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Some BDCs are experiencing spectacular rallies, but at some point the music will stop- Sober Look

This is a syndicated repost courtesy of Sober Look. To view original, click here. Reposted with permission.

When discussing the world of so-called “shadow banking” (see post), one should not forget the entities called Business Development Companies (BDCs). These are hybrids between investment and operating companies that can obtain up to 1:1 leverage on investors’ capital in order to lend to (and sometimes invest in) mid-sized businesses in the US. The interest on the loans is used to pay periodic (for example quarterly) dividend. With demand for yield continuing to drive valuations, some public BDCs have done tremendously well. NYSE-listed Triangle Capital (TCAP) for example is up over 63% on a total return basis (capital appreciation plus dividends) over the past year (vs. under 16% for the S&P500). A number of other BDCs have also had a spectacular performance recently.

Source: Ycharts

But as the middle market loan spreads decline, BDCs’ portfolio quality will decline as well. That’s because in order to be able to pay the same dividend, these companies have to increase the risk profile of their portfolios. They are finding it harder these days to underwrite quality companies’ debt at reasonable rates in this very competitive market – the pipeline of good deals is shrinking. Investors however just can’t seem to get enough of these shares, as the Fed continues to pump liquidity into the market. At least in some instances, valuations already seem frothy – which may not end well, particularly when the flood of central bank stimulus stops (and possibly long before then).

BDC Basics from Southerland

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Wall Street Examiner Disclosure: Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. No endorsement of such content is either expressed or implied by posting the content. All items published here are matters of information and opinion, and are neither intended as, nor should you construe it as, individual investment advice. Do your own due diligence when considering the offerings of information providers, or considering any investment.

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