The Promise and Pitfalls of Permanent Capital

By Randy Schwimmer

We’re seeing a rush to pound out new publicly-traded (and private) business development companies, with many launched and more lined up in registration. Managers have correctly identified the virtues of BDCs: one-to-one fund leverage, tax advantages for investors, access to permanent capital, double-digit return potential, the fact that banks can own them under Dodd-Frank… Need we go on?

These benefits have made BDCs the fastest growing path for capital formation in the mid-market. Unlike many of the legacy companies that focus on junior debt, the latest versions also invest in senior debt and unitranches. The theory is that, in a frothy environment with highly leveraged issuers, it’s better to lend at the top of the capital stack and let modest fund leverage assist your returns.

One launch making news is the Credit Suisse Park View BDC, which plans to raise $500 million to invest in companies with ebitda between $5 and $75 million. In other words, it’s a classic middle market business.

This move provides advantages all round. Firstly, it provides the bank with an outlet for a $221 million portfolio it transferred to Credit Suisse Asset Management. Those assets allow the new BDC to be significantly ramped from day one. Secondly, it gives outside investors the opportunity to participate in loans that are part of CSAM, rather than the bank. Finally, as a minority investor in the BDC, the bank doesn’t have to account for the loans on its balance sheet. Somewhere, regulators are smiling.

Related headlines involve Goldman Sachs finally taking its BDC public. Launched in 2012 as a privately traded company, it had grown its portfolio to $913 million of assets under management with the same sort of middle market borrowers as Park View.

There is one big concern about BDCs in the current environment. When shares trade below book value, BDCs are prohibited from issuing new shares without shareholder approval. That defeats the whole point of access to permanent capital.

Indeed, the average BDC share price has been below book for months. Some analysts say investors don’t really understand the advantages of these vehicles. Others believe investors do understand, but are making value judgments relative to other public options, such as reits and MLPs, which have arguably demonstrated greater price appreciation and asset growth. A third perspective is that “bad actors” in the BDC space have managed their companies in ways less favourable to investors, and that behaviour has tainted the entire sector.

Whatever the case, the inability to raise capital curtails those managers’ ability to grow their businesses. Some BDCs are unable to issue new shares and are too small to access other sources of capital.

In any case, experienced credit managers know that to grow through all cycles, you need diversified funding alternatives. When one vehicle is out of favour, for whatever reason, you need to rely on others.

In the long run, the winners in the asset management game will often be those managers that are most resourceful and creative about raising multiple sources of long-term capital. As we all learned coming out of the credit crisis, it’s not about who has the biggest hammer, but who has the most tools.

Randy Schwimmer is a former member of senior management and investment committees for two leading mid-market debt platforms. He is also founder and publisher of The Lead Left (, a weekly newsletter about trends and deals in the capital markets.

This column first appeared in the weekly newsletter of Creditflux, a leading global information source for the credit trading and investment market.

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