Is anyone ready for a 10.2% payment? The one who is powered by profits that should actually increase in line with interest rates?
If so, I have a three letter acronym for us:
Business development companies providing debt, equity, and other financing to small and medium-sized businesses, effectively acting like banks because banks often don’t want to take that level of risk. And because they invest primarily in companies that are not in the public markets, BDCs serve as a de facto private equity investment, but retail investors like us can participate!
BDC’s structures are similar to those of real estate investment trusts (REITs). Both were created by Congress – REITs in 1960, BDCs in 1980. And both enjoy special tax privileges, but on condition that at least 90% of their taxable profits are returned to shareholders as dividends.
But BDCs pay a lot more than REITs now. In fact, BDCs distribute 2.6 times more — one excellent yield of 10.2%:
Many BDCs also tend to prosper as rates rise. This is because they provide small business loans, and often times these loans have a “variable rate” component. So, higher rates mean more profits.
Remember, however, that there is no risk-free return of 10%. Selecting securities in the BDC space is always a challenge. We need to carefully consider the loans that BDCs make before we buy them. Today we’re going to take a look at three, paying between 8.9% and 9.6%.
Capital of Ares (ARCC)
Dividend yield: 8.9%
Capital of Ares (ARCC)– the largest BDC by market cap at just under $ 8 billion – is considered a safe bet in the space. If a business needs financing, Ares will find a way. BDC will invest in a variety of ways, from revolving debt, first and second lien loans, unity, non-controlling equity, etc.
ARCC’s investments are spread across 350 holding companies across a number of industries, but the most significant at the moment are healthcare, software / services, business and professional services, and consumer services. Target companies typically generate between $ 10 million and $ 250 million in EBITDA.
And he stands out compared to his peers.
The rebound in ARCC shares has continued in recent months in part due to rate optimism; 84% of its total investments, at fair value, are of a variable rate nature.
Shares recently paused after the company’s fourth quarter earnings, but there was a lot to like about the numbers. Net investment income (NII) of 54 cents per share was much better than estimates, and came on the back of record highs. It’s also 135% of what it needs to cover its 40-cent quarterly dividend.
Credit quality also improved and non-accruals (when payments are 90 days or more past due) decreased to 3.3% at cost, from 5.1% in the third quarter.
Ares Capital is trading around 6% above its net asset value, a modest premium to the value of its portfolio.
BlackRock TCP Capital (TCPC)
Dividend yield: 9.6%
BlackRock TCP Capital (TCPC), which has a portfolio of around 92% floating rate, also compares well to BDCs in general.
BlackRock TCP Capital, which outsources its management to Tennenbaum Capital Partners, an indirect subsidiary of BlackRock, invests primarily in senior secured debt of mid-market companies with an enterprise value of between $ 100 million and $ 1.5 billion. of dollars. Although its portfolio is smaller than ARCC’s, its 101 investments still offer a wide range of exposures.
Here Internet software and services, diversified financial services, software, and textiles / clothing / luxury goods are the biggest slices of the pie, but even that only accounts for less than 40% of its businesses; the remainder is distributed among about twenty other industries.
The company had yet to release fourth quarter results, but its preliminary release was encouraging. Net asset value is expected to improve by around 4% from the prior quarter, to $ 13.22 to $ 13.25 per share, which would indicate that the shares are trading at a discount of around 6%. In addition, its NII range of 34 to 35 cents per share was better than expected and easily covers the dividend of 30 cents.
It’s encouraging, but BlackRock TCP Capital is playing with a handicap. Unlike Ares, which has generated some dividend growth in recent history and maintained its regular payouts throughout the crisis, TCPC’s payout has not changed for years and has been further reduced. by 16% last summer. We retirement investors prefer payments we can count on.
PennantPark Variable Rate Capital (PFLT)
Dividend yield: 9.5%
It’s all in the name. PennantPark Variable Rate Capital (PFLT) invests in mid-market businesses almost entirely through senior secured variable rate loans. And this exposure gives it an advantage in 2021.
PFLT’s current portfolio includes 100 tidy investments, scattered across industries such as aerospace, education, retail, financial services, and transportation.
The fourth quarter saw its net asset value improve 4.3% to $ 12.32 per share, implying a modest 3% discount from current prices. That, and a yield of 9.5% –paid monthly-are intriguing.
The security of dividends, on the other hand, is not that great. His most recent quarterly NII was only 91% of what he needed to fund his payments. It’s bad. Worst of all, Janney Montgomery Scott analysts predict PennantPark Floating Rate NII won’t cover dividend in 2021 or 2022.
Brett Owens is Chief Investment Strategist for Contrasting perspectives. For more great income ideas, get your free copy of his latest special report: Your early retirement portfolio: 7% dividends every month forever.