Published by Bob Ciura on June 4th, 2017
Business Development Companies, or BDCs, have become popular among income investors, particularly retirees.
That is because BDCs, as an alternative asset class, offer very high dividend yields, thanks in part to a favorable tax structure.
For example, Solar Senior Capital (SUNS) has a current dividend yield of 8.4%.
Solar Senior’s yield towers above the average stock in the S&P 500 Index, which has a 2% dividend yield.
Not only that, but Solar Senior also pays its dividend each month, rather than once per quarter. This allows investors even faster compounding.
Solar Senior is one of just 21 stocks that pay monthly dividends.
Solar Senior offers a high level of income, and a way for investors to gain exposure to privately-held companies with the potential for growth.
BDCs make debt or equity investments in companies that have not yet gone public, which are typically at an earlier stage of development and require growth financing.
They are a way for people to invest in private companies, without having to gain accredited-investor status.
Solar Senior Capital is a value-oriented investment company. It invests predominantly in senior secured debt of privately-held middle market companies.
As of the end of the 2017 first quarter, Solar Senior had a $373 million investment portfolio. The portfolio is 97% floating rate.
It has a diverse portfolio, consisting of 54 companies spanning 23 industries.
Source: Investor Relations
In general, Solar Senior prefers to invest in defensive, non-cyclical industries. Not surprisingly, health care makes up the largest individual industry with 18% of Solar Senior’s investments.
Next is professional services, with 13% of the portfolio, followed by asset management and communications equipment, at 10% each.
At the end of last quarter, Solar Senior had an average exposure of $8.2 million, or 1.9% to each investment.
Solar Senior also has placed strategic investments in two separate entities, First Lien Loan Program (FLLP) and Gemino Healthcare Finance. Collectively, these investments represent approximately one-third of Solar Senior’s portfolio.
FLLP is a strategic joint venture with VOYA Investment Management, which issues loans to middle-market, entrepreneur, and sponsor-backed private companies.
Gemino makes senior secured loans to small and medium-sized businesses in the U.S. healthcare industry.
The strategic initiatives helped lead the way last quarter. Distributions from FLLP and Gemino increased Solar Senior’s weighted average portfolio yield by approximately 20 basis points in the first quarter.
Going forward, Solar Senior is about to add a third component to its strategic initiative portfolio.
One of the ways Solar Senior can generate growth is through new investment. The company has a sizable amount of capital left on the balance sheet.
Solar Senior ended last quarter with $180 million of available capital, subject to its borrowing base limitations.
Most of its investments will be placed in its strategic initiatives.
Investors should keep an eye on the new life science lending joint venture with its sister company Solar Capital, which was finalized last quarter.
The life science joint venture is expected to invest primarily in first-tier lien loans in the life science industry.
This is a key part of Solar Senior’s broader strategy to allocate additional investments to life science loans. It will enable Solar Senior to extend its investment universe to include public, later-stage, larger companies.
Solar Senior has committed $75 million of the $350 million of total equity financing for the joint venture. It expects the new joint venture to start investing as early as the current quarter.
The joint venture is expected to generate return on equity in the mid-to-high teens for Solar Senior, which would be a significant boot to net investment income moving forward.
The growth prospects for Solar Senior are reliant upon the health of its investment portfolio. Should its investments perform well, Solar Senior will report higher levels of net investment income, which then translates into higher shareholder dividends.
2016 was a good year for Solar Senior. Net investment income was $18.3 million. On a per-share basis, this came out to $1.42, an increase of 6.8% from the previous year.
This covered its distributions for 2016, albeit with just $0.01 to spare.
If the strategic initiatives generate enough growth, there could be room for Solar Senior to raise its distribution, which it has not yet done since 2012.
Conditions remained stable in the first quarter. Net asset value ticked up $0.01 per share from the fourth quarter, to $16.81.
Net investment income was $0.35 per unit in the first quarter, unchanged from the same period last year. This barely covered its quarterly distribution.
Management is committed to maintaining the current dividend during this time of heightened investment, and is confident the investments will elevate net income sufficiently above the distribution.
BDCs are considered pass-through securities, which means they are generally not taxed at the company level. This allows them to make high levels of distributions to investors, which results in their hefty dividend yields.
Shareholders are taxed on distributions, although one of the advantages of BDCs is that investors do not have to deal with K-1s each year. Instead, they are required to submit a 1099-DIV.
Solar Senior paid a distribution of $.1175 per unit for May 2017. This comes out to an annualized distribution of $1.41 per unit.
The company has not raised its dividend in the past five years, although it has not reduced its dividend either. And, its extremely high yield helps make up for its lack of dividend growth.
Based on Solar Senior’s recent unit price of $16.80, the stock has a yield of 8.4%.
Solar Senior is not an attractive choice for dividend growth investors, given its flat distributions. However, it offers a very hefty yield, more than four times the average dividend yield in the S&P 500 Index.
Solar Senior’s distribution coverage is tight right now, due in part to higher loan repayments.
That said, the company is confident the strategic initiatives will result in meaningful net investment income growth in 2018 and beyond.
Investors interested in high-yielding BDCs could find Solar Senior to be an attractive stock.
- Outside of BDCs, there are several other monthly dividend stocks to choose from. Click here for a royalty trust with a 6%+ dividend yield and monthly dividend payouts.