BDC performance, software exposure trigger pricing fears

Pessimism in the private credit market began over six months ago, notably preceding the recent software SAASpocalypse. These fears have accelerated, leading to BDCs trading at average discounts of over 20% to net asset values and investor redemption requests reaching double digits.

Last fall, driven by concerns around lower rates, rising non-accruals and dividend sustainability, public BDC equity valuations shifted from premiums to discounts compared with net asset values. These expectations for lower dividends were well-founded; Octus found that over 50% of BDCs, public and private, did not generate enough cash to fund their dividends. 

​Fears of mispriced assets accelerated with the recent software selloff as the gap between public and private market valuations widened. 

While half of broadly syndicated software loans maturing in 2028 trade below 90, just 5% of direct loans held by BDCs were marked below 90% of par. Octus found that BDC software exposure is close to 30%, which is higher than what is typically found using standard BDC reported sector categorization.

When it comes to which market is right, only time will tell. Many of the BSL loans maturing in 2028 are Covid-era loans issued during extremely low interest rate environments and haven’t seen success in refinancing efforts. Additionally, public markets’ selloff occurred after BDCs marked their books. 

​Many of the BSL loans maturing in 2028 are Covid-era loans issued during extremely low interest rate environments that have not yet seen success in refinancing efforts.

Additionally, the public markets’ selloff occurred after BDCs had already marked their books. This discrepancy is a primary reason investors are asking to exit privately traded BDCs; if investors lack confidence in the underlying value but can sell at NAV, redemption is a rational move. 

Adding to the contagion, rules allow BDCs to limit redemptions, causing investors to wait in line. Funds managed by Cliffwater, Morgan Stanley, and Blue Owl have all limited redemptions.  

​Is the selling overdone, or is now the time for investors to start dipping their toes back into the private credit water? Only time will tell. In the meantime, we expect to see a market of two halves: investors requesting capital back at elevated rates, contrasted by announcements like Saba Capital and Cox tendering for shares at substantial discounts.