Fifth Street Financial: Rare 13.5% Dividend Yield Among Financials

Nov. 3.11 | About: Fifth Street (FSC)

Looking for a dividend investment with a double digit yield outside of a mortgage REIT? With a 13.47% dividend yield, Fifth Street Finance Corp (NASDAQ:FSC) has the highest yield within the financial sector. Since Fifth Street also has a monthly payment schedule, it can be a reasonable option for income investors with short and long term horizons.

Fifth Street Finance Corp is a business development company (BDC) that pays out its earnings in a fashion similar to REITs. The company specializes in lending to private equity firms and medium sized businesses. Their financing deals primarily consist of bridge loans and expansion projects. Unlike larger corporations, smaller companies lack access to investment banking services. Instead, they use BDCs as an alternative method of financing. Fifth Street should benefit from the drying up of lending from commericial banks because it gives the company a better bargaining position for the terms of their loans. Low interest rates are also a strong headwind for Fifth Street because income investors will need to add on risk for needed yields.

Fifth Street's financial condition is stable and will be able to sustain its high dividend payments. The company has no long term debt and is trading at only 89% of its book value. Fifth Street is also highly profitable with a 55% profit margin. However, the underlying risk for Fifth Street is the company's procyclical business model. BDCs were one of the worst performing sectors during the 2008 crash due to the small businesses they financed falling into liquidity traps.

Whether or not investors buy Fifth Street depends on their outlook for the economy. If the economy maintains solid growth (or even the avoidance of a recession), Fifth Street is an excellent place to preserve capital as dividend payments will exceed any capital losses. However, if the US slips into recession, its small business borrowers can struggle with paying back debts and erode the asset base of the BDC as a whole rather quickly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.