TopYields

General BDC Overview

Dividend investors seeking monthly income can achieve their investment objective through several Business Development Companies (BDCs). These companies are cyclical investments that generally lend to speculative businesses that have difficulty accessing credit from traditional sources. BDCs also may hold equity interest, such as warrants, in invested companies or may buy the companies’ debt. As tax-advantaged investment vehicles, BDCs generally pass on at least 90% of their income to investors in a form of cash distributions (dividends). Hence, BDCs tend to pay high dividend yields. There are only about 28 BDCs in the United States, out of which merely six pay dividends on a monthly basis. Still, despite the appeal of monthly dividends of the select group of BDCs, all BDCs should be evaluated based on their risk profile and the total return potential.

As bank lending standards have tightened significantly since the financial crisis in 2008, lending opportunities for BDCs have increased substantially. In a rebounding economy, this has enabled BDCs to boost their investment portfolios. Many have done so in a way that reduces risk by lending to or investing in a large number of companies across the various business sectors. Still, even when risks are spread out across many companies and diversified across industries, the BDC business model is inherently risky, given that BDCs tend to lend to companies below investment grade or without a credit rating. As compensation for high risk, BDCs charge high interest rates or require high rates of return. When the economy is expanding, the borrower default risk is reduced and the overall BDC portfolio tends to perform well. This means that high lending rates or required rates of return translate into strong income and cash flow. In the current macroeconomic environment, many BDCs show positive trends of expanding net investment income. Indeed, some BDCs have much higher return on equity (ROE) than conventional commercial banks.

Given their status as pass-through entities, BDCs also tend to pay high dividends, providing for high dividend yields. This feature makes them appealing as income investments. For example, the average dividend yield for the 28 BDCs in the Wells Fargo Business Development Company Index is 9.78%, as of December 31, 2012. That yield is whole 7.58 percentage points or 4.4 times higher than the average dividend yield of the S&P 500 Index. Sure, elevated dividend yields also reflect higher risk inherent in the BDC business model. However, some BDCs are financially sound, and their higher yields relative to those of commercial banks make them attractive for some income investors.

BDCs Paying Monthly Dividends

As already noted, there are six BDCs that pay dividends on a monthly basis. Below is a closer look at each of the six BDCs.