OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR), secured debt rating, and unsecured debt rating for BlackRock Capital Investment Corporation (BKCC) at 'BBB-'. The Rating Outlook remains Negative. Today's rating actions have been taken as part of Fitch's periodic peer review of Business Development Companies (BDCs), which comprises 10 publicly rated firms.

BDC INDUSTRY OUTLOOK

Fitch's outlook for the BDC sector is negative; reflecting competitive underwriting conditions, earnings pressure, underperforming energy investments, unsustainable asset quality metrics, increased activist pressure, and limited access to growth capital. While some firms are better positioned, given their more conservative financial profiles and portfolio characteristics, others are likely to see rating pressure over the outlook horizon.

BDCs are heavily dependent on the equity markets to fund portfolio growth, but access to the market has been almost non-existent over the last 18 months as share prices continue to trade at steep discounts to net asset value (NAV). At March 7, 2016, rated BDCs were trading at an 18.3% average discount to NAV, thus preventing most from issuing stock without significantly diluting existing shareholders. While the reduction in portfolio growth is viewed favorably by Fitch, given tough underwriting conditions, some firms may struggle to close the trading gap, leaving them at a competitive disadvantage if and when investment opportunities arise.

The decline in commodity prices has yielded the first notable crack in asset quality performance for BDCs. More broadly, asset quality metrics remain at unsustainably low levels, in Fitch's opinion. While strong portfolio company performance has been supported by an improving economic environment, low interest rates are likely masking some potential underlying company-specific issues, as issuers have been able to refinance themselves out of trouble rather easily in recent years. Fitch believes asset quality metrics are likely to deteriorate over the near term; however, the pace of deterioration will be somewhat dependent upon the rate of change in interest rates, the backdrop of the broader economic environment, differing sector exposures, and the integrity of individual firms' underwriting.

Fitch has not observed a marked increase in leverage levels for the sector, with average leverage for investment grade-rated BDCs of approximately 0.74x at year-end 2015 compared to 0.60x at year-end 2014. However, there is a wide dispersion of leverage around the average, and those with the most energy exposure often also have the highest leverage ratios. Share repurchase activity has also increased in the sector in recent quarters, which could inflate leverage ratios further. Fitch believes that BDCs heavily focused on maximizing leverage run the risk of having less dry powder to deploy when if and when underwriting conditions improve, thus weakening earnings upside.

KEY RATING DRIVERS

IDRs AND SENIOR DEBT

The affirmation of BKCC's ratings reflects its solid asset quality, low leverage, sufficient liquidity, strong dividend coverage, low interest rate risk and its affiliation with global investment manager BlackRock, Inc. (BK), which should provide BKCC with enhanced risk management and back office capabilities, Wall Street relationships and broader industry and market knowledge.

Rating constraints include more limited funding flexibility than peers, modest portfolio investment concentrations, above-average exposure to energy investments and concentrated, albeit declining, equity positions. Rating constraints for the sector, more broadly, include the capital markets impact on leverage, given the need to fair value the portfolio each quarter, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.

The maintenance of the Negative Rating Outlook reflects the current challenging market environment for BDCs and BKCC's riskier asset profile, in Fitch's view, given above-average exposure to energy investments and relatively high investment yields despite the seniority of the debt portfolio, which have been originated in a very competitive environment. Additionally, there is some uncertainty around the long-term success of BKCC's new strategy resulting from the 2015 transition of management responsibilities to BK, which did not have prior experience managing a BDC.

Leverage, as measured by debt to equity, declined to 0.48x from 0.57x during the first nine months of 2015 as proceeds from equity sales and portfolio repayments were used to repay outstanding borrowings. Fitch views BKCC's low leverage as appropriate to provide a cushion for potential valuation movements, specifically in oil and gas investments, while access to the equity markets remain uncertain.

At Sept. 30, 2015, senior secured loans and notes accounted for 72% of the investment portfolio, consisting of 36.9% first lien loans and 35.1% second lien loans. Despite BKCC's senior focus, the yield on its income-producing portfolio, at cost, was higher than the peer average, which Fitch believes could be indicative of a higher-risk portfolio.

Total equity exposure, including preferred stock, decreased significantly during the first nine months of 2015 to 10.1% from 21.1% of the portfolio at fair value, as a result of the monetization of certain equity investments for realized gains. Fitch views the lower equity exposure favorably given the volatility of equity investment valuations and the potential impact on company leverage. Additionally, the redeployment of sale proceeds into more senior, yielding investments could further enhance credit performance, earnings and dividend coverage.

