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.
Main Street Capital
) is a BDC that specializes in equity, equity-related, and debt investments in small and lower middle-market companies. The company pays a monthly dividend of $0.15 per share, which translates into a dividend yield of 5.6%. The current monthly dividend is 11.1% higher than that paid in the same month a year ago. Its dividend is well covered by net investment income, with the coverage ratio of 88% of net investment income reported in the third quarter of 2012. Given its strong financial performance, the company has generated spillover taxable income (taxable income in excess of dividends paid) of $0.96 per share, as of September 30, 2012. In early January, Main Street Capital Corporation paid a special cash dividend of $0.35 per share. The stock has a high ROE of 22.6%, compared to an average ROE of 8.4% for the banking industry. MAIN has rallied nearly 41% over the past 12 months and is currently trading at a price-to-Net-Asset-Value (NAV) of 182%.
Fifth Street Finance
) is a BDC that provides financing to small-and-medium enterprises in connection with investments by private equity sponsors. The majority of the firm’s portfolio is in debt investments secured by first or second-priority liens. The company pays a monthly dividend of $0.0958 per share, with an annualized yield of 10.5%. The current dividend is the same as that paid in the same month a year ago but is 10.5% lower than that paid in December 2011. The company’s dividend coverage ratio of 103%, based on the December 31, 2012-quarter net investment income, looks a bit stretched. The company has an ROE of 9.9%. It is trading at a price-to-NAV of 111%, based on the December 31, 2012-quarter NAV of $9.88 per share. The stock is up 6.4% over the past 12 months.
Full Circle Capital
) invests in asset-based senior secured loans, mezzanine loans, and equity securities issued by small-and-medium enterprises. It focuses on the media, communications, and business services industries. The company pays a monthly dividend of $0.077 per share, with an annualized yield of 12.0%. The company’s current monthly dividend is the same as that paid in the same month a year ago. FULL’s dividend coverage ratio is 105% of the December 31, 2012-quarter net investment income. The stock has a low ROE of 3.6%. It is trading at a price-to-NAV of 96%, based on the December 31, 2012-quarter NAV of $8.03 per share. The stock is down 3.2% over the past year.
) provides “flexible private debt and equity capital to sponsor-owned and non-sponsor-owned middle market companies in the United States and Canada
.” It invests in senior and subordinated debt and equity of small-and-medium companies. Prospect Capital’s declared monthly dividends are $0.110050 per share for February 2013, $0.110075 per share for March 2013, and 0.110100 per share for April 2013. The annualized yield based on the February 2013 dividend is 11.6%. The current monthly dividend is about 9% higher than that paid in the same month a year ago. The company has a dividend coverage ratio of 114%, based on the aforementioned declared monthly dividends and the estimated net investment income per share in the current-year first quarter. PSEC has an ROE of 10.3%. The stock is currently trading at a price-to-NAV of 105%, based on the December 31, 2012-quarter NAV of $10.8 per share. The stock is up 5.3% over the past 12 months.
) invests in senior secured loans, subordinated loans, mezzanine debt, preferred stock, common stock and warrants to purchase common stock of small-and-medium enterprises. According to the firm, it is “publicly-traded buyout fund that seeks to make debt and equity investments in small and mid-sized businesses in the U.S. in connections with acquisitions, changes in control and recapitalizations.” Gladstone Investment’s current monthly dividend is $0.05 per share, with an annualized yield of 8.0%. The current monthly dividend is unchanged from that paid in the same month a year earlier. Gladstone Investment’s dividend coverage ratio is 100%, based on the December 31, 2012-quarter net investment income. GAIN has an ROE of only 0.4%. The stock is trading at a price-to-NAV of 86.6%, based on the December 31, 2012-quarter NAV of $8.65 per share. The stock is down nearly 8.0% over the past year.
) is a “specialty finance company that invests in debt securities, consisting primarily of senior term loans, senior subordinated loans and junior subordinated loans and, while not a current focus of the portfolio, may also invest in preferred and common equity or equivalents, of small and medium-sized companies.” The company’s current monthly dividend is $0.07 per share, which translates to an annualized dividend yield of 9.2%. The current monthly dividend is unchanged from that paid in the same month of the previous year. The company’s dividend coverage ratio is 91%, based on the December 31, 2012-quarter net investment income. The company’s ROE is only 0.8%. The stock is trading at a price-to-NAV of 100%, based on the December 31, 2012-quarter NAV of $9.17 per share. GLAD is up 9.8% over the past 12 months.