Barclays Defends BDC Risk Premiums Amid Market Turbulence

BDC Debt Spreads Widen to "Rarerfied Territory" as Investors Demand Higher Risk Premiums

Investors are increasingly demanding higher risk premiums to own the debt of business development companies (BDCs), reflecting their growing anxiety around private credit exposure. According to Barclays Plc, a broad-based index of BDC debt shows spreads climbing 80 basis points to 260 basis points this year, reaching "rarefied territory".

Unsecured BDC bonds have underperformed collateralized loan obligations (CLOs) by a significant margin, with spreads on BDC debt widening 75 basis points since January, compared to 20 basis points for CLOs. This difference is "justified" due to the lack of collateral or lower-quality assets backing BDCs, as well as their higher exposure to the troubled software sector, which averages 20% compared to 12% for CLOs.

An uptick in redemptions from some BDCs has also contributed to wider spreads this year. BDCs typically sell shares to retail investors and use that money to buy portfolios of corporate loans issued by small and mid-size companies, while also raising cash by issuing bonds and other debt to institutional investors.

Read also: Treasury Yields Experience Largest Increase in Two Weeks Following Release of Labor Market Data

The premium on BDC debt represents additional interest that investors charge on top of base interest rates. Spreads on BDC unsecureds have surpassed other parts of the investment-grade bond market, as well as some parts of the high-yield market, according to Barclays.

Despite the substantial widening in spreads, Barclays notes that the probability of a BDC defaulting on its unsecured debt is "very low today", thanks to their access to liquidity and leverage-to-asset coverage metrics.