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Moody's Downgrades Outlook of BDCs on Coronavirus Concerns

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Owing to the coronavirus-induced economic crisis, Moody’s Investors Service — the rating services arm of Moody's Corporation MCO — has downgraded the industry outlook for business development companies (“BDCs”) to negative from stable.

Reason for the Downgrade in Outlook

The rapidly spreading coronavirus along with falling oil prices has resulted in a severe credit shock across most of the sectors and markets. Moody’s believes that the BDC sector will likely be the most affected by the credit shock.

Per Moody’s, the crisis is expected to lead to a deterioration of asset quality, profitability and capital of BDCs. This is the main reason behind Moody’s lowering the outlook for the BDC sector. Moreover, given the implications of the outbreak on public health, Moody's views it as a social risk under its environmental, social and governance (“ESG”) framework.

Notably, Moody’s has also affirmed the ratings of nine individual BDCs, including Goldman Sachs BDC, Inc. (GSBD - Free Report) , Owl Rock Capital Corporation ORCC, Ares Capital Corporation ARCC, BlackRock TCP Capital Corp. (TCPC - Free Report) , FS KKR Capital Corp FSK, Oaktree Specialty Lending Corporation OCSL, Prospect Capital Corporation, Solar Capital Ltd. and TPG Specialty Lending, Inc.

Rationale Behind Ratings Affirmation

The virus outbreak, which is expected to lead to an increase in loan non-accruals and defaults, will likely negatively impact earnings and cash flow strength of BDCs, per Moody’s.

Also, the pandemic has resulted in the deterioration in economic outlooks in the United States as well as globally, resulting in declines in commercial activity levels. This has affected the financial profiles of most of the companies, including middle-market businesses within the United States, in which BDCs mainly invest.

Further, per Moody’s, the majority of the sectors will likely witness deterioration in their asset quality if the current operating and economic conditions persist. This will hamper the operating performance and capital strength of BDCs.

However, most of the BDCs that are rated by Moody's have modest exposure to the sectors that are among the hardest hit initially by the pandemic, including travel and leisure, hospitality, gaming, retail, restaurant, and energy, which is a positive.

Also, Moody's rated BDCs have strong liquidity positions, which will result in lower debt repayment risks over the next 1-2 years, with little debt maturing until 2022. In fact, most rated BDCs have sufficient liquidity to fund the immediate draw against commitments by their borrowers.

Thus, despite the expectation of deteriorating asset quality, the ratings of the above-mentioned BDCs have been affirmed by Moody’s, given their strong liquidity positions, adequate capital cushions and conservative investment portfolios.

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