PennantPark Floating Rate Capital LTD. (NASDAQ:PFLT), which is a business development company (BDC), has lowered their asset coverage from 200% to 150% as allowed by the Cnsolidated Appropriations Act of 2018 (the budget). The change is effective 4/5/2019.
What this means is that the BDC no longer has to have 200% coverage for senior securities–meaning baby bonds and preferred stock.
As an investor in senior securities in baby bonds and preferred stocks of BDC’s we think this is reason for concern. One of the reasons we buy these senior securities is because of the margin of safety provided by the asset coverage. With reduced coverage the risk rises for senior security holders so in theory the coupons on new issuance should rise–we shall see.
Business Development Companies hold many assets that can only be valued via Level 3 observation–in other words “just trust me” when it comes to asset valuation. Unfortunately we can’t always trust management to use good judgement and in particular when the economy comes under stress.
While we will not stop investing in the senior securities of BDC’s we will give them extra scrutiny when the quarterly reports are issued.
Previously Apollo Investment (NASDAQ:AINV) announced a similar change effective 4/4/2019. Their press release is here.
It should be noted that most BDC’s are also closed end funds. The leverage change only affect BDC’s at this time. Stock CEF’s are still required to maintain 200% asset coverage ratio.