Shares of publicly traded private-credit funds known as business-development companies (BDCs) have recently been trading at significant discounts to their net asset values (NAV), raising investor concerns about the transparency and stability of their balance sheets. The S&P BDC Index recently fell to 86% of NAV and has not traded at a premium since last September. While market anxiety over potential technological disruptions—such as artificial intelligence’s impact on software companies, which are major BDC borrowers—has contributed to the decline, the underlying issue of increasing and less transparent leverage within these funds may be a central factor.
BDCs have historically lent to middle-market companies with speculative-grade credit ratings and have attracted investors through their relatively high dividend yields. However, many now carry more debt than in the past, often in ways that are not immediately apparent on their public financial statements. A decade ago, federal regulations generally limited BDCs to borrowing roughly one dollar of debt for every dollar of equity. Congress doubled this cap in 2018, allowing BDCs to leverage up to twice their equity.
Despite this increase, BDCs are still less leveraged than traditional banks. Nevertheless, accounting rules specific to BDCs enable them to keep much of their debt off their own balance sheets. These rules typically discourage or prohibit BDCs from consolidating the financial results of portfolio companies they own outright or hold majority stakes in. Instead, BDCs record investments as single line items at fair market value, excluding the associated liabilities from their own accounts.
Research by the firm Octus highlights the impact of this structure. While the reported average debt-to-equity ratio of publicly traded BDCs was about 1.2 times equity, Octus estimated that on a “full look-through” basis — which takes into account the debt of portfolio companies — the actual average leverage rises to 1.5 times equity. For some smaller BDCs, this ratio exceeded three times equity, indicating substantially higher risk than appears on the surface.
Examples illustrate how this off-balance-sheet debt can obscure leverage. Blue Owl Capital Corp. (OBDC), trading near 80% of NAV, owns 68% of Blue Owl Credit SLF, which carries $1.7 billion of debt, or 2.8 times its equity, but does not consolidate it. OBDC valued this stake at only about 6% of its net assets. Similarly, Bain Capital Specialty Finance, trading at 81% of NAV, holds a majority interest in International Senior Loan Program, whose debt exceeds 10 times equity. New Mountain Finance trades for 75% of NAV and owns a majority stake in a lender with nearly four times equity in debt.
Ares Capital Corp., the largest publicly traded BDC, trades close to net asset value at 98%. It owns 100% of Ivy Hill Asset Management, which carries $9.9 billion in debt, more than six times equity, but this leveraging also remains off Ares’s consolidated balance sheet.
While some of this off-balance-sheet leverage is disclosed, the lack of full transparency leaves investors uncertain about the true extent of financial risk within many BDCs. This opacity poses particular challenges if market pressures intensify or if the private-credit sector faces difficulties, as investors may not fully understand the leverage embedded within their holdings. For many BDC investors, the complexities of the structure mean it is increasingly difficult to gauge their exposure with confidence.