Closed-Ended Funds Alter Strategies with Rate Hike in Mind
Who’s deploying leverage?
Closed-ended funds have taken advantage of ultra-low interest rates inside and outside the United States in order to earn spreads by deploying capital in asset classes that yield higher returns.
BlackRock Capital Investment (BKCC) commands a premium in valuations mainly due to lower leverage. The market sees this as safe since interest rates are expected to rise. The company has a net leverage of 0.45x as of September 30, 2015. The earning power of its investment portfolio and its low leverage puts the company in a strong position for the next few quarters.
Ares Capital’s (ARCC) net DE (debt-to-equity) ratio stood at 0.69x as of September 30, 2015. An average target of 0.65x–0.75x was set by management. The company is focusing on lowering its cost of debt and maintaining a prudent maturity level for its debt and diverse sources of capital.
Prospect is highly leveraged
Prospect Capital (PSEC) continues to make use of leverage to generate higher returns. The company’s fiscal 1Q16 debt-to-equity ratio fell marginally to 0.76x from its fiscal 4Q15 debt-to-equity ratio of 0.78 and its fiscal 4Q13 debt-to-equity ratio of 0.56x.
Prospect Capital still has significant unencumbered assets, matched book funding, access to diversified funding markets, and an unsecured fixed-rate liability focus. The company is looking at spin-offs and increasing leverage as sources for raising capital. More leverage should allow Prospect Capital to generate a higher return for its equity holders.
Reducing cost of debt
Closed-ended funds (PSP) are replacing their existing debt in order to reduce the effective rate of interest. Prospect Capital successfully reduced its cost of debt to 5.7% in the September quarter compared to a cost of debt of 6.3% in the September 2014 quarter. It achieved this reduction by repaying certain higher-cost debts and using its revolving credit facility efficiently.
The company reduced its weighted average stated interest rate on drawn debt capital to 5%, similar to the previous quarter. The cost could fall to 3.9% if the company were to borrow everything available to it under its revolving credit facilities.
TPG Specialty Lending (TSLX), American Capital (ACAS), and United Rentals (URI) are also working on reducing their cost of debt in order to improve their net margins.
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