Fitch's latest stress tests of BDCs focus on leverage ratios under downside scenarios to energy-related investments broadly, and oil & gas exposures specifically. The tests include a partial writedown of oil & gas-related investments, a partial writedown of all energy and energy-related industrials (including metals and mining, rubber and plastics, solar, and others), and a total write-off of all oil & gas-related investments. The tests are independent of any specific oil price levels or time frames.
Under each stress scenario, the overall effect on leverage ratios was modest across 10 Fitch-rated BDCs. In the case of a partial oil & gas investment writedown, the average BDC leverage ratio increased 2 bps, to 0.66x from 0.64x. The stress test on energy and energy-related industrials raised leverage 4 bps, to 0.68x. And a total write-off of oil-related investments brought average leverage up 10 bps, to 0.74x.
Notably, the starting point for average leverage, 0.64x as of September 2015, was materially higher than the beginning of the oil-price downturn in third-quarter 2014, when average leverage was just 0.54x for the rated universe. BDCs are required to maintain asset coverage ratios of 200% of capital in order to comply with the Investment Company Act of 1940 (and borrowing covenants), which limits their debt/equity ratios to under 1.0x. Thus, the leverage cushion has declined year over year.
BDCs did recognize losses on energy-related exposures in 2015. Rated BDC oil & gas investments had an average fair value that represented 84.9% of cost at Sept. 30, 2015. Fitch believes additional realized and unrealized losses will be recognized in 2016, given the magnitude of price declines and the length of time at such levels. Additionally, oil price hedges will provide less protection to portfolio companies in 2016, as some portion of remaining hedges are likely to roll off.
Individual BDCs with higher exposures include Apollo Investment Corporation and PennantPark Investment Corporation, which had 15.6% and 12% of their portfolios, respectively, in oil & gas investments at Sept. 30, 2015, according to Fitch's calculations. Leverage ratios for these two firms are the most impacted from an oil & gas write-off scenario, with both experiencing an increase in leverage above 1.0x.
In spite of the results of the stress tests, a number of other industry challenges, including competition, declining asset yields, unsustainable asset quality, increased leverage, an inability to access the equity markets, and expanded investment strategies continue to support Fitch's negative sector outlook for BDCs.
Four of 10 Fitch-rated BDCs have negative rating outlooks. Further rating pressure is possible should oil prices remain depressed near current levels of $30 per barrel for a long period. In Fitch's view, oil prices have yet to find a sustainable equilibrium. Our base expectation for oil prices in 2016 is $45 per barrel.