As Promised

We did warn months ago that 2025 was going to be a very bumpy year, and here we are. The Trump Administration has now delineated the extent of its global tariff reset. As we write this, the day after the announcement in the Rose Garden, the major indices are in free fall. However, this is far from over as U.S. trading partners big and small are determining their response. How the major partners respond will, in turn, determine if the U.S. increases the tariffs further. If not, negotiations might shave down the tariffs some countries or some sectors pay.

Early Scores Coming In

The economists have reportedly been up late hunched over their computers and already crunched the numbers – JP Morgan, UBS and Goldman Sachs are just three examples amongst the many we’ve surveyed- and they are “warning” of higher inflation showing up in the second and third quarter of 2025, and the chances of a U.S. recession sharply increasing. Much further down the road, nobody knows how countries, companies and investors will re-allocate capital to maximize profit/minimize losses in the face of these emerging new conditions.

Our Take

Obviously, our readers – and anyone who still buys a newspaper or is tuned to the news – know all the above. In any case, anything we say will become stale within hours as new developments are occurring fast and furiously. However, we are taking a deep breath and seeking to assess – as best we can – what the most likely impact all the above may have on the BDC sector. We’ve been listening to dozens of BDC conference calls since late January 2025 as well as following the developing public record of filings and press releases, which provide some tangible hints. However, as you’ll see some very important elements that affect BDC profitability and creditworthiness could go – depending on who you’re listening to – in completely different directions.

Anyway, we’re going to review potential future developments in likely order of certainty from strongest to wildly speculative. We’re using a time frame of up to 9 months – till the end of this historic 2025:

Investment Activity Will Slow

We’ve been hearing from multiple BDC sources that after a mini-surge after the election, less and less new loan deals are coming to market. The much promised M&A boom that was supposed to occur because of less regulation; lower rates and mounds of unspent private equity and lender capital is likely to be postponed till further notice. Companies will have to prove to lenders that their business has not been materially impacted by the macro-changes and lenders will be watching economic growth, interest rates, etc with a renewed sense of anxiety.

The last time a recession seemed to be in the air – in 2022 – the syndicated loan market essentially closed down. That’s likely to happen here again. In 2022, though, the BDCs remained willing and able to fund new deals but became more selective, which limited which borrowers came to market. So we expect to see less loans, less equity realizations and even less refinancing than was the case in 2024 and compared to what was expected at the beginning of the year.

If we’re correct, this will impact individual BDCs differently. Many count on new loans to book fee income. Debt refinancings are especially important – especially to venture debt lenders – to accelerate Original Issue Discounts and ETPs (End-Of-Term Payments)which can substantially boost yields. BDCs that have – for one reason or another – seen their portfolios drop below their optimal size will have a harder time finding the necessary new loans to grow their income.

On the other hand, lower investment activity will mean less repayments, allowing BDCs to enjoy for longer the contractual income they enjoy with 6,000 or so borrowers in the U.S. and beyond. This will also provide a reprieve from the dog-eat-dog new loan environment of the last year and – as we’ll discuss – the ever shrinking loan spreads and portfolio yields. Everything else being equal, total BDC investment income should not be much affected by slowing investment activity.

Loan Spreads Will Increase

As noted above, BDCs have been contending with ever narrower spreads on new loans since late 2023. Even more than a lower SOFR rate, “tighter” spreads have been the biggest contributor to the recent trend of lower revenues and profits at BDCs. BDC earnings peaked in 2023 and – by our calculations – were down about (8%) in 2024 and are headed (11%) further in 2025. This crisis should bring a reprieve for an undeterminable amount of time to this process. Admittedly, most BDCs have been claiming spreads had already leveled out.

This could not come at a more auspicious time for lenders of all sorts. As this article from Institutional Investor says “U.S. credit spreads are narrower than almost any other time in history”. Still, we’ll be very curious to see if we get a modest and short period of spread expansion – the most common sort of occurrence historically at time of crisis – or a sustained and significant re-pricing as seen in 2022-2023, which affected BDC profitability very favorably.

BDC Borrowing Costs Won’t Materially Change

When BDCs make new loans they’ll likely be able to book a higher yield, as discussed. above. However, when the BDCs borrow nothing much should change – except for the Fed Funds/SOFR rate which we’ll discuss shortly. About half of BDC borrowing is in the form of secured, floating rate loans. Spreads on these facilities are generally getting a little cheaper for BDCs and the pricing in place is locked up for years to come. Likewise, fixed rate unsecured notes pricing is contractually set for the remaining term of the notes.

The only movement might be at the edges if a BDC’s Revolver or unsecured note is coming up to maturity. Even then, we don’t expect any significant problems either in the renewal/refinancing of existing BDC debt or any change in the cost. BDC revolvers are highly secure for the lenders involved and – to a lesser degree – so are the unsecured notes. We track all the BDC Baby Bonds and there’s been no sign of investors pulling back. This week, the 31 issues we cover are down only (0.2%) – see the BDC Fixed Income Table. In the prior two weeks, the Baby Bonds were up in price.

