BDCL To Pay The Highest Dividend Since July 2015

| About: UBS ETRACS (BDCL)
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Summary

The increase in the net asset value of BDCL has caused an increase in the quarterly dividend.

The post-election divergence of BDCL from other UBS ETRACS 2x Leveraged High Yielding ETNs shows how BDCL can provide diversification that can mitigate ETN interest rate risks.

The prospects for BDCL depends mostly on that of the equity markets.

There are significant risks to both the stock and bond markets from the prospect of protectionism that could hurt BDCL among many other securities.

There could be upward pressure on financial asset prices from the increasing glut of savings.

On a year-over-year basis the UBS ETRACS 2xLeveraged Long Wells Fargo Business Development Company ETN (NYSEARCA: BDCL) has returned 41.1% based on a purchase on March 21, 2016 at $15.90, the March 21, 2017 price of $20.80 and the dividends of $2.853 paid since March 21, 2016. This does not include any reinvestment of dividends or any gains or losses on reinvestment of dividends. It also does not include my projected April 2017 quarterly dividend of $0.8261. The Index upon which BDCL is based is a float-adjusted, capitalization-weighted Index that includes business development companies listed on the major exchanges. There is an unleveraged ETN that is based on the same index, the UBS ETRACS Wells Fargo Business Development Company ETN ( BDCS). It should be noted that Wells Fargo (NYSE:WFC) only supplies the index and UBS Group AG ( UBS) is the issuer of the exchange traded notes.

In my article "BDCL: The Third Leg Of The High-Yielding Leveraged ETN Stool", I said that BDCL is highly correlated to the overall market, but may be a very good diversifier for investors seeking high income who are now heavily invested in interest rate sensitive instruments. Previously, I pointed out in: "17.8%-Yielding CEFL - Diversification On Top Of Diversification, Or Fees On Top Of Fees?" those investors who have significant portions of their portfolios in mREITs and in particular a leveraged basket of mREITs such as the ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEARCA: MORL) could benefit from diversifying into an instrument that was highly correlated to the S&P 500 (NYSEARCA: SPY).

The UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL) was shown to be highly correlated to SPY while only 5% of the variation in daily returns for MORL can be explained by the daily variation in SPY. Since CEFL yields not that much less than MORL, this suggests that a portfolio consisting of both MORL and CEFL would have close to a yield as a portfolio with only MORL, but considerably less risk. My article explained why adding BCDL to such as portfolio could result in a more efficient risk/return profile

The post-election performance of three UBS ETRACS Monthly Pay 2xLeveraged ETNs: MORL, CEFL and BDCL illustrates the advantages of diversification. All three have very high yields. However, a portfolio consisting of all three would have almost as much yield as a portfolio consisting only of any single one but considerably less risk

Table 1 below shows that since the election BDCL has done much better than CEFL or MORL.

Table 1. The Post-election Divergence of Selected Securities

11/8/2016

12/8/2016

Change Price

Change %

3/21/2017

Return* from 11/8/2016

BDCL

16.77

19.08

2.31

13.77%

20.8

28.44%

MORL

15.08

16.07

0.99

6.56%

16.77

16.74%

CEFL

16.14

16.7

0.56

3.47%

16.91

10.74%

*Includes BDCL dividend of 0.7393 with 1/9/17 ex-date

*Includes MORL dividend of 0.0324 with 12/9/16 ex-date, 0.7375 with 1/9/17 ex-date, 0.0325 with 2/8/17 ex-date, 0.0325 with 3/9/17 ex-date

*Includes CELF dividend of 0.2479 with 12/9/16 ex-date, , 0.3709 with 1/9/17 ex-date, 0.1027 with 2/8/17 ex-date, 0.2426 with 3/9/17 ex-date

In the month after the election, BDCL did much better than MORL and CEFL. The outperformance of BDCL has continued and it returned 28.44% from 11/8/2016 to 3/21/2017. This compares to the 16.74% and 10.74% returns of MORL and CEFL respectively, all after their are included.

