By Jonathan Weil
When a publicly traded private-credit fund trades for a big discount to its net asset value, it's a signal that the market doesn't trust the fund's balance sheet. That is often for good reason.
Shares of these funds, known as business-development companies, have slid hard. The S&P BDC Index is down to 86% of NAV and hasn't been at a premium since September. Investor concerns include the potential for artificial intelligence to disrupt software makers that are major borrowers.
But another factor might also help explain some of the recent shakiness: BDCs are more loaded with debt than they used to be, often in ways that are hard to discern. This means they are more fragile and have less room for error.
Sometimes the extra leverage doesn't count against the funds' legal limits, because the debt resides off their balance sheets. This extra leverage isn't always visible to investors because it usually doesn't have to be disclosed.
A decade ago, leverage at BDCs was capped by federal law so that, in general, they could borrow $100 for every $100 of equity. Congress changed the law in 2018, after prodding by the industry, and doubled the debt limit to two times equity.
BDCs still aren't highly levered compared with banks. BDCs have long been popular with individual investors because of their high dividend yields, and they typically lend to middle-market companies with speculative-grade credit.
But BDCs also have specialized accounting rules that let them work around the leverage caps. The rules often discourage or prohibit BDCs from consolidating companies they have invested in, even if they hold majority stakes or 100% ownership. That means the BDCs don't bring the assets and liabilities of their portfolio companies onto their own books. Instead, they record each investment as a single line item at fair market value.
Reported debt at publicly traded BDCs on average was 1.2 times equity, according to a March report by Octus. The research firm estimated it was 1.5 times equity on a "full look-through" basis, which includes debt at the companies or funds in which a BDC invests. At a few small BDCs, Octus estimated it was three times equity or higher.
The logic behind these rules is that investors should see the fair value of the investments rather than a cluttered balance sheet of many different businesses. But that comes with a trade-off. The rules let BDCs add leverage in ways that aren't always obvious. In good times the extra leverage helps juice investment returns, but in bad times it can amplify losses.
Sometimes BDCs report detailed financial information about the companies where they have lent money or own equity, if the holdings are significant enough to trigger disclosure requirements. But usually they aren't required to.
Consider Blue Owl Capital Corp., which trades for 79% of NAV. The fund, known as OBDC, owns 68% of a lender called Blue Owl Credit SLF but doesn't consolidate it. As of Dec. 31, Credit SLF had $1.7 billion of debt, or 2.8 times its equity. In general, that is a higher ratio than OBDC itself could have. OBDC valued the stake at $415 million, or about 6% of its net assets.
At least investors could see the leverage there, because OBDC disclosed Credit SLF's financial statements. By contrast, OBDC owned 88% of a lender called Wingspire Capital Holdings and valued the stake at $607 million, or about 8% of its net assets. But it didn't disclose Wingspire's balance-sheet data, so investors can only guess.
Another BDC, Bain Capital Specialty Finance, trades for 80% of NAV. It owns a majority stake in a lender called International Senior Loan Program, consisting of equity and subordinated notes. Combined, Bain valued the ISLP investments at $234 million, which was 21% of its net assets at year-end. It also disclosed ISLP's financial statements. Those showed about $687 million of debt and subordinated notes, which was more than 10 times equity.
New Mountain Finance trades for 74% of NAV and owns 80% of a lender called NMFC Senior Loan Program III. New Mountain valued its equity in the company at $160 million as of Dec. 31, which was 13% of its net assets. It also disclosed separate financial statements for the company that showed about $673 million of debt, which was 3.7 times equity.
A similar dynamic is visible at Ares Capital Corp., the largest publicly traded BDC, although its shares trade for only a slight discount at 98% of NAV. Ares Capital owns 100% of Ivy Hill Asset Management but doesn't consolidate it. Ivy Hill had $9.9 billion of debt as of March 31, which was more than six times equity. About $2.7 billion, or 19%, of Ares Capital's net assets consisted of the equity investment in Ivy Hill and a loan to the company.
Those are examples of off-balance-sheet leverage that is disclosed. But it is the hidden, undisclosed leverage and fear of the unknown that could become a greater concern if private credit's woes persist. Lots of BDC investors used to think they understood what they owned. For many there is no way they could know.
Write to Jonathan Weil at jonathan.weil@wsj.com
(END) Dow Jones Newswires
May 01, 2026 05:30 ET (09:30 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
Comments