High yield BDCs can carry plenty of risk. Here are three that should provide an element of safety.
I recently wrote about five important things to consider when buying a Business Development Company (BDC). Now I’ll choose three BDCs that currently fit that criteria.
But first, a quick review of BDCs. They must pay out 90% of their annual net income each year to shareholders.
BDCs provide secured debt and equity financing to middle-market companies with annual revenues of $10 million to $100 million. Their goal is to maximize the portfolio’s total return by generating current income from debt investments and capital appreciation by selling off their equity positions. Investments range from $5 million to $25 million. BDCs want good management at established companies that have cash flow and a competitive advantage.
BDCs are here because commercial banks don’t really service middle-market companies. Loans are for a three- to seven-year term, at 10% to 15%, plus a first-position lien on assets.
TCP Capital (NASDAQ: TCPC) is relatively conservative. It invests in the debt of middle-market companies that have an enterprise value of $100 million to $1.5 billion. To date, TCP has loaned $5.4 billion to 137 companies over the past 15 years, and aims for a range of $10 to $40 million per investment.
As of June 2014, it had 74 positions with a fair value of almost $900 million, almost all of which were secured senior debt yielding a weighted average of 10.7%. Its present Net Asset Value is about $15.43 per share, with the stock trading at $15.59, so it trades at a 1% premium.
Its book value has been climbing consistently, as has its dividend payout. It paid $0.34 in cumulative dividends by Q2 of 2012, and at this point it has paid out $3.75. Its portfolio is incredibly diversified, with almost 40 sectors and none of them accounting for more than 12% of the total portfolio.
It presently pays an 8.5% dividend yield.
Fifth Street Finance (NYSE: FSC) makes first lien, second lien, mezzanine debt and equity investments, and can handle much larger loans. In fact, those loans can go up to a quarter of a billion dollars and even syndicate deals up to half a billion dollars.
Fifth Street avoids investing in risky operations, and has about $2.7 billion invested with only about 25% leverage. That low leverage gives it room for mistakes, so if a big investment blows up, it won’t take the company down with it. The company reports that 99.5% of its investments are performing at or above internal expectations.
It is exceptionally well managed, to the point where it holds one of six spots that have investment-grade-rated debt, with Standard & Poor’s rating its outlook as “positive”.
FSC pays an annualized dividend of $1.00 per share; with the stock now at $7.92, that’s a yield of 10.4%.
For aggressive investors, you may want to consider UBS E-TRACS 2x Wells Fargo Business Development Company ETN (BDCL). This ETN uses a 2x leverage feature, so it exactly tracks twice the value of its underlying assets, as represented by the Wells Fargo Business Development Company Index, consisting of over two dozen BDCs. You are well insulated against disaster here, barring a major economic meltdown that torpedoes many of the companies the BDCs themselves invest in. It yields 17.5%.
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