Business development companies (BDCs) are making another push at lifting restrictions on the amount of borrowed money they can put to work.

Legislation to increase the amount of leverage in the portfolios of these closed-end funds was introduced with HR 1800 in 2013, only to stall. BDCs are hoping it will be reintroduced. The House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing this week on a discussion draft developed by Congressman Mick Mulvaney (R-SC).

BDCs provide financing—usually between $10 million to $50 million—to middle market companies in the form of unsecured and secured loans. The market segment was created by Congress in 1980 and is increasingly competing for some of the same borrowers as banks.

Leading up to the June 16 hearing, Brett Palmer, president at the Small Business Investor Alliance (SBIA), which represents a significant proportion of the BDC industry, told Leveraged Finance News the goal was to educate Congress and policymakers on ideas to enhance this segment of the growing lending marketplace.

“Once they get past that hearing, there will likely be legislation introduced,” Palmer said. “We would hope that would happen and we will get to that point. But the industry has to continue to make its case. And as the industry grows and gets bigger, we all have to be singing from the same song sheet.”

Currently, there are more than 80 BDCs in the U.S. The market experienced an uptick during the 2008-2009 economic recession when middle market companies had less access to capital, allowing for loan balances to triple.

Vincent Foster, chairman, CEO and president of Houston-based BDC Main Street Capital Corporation, provided testimony to the Committee on behalf of SBIA.

“While BDCs have extensive oversight and disclosure requirements, providing clarity and transparency for investors, the current regulatory regime for BDCs is outdated and unnecessarily burdensome,” Foster said at the June 16 hearing. “These burdens make the BDC capital raising process less flexible, less efficient and more expensive than necessary, while providing little improvement to investor protection or additional transparency as result.”

One of the more important recommendations addresses the asset coverage ratio.

Currently, BDCs are limited to a 1:1 debt-to-equity ratio, while banks and other financial vehicles are often leveraged at a 9:1 ratio. A more ideal leverage for BDCs would require a “modest increase” to 2:1, which would enable BDCs to deploy significantly more capital to small and mid-size businesses, Foster told the Committee.

“Simultaneously, BDCs will be able to reduce the risk in their portfolios, as they can invest in lower yielding, lower risk investment and still generate valuable returns and dividend to their shareholders,” he said.

The discussion draft offers two ways to increase leverage.

With the first option, the BDC would conduct a vote of their Board of Directors, with a 12-month waiting period after the vote. When the one-year mark is reached, the BDC may access the increased leverage.

The second option would also require the BDC to conduct a shareholder vote, but at an annual or special meeting, with more than 50% of shareholders voting in favor of the increased leverage. Under this option, however, the BDC would be able to access immediately.

This process is expected to provide adequate time and means for BDC shareholders to exit or sell their shares in the BDC, or allow for them to vote on the leverage change. There would be other requirements as well. BDCs would have to notify the SEC and investors by filing an 8-K within five days of the board vote, place a notice on their website and periodically disclose the change in asset coverage ratio has been approved in filings.

“These are meaningful investor protections and we support their inclusion,” Foster said.

A proposed change to the Investment Company Act of 1940 to streamline the offering, filing and registration processes for BDCs at the Securities and Exchange Commission and remove unnecessary compliance costs, was also presented. When addressing this at the hearing, Foster showed a stack of paper and asked the Committee, “Do four inches of paper protect better than half an inch?”

“Those are not particularly fancy reforms, but make BDCs operate a whole lot smoother and whole lot more quickly,” Palmer explained prior to the hearing. “It allows them to have paperwork be streamlined. These are things that are universally agreed upon by everyone and makes sense.”

These draft recommendations are the first step in setting the stage for legislative changes, which would be the latest win for BDCs.

The industry scored a victory last December when the SEC released new guidance allowing for them to co-invest with the limited partner of a private fund owning at least 5%, but no more than 25%, of the private fund’s outstanding voting securities. Prior to the change, BDCs were prohibited from investing in the same companies as the private funds under common management.

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