3 BDCs Paying 10%+: 2 Hopefuls, 1 Hopeless Wreck

Brett Owens, Chief Investment Strategist
Updated: September 8, 2017

Business development companies (BDCs) are dividend powerhouses that typically yield anywhere from high single digits to low double digits. And in fact, the group of three BDCs I’m going to show you today each throws off a yield of more than 10%!

But most investors – even income-seeking folks – aren’t familiar with them. If that includes you, or you’re just looking for safe 10% yields or better, read on.

BDCs were created in the 1980s by the U.S. government to help small- and midsize businesses finance their growth – via debt, equity and other financing. And by doing so, they also help create American jobs. In return, they’re regulated much like real estate investment trusts (REITs) in that they must deliver 90% or more of their taxable income to shareholders in the form of dividends. They also can use debt leverage to boost their businesses, and in turn make their dividends even sweeter.

Despite their high yields, BDCs tend to fly low under Wall Street’s radar. They’re not as exciting as big tech stocks like Apple (AAPL), and their businesses aren’t as easy to decipher as consumer stocks like Coca-Cola (KO) or Kraft Heinz (KHC).

I say “good”! BDCs’ low profiles cause many of them to be underloved and undervalued.

Just don’t mistake “cheap” for “value.” Today, I’m going to look at a trio of BDCs yielding 10% or more, and while there’s real potential in a pair of these, you’ll also see how seeming values can be a siren’s song.

Prospect Capital (PSEC)
Dividend Yield: 10.75%

Prospect Capital Corporation (PSEC) has been up to absolutely no good since we last discussed it at the end of May. PSEC shares are down more than 20% since I last warned you about the company’s operational weakness.

That’s because Prospect Capital went from weak to wreck.

Dividend coverage has weakened over the past few quarters, and many investors increasingly sold out across August, fearing a distribution cut. Those fears were confirmed late in the month. Prospect Capital’s fiscal Q4 earnings report included a 27% drop in net investment income (NII) to just 19 cents per share – not nearly enough to cover its 8.33-cent monthly payout.

PSEC “fixed” the problem, though, dropping its future distributions to just 6 cents per month.

Shares still yield nearly 11% thanks to their precipitous plunge, and they even trade at a 30% discount to net asset value (NAV). Don’t bite. Prospect Capital has to prove it can get its house in order – and not just by stripping its dividend to the bone to match its decaying operations.

Prospect Capital (PSEC): This Is NOT How a Dividend Chart Should Look

Newtek Business Services (NEWT)
Dividend Yield: 10.1%

Newtek Business Services (NEWT) is a relatively new player on the BDC block, around since 1998 and publicly traded since 2000, but it only converted to a business development company back in 2014. It also feels different, with a glossy website that looks more like a commercial banking portal than a dry BDC information dump.

But Newtek doesn’t just feel different – it is different.

Newtek is a direct business lender that offers financing solutions “from $10,000 to $10 million,” and has approved $2 billion-plus in business loans to date. But it offers so, so much more. Newtek’s list of services include things such as electronic payment processing; commercial, health and benefits insurance; even web design!

While the company’s success has led Wall Street to bid it up to a considerable premium at the moment, the potential for both business and dividend growth is enough to overshadow that. Sometimes, you just need to pay for quality. NEWT’s adjusted NII last quarter jumped nearly 45% year-over-year to 41 cents per share, following a 33% increase in Q1. That shows how much things are accelerating; 2016’s adjusted NII was just 5% better than 2015.

The only thing you’ll have to get used to is a dividend that varies from quarter to quarter, versus many BDCs that have set payouts. But the trend in 2017 is higher, and that’s what really matters.

Newtek Business Services (NEWT) Is a Small But Sprightly Dividend Play

Monroe Capital (MRCC)
Dividend Yield: 10%

Monroe Capital (MRCC) isn’t one of the biggest names in the BDC space, but it’s a solid yielder, a solid performer and a company worth adding to your watch list.

Monroe Capital provides capital to lower middle-market businesses via several avenues, including senior debt, unsubordinated debt and even equity investments. It sticks to the lower middle market because it believes doing so offers “more attractive economics, lower leverage, direct access to borrower management and improved information flow.” Its targets must have a minimum EBITDA of $3 million annually.

While MRCC invests in a wide basket of industries, it has specialty teams dedicated to the healthcare and technology sectors, among others. Its healthcare investments, for instance, include the likes of Priority Ambulance, nursing care specialist CarePlus Home Health and Pivot Physical Therapy.

Monroe Capital is, unlike PSEC, operationally sound. Specifically, the company reported its 13th straight quarter of full dividend coverage in early August, with NII of $6.088 million that was slightly higher than the previous quarter’s $6.034 million. On a per-share basis, NII of 35 cents fully covered the distribution.

Monroe Capital (MRCC) Looks Good, But Not Great … Yet!

But don’t jump in quite yet.

MRCC trades without any meaningful discount to NAV right now despite a 10% decline in 2017, and while NII is enough to cover the dividend, it’s not doing so by enough to really justify an increase in the near future.

The Retirement Portfolio You NEVER Have to Touch!

Dividend growth is one of the three vital components of an “ultimate retirement stock” which is precisely why Monroe Capital is on my “watch” list, and not my “buy” list. While I love its 10% dividend, that payout will lose its oomph over time to inflation if management doesn’t keep upping the ante.

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Most pundits that talk about so-called “retirement stocks” will point you in the direction of no-growth blue chips that yield 3%, maybe 4% if you’re lucky. But even if you’ve saved up $500,000 for retirement, 4% annually is just $20,000 a year. You and I both know that even with Social Security tucked in there, that’s not a comfortable retirement.

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