCs. The ETF is top-heavy as its top three holdings Ares Capital (ARCC), Fs Kkr Capital (FSK), and Owl Rock Capital (ORCC) combine for about 45% of the roster.
While that implies some level of concentration risk, the other side of the coin is that some of the larger BDCs, including some of the aforementioned trio, rank among the industry’s higher-quality names. That implies some level of resilience in an uncertain economic climate.
“Some BDCs are better positioned to navigate sector headwinds given consistent underwriting standards and lower-risk portfolios, as well as stronger asset coverage cushions and funding profiles. Over time, a variance in these factors could lead to further differentiation among BDCs’ ratings and/or outlooks,” added Fitch.
Another potential benefit for BIZD investors is that with banks tightening credit standards in anticipation of an economic slowdown, some corporate borrowers may be compelled to work with BDCs, potentially boosting lending activity among BIZD member firms.
“Middle market deal structures and terms have become more favorable for lenders over the past year, as evidenced by wider spreads, lower underlying leverage, and tighter covenants. Fitch believes BDCs with incremental capacity to targeted leverage ranges or the ability to issue accretive equity could be at a competitive advantage for new origination opportunities, particularly as market activity increases,” concluded Fitch.
Additionally, the bulk of the loans made by BIZD member firms have floating rate components, which reduces the interest rate sensitivity of the ETF and its components. On that note, if in May the Federal Reserve provides some indication that it’s nearing the end of its tightening cycle, BIZD could be among the beneficiaries.
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