BDC Non-Qualifying Assets: Are "Bad-Assets" Actually Bad?

This commentary reviews non-qualified assets within business development companies (BDCs) and the credit implications with them.

-- Typically, BDCs provide financing to middle market companies which are often owned by financial sponsors. Outside of qualifying portfolio companies, BDCs may invest up to 30% of their total assets in non-qualified assets.

-- Non-qualified assets may include international companies, public companies with a market cap over $250 million, joint-ventures or other operating platforms.

-- At 2Q24, the average non-qualifying assets to total assets of our public and private BDC credit ratings was 19.1% with most BDCs operating well within the 30% constraint. If a BDC is above the limit, it may only invest in eligible assets until ineligible assets are back under 30%.

-- If non-qualified assets enhance earnings, while limiting or reducing the BDC's risk profile through diversification, then these assets may be positive from a credit perspective. However, if the non-qualified assets increase operational risk, foreign exchange risk, or are in an asset class well outside the management's investing expertise, it would be viewed negatively.

"From a credit perspective, we believe that BDCs should focus on their primary investment mandate of credit-focused investing dedicated to capital preservation over higher concentrations of alternative strategies which have the potential to increase operational risk or cause management to lose focus on their core strategy." said Watson Tanlamai, CFA, Vice President - Global FIG.