Unlike MORL and CEFL which pay monthly dividends, BDCL pays quarterly. As can be seen in the table 2 below, of the 41 Business Development Companies that comprise the index upon which BCDL is based, 27 pay dividends quarterly, 13 pay dividends monthly, and one Capital Southwest Corp (NASDAQ:CSWC) pays on what could best be categorized as on an irregular basis.

While each of the Business Development Companies that comprise the index upon which BCDL is based have their own specific risk factors. The power of diversification can make a portfolio now comprised mainly of high yielding interest-rate sensitive instruments more efficient when BDCL is added to that portfolio.

As I explained in the article 30% Yielding MORL, MORT And The mREITs: A Real World Application And Test Of Modern Portfolio Theory, a security or a portfolio of securities is more efficient than another asset if it has a higher expected return than the other asset but no more risk, or has the same expected return but less risk.

Portfolios of assets will generally be more efficient than individual assets. Compare investing all of your money in one security that had an expected return of 10% with some level of risk, to a portfolio comprised of 20 securities each with an expected return of 10% with same level of risk as the single security. The portfolio would provide the exact same expected return of 10% but with less risk than the individual security. Thus, the portfolio is more efficient than any of the individual assets in the portfolio.

Table 2 below shows the components of BDCL along with the price, weight, dividend and ex-dividend date for each. From this data I calculated a projection for the next quarterly dividend of BCDL to be $0.8261. All but two of the Business Development Companies that comprise the index upon which BDCL and BDCS is based have announced dividends with ex-dates in the first quarter of 2017. MVC Capital Inc (NYSE:MVC) declared two quarterly dividends in the 4th quarter of 2016 and thus will not have a dividend with an ex-date in the 1st quarter of 2017. Medallion Financial Corp (NASDAQ:MFIN) will not be paying dividends in the first quarter of 2017. MFIN will no longer be a registered investment company. MFIN finances taxi medallions. The value of a taxi medallion, which is the right to operate a single taxi cab in New York City, once exceeded a million dollars. However, since the advent of Uber and similar smart phone-based car services, taxi medallion prices have fallen and MFIN has fallen on hard times. MFIN has the smallest weight in the index that BDCL is based on with a weight of only 0.21% and is likely to be leaving the index.

Most of the Business Development Companies that comprise the index upon which BDCL and BDCS is based maintained the same level of dividends as in the previous quarter. However, there were some special circumstances as well as dividend increases and decreases from prior periods.

There were some changes that will impact the first quarter of 2017 dividend relative to the 2016 fourth quarter BDCL dividend. Golub Capital BDC Inc. (NASDAQ:GBDC) declared the same regular $0.32 dividend for the first quarter of 2017 and the prior quarter, but had a $0.25 special dividend in the 2016 fourth quarter. Fifth Street Finance Corp (NYSE:FSC) pays monthly dividends. It paid monthly dividends of $.06 from March 2016 through to February 2017. For March and June 2017 it declared quarterly dividends of $.06, to be followed by a quarterly dividend of $0.125 in September 2017. PennantPark Investment Corp (NASDAQ:PNNT) reduced its' quarterly dividend to $0.18 from $0.28. BlackRock Kelso Capital Corp (NASDAQ:BKCC) reduced its' quarterly dividend to $0.18 from $0.21. Fidus Investment Corp (NASDAQ:FDUS) declared the same regular $0.39 dividend for the first quarter of 2017 and the prior quarter, but had a $0.04 special dividend in the 2016 fourth quarter. TICC Capital Corp (NASDAQ:TICC) reduced its' quarterly dividend to $0.20 from $0.29. CSWC declared a $0.19 and a $0.26 dividend with a March 2017 ex-date for a total of $0.45 as a contribution to the BDCL dividend. In the fourth quarter of 2016 CSWC declared a $0.17 dividend. Newtek Business Services Corp ) reduced its' quarterly dividend to $0.36 from $0.40. Fifth Street Senior Floating Rate Corp (NASDAQ:FSFR) paid monthly dividends totaling $0.19 in the first quarter of 2017 as compared to $0.225 in the fourth quarter of 2016. Alcentra Capital Corp (NASDAQ:ABDC) declared the same regular $0.34 dividend for the first quarter of 2017 and the prior quarter, but had a $0.03 special dividend in the first quarter of 2017 but no special dividend in the 2016 fourth quarter. Horizon Technology Finance Corp (NASDAQ:HRZN) paid monthly dividends totaling $0.30 in the first quarter of 2017 as compared to $0.33 in the fourth quarter of 2016. Great Elm Capital Corp (NASDAQ:GECC) paid three monthly dividends of $0.0833 in the first quarter of 2017. The first dividend ever paid by GECC was $0.166 with an ex-date of December 28, 2016. CM Finance Inc (NASDAQ:CMFN) reduced its' quarterly dividend to $0.25 from $0.3516.

