BDC Review Redux: Part 1 - The Not So Newbies

by: Philip Mause

A little more than a year ago I wrote a series of articles about Business Development Companies (BDCs) and I promised to update it from time to time. I will try to cover virtually every BDC in the series so that investors have a place to go in order to assess the entire sector. Last year, some readers helped me out by pointing out names that I had missed and, by the end of the series, I think we had roped them all in.

I got interested in BDCs in 2009 when I discovered that many of them were trading at tiny percentages of net asset value (NAV). The flagship of the BDC fleet (Allied Capital) had come under fire - both from the SEC and Mr. David Einhorn - and had collapsed in value; there was a lot of controversy but it was undeniable that Allied had made some bad loans and its assets were shrinking in value. Its debt was trading at 20-30 cents on the dollar. This debacle infected the entire sector and led investors to shy away from BDCs at a time when they were comparatively attractive and risk free alternatives to fixed income investment.

Because BDCs use very limited leverage and generally own debt instruments, a balance sheet-oriented investor can make calculations and determine the "cushion" against debt defaults that the discount to NAV provides. As 2009 wore on, many BDCs became very attractive investments and then began trading up closer to NAV. There are now very few opportunities to acquire BDC stock at a significant discount to NAV and those opportunities come with certain risks. In other words, the sector is becoming priced more in accord with its actual risks and prospects for appreciation.

By way of background, BDCs are subject to various regulations which limit leverage to a one to one debt/equity ratio and impose certain restrictions on investments. Most BDCs are regulated investment companies (RICs) and are subject to special tax provisions which eliminate corporate income tax,require that 90% of income be distributed to shareholders, and require that dividend income to shareholders be taxed as ordinary income. As a result, BDCs tend to have a high dividend yield and have become very attractive to investors in the current low interest rate environment.

The first article in the series dealt with "newbies" - BDCs that had recently gone public as of August 2011. They are an interesting subset because most of their current assets consist of business loans made at some time since the Panic of 2008 and therefore reflect new credit standards. The performance of these companies illustrates what one analyst called "new balance sheets" created afresh after the credit debacle and may give us a picture of how the economy is developing. There are some newbies that were not covered in the first article and I will deal with them in subsequent articles; this article merely updates the six BDCs featured in the first article. After the name and symbol of each company, I will provide Monday's closing price, the closing price on August 29, 2011 when the original article was written and the current yield.

1. Horizon Technology (NASDAQ:HRZN) ($16.45) ($15.59) (10.95)

2. Solar Capital (NASDAQ:SLRC) ($22.75) ($21.98) (10.56)

3. Golub Capital (NASDAQ:GBDC) ($16.20) ($14.85) (7.91)

4. Full Circle Capital (FULL) ($8.14) ($6.98) (11.35)

5. PennantPark Floating Rate (NASDAQ:PFLT) ($13.05) ($11.89) (7.59)

6. Solar Senior Capital (NASDAQ:SUNS) ($18.21) ($15.45) (7.73)

Neither SUNS or SLRC have any particular connection or orientation to the solar energy industry. FULL and SUNS are both oriented to senior secured loans and have done quite well by their shareholders - probably reflecting the continued preference for "safety" in these kinds of investments. FULL's portfolio is actually 93% senior secured loans; on the other hand, FULL has experienced some losses on its portfolio. With an NAV of $8.59 a share as of the last reporting period, FULL offers the conservative investor an attractive way to obtain yield with limited, but some, risk. FULL's portfolio of loans at the outset included some older loans transferred to it as it was starting operations; some of these have been replaced with newer loans. Both FULL and SUNS have begun using a modest amount of leverage.

HRZN focuses on venture capital and private equity supported new and emerging companies - a large number of which are in the technology and life sciences areas. So far, it has done well and has not seemed to be subject to substantial credit quality deterioration. HRZN raised some equity this summer at a price of $16.20. Recently, there has been a decent amount of insider buying.

GBDC is a relatively large and growing BDC and has been willing to utilize leverage - debt is now at about one third the value of gross assets (still well below the limit for BDCs). PFLT, not surprisingly, invests in floating rate debt and thereby gives investors some protection from rising interest rates. It is trading at a small discount to last quarter's NAV. SLRC has over $1 billion in assets and has debt at the level of about one third of gross assets. It has a broadly diversified portfolio of business loans and seems to have been revising earnings estimates upward lately. SLRC has also has had a modest amount of insider buying this year.

The performance of this group of stocks has not been stellar but has been solid and, when combined with the very healthy dividend yields, has provided shareholders with attractive returns. The solid performance suggests that the small and mid-sized business loan market is reasonably healthy and that the credit standards used since the Panic of 2008 have held up decently. As I have written in the past, BDCs should be a part of an income oriented investor's portfolio - ideally suited for an IRA or other tax sheltered investment vehicle because of the ordinary income treatment of the dividends.

Disclosure: I am long ARCC. 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.