Subprime Loan BDCs Take Advantage of Pandemic Opportunities

NEW YORK, June 15 (LPC) – Subprime credit business development companies (BDCs) become increasingly active in the private credit space as the coronavirus pandemic continues to strain more traditional sources of credit for small and medium-sized businesses.

A handful of companies, including Hercules Capital, Horizon Technology Corp, and TriplePoint Venture Growth, target fast-growing, fast-growing companies that generate outrageous returns compared to traditional middle-market private credit.

Unlike banks which are generally more conservative in their investments, these BDCs provide debt to startups and growing businesses that do not have positive cash flows or significant assets to use as collateral.

The life sciences and technology sectors, favored by venture capital (VC), are also favorites of this type of risk lender.

Hercules, a BDC with a net asset value of US $ 1.1 billion, recently entered into a US $ 100 million debt program for oncology company G1 Therapeutics to fund its development of trilaciclib, a medicine designed to help patients during chemotherapy. Horizon Technology Corp reported a series of deals over the past month, including a US $ 15 million loan to Emalex Biosciences to fund clinical trials for its Tourette syndrome treatment drug.

“We feel good about the life sciences market right now. There is a lot of capital flowing into this market, ”said Jerry Michaud, CEO of Horizon, in a telephone interview.

DOUBLE DIGIT

Since risky debt combines loans with warrants, or rights to purchase shares, to offset the higher risk of default, it can also provide double-digit returns.

Debt is provided at a higher price compared to traditional private credit financing and generally has a shorter term, with maturities ranging from 36 to 48 months.

Funding generally depends on the milestones taken by the borrowing companies, whether it is regulatory approval of a drug or a certain level of sales.

The loan-to-value ratio (LTV), a standard measure of risk assessment, is typically between 10% and 30% for venture capital debt, Michaud says, significantly lower than middle-market private credit agreements that can range from 60% to 80%. .

In the recent first quarter earnings season, Hercules, Horizon and TriplePoint, all publicly traded BDCs, reported a slight decline in their respective net asset value per share, compared to the average decline of 14% for the industry, according to Refinitiv BDC Collateral.

Non-accumulations were low and debt ratios hovered around the single level, also below the industry average of 5.5%.

Unlike stocks at other BDCs that target the mid-market, Hercules and Horizon stocks trade above net asset value, suggesting investor confidence in subprime loans.

The high net asset values ​​are driven by the fact that venture capital firms have record amounts of capital that can be deployed to help businesses and fund new investments.

“Steps have been taken by the portfolio companies to cut costs and strengthen the balance sheet, and this goes hand in hand with the fact that they are typically backed by multiple VCs,” said Tim Hayes, analyst at B Riley FBR, in a phone. interview. “There is a ton of venture capital on the sidelines to support the companies in the portfolio. “

In 2019, venture capital funds raised US $ 46.3 billion in 2019, the second-highest since the record year of US $ 58 billion in 2018, according to data from research firm Pitchbook and the National Venture Capital Association trading organization.

When releasing its first quarter results, Hercules said that a fifth of the companies in its portfolio were able to raise new shares or subordinated capital from outside sources.

“What we’ve seen so far is the continued determination and action to protect balance sheets, lengthen leads and ensure companies have enough cash on their balance sheets to survive a prolonged period of uncertainty. and volatility, ”said Scott Bluestein, CEO of Hercules. , in the company’s first quarter earnings call last month.


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