Business Development Companies, or BDCs (BIZD), are a great source of passive income for investors because they invest primarily in broadly diversified portfolios of senior secured debt. Moreover, these loans are almost entirely floating interest rate loans, making them nice portfolio diversifiers alongside other high yield investments that often suffer from rising interest rates (such as REITs (VNQ), utilities (XLU), and midstream infrastructure (AMLP, MLPX)). In this article, we will look at the five largest BDCs by market capitalization to see if these companies – which offer well-covered dividend yields ranging from 7%-13% – are worth buying.
#1. ARCC Stock
The largest BDC – Ares Capital (ARCC) – has a lot going for it right now.
First of all, ARCC reported a 26% year-over-year increase in core earnings per share in Q2, which was primarily driven by the benefit of higher interest rates on new and existing investments.
Furthermore, ARCC’s GAAP earnings per share for the quarter came in at $0.61, easily covering its dividend. The quarterly dividend of $0.48 was also well covered by the net investment income per share of $0.57 during Q2, resulting in a sturdy 1.19x coverage ratio. When combined with its significant amount of spillback income, ARCC’s dividend appears quite sustainable for the foreseeable future.
Another major positive for ARCC is that – despite paying out a significant dividend to shareholders – its Net Asset Value (NAV) per share continues to grow, posting a sequential increase of $0.13 (0.7%) in Q2. Furthermore, there was a sequential uptick in the weighted average yields on income-producing securities and total investments by 20 basis points, reaching 12.2% and 11.0% respectively, while the net interest and dividend margin also saw a 40 basis point sequential increase, settling at 7.9%.
On the leverage front, the ratio witnessed a decline, moving from 1.09x to 1.07x sequentially, giving it a very solid investment grade balance sheet.
Additionally, non-accruals showed sequential improvement, dipping from 2.3% to 2.1% on an amortized cost basis and from 1.3% to 1.1% on a fair value basis, reflecting strong underwriting performance.
With a 10.1% dividend yield and solid underlying fundamental performance, ARCC looks like a solid blue-chip BDC to own during these uncertain times.
#2. FSK Stock
The second largest BDC – FS KKR Capital Corp (FSK) – presents a compelling investment opportunity as well for several reasons.
First of all, while its Net Asset Value per share witnessed a sequential dip in its latest quarterly report, net investment income per share improved by $0.01 sequentially to $0.82 while providing a very healthy 1.28x coverage ratio on the regular quarterly dividend, and even provided a hefty 1.09x coverage ratio of the total dividend of $0.75, which included $0.11 in special dividends.
The company’s balance sheet also remains solid, with an investment grade credit rating and $3.5 billion in liquidity with a pretty favorable debt maturity ladder. Moreover, its net debt to equity ratio declined from 1.18x in Q1 to 1.13x at the end of Q2, reflecting management’s efforts to position the company to weather a potential economic downturn.
Furthermore, FSK’s underwriting quality continues to improve, with a non-accrual rate of 2.5% on a fair value basis as of the end of Q2 marking a sequential decline from 2.7% at the end of Q1. This steady improvement is primarily due to the fact that KKR Credit loans are replacing FSK’s poorly underwritten legacy loans and bodes well for the BDC’s future. In fact, as of the end of Q2, a substantial 86% of FSK’s total portfolio had been underwritten by KKR Credit, and these investments had a mere 0.6% non-accrual rate on a fair value basis. This implies that the majority of FSK’s current non-accruals originate from the residual 14% of the portfolio, which continues to diminish as a percentage of FSK’s portfolio as time progresses.
With a dividend yield of over 13% that is well covered by earnings, a solid balance sheet, and improving underwriting performance, FSK is positioned to deliver exceptional total returns to shareholders.
#3. OBDC Stock
The third largest BDC – Blue Owl Capital Corporation (OBDC) – grew its net investment income by $0.03 per share during Q2, improving it to $0.48 per share, marking a second consecutive quarter of record NII. Moreover, this growth in NII translated into additional cash distributions for shareholders, with the Board approving a supplemental dividend of $0.07 per share for the second quarter, in addition to a previously declared $0.33 regular dividend, totaling dividends of $0.40 for the quarter.
OBDC’s underwriting performance has also been solid, with non-accruals coming in at just 0.9% on a fair value basis. Its investment grade balance sheet also is well positioned, with significant liquidity and a reasonable 1.14x leverage ratio.
Given that its regular dividend is covered by a very conservative 1.45x by net investment income, OBDC’s 9.8% regular dividend yield (which is being enhanced significantly by special dividends) looks quite attractive and safe. Moreover, given that it is trading at an 11.5% discount to NAV, investors enjoy a meaningful margin of safety in the shares as well.
#4. BXSL Stock
The fourth largest BDC – Blackstone Secured Lending Fund (BXSL) – has been growing its net investment income per share at a very strong rate lately, increasing it from $0.93 to $1.06 sequentially and 71% year-over-year in its latest quarter, thanks to rapidly rising interest rates. As a result, it was able to cover its significant dividend by 1.51x with net investment income.
BXSL’s dividend also looks quite secure thanks to its reasonable 1.15x leverage ratio and the fact that a substantial 98.4% of the portfolio is invested in first-lien, senior secured debt, and its debt investments maintain a 46.5% average loan to value.
Finally, BXSL’s underwriting performance has been exceptional, with a remarkably low 0.1% non-accrual rate on a fair value basis.
#5. MAIN Stock
Last, but not least, the fifth largest BDC – Main Street Capital (MAIN) – has the most impressive long-term total return and dividend growth track record of just about any BDC.
In Q2, MAIN set new quarterly records for net investment income per share, distributable net investment income per share, and Net Asset Value per share for the fourth consecutive quarter, reflecting its strong momentum in the current environment of rising interest rates alongside relatively stable – albeit slow – economic growth. The company’s lower middle market portfolio companies continued to perform well, contributing to another quarter of net asset value appreciation and strong dividend income. As a result, MAIN’s NAV per share experienced an uptick.
Another major benefit of MAIN is that it benefits from having internal management, which gives it a very efficient cost structure. The company has a diversified portfolio of 211 companies across various industry segments and maintains a low non-accrual rate, with nine investments on non-accrual status, accounting for around 0.3% of the investment portfolio at fair value and 1.7% at cost. MAIN’s focus on its Lower Middle Market (LMM) portfolio, which yields almost 13%, and its strategic investment in both lower middle market and private loan portfolios, has been pivotal in driving its strong performance over the long-term. Moreover, the company’s DNII in Q2 exceeded the monthly dividends paid to shareholders by 66% and the total dividends paid by 24%, enabling it to deliver significant value to shareholders while also conservatively retaining a substantial portion of its income and growing NAV per share.
While MAIN is one of the most expensive BDCs in the market today given its significant 43.4% premium to NAV and its relatively low 7.1% dividend yield, its impressive track record, strong underwriting performance, attractive cost structure, and very safe dividend coverage, make it a solid pick for more conservative investors. Another perk for MAIN – in contrast to these other four BDCs – is that it pays a monthly, rather than quarterly, dividend.
Investor Takeaway
With their tax advantages, high dividend yields, solid balance sheets, and relatively conservatively positioned portfolios, these five BDCs offer investors a great way to access lucrative and relatively secure sources of passive income while also helping to hedge their portfolios against higher for longer/rising interest rates. Our favorite pick of these five is FS KKR Capital Corp given its steep 21.1% discount to NAV and leading 13.1% dividend yield. However, we think each has significant and unique strengths that could make them good candidates for a diversified dividend portfolio.
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