KEY RATING DRIVERS
The rating affirmation reflects BKCC's experienced management team, demonstrated ability to operate through a cycle, strong asset quality, improved funding flexibility, and the strength of the company's historic relationships with BlackRock, Inc. and the principals of
Rating constraints include the capital markets impact on leverage, given the need to fair value the portfolio each quarter, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.
The Rating Outlook revision for BKCC reflects the weaker dividend coverage on a cash earnings basis, increased portfolio equity exposure combined with an increase in leverage, and increase in unsecured debt investments, which could be signaling a higher risk appetite.
BKCC's dividend coverage declined to 88% in 2013, from 103.4% in 2012, due to a decrease in net investment income generation. Fitch believes dividend coverage could improve if proceeds from the sale of equity investments are redeployed into income-producing securities, but given the competitive market environment, it could take some time for that to occur. If BKCC cannot cover the dividend with net investment income in the medium term, Fitch would view a dividend cut as prudent. Absent that, negative rating action could result, reflecting the use of principal proceeds to cover dividend shortfalls.
BKCC's total equity exposure, including preferred stock, was 21.9% of the portfolio at year-end 2013, compared to 13.5% at year-end 2012, due largely to the appreciation of several portfolio positions, some of which represent restructured debt investments. At the same time, leverage rose to 0.67 times (x) at
Fitch believes BKCC's equity exposure could decline in the near term, as a large investment could potentially be sold. The company sold its investment in portfolio company,
Historically, BKCC has focused on senior secured debt investments, but during 2013 these investments declined, and represented 61.9% of the total portfolio at
Core operating performance, adjusted for the non-cash incentive payment accruals, declined in 2013 due to lower investment income and increased operating expenses. Interest income declined 7.6% from 2012, due to lower average cash-yielding portfolio investments and a lower weighted average yield during the period. Net investment income declined 14.2% to
Fitch believes BKCC's operating performance in 2014 will be highly dependent on the company's ability to redeploy proceeds from the sale of its equity investments into attractive risk-adjusted investment opportunities.
BKCC's asset quality has generally improved, although several larger investments needed to be restructured in recent years. As of
BKCC's liquidity profile is sufficient with
The ratings of BKCC could potentially be downgraded over the next 12-24 months if net investment income dividend coverage remains relatively weak and/or leverage is not appropriately managed relative to portfolio equity exposure. Additionally, should the recent decrease in secured investments as a percentage of the total portfolio represent a shift in the firm's risk appetite, which translates into weaker asset quality performance as recent vintages season, ratings may be downgraded. Any potential reduction in equity exposure would be evaluated in the context of how such proceeds are reinvested, in terms of asset seniority and loan terms, particularly given the current aggressive credit conditions. This may take some time to observe depending on the pace at which proceeds can be deployed.
More broadly, Fitch sees a number of emerging industry challenges that could pressure ratings, or at least increase rating differentiation amongst BDCs over a longer-term horizon. These challenges include a potential increase in regulatory leverage limits and increased competition, which are yielding tighter market spreads and looser underwriting terms, including higher underlying portfolio company leverage and weaker covenant packages. Should competition continue to intensify, market yields could decline further, which would reduce earnings generation and pressure dividend coverage for the space.
Conversely, BKCC's Rating Outlook could be revised to Stable if leverage is appropriately managed relative to portfolio equity and dividend coverage aligns closer to peers.
Fitch has affirmed the following ratings:
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Secured debt at 'BBB-;
--Unsecured debt at 'BBB-'.
The Rating Outlook has been revised to Negative from Stable.
Additional information is available at 'www.fitchratings.com'.
--'Global Financial Institutions Criteria' (
--'Investment Manager and Alternative Funds Criteria' (
Global Financial Institutions Rating Criteria
Investment Manager and Alternative Funds Criteria
Source: Fitch Ratings
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