Business development sector faces deteriorating outlook in 2025

November 28, 2024 (MLN): A confluence of sector-specific trends and broader economic indicators will continue to chip away at performance for business development companies (BDCs) in 2025, though Fitch Ratings points to continued ratings stability overall for the sector in its new outlook report.

Fitch’s maintains a deteriorating 2025 sector outlook for BDCs. “Many rated BDCs are affiliated with broader investment manager platforms, which should support their market positions and access to deal flow in the competitive environment,” said Senior Director Chelsea Richardson.

“Still, rate cuts, spread compression and upticks in non-accruals will drive lower portfolio yields given the majority of BDCs’ debt investments are floating-rate.”

Rising non-accruals could translate into more realized losses for BDCs in 2025 as underperforming investments are restructured and/or exited. Another area of heightened attention revolves around payment-in-kind (PIK) income, which will weaken cash coverage of dividends.

“Lower interest rates could reduce the need for borrowers to utilize PIK flexibility over time, though PIK income will remain elevated next year given competitive market dynamics,” said Richardson.

Despite sector deterioration, ratings are largely stable. Fitch expects BDCs will remain selective on origination throughout next year while maintaining asset coverage cushions at an appropriate level to account for potential market volatility and realized losses.

“We expect continued divergence in asset quality and outsized realized losses could in time begin to pressure BDC ratings,” said Richardson.

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