Business development company language added to spending bill allows for increased leverage

BDC reform was tacked onto the $1.3 trillion appropriations bill signed by Trump on Friday

Mar 23, 2018 @ 2:24 pm

By Mark Schoeff Jr.

Legislation that would allow business development companies to increase their use of debt and potentially boost returns became law Friday afternoon.

The BDC measure was included in a $1.3 trillion appropriations bill approved by the House on Thursday and the Senate early Friday morning. After threatening to veto the spending bill, which will fund the government through the end of September, President Donald J. Trump signed it early Friday afternoon.

Although a BDC reform bill was first introduced in the House in 2012, its latest version raced ahead on a fast track.

The legislation, which would allow BDCs to increase their debt-to-equity leverage from 1:1 to 2:1 and ease filing requirements, was approved by a 58-2 vote in the House Financial Services Committee in November. A companion bill introduced in the Senate had 17 co-sponsors, including 12 Democrats.

The bipartisan momentum helped it enter negotiations over the spending bill, which is likely the last piece of must-pass legislation before November's mid-term elections.

"It's the biggest regulatory change I've seen in the BDC space probably ever," said Ryan Lynch, managing director at Keefe Bruyette & Woods, an investment bank specializing in financial services. "It's going to provide much more flexibility to every BDC."

The investment vehicles provide loans to private middle-market U.S. businesses and also can invest in financial companies.

The speed of the legislative process this year is a product of work done on the BDC bill over the years, according to Anya Coverman, senior vice president for government affairs and general counsel at the Investment Program Association, an interest group for alternative investments.

This year's version jettisoned previously controversial provisions, including one that would allow BDCs to invest in registered investment advisers.

"This is something that's been worked on for a number of years. It's not a surprise that the [BDC bill] is making its way to finally becoming law," Ms. Coverman said. "It's always been aimed at doubling down on the positive impact BDCs have on the economy and small business."

Advocates for BDCs stress their role in helping domestic startup companies get financing when they can't obtain it from traditional banks. Investment advisers and brokers use BDCs to diversify client portfolios and add income streams.

But the investments can be risky, and the sector has suffered setbacks in sales and equity fundraising.

The increase in BDC leverage allowed by the bill will benefit fund managers but potentially harm retail investors, the advocacy group Americans for Financial Reform said in a Thursday statement.

"BDCs already charge much greater fees to investors than comparable investment products," AFR said. "This change simply serves to increase profits for private-equity managers while harming ordinary investors."

Michael Gerber, executive vice president of FS Investments, an asset manager specializing in alternative investments, countered that the BDC reforms will make them a better investment.

"It should be beneficial to investors as managers should lower legal, administrative and borrowing costs while building better, risk-adjusted portfolios that generate competitive returns," Mr. Gerber wrote in an email.

But Robert Grunewald, chief executive and founder of Flat Rock Capital, a BDC, said that by adding leverage, BDCs will compete more aggressively to provide loans for small businesses, which could drive down yields.

"That will be good for borrowers but not necessarily good for BDC shareholders," Mr. Grunewald said.

The pending changes to BDCs make them a potentially more unpredictable investment, according to Mr. Lynch.

"You're going to have more volatility of results," he said. "That makes it much more important to understand the BDCs you're investing in."

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