Fitch Ratings’ sector outlook for business development companies (BDCs) is worsening for 2021, driven by the expectation for weaker asset quality metrics and the potential for valuation volatility as a result of the challenging economic backdrop, which will lead to pressure on asset coverage cushions.

In a new report, Fitch said it believes cash earnings will be negatively affected by lower interest rates, higher levels of non-accrual investments and an increase in paid-in-kind (PIK) income, which will lead to weaker dividend coverage metrics for some BDCs. Rating

Fitch revised its rating outlook for BDCs to negative from stable for 2021, underpinned by Negative Rating Outlooks on five of the 13 rated BDCs. Fitch expects an increase in credit issues across BDC portfolios in 2021, which highlights the need for BDCs to maintain asset coverage cushions at levels sufficient to account for higher losses.

While some firms are better positioned, given lower leverage and larger covenant cushions, others could face negative rating momentum over the Outlook horizon should asset coverage cushions fall below Fitch’s benchmark ratios.

Premium Fitch subscriber can access the full report here.