A reader has informed me about yet another Business Development Company (BDC) - Keating Capital. It is not yet listed but has applied for a NASDAQ listing under the symbol of KIPO and hopes to be listed by the end of the year. Its website is keatingcapital.com. It is apparently following a strategy similar to that of GSV Capital (NASDAQ:GSVC), investing in the stock of companies which have not yet gone public in the hope that this will present opportunities to reap gains upon the IPO of the company or later on as the company trades up.
I think that a few concluding thoughts about this interesting corner of the stock market are probably appropriate. First of all, BDCs have very limited leverage and this served them reasonably well during the Panic of 2008. While a number of the BDCs suffered major declines in their stock prices and had to write down assets leading to losses, to my knowledge there was no situation in which a BDC actually had to go out of business and/or file bankruptcy. Allied Capital was taken over by Ares Capital (NASDAQ:ARCC) and Patriot Capital was taken over by Prospect Capital (NASDAQ:PSEC) but my impression in each of these cases is that bankruptcy was not imminent.
BDCs also performed reasonably well during the interest rate increase period earlier in the decade just past. I have described this in another article. BDCs have many floating rate loans and, in any event, tend to have relatively short term loans, and this enables them to increase gross income as rates rise (although there is sometimes a lag).
Because of the requirement that they disperse a large proportion of their income as dividends, it is difficult for BDCs to grow without engaging in secondary offerings. CLOs and SBIC subsidiaries create some opportunities to expand for BDCs but the primary mechanism for expansion is the issuance of additional stock. The 2010-2011 time period has seen a number of issuances of BDC stock - some in the form of secondary offerings and a substantial number in the form of Initial Public Offerings - this is responsible for the increase in the number of BDCs and some of the difficulty analysts are having in keeping up with the group. I believe that QE2 probably played a role in pushing money out of the Treasury market and creating an atmosphere conducive to these successful stock offerings. The stock offerings put more money in the hands of the BDCs and that, in turn, created another lending resource for small and middle sized companies.
I am sometimes asked whether I would change anything in terms of BDC regulation. I believe that more flexibility should be built into the dividend rules so that a BDC that is in or near to leverage trouble can reduce or eliminate dividends and build up capital to get itself out of the leverage trap. On another note, I think BDCs should consider setting up a trade association to represent their interests in Washington and to help make the public and investors more aware of their fundamentals and the role they play in making funds available to small and middle sized businesses.
In fundamental terms, the shifting of lending from depository institutions to BDCs means that more loans are being made from the equity of the lender and this tends to stabilize the system because lenders have no obligation to pay interest on equity or to repay an equity investor his "principal" at a certain maturity date. It should probably be viewed as part of the "deleveraging" of America and, thus, is probably a positive step.
From an investor's point of view, BDC stocks offer an attractive source of yield. In recent months, BDC stocks have been rather volatile: an investor who picks a target price below which he will be a buyer can probably pick up some of these stocks at deep discounts to book value. These opportunities may not last forever and, thus, an investment of time to learn something about the sector will likely be well rewarding.