Trouble brewing for BDCs? Fitch predicts bumps on the road to 2025

WEB DESK: Business development companies are likely to face challenges in 2025 owing to a number of industry-specific issues and wider economic trends, according to a recent report by Fitch Ratings.

Despite these difficulties, Fitch is of the view that overall ratings for the sector will remain stable.

Fitch maintains negative outlook for BDCs in 2025 although many of these companies are part of larger investment management platforms which helps them maintain their competitive position and access to deals.

Contrastingly, Chelsea Richardson, a Senior Director at Fitch, said factors like potential interest rate cuts, narrowing profit margins and an increase in underperforming loans (non-accruals) could lower returns on BDC portfolios most of which are tied to floating-rate debt.

The rise in non-accruals which refers to loans that no longer generate interest could result in more financial losses for BDCs next year as troubled investments are restructured or sold off.

Another concern includes increasing reliance on payment-in-kind (PIK) income—where firms pay dividends and interest in stock rather than cash—making it harder for BDCs to maintain cash dividends.

Richardson said that while lower interest rates could reduce need for borrowers to rely on PIK income, competitive market conditions suggest that PIK income will stay high next year.

Despite the tough environment, Fitch expects BDCs to remain cautious in their lending and investment strategies, ensuring they have enough financial cushion to manage potential market risks and losses.

According to Richardson, however, if the quality of assets continues to decline and losses grow, BDC ratings could come under pressure in the future.

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