Credit Performance May or May Not Change

Through the end of 2024, BDC credit performance overall was pretty good. 21 BDCs posted an increase in their Net Asset Value Per Share in 2024 over the 2023 level and 8 others were less than (2%) down. Undoubtedly, though, there has been a large minority of underperformers: 11 BDCs saw their NAVPS drop by (6%) or more. Overall, though, credit performance has been “robust” given that we’re talking about highly leveraged non-investment grade companies.

The BDC managers were repeatedly asked on their conference calls whether tariffs were having any meaningful sort of negative effect on their portfolio companies. A great deal of talking ensued but the bottom line was that very, very few instances of actual impact were cited and not much was anticipated.

As always, we believe it’s just too early to tell. The likelihood is that any deterioration in underlying company performance won’t show up till the IIQ 2025 results come out in the summer. Realistically, if trouble is headed this way, we won’t see the impact in company valuations till the III or IVQ 2024 and are unlikely to see a raft of defaults – if any are forthcoming – till 2026.

BDC portfolio companies – for a variety of reasons that we don’t have time to discuss here – performed much better than most expected during Covid and that may prove to be true this time round even if we get a drop in economic growth. Even in mild recessionary conditions, we are not unduly concerned about a particularly high level of BDC credit losses. Both the BDCs and the private equity sponsor owners have a long term outlook and plenty of capital. Moreover, the BDCs have the advantage of mostly not being involved in some of the sectors most vulnerable to higher input costs. However, if we get a deep recession with no obvious way out and/or a financial crisis that does not yet exist, BDCs might have a much harder time credit-wise. As with everything to do with this chapter in American capitalism, only time will tell.

SOFR May or May Not Change

We’ve never liked that the Fed has a “dual mandate”: both to keep inflation under control and ensure “full employment”. In our minds, the latter is the responsibility of the U.S. government and not a small number of un-elected Fed governors. On the other hand, tackling inflation seems to be the appropriate mandate for the Fed. The problem is that we never now which mandate the Fed is going to prioritize, especially when they are at odds with another. Like right now.

The general consensus is that inflation will increase due to tariffs. This would argue for Chairman Powell keeping interest rates high, or even increasing them. The other consensus developing is that tariffs will cause a slowdown in the economy and an increase in unemployment. This would normally lead the Fed to reduce rates to boost a failing economy. Right now neither expected consequence has yet occurred and we don’t know which problem the Fed will seek to address most urgently.

The markets are confused as well. A financial publication reported the following right after “Liberation Days”:

Market expectations for a Federal Reserve rate cut in May are climbing fast, fueled by fears that President Donald Trump’s newly announced tariffs could push the US economy closer to a recession.

On Thursday, traders placed a 24% bet on a rate cut at the Fed’s May meeting, up sharply from just 11% the day before, according to the CME FedWatch Tool. A week ago, the odds stood at around 12%.

The likelihood of a back-to-back May and June quarter-point cut has also risen, climbing to 15%. Though June’s cut probability slipped slightly to 56.5% from 60.6% the day prior, economists say the tone of incoming policy signals and data will be critical.

On the other hand, the Fed has made abundantly clear that any rate decision will be “data driven”, as discussed in a recent Barron’s article:

The White House has moved forward on some policies, such as implementing higher tariffs on goods from China, but has also backtracked on others, such as tariffs on Mexico and Canada. Powell said that the uncertainty around such changes and their likely economic impacts remains “high.” As such, he believes that the Fed doesn’t need to move quickly to adjust policy in response yet.

“It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy,” Powell said. “As we parse the incoming information, we are focused on separating the signal from the noise as the outlook evolves. We do not need to be in a hurry, and are well positioned to wait for greater clarity.”

These are irreconcilable positions and leaves us unsure as ever about what might happen to interest rates in 2025. One could make a case for rates staying stable (good for BDCs); increasing (very good for BDCs) or dropping a little (not so good for BDCs) or a lot (bad for BDCs, especially if the Fed is seeking to mitigate a recession).

To our minds, this is the most important variable affecting BDC earnings in 2025 but also the most uncertain. The most worrying development would be a sharp downward shift in the Fed Funds rate in the next few months, both cutting BDC earnings and investor confidence.

Conclusion

For BDCs, the Brave New World which the Trump Administration is constructing may not be as negative for its earnings and book value as one might assume at first glance.

More than ever, though, most everything will depend on whether the Fed reads recession as the pre-eminent risk and sharply cuts interest rates (1.0% or more in 2025).

Whether they will or they won’t is unknowable at this point but our personal view is that they won’t.

Gulp

BDC investors, though, are beginning to lose their nerve.

BIZD has dropped from a 2025 high of $17.82 on February 19, 2025 to $16.08, a (9.8%) decline – and very close to “Correction” mode.

We can’t say if the BIZD price drop will continue and that’s outside our self imposed remit.