When it comes to seeking out high-yield investments in a low-yield bond world, many investors have gone far afield to pull in dividends that exceed 5%. Business development companies, or BDCs, came onto investors’ radars a few years ago, thanks to their interesting structure requiring 90% of net income to be distributed to shareholders.
BDCs raise much of their funding capital via initial public offering, but also use that capital to leverage against borrowings. So BDCs will borrow capital at a relatively low rate and lend it out at much higher rates.
The money is usually loaned to “middle-market companies” that need growth capital. Hence, the name “business development companies.”
BDCs will usually take warrants along with the money they loan, so if their borrower is successful, they can buy into the business at a favorable price and flip the investment if they so choose.
BDCS With Killer Yields: Etracs Linked to the Wells Fargo BDC Index ETN (BDCS)
If you are nervous about getting into an individual BDC, then why not go for a broadly diversified basket? The UBS AG Exchange Traded Access Securities (E TRACS) Linked to the Wells Fargo Business Development Company Index (NYSEARCA:BDCS) does exactly that, investing in over 40 BDCs — pretty much all of them — and thus providing you the safety and security of knowing that if one blows up, the whole basket won’t.
BDCS currently has an annualized yield of 7.6%.
There is some risk associated with this basket, albeit a small one. The whole idea of business development companies is predicated on two things. First, that they can make money via the spread in what they charge for loans and what they are charged. As rates rise, these BDCs need to maintain a lot of floating rate debt mix to charge their borrowers.
The other risk, which is extremely unlikely, is that the economy blows up and these middle-market companies just stop growing dead in their tracks.
BDCS With Killer Yields: TCP Capital (TCPC)
TCP Capital Corp (NASDAQ:TCPC) specializes in the arena that I like the best, which is offering loans between $10 million and $45 million to middle-market companies with enterprise values that range from small ($100 million) to large ($1.5 billion).
As of the end of 2016, TCPC had both debt and equity positions in about 90 companies, totaling over $1.3 billion. Almost all of this is debt, by the way. The weighted average yield for that debt portfolio is a very attractive 10.9%, and 81% of that debt portfolio is floating rate. That’s great news in a time where rates are rising, since it means most of the loans are not going to get eaten away by the Federal Reserve.
TCPC trades at just under $17 and yields 8.53%. The company is also raising more capital via a secondary offering, so obviously business is booming and it has enough demand so as to need more capital.
BDCS With Killer Yields: Gladstone Capital (GLAD)
Gladstone Capital Corporation (NASDAQ:GLAD) has advantages that other BDCs share, which is that they tend not to correlate with the overall market. That’s because the investments Gladstone makes are in companies that aren’t correlated to the overall stock market so much as the economy. Even then, GLAD investments are diversified, so that it would take a broad economic slam to really harm the company.
GLAD yields about 8.6%, and this is because it generates very modest and predictable payments from its borrowers. It invests between $7 million and $30 million in those same middle-market firms and earns a nice spread on its own debt financing. Like most BDCs, it will charge rates between 10% and 16%, which are substantially higher than the funds it sources for those loans.
The other element about GLAD that I like is that the terms of these loans are also diversified, running between three and seven years, and usually enjoying a senior position.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he owned BDCS. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at [email protected].