U.S. investors squeezed by low bond yields and discouraged by the volatile stock market have pumped more than $50 billion into business development companies, or BDCs, in the last 10 years, in hopes of earning more.
BDCs typically invest in debt sold by U.S. middle-market companies, including private-equity merger targets, energy-development projects, and mainstream companies that don't qualify for cheap bank loans.
For the hope of higher, steadier interest yields, BDC investors often pay high broker fees. Many of their funds are closed-end, which means you can't readily sell them before they mature.
One of the largest BDC sponsors is Philadelphia-based Franklin Square Investment Corp. and its affiliates, founded by lawyer Michael Forman and dorm-and-hotel mogul David Adelman.
Franklin Square employs more than 300 brainy people, investing $17 billion in client money, mostly from its new offices at the former Navy Yard, where Forman recently cohosted a fund-raiser for Democratic presidential hopeful Hillary Clinton.
The collapse of energy prices and the slowdown in the high-risk credit markets have hurt BDC valuations, driving Franklin Square's main fund below $9 a share for the first time since its public offering two years ago, though spokesman Marc Yaklofsky noted that the shares have still outperformed the S&P 500 so far this year and over the last 12 months. Franklin Square Investment Corp. closed at $9.30 on Friday.
Forman, in a conference call earlier this month, told investors that his portfolio managers at GSO Blackstone see the weakened credit markets not as a threat, but as "an opportunity" to buy valuable assets cheap.
Franklin Square has enjoyed an investment-grade BBB credit rating from Standard & Poor's, several grades below blue-chip corporate debt though among the highest of any BDC group.
But on Tuesday, S&P analysts Trevor Martin and Sebnem Caglayan threatened to cut the credit ratings of Franklin Square and three other BDCs, citing continued exposure to energy-company debt and the general increase in bad-debt fears as economic growth slows.
It still has plenty of capital, but Franklin Square's "history only extends back to 2009, and therefore it has operated in a relatively benign credit environment," the analysts noted. A two-step rating cut to junk-bond status would make it tough for Franklin Square to raise more capital.
S&P hasn't actually cut Franklin Square's rating, and the rival Fitch credit rating agency says it has no plans for a downgrade, Yaklofsky said.
"We're not surprised" by S&P's concerns, "given the recent volatility in the credit and energy markets," he told me. "We believe credit quality remains strong, and we are pleased with the overall growth of our portfolio."
Recent Franklin Square investments include $260 million to fund the private-equity firm New Mountain Capital's purchase and merger of the software makers Trover Solutions Inc. and Equian L.L.C., as well as $181 million to help refinance Pittsburgh Glass Works, which makes automobile windows.