There is an enormous opportunity in lending to middle-market companies right now, and business development companies (just BDCs for short) are perfectly positioned to benefit.
BDCs were created by an amendment to the Investment Company Act of 1940 and specialize in providing funding sources for small- and middle-market companies. Where this gets interesting to anyone playing the market is that to avoid taxation, BDCs must pass along at least 90% of their taxable income to investors.
Thus, they’re another way to get your dividends.
As banks have stepped away from riskier lending in the aftermath of the credit crisis, BDCs have stepped up and filled the void. It is a huge opportunity and provides income seeking investors an opportunity to join the big private equity funds in profiting from the situation.
BDCs to Buy – Apollo Investment Management (AINV)
AINV Dividend Yield: 9.3%
My favorite BDC for individual investors is Apollo Investment Management (AINV). AINV makes loans to and invests in middle market companies and they have the expertise of a parent company — Apollo Global Management (APO) — that is one of the most successful private equity firms in the world.
Apollo has repositioned its portfolio in favor of senior secured loan, and the majority of the portfolio is variable-rate so they could actually benefit from higher interest rates. The company has investments in 111 different companies spread across a wide range of industries as of the end of the first quarter.
AINV stock itself currently trades at just 96% of net asset value and currently yields 9.3%.
BDCs to Buy – Fifth Street Finance (FSC)
FSC Dividend Yield: 10.1%
Fifth Street Finance (FSC) is a BDC that lends to and invests in small- and mid-sized companies in connection with an investment by private equity sponsors. FSC has a diversified lending portfolio that is focused on the top of the capital structure, as 83% of the loans are senior secured obligations.
FSC has a working relationship with more than 250 private equity fund sponsors that helps the company find and fund attractive loan and investment opportunities. Currently, FSC has investments in or loans to 124 companies spread across 15 different industry groups.
FSC shares trade right around net asset value and pay a monthly dividend that adds up to a 10.1% yield.
BDCs to Buy – KCAP Financial (KCAP)
KCAP Dividend Yield: 12.6%
KCAP Financial (KCAP) invests in companies with between $7.5 million and $50 million of EBITDA. KCAP focuses on mid-market lending, buyout funding and mezzanine investments. The currently have investments in 93 different companies spread across 24 different industry groups.
KCAP’s average loan is just $3.8 million. The majority of their investments and loans are floating rates, so they would see an income and dividend increase from higher interest rates.
KCAP stock is trading just above net asset value, and it currently yields 12.6%.
As of this writing, Tim Melvin was long AINV.