Table 2 below shows the most recently declared dividend for each of the BDCL components. The table also shows the price, weight, the ex-dates, contribution to the dividend and the dividend frequency of the components that pay dividends. In the frequency column "q" denotes quarterly and those that pay monthly have an "m". The irregular dividend payer has an "i".

Taking into account the 39 of the 41 Business Development Companies who pay dividends with ex-dates in the first quarter of 2017, I projected that BDCL's quarterly dividend paid in April 2017 will be 0.8261. That will be the highest quarterly dividend since the $0.8862 paid in July 2015.

The major reason for my projected increase in the BDCL dividend is the increase in the net asset or indicative value. The dividend for a UBS ETRACS 2xLeveraged ETN is impacted by the rebalancing of the portfolio each period to bring the amount of leverage back to 2X. As the value of the Business Development Companies in the portfolio increases, portfolio assets must be increased to maintain the leverage level. This increases the dividend, separate from any increases or reductions in dividends by the Business Development Companies in the portfolio. The relationship between the net asset value of a UBS ETRACS 2xLeveraged ETN and the dividend is explained more fully in: "MORL's Net Asset Value Rises - Implications For The Dividends."

That BDCL performed much better than MORL and CEFL since the election is logical. There has been a post-election movement out of fixed income securities into equities based on the belief that the Trump administration will enact a huge debt financed fiscal stimulus which will bring real GDP growth up to 4% and thus be extremely inflationary. That would result in higher interest rates. As I explained in: "MORL Dividend Yield Of 23.2 Percent May Overcome Fears Of Higher Interest Rates", for various reasons I have some doubts concerning that theory and I think that some possible actions by the federal government going forward could actually be deflationary. Nevertheless, the stock and bond market seems to have embraced the idea that the Trump administration will be highly inflationary.

MORL, based on an index of mREITs is highly sensitive to the bond market. Anyone who follows the mREITs would have assumed that the 50+ basis point in increase in treasury 10-year yields would have resulted in a sharp decline in the mREITs. That was certainly the case in previous sharp increases in treasury 10-year yields, especially during the 2013 taper-tantrum. If an observer of the divergence between treasury 10-year yields and mREITs looked for an explanation, the first thing to examine would be the behavior of the mortgage-backed securities. In "Why The Post-Election Divergence Of mREITs From Treasuries And Mortgage-Backed Securities" I discussed the anomaly of mREITs outperforming both the benchmark treasuries and mortgage-backed securities in the month following the election.

CEFL is based on an index of higher yielding closed-end exchanged traded funds. Some of the closed-end exchanged traded funds contain common stocks, usually the high dividend paying variety. Many of the closed-end funds in the index that CEFL is based on contain high yield bonds. These junk bonds are considered to have some equity-like characteristics. However, to the extent that those bonds are longer-term obligations with fixed coupon rates, they are impacted by declines in the overall bond market like that which has occurred since the election. In contrast, it is highly unlikely that any of the business development companies that comprise the index upon which BDCL is based would hold any longer-term obligations with fixed coupon rates. The only debt securities that business development companies would normally hold in the course of their business would be loans to the companies that the business development companies have invested in. Those debt instruments would usually be convertible into equity and have adjustable interest rates.

The outlook for BDCL depends more on the equity markets than the bond markets. One thing that is strange in the post-election period is that uncertainty seems to be increasing rather than decreasing. Now that the election results are known it might have been expected that government policy would be easier to forecast. However, the range of possible policies with regard to economic and financial outcomes seems to be widening.

