Private Credit Rebounds as Shared BDC Loans Reach 55%

The overlapping portion of Business Development Company fund portfolios has surged from about 10 percent in 2010 to more than 55 percent today, raising concentration risk across the private credit market even as BDC stocks rebound from earlier-year lows.

"We continue to feel good about NCDL's platform, its low exposure to software portfolio company loans, and its institutional investor base," said Arren Cyganovich, analyst at Truist. "We see shares as overly discounted given their credit performance and relatively low software portfolio company exposure."

The rebound has been uneven across the sector. Nuveen Churchill, a BDC focused on senior secured loans to middle-market companies, trades at $12.32 after falling about 9 percent over the past six months, with a forward dividend yield of 11.5 percent. Global Net Lease, a net-lease REIT, trades at $9.22 with an 8.4 percent yield. Both have received Buy ratings from analysts despite the broader overlap concern.

The concentration risk matters because a single default event in a shared loan could now ripple through more than half of a typical BDC's portfolio, compared with just one-tenth in 2010. If a major borrower in a shared credit fails, the correlated losses could compress net asset values across multiple BDCs simultaneously, amplifying the impact on stock prices.

The overlap trend reflects the maturation of the private credit market, where a relatively small pool of large borrowers has attracted capital from multiple lenders. Churchill, Nuveen Churchill's investment specialist, manages $66 billion in committed capital across approximately 300 private equity firms. About 90 percent of its investments are first-lien term loans, and more than 94 percent are floating rate.

Nuveen Churchill reported second-quarter investment income of $44.3 million, down more than 16 percent year over year, though net investment income of 41 cents per share beat expectations by 2 cents. Global Net Lease reported revenue of $112.5 million in the second quarter, down from $124.9 million a year earlier, but beat forecasts by nearly $2.8 million.

Rising Correlation, Falling Margins of Safety

The overlap data point is particularly concerning because BDCs have been increasing leverage and expanding into riskier segments of the credit spectrum to maintain yields as interest rates decline. Lower portfolio yields, caused in part by the decline in interest rates over the past year, have pressured revenues across the sector.

For Global Net Lease, the company has been intentionally reducing its portfolio by selling properties to pare back debt, which cut into revenues and adjusted funds from operations. The company's adjusted FFO of 22 cents per share in the second quarter was down from 24 cents a year earlier, though it beat expectations by 2 cents. Its $535 million all-stock acquisition of Modiv Industrial, completed this month, is expected to be 4 percent accretive to AFFO per share, according to BMO analyst John Kim.

What the Overlap Means for Investors

The 55 percent overlap figure suggests that the private credit market has become more correlated than at any point in its modern history. When BDC funds share more than half of their loan books, a single credit event can trigger simultaneous markdowns across the sector, compressing net asset values and dividend coverage ratios.

The last time the private credit market faced a systemic stress test was during the 2020 pandemic selloff, when BDC net asset values fell sharply before recovering. But the overlap was far lower then, meaning the current market has not yet been tested with this level of correlation.

For investors, the trade-off is clear: higher dividend yields on BDC stocks come with greater systemic risk. Nuveen Churchill's 11.5 percent yield and Global Net Lease's 8.4 percent yield are attractive on the surface, but the growing overlap in loan books means these yields could be more vulnerable to a sector-wide downturn than historical experience suggests.

This article is for informational purposes only and does not constitute investment advice.