April 25, 2024 - As a source of permanent capital for alternative asset managers, Business Development Companies (BDCs) have proved to be very popular structures and BDC AUM represents a significant share of the private credit landscape. According to LSEG LPC, BDC AUM reached a new high of $315 billion at the end of 2023 – representing a 4% increase during 4Q23 and a 15% gain over the course of the year. Despite the popularity of BDCs – and the transparency BDCs afford – these vehicles are not well understood.
We have prepared a primer series on BDCs that unpacks the lessons in the “Nuts and Bolts of BDCs” webcast. Part 1 introduced the three types: publicly-traded BDCs, non-traded BDCs and private BDCs. This Part 2 offers a review of the regulatory reporting requirements for BDCs that make BDCs very transparent vehicles.
A BDC is fundamentally a hybrid of a closed-end investment company and an operating company in that it is subject to the ’34 Exchange Act and the ’40 Act. The “operating company” characteristics stem from BDCs being SEC registrants. This means that all BDCs are subject to the panoply of SEC reporting obligations. This includes quarterly and annual reports (10-K/10-Q), event-based current reports (8-K) and proxy statements. Depending on its filing status, a BDC must file its 10-Q within 40 or 45 days and its 10-K within 60, 75 or 90 days. (The reporting cadence of BDCs generally determines when market data/research is updated.)
Despite sharing the same reporting requirements as operating companies, the contents of a BDC’s filings are different and are reflective of it being an investment company. Unlike private funds, BDCs are required to do a full schedule of investment as SEC registrants. Each investment is reported in detail as a separate line item, including but not limited to the applicable interest rate and margin, the maturity date, whether it is a “qualifying” or “non-qualifying” asset, whether the asset is on non-accrual, if income is earned as PIK or otherwise, and, for the equity portfolio, whether it is income producing or non-income producing.
Importantly, these reports include the marks for each investment, the costs basis and amount of principal for the investment and its fair value. Unfunded commitments are also identified and fair valued. This means that all BDC assets must be valued on a quarterly basis and “fair value” for this purpose is determined by the BDC’s board of directors. There is no single standard for determining fair value so there is variation across vehicles, but each BDC applies its valuation process consistently for all assets.
Valuations play an important role in the life of a BDC because BDCs shares trade at a premium or discount to its net asset value (NAV). If a BDC’s shares are trading at a discount, the BDC is not able to sell shares without shareholder approval (which needs to be obtained annually). In practice, to raise equity capital BDC shares need to be trading at a level above their NAV that would at least clear the discount paid to underwriter(s) plus gross spread.
As noted above, Part 2 is a brief look at one side of BDC regulation – the ’34 Exchange Act. The takeaway? BDCs are as transparent as public companies. Given BDCs account for approximately 40% of the private credit market BDC reporting offers meaningful visibility into private credit – more than one might think. Next in the series we will focus on the other side of BDC regulation – the limitations and restrictions imposed by the ’40 Act.