The major risk to the financial markets and equity markets in particular is that of protectionism. The Border Adjustment Tax is still a real possibility. As was explained in The Border Adjustment Tax - A Very Bad Idea Whose Time May Be Rapidly Approaching the Border Adjustment tax could lead to severe coordinated retaliation. The World Trade Organization permits border adjustments for indirect levies such as sales taxes and value added taxes, but not for income taxes. A sales tax or value added taxes tax consumption by the residents of the country which imposes it, but not the residents of other countries. So disallowing the cost of imports for tax purposes would violate World Trade Organization rules as well as most other free trade agreements signed by the United States. This could lead to the USA leaving the World Trade Organization and disruptions of supply chains world-wide.

There is considerable uncertainty concerning fiscal and fiscal policy. As of this writing the fate of the bill introduced by the House Republicans, the American Health Care Act, to replace the Affordable Care Act (Obamacare), remains uncertain. My guess is that since the Republican's complaints about the bill seem equally divided between those on the right who consider the bill to be "Obamacare light" with still too much government regulation and spending on benefits, and those more moderates who are not happy about the 24 million projected to become uninsured by the bill, the final version of the bill will likely be similar to its present form.

Without considering the merits of the bill, the macroeconomic implications of the bill have interesting consequence for the financial markets. The "March 13, 2017 Congressional Budget Office analysis of the American Health Care Act" did not include any discussion of any macroeconomic implications of the Act. This was a violation of the rules of the House of Representatives as the act is "major legislation" as defined by the House rules enacted in 2017. Possibly, deciding that discretion was the better part of valor, the 2017 Congressional Budget Office analysis of the American Health Care Act explained: "because of the very short time available to prepare this cost estimate, quantifying and incorporating those macroeconomic effects have not been practicable." However, for those familiar with the basic economic concept of the balanced budget multiplier estimating the macroeconomic impacts of the Republican's American Health Care Act is quite possible.

I am sure that the House Republicans did not consider whether their bill would impact the supply and demand of loanable funds in the financial markets. However, if one wanted to design an Obamacare replacement bill, given the constraints that the bill had to meet certain budget and benefits criteria, that would increase the savings glut, it would be hard to imagine one more effective than the House Republican's bill. This could put upward pressure on the prices of financial assets.

The Congressional Budget Office analysis of the American Health Care Act also concluded that there would be 24 million more people uninsured as a result of the bill. This, incredibly is more than the 23 million more people that could become uninsured as a result of simply repealing Obamacare. This seemingly bizarre result is primarily because if the pre-Obamacare rules were in effect, insurance companies could deny health insurance to people with pre-existing conditions and cancel policies of those who failed to disclose pre-existing conditions. Thus, health insurance companies could charge younger healthier people lower premiums and more of them would get health insurance.

With 24 million more people uninsured as a result of Republican's American Health Care Act, consumption of health care would be reduced significantly. Increasing the number of uninsured by 24 million would have a profound negative impact on aggregate spending on healthcare goods and services. This reduction in GDP would be in addition the balanced budget multiplier concept impacts from the disparate marginal propensities to consume between the high-income and other households.

Those with health insurance covered spend about 25% more for health care than those without. Having 24 million more people uninsured would reduce Federal Government spending by about $1.2 trillion over the next ten years. The Congressional Budget Office analysis of the American Health Care Act concluded that over the 2017-2026 period federal outlays would be reduced by $1.2 trillion and revenues would be reduced by $0.9 trillion. Thus, the deficit would be reduced by $0.3 trillion.

The balanced budget multiplier concept is that an increase in government spending matched by an increase in taxes results in a net increase in GPD by the same amount. Likewise, and relevant in this instance, decrease in government spending matched by an decrease in taxes results in a net decrease in GPD by the same amount. Obviously, a decrease in government spending combined with a smaller decrease in taxes results in a decrease in GPD by an even greater amount. Additionally, the reduction in GDP should be more, the balanced budget multiplier concept assumes that there is one marginal propensity to consume for both those who receive the government outlays and those whose taxes are changed. However, that is clearly not the case here.

