My Wish for BDCs in 2015: Better Disclosures

By Markets Fool.com

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The business development company industry is in an obvious growth phase. The industry rose from relative obscurity to a significant portion of yield-paying stocks after the financial crisis.

As the industry matures, it's time to for the industry to adopt a few standardized "best practices" in financial reporting. I have a few suggestions.

1. Standardize nonaccrual accounting
Some BDCs put a loan on nonaccrual when it hasn't received an interest payment for 30 days. Others wait 90 days. The difference is significant -- two months is a long time to wait for a scheduled interest payment.

Settling on a common timeline for non-accruals would allow investors to better compare one BDC to another.

2. Reveal true interest rate exposure
The BDC industry loves to tout the fact that rising interest rates will help their bottom-line profits. What BDCs don't tell investors is that rising rates aren't necessarily a boon. Many industry players would see their income fall if rates went up only a modest amount -- less than one percentage point. After that, virtually all BDCs would start to see their earnings rise. I looked at interest rate floors for a number of BDCs just a few months ago.

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Unfortunately, BDCs tend to disclose only the most convenient scenarios in their financial filings. One in particular discloses the impact of a five percentage point increase in rates! Talk about a pipe dream, given that rates are essentially zero.

The industry owes it to its investors to disclose the impact of rising rates at small intervals -- say 0.50% at a time, all the way up to a much larger, 3%-5% movement. Sure, it's easy to figure out with a few minutes and a spreadsheet, but that's all the more reason for BDCs to publish reasonable rate exposures in their filings.

3. Better investment information
BDCs are required to disclose when an investment will mature. They aren't, however, obligated to disclose when an investment was made.

Doing so would help investors better understand a company's vintage diversification. It's probably safe to say that an investment made in 2011 is a better risk than one made in the summer of 2014, when cash was cheap and spreads were lower.

4. Publish tables of investment changes
It's relatively common for a BDC to swap a debt investment in a portfolio company for an equity investment when things turn sour. The larger equity cushion protects the debt investors and reduces the portfolio company's ongoing interest expenses.

These changes are significant events, and it would be my wish that the industry made a concentrated effort to document and explain these changes when they happen.

Most get little more than a line-item mention, despite the debt to equity conversion being an obvious sign of weak portfolio company performance.

One can dream
Unlike other yield industries like REITs, BDCs have hardly earned the title of being an "asset class." In 2013, the industry may have even taken a step backward in its adoption among investors, as it was categorically thrown out of popular stock indexes. Every industry has its growing pains.

Now that publicly traded BDCs are trading at below net asset value, investors have a lot more leverage to ask for better information from the BDCs in which they have invested. BDCs have little need to disclose more information to investors when their shares are trading at premiums to net asset value.

Some simple changes to disclosures, and some standardization among the industry's players, could go a long way to inform the individual investors on whom BDCs rely.

The article My Wish for BDCs in 2015: Better Disclosures originally appeared on Fool.com.

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