| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
— Capital Calls —
For a short while after the credit crunch hit, business development companies -- publicly traded, closed-end funds serving the middle market -- looked as if they were thriving. Unlike the rest of the financing markets, their balance sheets showed relatively low leverage risk, given the BDCs' prescribed debt to equity ratio at 1-to-1, plus they had capital to invest, at least for a time. But markets, or more precisely mark-to-market, eventually wreaked havoc on legacy portfolios of mezzanine debt and equity investments, and BDC stocks have been pummeled. Some private equity wannabes might be heaving a sigh of relief that their BDCs never took off, now that they have the benefit of distance. BDCs work exceedingly well when markets are up, but the reverse is true when they tumble. To fund operations, a BDC must issue new stock, because it pays out most of its earnings in dividends. A BDC is usually precluded from selling new shares of its common stock at less than net asset value without shareholder approval or unless such shares are issued through a rights offering.
The sector as a whole has taken it on the chin, but Allied Capital Corp. of Washington appears to have absorbed more than its fair share of collateral damage. The firm blames the broader financial crisis, but analysts say it's difficult to disassociate Allied's troubles from its long-running battle with short sellers led by New York hedge fund Greenlight Capital Inc. and founder David Einhorn. Einhorn has had Allied in his cross hairs for several years now, alleging fraudulent dealings over Allied portfolio company Business Loan Express LLC, now known as Ciena Capital LLC. Allied has denied allegations, but a federal investigation is still pending. Einhorn devoted an entire book to the subject, "Fooling Some of the People All of the Time," published in May. Ciena, a small-business lender, filed for bankruptcy protection on Sept. 30. Allied says Ciena, which it acquired in 2000 and was one of its largest investments, continues to experience "significant deterioration" in the value of its assets due to the uncertainty in the financial markets, falling bid prices and a reduction in the number of loan buyers. Allied's $327 million outlay in Ciena has been written down to zero over the past several quarters as of mid-2008. But some analysts warned that Allied was exposed to $320 million in unconditional guarantees of Ciena's outstanding obligations, which could eat into its spillover income for the coming quarters and slash the dividend. To fund the payment, the BDC says it used cash resources of $149 million and borrowings of $170 million. Allied says it has been harvesting capital gains from the sale of debt and equity. As of the end of June, it retained about $200 million in cash and had borrowings on its $632.5 million line of credit of $170 million, along with standby letters of credit of roughly $124 million. American Capital Ltd. of Bethesda, Md., perhaps the most aggressive BDC, was recently downgraded by J.P. Morgan Securities Inc. on concerns that the firm may not be able to maintain its dividend rate in the coming quarters "without a significant improvement in the current environment" of lower valuations and slowed deal activity. Kohlberg Capital Corp., which has a relationship with Mount Kisco, N.Y., private equity firm Kohlberg & Co. LLC, was faring better than average until recently, when it decided to go for a rights offering, then withdrew it amid the Wall Street crisis while cutting its dividend. Worse is yet to come, though. As David Chiaverini, a vice president at BMO Capital Markets Corp., puts it, very simply, "Credit quality is weakening." -- John E. Morris contributed to this article.
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
