The Most Important Thing for These High Yield Stocks

Investment yields matter, but one of the biggest differentiators in alternative finance is raising low-cost capital.

Apr 7, 2014 at 9:15AM

Bdc Debt


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?
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Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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