Business development companies (BDCs) can be attractive investments for income investors as they're required to distribute virtually all of their income to investors each year. As a result, BDCs generally yield 6% or more, three times more than the S&P 500.
Golub Capital BDC (GBDC 0.36%), TPG Specialty Lending (TSLX 0.14%), and New Mountain Finance (NMFC 0.59%) round out a solid roster of business development companies with beefy dividend yields. Here's the case for adding these companies to your portfolio.
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All about deal flow
Golub Capital BDC has the advantage of being part of the Golub Capital complex, a leading lender in the middle market. Its privileged position enables it to both control the underwriting process and be choosier when it comes to selecting good credits.
The BDC ended the first quarter with 185 different investments, of which the 10 largest made up 19% of its portfolio at fair value. In contrast, many other BDCs hold fewer than 100 investments, with more concentration in their top holdings. Furthermore, virtually all of its portfolio is invested in lower-risk first-lien loans and "one-stop" transactions, which are less likely to experience losses than riskier second-lien loans and equity investments. Only 4% of the portfolio is currently tied up in equity investments, a figure well below the typical BDC equity exposure of 10%.
Importantly, management runs the business for the benefit of shareholders, rather than exhibiting the self-serving behavior of many of the industry's higher-yielding companies. Notably, management has collected a fraction of incentive fees it would otherwise earn if it threw risk controls out the window and chased higher-yielding (but higher-risk) investments.
Shares rarely trade cheap, but even at a current price of 1.2 times net asset value (book value), Golub Capital BDC is a compelling choice for yield-seeking investors.
True differentiation
If you asked me to sum up what makes TPG Specialty Lending unique, I'd tell you that they don't lose money. That's not entirely true, of course, but when credits go bad, TPG Specialty usually nets out just fine.
Speculative credits are its forte. As recent examples, it made a full recoveries on its investments in Sports Authority and Aeropostale. Its current portfolio includes a loan to Payless Shoes, which it also anticipates will go through bankruptcy or restructuring. The Payless loan was last marked at a level that indicates that a workout should result in a complete repayment, too.
In the case of Payless, that loan yields 8%. The Sports Authority loan yielded more than 9%. Rarely do high-priced loans end up with favorable outcomes, but TPG Specialty Lending is known to pull rabbits out of its hat, given that it underwrites and structures loans with the downside in mind.
Like Golub Capital BDC, TPG Specialty Lending trades at a seemingly permanent premium to book value. Shares currently trade at about 1.25 times book value, and sport a current yield of about 7.6%. Having more than earned its dividend with operating income, investors can look forward to the potential for special dividends on top of its current quarterly distribution.
Credit where it's due
Investors willing to take a step up on the risk spectrum may like what they find with New Mountain Finance, which currently yields 9.4%.
New Mountain is a capable private equity investor and lender. While one can argue that New Mountain Finance has, at times, been aggressively managed -- it frequently raises new capital by selling stock at negligible premiums to book value -- it's notable that management has repeatedly waived fees as necessary so that it earns its dividend from net operating income.
Admittedly, elective fee waivers aren't the same as contractual reductions in management or incentive fees going forward. Management could pull the rug on fee waivers at any time, but doing so would put an end to the company's growth, and thus management's earnings over the long haul.
So long as the fee waiver support continues, there's a clear case for New Mountain Finance as a higher-risk, but higher-yielding choice in the business development company industry. A willingness to defend the dividend is an attractive quality in any BDC, as many companies have simply let shareholders bear the brunt of lower earnings with decreased payouts.