In October 2014, BKCC, along with Gordon Brothers Group, established Gordon Brothers Finance Company (GBFC), a commercial finance company with $324.8 million in assets at Sept. 30, 2015. GBFC acquired a diversified pool of asset based loans utilizing third party leverage facilities. As of Sept. 30, 2015, BKCC's investment was $111.3 million at fair value, consisting of a $30.1 million equity stake and $81.2 million of unsecured notes. Fitch considers BKCC's investment in Gordon Brothers Finance Company as a levered equity position, despite it being structured as a combination of debt and equity positions, since BKCC controls the firm and is in a first loss position. Still, Gordon Brothers does have a relatively diverse portfolio, which may mitigate valuation volatility. On an adjusted basis, accounting for Gordon Brothers as an equity investment, as of Sept. 30, 2015, BKCC's equity positions accounted for 17.2% of the investment portfolio, which is above average.
BKCC had no non-accruals at Sept. 30, 2015, continuing a trend of no reported loans on non-accrual status since the third quarter of 2012. However, New Gulf Resources, LLC (New Gulf) filed for chapter 11 bankruptcy in December 2015 and has been placed on non-accrual status by another BDC that holds a position in the company. Fitch believes that the investment in New Gulf, which represents 1.3% of the portfolio at fair value and 2.2% at cost, could also be placed on non-accrual status by BKCC.

At Sept. 30, 2015, oil and gas investments accounted for 10.3% of BKCC's portfolio on a fair value basis, which was the third highest among rated peers. Fitch ran a stress on the exposure and believes the impact to BKCC is manageable due to its low leverage levels. A stress on the whole energy portfolio would cause leverage to increase by five basis points, all else equal, while a stress on the oil and gas book would cause leverage to increase by two basis points. A complete write-off of the oil and gas portfolio, which Fitch does not believe is a likely outcome, would increase leverage by eight basis points to 0.56x.

Since cutting its dividend in May 2014, a move deemed prudent by Fitch, BKCC has maintained strong dividend coverage. During the first nine months of 2015, net investment income, excluding the capital gains incentive fee accrual, exceeded dividends by over 13%. Fee income declined by 65% during the first nine months of 2015 compared to the same time period in the prior year, but this was offset by a 10% increase in interest and dividend income. Fitch views the lower reliance on fee income positively since a decline in origination volume could lead to earnings pressure.

BKCC's liquidity profile remains sufficient with $7.2 million of balance sheet cash and $327.75 million of available capacity under its senior secured credit facility, subject to borrowing base requirements, at Sept. 30, 2015. On Feb. 19, 2016, capacity under the senior secured credit facility was increased by $35 million. Investment repayments and exits resulted in cash flows of $323.9 million for the first nine months of 2015, down 35% from the same time period in 2014. This was consistent with the slowdown in repayment activity across the industry as the low interest rate environment has yielded increased refinancing activity. Fitch believes the pace of repayment activity could continue to slow in 2016, particularly if loan yields increase.
BKCC had $158 million of senior secured notes that matured in January 2016. Management previously stated on an earnings call that BKCC intended to refinance these notes with secured revolver borrowings. BKCC has been less active than its peers in the unsecured markets, having accessed the market only once in February 2013. Fitch expects the company may try to opportunistically access the unsecured markets in the future, which would improve funding flexibility.

BKCC initiated a share repurchase plan in 2008, which has been extended on multiple occasions since then. Most recently, in July 2015, the Board of Directors approved an extension to the plan and an increase to the remaining amount of shares authorized to be repurchased to a total of 4 million shares. The repurchase plan was extended until the earlier of June 30, 2016 or until the approved amount of shares is repurchased. Since inception of the share repurchase plan through Sept. 30, 2015, BKCC had repurchased approximately 2.5 million shares for $18.4 million, including approximately 0.7 million shares for $6.1 million in the first nine months of 2015, allowing for an additional 3.3 million shares to be repurchased under the current program. As of March 7, 2016, the public equity of BKCC was trading at a discount to net asset value of 15.7%. BDC management teams are facing pressure to repurchase additional shares, which may be more accretive to shareholders than new investments, but could also increase leverage.

RATING SENSITIVITIES

IDRs AND SENIOR DEBT

Ratings could be downgraded if BKCC experiences material asset quality deterioration, in non-energy investments, which indicates broader underwriting issues, or in the oil and gas portfolio given BKCC's high exposure relative to peers. Negative rating action could also be driven by a weakening liquidity profile, a decline in dividend coverage, an increase in leverage beyond the targeted range, and/or failure to improve funding flexibility by increasing the proportion of unsecured debt in its funding mix.

The Rating Outlook could be revised to Stable if BKCC demonstrates solid operating performance in the challenging operating environment, does not experience material portfolio losses (realized or unrealized), and is able to reduce exposure to oil and gas investments without outsized incremental losses. An Outlook revision back to Stable would also be conditioned upon the maintenance of appropriate balance of leverage, relative to the risk profile of the portfolio, the maintenance of strong dividend coverage and continued execution on its stated strategy now that BKCC has been integrated into the broader BK platform.

Headquartered in New York, NY, BKCC is an externally managed BDC incorporated on April 13, 2005. As of Sept. 30, 2015, the company had investments in 43 portfolio companies amounting to approximately $1.15 billion.

Fitch has affirmed the following ratings:

BlackRock Capital Investment Corporation
--Long-term IDR at 'BBB-';
--Senior Secured Debt at 'BBB-'; and
--Senior Unsecured Debt at 'BBB-'.

The Rating Outlook is Negative.