The income opportunity with non-bank business lenders.

music selection:  “Paradise” — Tesla

Each Friday at the raptor I cover opportunities to earn income in early retirement via dividends, distributions, and interest.  There is one entire sector I haven’t covered yet that offers consistently high yields.  That is the Business Development Companies (BDC) sector.  These are companies that make loans to small to medium sized businesses.  The customers are usually too large to be serviced by a local bank but too small to draw the interest of investment banks to do underwriting for a bond issue.

These firms still need working capital and often times money for expansion capex.  BDCs are able to borrow short and lend long to take advantage of the yield curve.  There is much less risk than with a mortgage REIT as the loans tend be heavily skewed toward variable rate loans.  The BDC often provides additional consulting services for fees and frequently is awarded an equity stake or negotiates convertible debt.

You end up with a company that is a lot like a bank but without the overhead of multiple branches and huge customer service teams necessary to service retail depositors.  And they have the kicker of equity in fast growing small businesses.  The returns can be very strong.

Because this is lending that can’t or won’t be serviced by traditional lenders, congress carved out a tax benefit for these companies to ensure small and medium businesses would have access to capital.  When these companies pay out the vast majority of their operating profits as distributions as per IRS requirements, they become “tax exempt” at the federal level.  You will still need to pay taxes on your distribution income.

As a result of the unusual tax treatment of these companies, they tend to pay large and stable distributions.  They have low volatility and make excellent retirement investments.  Today, I’m going to share three of my favorite high yielders from this space and a bonus opportunity with a double leveraged ETF that follows the Wells Fargo BDC index.

Prospect Capital Corporation (PSEC) is a BDC with a 2.5 billion market cap.  It pays monthly distributions that have held up reasonably well against declining interest rates in the broad market.  I personally hold this investment and think it has great upside in a rising interest rate environment.  It currently yields 10.40% on an annualized basis.  You can eek out an extra percent of yield or so by writing covered calls against your position as this issue has liquid options available.

Apollo Investment Corporation (AINV) is a BDC with a 1.1 billion market cap. It pays a stable quarterly distribution.  I have held this investment in the past and did quite well.  Unfortunately, it appreciated faster than expected and shares were called away from me as the result of using a covered call position to juice cash returns.  It currently yields 10.97% on an annualized basis.

BlackRock Capital Investment Corporation is (BKCC) is BlackRock’s entrance in the BDC space.  Hopefully, BlackRock needs no introduction as it is a legendary investment company.  The ETF is small with a 0.4 billion market cap.  Options exist but I recommend caution in using them as volumes and liquidity are very low.  The company does however pay a quarterly distribution that is good for a 12.16% annualized yield.

Finally, there is the UBS E-Tracs 2x Leveraged Long WF BDC ETN (LBDC).  This is a double leveraged ETN from UBS that tracks double the monthly movement in the Wells Fargo BDC index of 20 leading BDC companies.  While it carries double the potential reward, be warned it is subject to double the risk in a falling interest rate environment.  You may find that you are well compensated for this risk however by the very strong 17.39% annualized yield.

Devour your prey raptors!

(Lizard King was formerly long AINV and is currently long PSEC).

Friday Fixed Income – Business Development Companies (BDC)

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