The U.S. Capitol building stands past visitors at the Washington Monument in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

Apollo to Ares Get a Big Win in $1.3 Trillion Spending Bill

(Bloomberg) -- Private-equity titans including Apollo Global Management LLC and Ares Management LP are poised to score a big win after lawmakers included in the $1.3 trillion spending bill a measure the industry has been lobbying over for years.

In a last-minute change to legislation that funds federal agencies, lawmakers added language Wednesday that would allow investment companies controlled by private-equity firms to borrow more money and increase their lending. The revision would ease rules for what’s known as business development companies, which provide capital for startups.

Congressional leaders from both political parties struck a deal on the spending proposal after weeks of debate, likely heading off a government shutdown. By providing more money for border security, infrastructure and the military, it’s designed to appeal to Republicans and Democrats. The House is scheduled to vote on the bill Thursday and President Donald Trump would likely sign the plan into law soon after it wins final passage, which may come on Friday.

The negotiations came at a good time for private-equity firms, which have been scrambling to get their provision attached to any legislation that’s headed for the president’s desk. The industry had tried but failed to persuade lawmakers to add the measure to a bipartisan bill working its way through Congress that rolls back banking rules. With its inclusion in the spending plan, some analysts predicted it could be easier to pass the banking legislation.

Leverage Rising

BDCs are similar to private-equity funds in that they buy stakes in businesses and make loans. But instead of soliciting capital from pension funds and other sophisticated investors, many raise money by selling shares that trade on stock exchanges.

The structure allows mom-and-pop investors to participate in opportunities that are typically limited to institutions and the financial elite. Private-equity firms profit from BDCs because they manage the underlying investments, and charge fees for doing so.

The Wells Fargo Business Development Company Index, which tracks the biggest BDCs, rose as much as 1.9 percent. Shares of Apollo Investment Corp. increased as much as 2.9 percent to $5.60 in New York trading, while Ares Capital Corp. gained as much as 5.3 percent to $16.08.

More Leverage

The measure tacked on to the spending bill Wednesday would allow BDCs to borrow $2 for every $1 of assets they own, eliminating an existing cap that restricts leverage to a 1-to-1 ratio of debt to equity.

That could increase the companies’ earnings by as much as 20 percent, said Ryan Lynch, an analyst at Keefe, Bruyette & Woods. BDCs controlled by Ares, Apollo and Carlyle Group LP are among those that would benefit, he added.

“This would be the biggest change this industry has seen,” Lynch said. “Game changer may be too strong, but this is definitely very significant.”

Lawmakers rejected including the BDC measure in a bill overhauling the 2010 Dodd-Frank Act that cleared the Senate earlier this month. A key concern was that adding measures that aided Wall Street firms would cause Democrats -- whose support was needed to pass the legislation -- to walk away. Sixteen Democrats ultimately voted for the Dodd-Frank revamp March 14.

Hensarling’s Demands

But House Financial Services Chairman Jeb Hensarling said last week his chamber won’t just rubber stamp the Senate bill on banking regulations. The Texas Republican insisted that at least some measures that have cleared his House panel be added, with easing rules for BDCs among his top goals.

The inclusion of the BDC provision in the spending bill could serve as a “significant concession” to Hensarling that makes him more likely to back the Senate’s Dodd-Frank overhaul, said Capital Alpha’s Charles Gabriel.

Champions of the BDC measure say it will trigger economic growth by bolstering investments in small businesses. They argue it’s a modest increase in leverage that doesn’t pose any systemic risk and that firms aren’t likely to borrow as much money as the new rules would allow.

But critics say it would increase risks for retail investors. BDCs often provide financing that traditional banks won’t, making loans to companies that are struggling to grow. And they typically charge interest rates that are much higher than banks. If the underlying businesses fail, it’s BDC shareholders who might be left holding the bag.

Increasing Risk

Permitting BDCs to double their leverage will “significantly” raise the likelihood that one or more of the companies will fail in a market downturn, according to Mercer Bullard, a professor at the University of Mississippi School of Law, who testified before Congress on the issue last year.

The BDC provision appeared near the end of the more than 2,000 page spending plan. Although lawmakers had six weeks to come up with a deal, the final version didn’t emerge until two days before government funding is set to expire.

“This process is a comically terrible way to govern,” said Compass Point Research & Trading analyst Isaac Boltansky in a research note. “This has become the new normal for the budget process as we have become accustomed to lawmakers lurching from deadline to deadline, but the releasing of a bill of this magnitude and pushing for a vote the following day is patently absurd.”

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