One of the things that struck me during the 2008-09 crisis was the devastation created by excessive leverage. Banks, hedge funds, and other entities had bloated returns beefed up by leverage and, when things started heading south, there was a very deep and unsettling dip in the roller coaster ride. Leverage enables investors to amplify returns on investments that are growing or yielding more than the borrowing cost on the leverage. Thus, if an investment yields 10%, a completely unleveraged portfolio containing the investment will simply yield 10% while a portfolio leveraged 5 to 1 using debt with 5% interest will yield 35% and, at 10 to 1, the portfolio will yield 60%.
Unfortunately, leverage works in both directions and, in that portfolio with 10 to 1 leverage, a 5% decline in the value of the investment will produce a 55% decline in the book value of the portfolio. During the financial crisis, this phenomenon was intensified by the fact that managers were often forced by lenders to liquidate assets in order to pay down debt, and when everyone tries to sell at the same time, prices have a nasty way of going down, leading in turn to another round of margin calls and distressed sales. One author claims we are living through the "age of deleveraging."
In early 2009, I noticed another troubling phenomenon. Quite a few of the Business Development Companies (BDCs) I was following were beset by "lender problems." As always, lenders can be counted on the turn into rapacious skinflints at the worst possible time and that was what was happening. Like a band of hyenas on crystal meth, banks and other lenders pulled lines of credit, demanded onerous terms, and fixated on covenant issues, even in situations in which there was no reasonable probability that they would not ultimately get paid. It made me realize how nice it must be not to have the fist of a short-sighted, panicky tightwad wrapped around your throat. In other words, how nice it would be to be debt-free.
It is, therefore, perfectly understandable that investors may prefer to avoid leveraged investments and companies that use leverage. It was certainly my inclination in 2009 and many of my positions were chosen in such a way as to avoid the dangers of leverage. In the current market, I have become willing to tolerate some leverage but it still makes me nervous. For example, I own Annaly (NLY) despite the considerable leverage.
For those investors who want to avoid leverage or who, like me, prefer to limit it, I have put together a list of 5 companies with little or no leverage, each of which pays a decent dividend. In each case, I am providing the symbol, Tuesday's closing price, the amount of net debt or net cash, the leverage (debt as a percentage of total assets) and the dividend yield. Three are BDCs and two are Real Estate Investment Trusts (REITs)(one is an equity REIT and one is a mortgage REITs).
1. TICC Capital (TICC) ($11.19) (0 debt - $69 million net cash)(0)(8.5%);
2. LTC Properties (LTC) ($29.34) ($78 million) (13%) (5.7%);
3. PMC Commercial Trust (PCC) ($8.66) ($75 million) (30%) (7.4%);
4. Gladstone Investment (GAIN) ($7.58) (0 - $71 million net cash) (0) (7.0%);
5. NGP Capital (NGPC) ($9,14) (0 - $18 million net cash (0) ( 7.4%)
It is not surprising that the list is dominated by BDCs; BDCs have statutory limits on leverage and some had near-death experiences with lenders in 2008-09, so that leverage is very limited throughout the sector. LTC has unusually low leverage for an equity REIT(a REIT that actually owns properties rather than mortgages). It is very conservatively managed and did reasonably well through the crash.
Investors should be aware that LTC has very recently obtained a $210 line of credit and, although the most recent quarter's balance sheet probably still correctly reflects leverage, it is likely that in the near future LTC will use some or all of its credit to buy assets and this will increase leverage.
PCC originates SBA loans and tends to sell off the guaranteed portion of the loans. It is therefore an unusual mortgage REIT operating in a niche market.
The 3 BDCs(TICC, GAIN, and NGPC) are all able to pay decent dividends because they obtain high interest rates on their portfolio loans. Thus, they make loans that are considerably riskier than the agency mortgages owned by NLY, but they avoid leveraging their portfolios.
As I said above, I do not think that "leverage avoidance" should be the only consideration in assembling a portfolio of dividend paying stocks and I own NLY and other leveraged mortgage REITs as well as some BDCs that have modest leverage. On the other, for the investor who is adamantly opposed to leverage, these stocks offer the opportunity to obtain attractive dividend yields.
Even for investors willing to tolerate leverage, these stocks are worth examination because they may perform better in a "squall" and they may be able to seize opportunities to grab distressed assets at a discount more readily than companies that are leveraged going into the "squall."