Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



The Most Important Thing for These High Yield Stocks


Any financial company, be it a bank or BDC, has two main earnings drivers: the cost of funds, and yields on their investments.

Today I wanted to look at the BDCs to compare funding costs from company to company. You'll find that how a BDC chooses to fund its balance sheet has a huge impact on its cost of debt, and its profitability.

Here's a table of 5 different BDCs, and their respective funding costs:

BDC Name

Weighted average cost of debt

Debt to equity ratio

Ares Capital Corporation (NASDAQ: ARCC  )



Prospect Capital (NASDAQ: PSEC  )






Main Street Capital (NYSE: MAIN  )



Triangle Capital (NYSE: TCAP  )



The table above shows little correlation between debt levels and interest costs. Although higher leverage generally means higher-risk for the lender (and higher interest for the borrower), the makeup of debt types has a more significant impact on a BDC's total funding costs.

Main Street Capital is an excellent example of a company that manages to keep its funding costs low. It borrows a significant portion of its funding from the Small Business Administration and a credit facility at 3.8% and 2.4% respectively. Likewise, THL Credit sources funds from a term loan and revolver, reducing its interest expense to just 3.6% on average.

Higher cost borrowers, like Ares Capital, Prospect Capital, and Triangle Capital, source proportionately more of their funding in the form of long-term debt. Ares Capital, for example, sourced roughly 7% of its debt funding from a credit facility -- the remainder comes from a variety of higher-cost, long-term notes. Prospect Capital didn't use a dime of its credit facility as of its last earnings report. Triangle Capital sourced just under 3% of its borrowings from its credit facility. Notice a trend? When BDCs aren't using their credit facility, their debt costs soar. 

But there is plenty of upside, too. Unused credit facilities, when turned back "on," allow a BDC to cut down its cost of funding and grow its net interest margin.

Why it matters
Yields are falling for most BDCs as more capital flows into the markets in which they invest. But what really matters isn't the rate BDCs earn on their investments. What matters is the spread -- the difference between their funding costs and portfolio yields.

As investment yields decline, those with the highest funding costs will see the biggest change in their earnings over time. They'll have only a few choices: accept more investment risk, or start seeking out lower-cost debt funding. It's just that simple. Earnings reports are only one month away. I'll be paying attention to the companies that are making creative moves to lower their cost of debt. You should be, too. 

Is this a better dividend option than BDCs?
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Read/Post Comments (0) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2900340, ~/Articles/ArticleHandler.aspx, 8/30/2015 4:17:32 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

Today's Market

updated 1 day ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:00 PM
ARCC $15.68 Up +0.31 +2.02%
Ares Capital Corp CAPS Rating: ****
MAIN $28.54 Up +0.12 +0.42%
Main Street Capita… CAPS Rating: ****
PSEC $7.71 Up +0.21 +2.80%
Prospect Capital C… CAPS Rating: ****
TCAP $20.03 Up +0.52 +2.67%
Triangle Capital C… CAPS Rating: ****
TCRD $12.40 Up +0.10 +0.81%
THL Credit, Inc. CAPS Rating: *****