The bulk of the tax cuts in from the House Republican's American Health Care Act are due to repeal of the surtax on certain high-income taxpayers' net investment income; and to repeal of the increase in the Hospital Insurance (Medicare) payroll tax rate for certain high-income taxpayers. Those high-income taxpayers' certainly have a lower marginal propensity to consume than the general population. High-income taxpayers would tend to save a much higher proportion on any extra disposable income they receive from the tax cuts. The lower income people who will receive lower subsidies and thus have to pay more in insurance premiums and other out of pocket expenses will likely reduce their total spending, as opposed to reducing savings.

As was described in: "MORL Still Attractive With 21.6% Dividend Yield, However, Uncertainty Is Increasing"

One does not have to be a Keynesian to see that shifts in income to those with lower marginal propensities to consume will cause an increase in savings and a decline in consumer spending. The wealthy clearly have lower marginal propensities to consume. As I explained in a Seeking Alpha article "A Depression With Benefits: The Macro Case For mREITs":

Shifting income to the rich by taxing dividends, capital gains, inheritances and corporate profits much less than the tax rates on wages also tends to make more funds available for investment since when the investment is taxed relatively less, more funds are made available for the investment.

The shift of wealth from the middle class to the very wealthy has profound impacts on the economy and securities markets. It creates a cycle where initially the wealthy pour significant amounts into investments they perceive to be safe. This can first cause an increase in economic activity. In 2005 many considered mortgage-backed securities with adjustable interest rates to be essentially risk-free. This was especially true for those rated AAA by Moody's and S&P. This resulted in overinvestment in the real estate sector. The middle class eventually could not service the mortgage debt on their homes nor could they buy enough goods at shopping centers and department stores to generate enough funds to prevent many residential and commercial mortgages from defaulting.

The shift of the tax burden in the United States from the rich to the middle class has been a major factor is creating the glut of savings which has supported higher prices for financial assets. There were minor moves during the Obama administration to shift the burden back to the wealthy. These included reinstatement of the estate tax and some increase in the tax rates for higher incomes including as part of the Affordable Care Act. As these are reversed and the tax burden is further shifted away from the rich the glut of savings will grow. Thus, savings and investment/ supply and demand of loan-able funds factors will become increasing more powerful drivers of higher prices for financial assets.

As the supply of loan-able funds increases faster than the demand from borrowers interest rates will be pushed down. The equity market will also initially benefit from lower interest rates as the growing pool of savings seeks securities to invest in. In a longer run the excess of savings will enable new businesses to start that otherwise might not have been able to obtain financing. These new businesses could create additional competition for existing companies which could eventually reduce profit margins and stock prices. To the extent that small business and potential entrepreneurs are now stifled by overregulation and red tape, a Trump administration that reduces those impediments to new start-ups could also eventually curtail profits for existing firms.

My projection of $0.8261 for the BDCL April 2017 dividend would be a trailing four-quarter annual rate of $3.009 This would be a 14.5% simple yield, with BDCL priced at $20.80 and an annualized quarterly compounded yield of 15.3%. If someone thought that over the next five years market and credit conditions would remain relatively stable, and thus, BDCL would continue to yield 15.3% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $203,488 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $15,300 first-year annual rate to $31,134 annually.

Table 2. BDCL and BDCS components prices and dividends as of March 21, 2017

name

ticker

weight(%)

