This is a follow up to my recent "Projected BDC Returns Vs. Risk"
article and combines my risk profile series to assess if the current dividend yield for each BDC justifies the amount of perceived risk and potentially an indication of which BDCs are underpriced. However this does not take into account the potential for net asset value ("NAV") per share growth that I will cover later in this series. In theory, stocks with higher amounts of risk should pay investors with correspondingly higher amounts of return. Some BDCs have larger amounts of first lien senior secured loans at floating rates with much lower amounts of risk but lower yields as well. The amount of leverage that a company uses to increase returns and net investment income ("NII") is also a factor when considering the amount of risk involved but allows BDCs to pay higher dividends.
In this article I will provide:
- Appropriate yield ranges based on risk levels
- Adjusted yields based on projected NII
- Yield vs. risk analysis
When considering dividend yields it is important to include special dividends as well as the potential for dividend increases or cuts depending on projected NII. In a recent series of articles "BDC Risk Profiles" I looked at portfolio credit quality, investment asset classes, diversification, non-accrual rates, portfolio yield, fixed/variable rate loans, leverage, interest rate sensitivity, volatility ratios, market capitalization, insider ownership and trends, institutional ownership and trends, and management/operational history for each BDC. I then used various weightings to come up with an overall relative risk rank.
The table below shows the current dividend yields with an average of 9.5% and the "standard deviation" that statistically measures the variation of the yields compared to the average, with 68% of BDCs falling within one standard deviation from the average or between 7.8% and 11.3%. Then I used the relative risk rank for each to indicate the appropriate yields with the 'safer' BDCs closer to 7.8% and the 'riskier' ones closer 11.3%.
The next table compares the yield range and implied risk levels with the current dividend yield adjust for projected NII levels and special dividends. I only adjusted the BDCs with much higher or lower coverage levels and assumed that the others within 5% would most likely not need to adjust future dividends. For ACAS I used the projected 2013 NII per share of $0.91 as a proxy for potential dividend yield. There was a tight correlation between adjusted and implied yields with 14 of the 25 BDCs that I cover falling within 1% of expectations. The table below shows the variance between the yields implied by the relative risk rank and the adjusted yields for each as well as indicating which ones that I believe are over or under priced based on this analysis. I have also included a key showing which suggested portfolios each BDC is in.
Some of the things that I learned from this exercise:
- BDCs with higher historical NAV growth rates are priced higher (using this methodology) such as American Capital (ACAS), Triangle Capital (TCAP), Hercules Technology Growth Capital (HTGC) and KCAP Financial (KCAP).
- Some of the BDCs that I consider overpriced using other methods are in-line (using this methodology) such as Main Street Capital (MAIN), Fidus Investment (FDUS) and Golub Capital BDC (GBDC), even though all three have higher NAV growth rates as well.
- If BDCs such as Fifth Street Finance (FSC), Full Circle Capital (FULL) and Solar Senior Capital (SUNS), cut dividends to match projected NII they are still adequately priced.
- Prospect Capital (PSEC) is the best bang for your buck (using this methodology).
- NAV per share multiples are not the key to BDC pricing.
- Investors expect higher yields for higher risk (obviously).
I will try to update these charts on a quarterly basis. Investors should only use this information as a starting point for due diligence. See the following for more information: