When is a loan more than a loan?
Robinson and Wallskog’s paper finds that BDCs tend to extend loans that are markedly different from those of traditional banks, in part because “BDCs lend to companies that don’t look creditworthy to a bank”, says Robinson.
Wallskog adds: “One surprise was that BDCs provide a complex array of securities, including equity, warrants, options, and preferred and common stock, in addition to loans.” The paper finds that, on average, BDCs hold about half of their portfolios in what it calls “non-bank-like” loans.
Yet there are distinctions. The paper categorises BDCs into PE-affiliated and independent. PE-affiliated groups, which are often much larger than independent BDCs and rely on their parent firms for deal sourcing, generally provide more bank-like products and have more institutional investors. By contrast, independent BDCs are more likely to supply equity-oriented products and have more individual investors.
Overall, the findings tally with the argument that private credit fills a genuine market need and that financing structures offered by institutionally funded private credit vehicles may differ from those in independent BDCs.
One surprise was that BDCs provide a complex array of securities, including equity, warrants, options, preferred and common stock, in addition to loans.
Melanie Wallskog, Duke University
Richard Miller, CIO and group managing director of TCW’s Private Credit Group, observes that the asset class emerged as bank loans became more difficult for mid-market companies to access. “Most private credit consists of senior secured lending,” he says. “Debt financing is critical for middle-market growth. These firms may not meet bank lending criteria, but there is a sound investment case for lending to them. Private credit fills that gap, albeit at a higher interest rate to reflect the risk. Importantly, we spend time understanding the business and tailoring the loan structure, timing, and covenants to what the company can realistically achieve.”
The researchers say that BDCs’ risk profiles and betas sit between those of banks and PE firms. By combining different securities, BDCs structure investments that deliver current yield, capital appreciation, and equity exposure. “This makes them well suited to individual investors who can’t tolerate the illiquidity of a pure PE position,” says Robinson. These findings have implications for how regulators might best approach the question of private credit and systemic risk, as we explore later.