price

ex-date

dividend

freq

contribution

Ares Capital Corp

ARCC

15.76

17.28

3/13/2017

0.38

q

0.1436

Prospect Capital Corp

PSEC

11.1

9.02

4/26/2017

0.08333

m

0.1274

Fs Investment Corp

FSIC

8.79

9.55

3/20/2017

0.22275

q

0.0849

Main Street Capital Corp

MAIN

6.82

36.88

5/17/2017

0.185

m

0.0425

Apollo Investment Corp

AINV

4.87

6.16

3/17/2017

0.15

q

0.0491

TPG Specialty Lending Inc

TSLX

4.27

20.04

3/29/2017

0.390

q

0.0344

Hercules Technology Growth Capital Inc

HTGC

4

14.63

3/2/2017

0.31

q

0.0351

Golub Capital BDC Inc

GBDC

3.82

19.07

3/3/2017

0.32

q

0.0266

TCP Capital Corp

TCPC

3.35

16.78

3/15/2017

0.36

q

0.0298

New Mountain Finance Corp

NMFC

3.18

14.55

3/15/2017

0.34

q

0.0308

Solar Capital Ltd

SLRC

3.16

21.73

3/21/2017

0.4

q

0.0241

Goldman Sachs Bdc Closed End Fund

GSBD

2.74

24.94

3/39/2017

0.45

q

0.0205

Triangle Capital Corp

TCAP

2.68

18.49

3/6/2017

0.45

q

0.0270

Fifth Street Finance Corp

FSC

2.1

4.63

3/13/2017

0.02

m

0.0113

PennantPark Investment Corp

PNNT

2.01

7.73

3/20/2017

0.18

q

0.0194

BlackRock Kelso Capital Corp

BKCC

2

7.25

3/16/2017

0.18

q

0.0206

Medley Capital Corp

MCC

1.45

7.43

2/17/2017

0.22

q

0.0178

Fidus Investment Corp

FDUS

1.39

16.56

3/8/2017

0.39

q

0.0136

PennantPark Floating Rate Capital Ltd

PFLT

1.31

13.65

3/20/2017

0.095

m

0.0113

TICC Capital Corp

TICC

1.29

7.02

9/13/2017

0.2

q

0.0152

THL Credit Inc

TCRD

1.12

9.57

3/16/2017

0.27

q

0.0131

Gladstone Investment Corp

GAIN

0.97

8.77

3/20/2017

0.0625

m

0.0086

Solar Senior Capital Ltd

SUNS

0.91

17.52

3/21/2017

0.1175

m

0.0076

Monroe Capital Corp

MRCC

0.91

15.18

3/15/2017

0.35

q

0.0087

Capital Southwest Corp

CSWC

0.88

16.18

3/13/2017

0.45

i

0.0101

Gladstone Capital Corp

GLAD

0.82

8.95

3/20/2017

0.07

m

0.0080

Triplepoint Venture Growth BDC Corp

TPVG

0.82

13.9

3/29/2017

0.36

q

0.0088

Newtek Business Services Corp

NEWT

0.78

16.52

3/16/2017

0.36

q

0.0070

Capitala Finance Corp

CPTA

0.78

14.19

3/21/2017

0.13

m

0.0089

Fifth Street Senior Floating Rate Corp

FSFR

0.68

8.68

3/13/2017

0.19

m

0.0062

Stellus Capital Investment Corp

SCM

0.64

14.2

3/29/2017

0.1133

m

0.0063

MVC Capital Inc

MVC

0.62

8.85

12/28/2016

0.135

q

0.0000

Alcentra Capital Corp

ABDC

0.53

13.26

3/29/2017

0.37

q

0.0061

Garrison Capital Inc.

GARS

0.53

9.49

3/21/2017

0.28

q

0.0065

KCAP Financial Inc

KCAP

0.5

3.95

4/5/2017

0.12

q

0.0063

American Capital Senior Floating Closed Fund

ACSF

0.49

13.3

4/18/2017

0.097

m

0.0044

Horizon Technology Finance Corp

HRZN

0.47

10.59

5/17/2017

0.1

m

0.0055

OFS Capital Corp

OFS

0.37

14.75

3/17/2017

0.34

q

0.0035

WhiteHorse Finance Inc

WHF

0.32

13.83

3/23/2017

0.355

q

0.0034

Great Elm Capital Corp

GECC

0.28

10.9118

3/29/2017

0.083

m

0.0026

CM Finance Inc

CMFN

0.27

10.1

3/15/2017

0.25

q

0.0028

Medallion Financial Corp

MFIN

0.21

2.23

0

q

0.0000

Disclosure: I am/we are long BDCL, MORL, CEFL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.