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3 BDCs Worth Exploring for Yield

Income investors should get familiar with this type of company

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In an excellent primer May 24, InvestorPlace contributor Lawrence Meyers highlighted the ins and outs of business development companies. This relatively anonymous investment vehicle was created in 1980 by an act of Congress to help public equity capital flow to private businesses. Like REITs, BDCs must distribute at least 90% of their “investment company taxable income” to be considered a regulated investment company, or RIC for short.

The main thing to remember about BDCs is that they fill a gap in commercial lending. As a result, they often make loans with higher interest rates than usual — and while this generates higher income for the BDC, it also can lead to a higher rate of nonperformance.

Keeping this in mind, I’ll recommend three BDCs that stand out from the crowd:

Main Street Capital

My first recommendation is Main Street Capital (NYSE:MAIN), a Houston-based company that provides equity and debt investments to small- and middle-market firms with revenues of $10 million-$150 million and EBITDA of $3 million-$20 million.

Many of the companies Main Street lends to aren’t household names; nonetheless, a few that should ring a bell include The Tennis Channel, Golden Nugget hotel, Totes Isotoner and Ziegler’s New York Pizza Department.

Once Main Street completes its due diligence, a presentation is made to its investment committee. The next step is to go to its credit committee and make a second presentation. Only when a majority of both committees green light an investment are the legal documents drawn up for funding.

Upon funding, MAIN implements an ongoing rating system ranging between 1 and 5, with 1 being a portfolio company that is performing significantly beyond expectations, and 5 a portfolio company that is significantly underperforming. As of the end of December 2011, 96.8% of its $548.6 million in investments were meeting expectations or higher. It finished 2011 with 22.9% of its investments at the highest rating possible, up 790 basis points from 2010. Should you invest in Main Street, it will be important to watch this number at least annually.

The other two metrics you’ll want to keep an eye on are net realized income and net change in unrealized appreciation. If both of those are going up, life is good. In the first quarter ended March 31, net realized income increased 184% to $21.0 million, and the net change in unrealized appreciation increased by 14.5% to $4.7 million. MAIN’s net realized income was significantly higher in Q1 2012 compared to Q1 2011 because it partially or fully exited from two investments for a gain of $8.1 million.

MAIN, up about 14% in 2012, has outperformed the S&P 500 every year since becoming a public company in 2007. Best of all, it currently yields 7.4%.

Medallion Financial

Did you know it now costs $1 million to buy a corporate taxi medallion in New York City? In 10 years, the cost of one of these babies has risen 400%! It’s no wonder then that there’s a market for medallion loans in New York City and other parts of the country.

Article printed from InvestorPlace Media,

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