The recent spike in interest rates and attendant interest rate increase "panic" has helped create some bargains in the business development company (BDC) sector. BDCs are generally "regulated investment companies" (RICs) and operate under special tax and regulatory provisions and are generally subject to tax rules under which the BDC pays no federal income tax but must pay 90% of income to shareholders who are, in turn, required to pay taxes on the BDC dividend at the ordinary income tax rate rather than the lower rate generally applicable to corporate dividends. BDCs are also subject to certain limitations on their investments. Most BDCs invest primarily in loans to middle market and small-cap companies. Leverage is limited to a debt level equal to net equity. No BDCs actually failed during the Crash although some took a nasty hit due to problem loans and tightening credit conditions, which forced liquidation of assets at a loss.
I generally emphasize Net Asset Value (NAV) in looking at BDCs. NAV is simply the total fair value of all assets minus liabilities. Loans are generally marked to fair value so that non-performing loans are discounted. BDCs, which are stuck with low interest rate loan assets generally can redeploy into higher interest rate loans in a reasonable time period because most BDC loans are relatively short term. Thus, NAV provides a good measure of BDC value in most cases and, over a reasonable time period, provides a useful benchmark for estimating potential earnings. BDCs often have sizable equity holdings and fair value estimates of those holdings are more problematic and volatile. However, a big enough discount to NAV provides the investor with a helpful margin of error in this regard.
With respect to American Capital (ACAS), Gladstone Investment (GAIN), and MVC Capital (MVC), the table below provides Friday's closing price, the low price during the past week, NAV, the current discount to NAV and dividend yield. All data is based on recent SEC filings and information from corporate websites.
|Price 6/7||Week's Low||NAV||Discount||Yield|
ACAS has made an election to discontinue being a RIC with respect to tax status and has not been paying dividends. MVC's NAV as of the end of the last fiscal quarter was $16.29 but I have made additions due to share repurchases and the sale of a substantial asset for more than book value since that date. GAIN pays monthly dividends which may be attractive to some investors.
Each of these companies has its own story to tell. ACAS, which I have recently analyzed in more detail here, has an investment management arm and there may have been some concern that the value of this asset could be diminished as agency mortgage REITs run into problems due to rising interest rates. ACAS's subsidiary gets paid based on assets under management and so is somewhat insulated from the day to day vagaries of the market. On the other hand, assets under management have increased in recent years due to public offerings of equity and this avenue for growth may become more problematic as rates increase. ACAS has been fairly aggressive buying back shares and NAV has steadily increased in recent quarters. At some point, ACAS will very likely resume dividends and this may be a factor in pushing the price up to NAV.
MVC has had relatively high holdings of equity in middle sized companies - some of which have worked out very well. Management seems to be implementing a strategy of redeploying capital in the more traditional direction of loans to middle market companies (especially at the smaller end of the middle market spectrum). This will tend to produce more yield and higher dividends as time passes and capital is redeployed. MVC also has a share repurchase program. MVC recently realized a large gain on the sale of Summit Research Laboratories; the next few quarters will give us a better window on the "new MVC" as that capital is redeployed.
GAIN has been more of a traditional BDC. It is one of a group of companies run by David Gladstone who has been a major figure in the BDC world. GAIN ran into problems with inflexible lenders during the Panic of 2008-09 but is definitely on the mend. GAIN has a high proportion of floating rate loans as assets and is thus less subject to the impact of rising interest rates. Its recent financial results indicate rising income and the potential for dividend increases.
These companies are trading at discounts to NAV, which should close up over the next year or two. Opportunistic investors should look for market pull backs to open up even more attractive entry points for each of these companies. I would advise a long position at current prices on each of these but, of course, would be more inclined to "back up the truck" if the market creates even bigger discounts.