We believe high-yielding BDC equities, many currently paying 10%+ yield, can become productive building blocks for long-term investors’ income-oriented portfolios if they carefully choose BDC management teams and entry prices. We will address one of the BDC business fundamentals – their funding structure- in this blog, considering the recent headlines about SBV and bank runs.

On Friday, March 10^th, the government seized the asset of SVB Financial Corp (SVB), parent of Silicon Valley Bank, after it experienced a run on the bank. Over the weekend, the regulators took control of another bank, Signature Bank. Federal agencies then announced emergency measures to guarantee all deposits of both failed banks and make emergency lending facilities available to all banks to shore up confidence in the US banking system. Despite the emergency response from the government, the fear of contagion still runs high as many regional banks are selling off upon the market opening on Monday, March. 13^th.  What are the implications for other lending sectors? Can BDCs experience a “bank run”?

BDCs lend to private small- to medium-sized companies (SME), primarily at floating rates based on SOFR (Secured Overnight Financing Rate) plus a spread. BDCs can and typically do borrow up to approximately 2/3 of their asset size. Investors in BDC equities effectively own a lending business, earning the difference between SME loan yields and financing and operating costs, almost like a bank.   

Almost, but not exactly.   Short-term deposits is one of the primary funding sources of a bank, and retail customers can withdraw their short-term deposits at will. When an extraordinary amount of withdrawal requests overwhelms a bank, a bank run, such as with SVB, occurs. In contrast, BDCs are funded by floating-rate credit facilities and fixed-rate bonds. Large banks typically provide renewable credit facilities, and institutions or retail investors purchase the 5–7-year maturity fixed-rate bonds. Neither the credit facilities nor the bonds can be “withdrawn” at will. Therefore a “bank run” will not happen to a BDC.

However, we caution that any impact of bank runs, rising rates, and a slowing economy are still playing out on many financing institutions, BDCs included. Therefore, we are closely monitoring the few selected BDCs in clients’ portfolios. We gain comfort from the fact that teams with a history of prudent lending practices and solid credit performance through economic cycles manage these BDCs. In addition, most management teams are affiliated with more prominent alternative asset management parent firms whose scale and resources can help BDCs’ lending process and access to the capital markets. These BDC management teams also demonstrated the expertise and capital to seize opportunities during past economic downturns and become even stronger players in the private lending market.