First published: 20 JUNE 2018
On June 18, 2018 Goldman Sachs BDC (NYSE:GSBD) announced by press release that Fitch Ratings had assigned the BDC an investment grade rating of BBB-.
The outlook was “stable”.
“We are particularly gratified by Fitch’s acknowledgment of GSAM’s differentiated risk management and proprietary loan sourcing capabilities in its assessment.” said Brendan McGovern, CEO of the Company”
The BDC Reporter has not yet reviewed the full text of Fitch’s report.
However, this appears to be the first investment grade rating handed out to a BDC that has adopted the new higher leverage allowed under the Small Business Credit Availability Act.
As reported on multiple earlier occasions, S&P Global Ratings has warned that any BDC which adopts the new asset coverage/leverage standard faces an almost automatic ratings review and downgrade.
Fitch Ratings approach has been different from the outset, but this is the first instance where an investment grade rating has been announced for a specific BDC.
We are not surprised by Fitch’s decision.
Weeks ago, the BDC Reporter pointed out that Fitch was differentiating itself from the hard line approach initially adopted by S&P.
The latter’s approach has been roundly critiqued by numerous BDC managers (in a circuitous, non offense taking way), analysts and others.
Given that rating debt is itself a businesss, the BDC Reporter wonders how much this shift in the BDC leverage landscape reflects competition between Fitch and S&P for issuer rating mandates ?
In any case, Fitch’s actions are likely to increase pressure on S&P to change/soften its approach going forward.
With many BDCs still waiting on the sidelines about adopting the new leverage – partly due to S&P’s initial negative reaction to a potential doubling of funds leverage – this is not an academic issue.
How S&P reacts to the many “constructive meetings” currently being held with various BDCs each touting their “differentiated risk management” will have a major impact on the immediate future of the BDC sector.
From our standpoint – and we like to think we dig as deep as one can into the portfolios of BDCs like GSBD – we find the argument that a BDC can double its leverage and increase loan assets by one third to one half without materially increasing its risk profile – as Fitch seems ready to accept – is laughable.
Imagine if the government was lobbied into allowing the speed limit to be increased to 140 miles an hour and argued in justification that there would be no increase in accidents on our roads, but we’d all get to our destinations quicker…
After all, the BDCs that had ratings prior to the new law were already only just investment grade (various shades of BBB). Whatever S&P says, common sense suggests that a very large increase in assets (financed exclusively by debt) on the same amount of equity capital AND at a time when loan credit quality, terms and protections are the weakest in a generation, must result in a shift in potential risk.
Moreover, neither GSBD or many of the other BDCs chafing at the bit to double down on leverage, have been in business through an entire economic cycle.
Those of us who have (several times over) know that leveraged lending is a highly cyclical business where the bulk of credit troubles are bunched into the end of one cycle and the beginning of the next.
The (relatively) low but not insubstantial credit losses GSBD has suffered since coming to market at the beginning of this decade are likely to be dwarfed by what will occur in the Next Recession, regardless of the BDC’s “differentiated risk management”.
While we’re on that subject, let’s call a spade a spade and point out that no lender – however unique their credit approach or the number of diplomas held by their professional staff – can avoid credit losses in leveraged lending. BDCs lend to non investment grade companies – and to the “riskier” ones amongst them to boot- and material setbacks should be expected.
Of course, what will happen is that Fitch will – one day – downgrade GSBD’s debt when credit losses mount as they must.
In the short term, though, the issue that BDC investors – both in debt and equity – should be most alert to is what S&P will do.
As we’ve projected before, we expect that sooner rather than later the rating group – the last bulwark besides the BDC Reporter against unduly high BDC leverage – will find a way to look the other way and bless what they have said they would not.
Even if we’re wrong and S&P sticks with its current approach, we still expect many BDCs to proceed with higher leverage anyway, leaving S&P in a tight spot.
UPDATE: July 5, 2018
We have subsequently learned that S&P - true to its word - downgraded both GSBD and the Convertible debt on hearing that the BDC had opted to leverage up.
The BDC itself was reduced by one notch to "junk" status or BB+.
The 2022 Convertible - which was privately placed and has been expanded - was downgraded by two notches to BB.
GSBD's reaction ?
They requested that S&P "withdraw" its rating, which the rating group has done.
As a result, GSBD no longer has a rating from S&P, either for the BDC as a whole or for any debt issue.
We wrote a long thought piece about what this might mean in another Premium post today (July 6, 2018), which we'll republish at a later date.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GSBD over the next 72 hours.