BDC Investment Outlook 2025: Why I'm Keeping My Expectations in Check

Look, I've been around the BDC block a few times. And while I'm still a card-carrying member of the BDC fan club (with several long positions to prove it), I need to have a heart-to-heart with you about 2025. Spoiler alert: If you're expecting another year of champagne-popping 15% returns like we saw with the BDC index (BIZD) recently, you might want to switch to sparkling water.

Why Am I Being Such a Party Pooper?

Well, my friends, we're facing what I like to call "The Triple Threat" of BDC headwinds:

1. The Interest Rate Tango: Remember how we all loved floating rate loans when rates were climbing? Well, what goes up must come down, and now we're facing the awkward situation where our BDCs are like that friend who showed up overdressed to a casual party. The Fed's dot plot is looking more like a connect-the-dots puzzle heading south.

2. The Great Refinancing Adventure: Remember that commercial real estate debt wall everyone's talking about? Well, BDCs have their own version of this drama. Some of our favorite players will need to refinance their fixed-rate borrowings at rates that'll make their CFOs need a stiff drink. Take Oaktree Specialty Lending (OCSL) - they're looking at refinancing $300 million in 2025, which is about as fun as refinancing your mortgage right after rates doubled.

3. The Default Dance: DefaultSo What's an Income Investor to Do?

   Now, before you start panic-selling your BDC portfolio faster than tickets to a Taylor Swift concert, let me share my "Sleep Well at Night" BDC strategy. Because let's face it - I'm here for the dividends, not the drama.

   Here's my BDC shopping checklist (think of it as the "Tinder profile" for quality BDCs): rates in leveraged loan markets are climbing faster than my heart rate during tax season. And that's not great news for our BDC friends who play in this sandbox.

Oaktree Specialty Lending (OCSL)

Oaktree Specialty Lending (NASDAQ: OCSL) finds itself navigating through increasingly choppy waters, and investors need to keep their life jackets handy. Here's why this BDC might face some serious headwinds in the coming months:

A. The Dividend Tightrope Act

Currently, OCSL is walking a tightrope with its dividend coverage ratio sitting right at 100%. That's like having exactly enough money in your checking account to cover your bills – it might work when everything goes perfectly, but life has a funny way of throwing curveballs. With no buffer zone, any of the following could force a dividend cut:

• A single large loan going non-accrual

• Further compression in interest rate spreads

• Increased cost of funding

B. The $300 Million Question

As Fitch notes:

That $300 million in debt coming due in 2025? Let's put that in perspective:

• Represents 18% of OCSL's total outstanding debt

• Currently sitting at below-market rates

• Will need to be refinanced in a higher-rate environment

• Could add significant pressure to already-tight dividend coverage

The timing couldn't be worse – it's like having to refinance your mortgage right when:

• Interest rates are elevated

• Your income is under pressure

• Your emergency fund is depleted

C. The Non-Accrual Nightmare

OCSL is already wrestling with troubled assets in its portfolio. Recent non-accruals include:

• Multiple investments requiring restructuring

• Increasing pressure on portfolio company performance

• Rising risk of additional loans moving to non-accrual status

Fitch had a few things to say about non-accruals earlier in 2024…

OCSL isn't facing a crisis, but it is facing a convergence of challenges that could make 2025 a pivotal year. The combination of tight dividend coverage, significant debt refinancing needs, and existing portfolio stress creates a potentially volatile situation.

Remember: In the BDC world, it's better to miss some upside than to catch a falling knife. While OCSL has the backing of the Oaktree platform, which shouldn't be underestimated, the math of their current situation suggests caution is warranted.

As Warren Buffett famously said, "Be fearful when others are greedy, and greedy when others are fearful." But in OCSL's case, it might be worth waiting to see how these challenges play out before getting greedy.

So What's an Income Investor to Do?

Now, before you start panic-selling your BDC portfolio faster than tickets to a Taylor Swift concert, let me share my "Sleep Well at Night" BDC strategy. Because let's face it - I'm here for the dividends, not the drama.

