High rates and lower bank lending may lift BDCs

Today's economic conditions are attractive for BDCs (business development companies), and some benefit from businesses seeking alternative financing sources.

  • As banks tighten lending standards, more companies are turning to BDCs for financing.
  • BDCs that focus on smaller and technology-oriented companies are seeing a meaningful increase in their opportunity set.
  • The economic environment supports high interest rates and low default rates — a compelling combination for BDCs.

As the Federal Reserve has tightened interest rates over the past 18 months, banks have tightened lending standards. Many BDCs are poised to fill this gap in credit markets. In particular, BDCs that specialize in serving smaller and middle market companies ($50M or less in EBITDA) are benefiting, as are those with a focus on technology companies. The collapse of Silicon Valley Bank in March 2023 was a key turning point for these segments, in our view, spurring a growing number of small and tech-oriented companies to consider BDCs as a source of financing.

Bank loans to small businesses are at the lowest levels in a decade

Bank loans to small businesses are at the lowest levels in a decade

Source: Bloomberg. The NFIB Small Business Credit Conditions Availability of Loans is a component of the NFIB Small Business Optimism Index/Small Business Credit Conditions that measures the ease of obtaining small business loans. The data represent the net percent of regular borrowers who find loan availability “easier” minus those who find it “harder” compared to three months earlier.

Putnam BDC Income ETF (PBDC) can take advantage of this potential growth opportunity. With an active strategy, we can build an attractive level of exposure to this emerging trend. Individual BDCs might be over- or underexposed to smaller companies and the technology sector. We can actively position the ETF in several BDCs to gain exposure to areas of the market with compelling opportunities.

Outlook on the BDC landscape and the economy

While we see challenging economic conditions ahead, this may also be favorable for BDCs. The economy continues to slow gradually under the Federal Reserve's hawkish interest-rate policy. We believe interest rates might rise even more and stay at a high level for a considerable period. This upward bias to rates continues to directly drive BDC profitability and, hence, near-term shareholder dividends.

Meanwhile, we are concerned that the bank liquidity crisis, the drawdown of consumer savings built up during past government stimulus, and the impending resumption of college loan payments together pose a risk of recession in the near term. However, if the economy can muddle along, remaining lackluster but without contracting, it should provide enough momentum to keep loan default rates reasonable. The yields available from BDCs would be attractive when compared with small- and mid-cap equity market returns.

If a recession happens in 2024, it could adversely affect BDCs along with the broader equity markets, in our view. Losses on loans could be a problem for BDCs. However, we believe our active approach to investing can uncover companies that have already evolved their lending and borrowing practices to mitigate the risk of book value destruction through losses on their loans. Amid these economic conditions, we will continue focusing on more defensive strategies relative to the fund's benchmark.

Learn more about Putnam BDC Income ETF.

Consider these risks before investing: Business development companies (BDCs) generally invest in less mature U.S. private companies or thinly traded U.S. public companies, which involves greater risk than well-established publicly traded companies. The fund will be sensitive to, and its performance will depend to a greater extent on, the overall condition of the financials sector.

The use of leverage by BDCs magnifies gains and losses on amounts invested and increases the risks associated with investing in BDCs. A BDC may make investments with greater risk of volatility and loss of principal than other investment options and may also be highly speculative and aggressive. Certain BDCs may also be difficult to value since many of the assets of BDCs do not have readily ascertainable market values.

As a non-diversified fund, the fund invests in fewer issuers and is more vulnerable than a more broadly diversified fund to fluctuations in the values of the securities it holds. Our investment techniques, analyses, and judgments may not produce the outcome we intend. The investments we select for the fund may not perform as well as other securities that we do not select for the fund. We, or the fund's other service providers, may experience disruptions or operating errors that could have a negative effect on the fund. You can lose money by investing in the fund.

You should consider the fund's investment objectives, risks, charges, and expenses carefully before you invest. This and other important information is contained in the fund's prospectus or summary prospectus available on putnam.com or by calling 1-833-228-5577. Please read carefully before you invest.

Putnam ETFs are distributed by Foreside Fund Services, LLC. Foreside is not affiliated with Putnam Investments.