Key Takeaways:
Rising financing costs are squeezing the private credit sector as investor concerns mount, a trend highlighted by Moody's recent downgrade of FS KKR Capital's (FSK) debt to junk status, pushing average BDC bond yields above 6.5 percent.
"Current bond spreads make leverage less economic for BDCs," said David Eichhorn, CEO of NISA, a fixed-income asset manager with $470 billion under management that has analyzed the sector.
The average yield on publicly traded debt from business development companies has climbed from under 6 percent at the start of the year to around 6.5 percent, according to Raymond James and Bloomberg data. Yield spreads relative to risk-free Treasuries have widened by half a percentage point to 2.5 percentage points. Bonds from Blackstone Private Credit Fund (Bcred) and Blue Owl Capital (OBDC) now yield about 6.5 percent, while some issues from Carlyle Secured Lending and Blue Owl Technology Finance trade closer to 7 percent.
This trend poses a direct threat to the BDC model, which employs roughly a dollar of debt for every dollar of equity to boost returns and sustain dividend yields that are often near 10 percent. If persistent, higher borrowing costs will narrow net interest margins, potentially forcing BDCs to reduce shareholder payouts and making it harder to offset high management fees that can exceed five percentage points.
The downgrade of FS KKR Capital's bonds to a Ba1 "junk" rating from Baa3 was a key trigger for the recent widening in spreads. Moody’s cited the firm's “continued asset quality challenges, which have resulted in weaker profitability and greater net asset value erosion over time relative to business development company (BDC) peers.” Following the downgrade, FS KKR's five-year bonds yielded about 7.5 percent.
The company's shares have fallen approximately 25 percent this year, trading at a 50 percent discount to their year-end 2025 net asset value. This decline in NAV has, in turn, increased the firm's leverage ratio, a point of concern noted by the rating agency.
The concerns extend beyond a single firm. The VanEck BDC Income ETF, a broad measure of the sector, is down 15 percent this year. Meanwhile, some large semi-liquid private funds, including those managed by Blue Owl, have experienced elevated redemption requests, forcing them to limit investor withdrawals to the contractual 5 percent quarterly limit.
BDC managers argue that the public bond market is just one component of their financing structure, which also includes bank loans and securitizations with staggered maturities. They contend that more attractive yields on new private credit loans—which are typically floating-rate and tied to the SOFR benchmark with an average margin of five percentage points—can offset the impact of higher debt costs.
Most BDC debt is issued via private placements to institutional investors. However, a small number of "Baby Bonds" from issuers like Gladstone Investment and New Mountain Finance trade on public exchanges, typically yielding between 7 and 8 percent.
This article is for informational purposes only and does not constitute investment advice.