Here's my BDC shopping checklist (think of it as the "Tinder profile" for quality BDCs):

1. Dividend Coverage Above 110%: The Paycheck Security Blanket

This is like having a savings account on top of your regular income. That extra 10% above dividend payments isn't just showing off - it's crucial because:

• Provides buffer against potential NII (Net Investment Income) compression

• Allows for reinvestment without stretching resources

• Creates room for special dividends in good times

• Acts as insurance against unexpected portfolio hiccups

A BDC paying out 100% of its NII is like living paycheck to paycheck in a six-figure job - technically fine but unnecessarily risky.

Drawing on data from the BDC Universe, we can get a quick look at the coverage for a BDC. Which of the following two options would you prefer?

Which is best? I clearly like option B better… And which are these?

A. Oaktree Specialty Lending Corporation (OCSL)

B. Blackstone Secured Lending Fund (BXSL)

2. Leverage Around 1.0x or Lower: The Debt Diet

Think of leverage like carbs in a diet - you need some, but too much can be problematic. A 1.0x leverage ratio means for every dollar of equity, the BDC has borrowed a dollar. Why is this our sweet spot? Because:

• It provides enough firepower to fund new investments and grow

• Keeps us safely below the regulatory maximum of 2.0x

• Offers a cushion if portfolio companies hit rough patches

• Allows flexibility to opportunistically buy assets during market stress

When a BDC runs at 1.3x or higher, they're like someone who maxed out their credit cards before a recession - not a good look.

3. Clean NII Profile: The Quality Income Test

PIK (Payment-in-Kind) income is like IOUs from your roommate - sure, they count as income, but try paying your rent with them. A clean NII profile means:

• Majority of income comes from cash interest payments

• Limited reliance on PIK income

• Minimal dependence on one-time fees

• Predictable, recurring income streams

We want steady Eddie cash flows, not a portfolio full of "trust me, I'll pay you later" promises.

4. Strong Portfolio Company Stats: The Financial Fitness Test

Just like you wouldn't skip checking your date's social media, you shouldn't skip checking portfolio company health. That 2.0x interest coverage ratio means:

• Portfolio companies can pay their interest twice over from earnings

• Room for error if business conditions deteriorate

• Lower probability of landing in the non-accrual danger zone

• Better positioning for potential refinancing

A portfolio of companies below 1.5x coverage is like a dating pool full of people still living in their parents' basement - potentially problematic.

5. A Quality Equity Exposure: The Portfolio Diversification Play

This is your portfolio's secret sauce. Quality equity exposure means:

• Potential for capital appreciation during exits

• Natural hedge against interest rate risk

• Opportunity for outsized returns during market recoveries

• Source of fee income from portfolio company transactions

Think of it as having Netflix stock before everyone started streaming - sometimes those equity kickers can really kick.

6. No Sketchy Debt Coming Due: The Clean Credit Report

This isn't just about avoiding debt - it's about smart debt timing. I’m looking for:

• Well-laddered debt maturities (spread out over time)

• No large chunks of below-market-rate debt needing refinancing soon

• A mix of secured and unsecured debt

• Established relationships with multiple lenders

Remember OCSL's $300 million coming due in 2025? That's like having your mortgage, car loan, and student loans all due the same month - a scenario best avoided.

The Final Word (and 4 Picks for More Research)

If you're still with me, here are several top picks for your further research that may be well-positioned for weathering the 2025 BDC storm:

For the equity lovers:

• Fidus Investment (FDUS) - My favorite steady Eddie (about 8+% equity exposure)

  • This is my largest BDC position in our family portfolio

• Hercules Capital (HTGC) - A the tech-savvy player with powerful growth exposure (about 4+ equity exposure)

  • NB: HTGC currently trades at a high premium to NAV/book so it may not be a good time to enter based on valuation.

For the first-lien conservatives (both at about 97% 1st lien):

• Kayne Anderson BDC (KBDC) - The new kid with old money smarts

• Blackstone Secured Lending (BXSL) - The institutional favorite

Finally - can BDCs perform strongly as investments? My answer is YES: