Updated on May 21st, 2021 by Bob Ciura
Business Development Companies, or BDCs, have become popular among income investors. That is because BDCs, as an alternative asset class, offer very high dividend yields, thanks in part to a favorable tax structure. The companies generally achieve extremely high yields on their investments, which they pass along to shareholders in the form of distributions.
For example, SLR Senior Investment Corp. (SUNS) has a current dividend yield of 7.9%. Not only does SLR have a very high yield more than five times that of the S&P 500 Index, it also pays its dividend each month, rather than once per quarter. This allows investors even faster compounding, with more frequent dividend payments.
SLR is one of fewer than 60 monthly dividend stocks.
You can download our full Excel spreadsheet of all monthly dividend stocks (along with metrics that matter like dividend yield and payout ratio) by clicking on the link below:
SLR offers a very high level of income, and a way for investors to gain exposure to privately-held companies with the potential for growth.
The company certainly is not without risks, but for those investors that can stomach a bit of uncertainty, SLR’s yield may be worth it. This is particularly true as yields on other income investments continue to move lower.
Business Development Companies 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 offer a way for people to invest in private companies without having to gain accredited-investor status. In addition, BDC’s generally have widely diversified portfolios, offering investors the protection of diversification by simply owning the BDC rather than many smaller investments.
SLR is a value-oriented investment company. It invests predominantly in senior secured debt of privately-held middle market companies.
The company targets investments in entities with revenues of at least $50 million and EBITDA of at least $15 million, offering a measure of safety, as companies with these characteristics are sizable and profitable. Companies that meet these needs are generally well established and therefore offer less risk during a downturn, for instance.
Solar Senior generally invests $5 to $20 million of its capital in each position, meaning its portfolio is never too concentrated on one or a handful of positions. This helps the company diversify away its risk from portfolio concentration.
One of the ways SLR can generate growth is through new investment. The company has a sizable amount of capital left on the balance sheet.
The growth prospects for Solar Senior are reliant upon the health of its investment portfolio. Should its investments perform well, SLR will report higher levels of net investment income, which then translates into higher shareholder dividends.
On May 5th, 2021, SLR reported its Q1–2021 results for the quarter ended March 31st, 2021. Gross and net investment income (NII) came in at $8.8 million and $3.2 million, a 25% and 44% decline year–over–year, respectively. The massive declines were attributed to the company’s portfolio yield (currently around 9.5%) falling due to its exposure to LIBOR (London Interbank Offer Rate) and an overall smaller portfolio due to exiting some of its investments.
As a result, NII/share was $0.20 vs. $0.35 during the comparable period last year. NAV/share remained stable quarter–over–quarter, at $15.91, as the company’s dividend cut in 2020 helped in not deteriorating NAV further due to the current pressured performance.
The investment portfolio remains diversified, with approximately 203 unique borrowers in over 115 industries with an average issuer exposure at $2.4 million, or less than 0.5% of its total loans. Management expects the company’s portfolio and earnings to grow in the coming quarters from its growing pipeline of first–lien cash flow and asset–based loan investment opportunities.
Therefore, we retain our NII/shares estimates at $1.30. We do not expect much dividend growth from SLR going forward.
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 the K-1 form each year. Instead, they are required to submit a 1099-DIV.
SLR pays a monthly distribution of $.10 per unit, since it reduced its payout from $0.1175 in 2020. This comes out to an annualized distribution of $1.20 per unit. While the dividend reduction was discouraging, the yield is still quite robust at nearly 8%.
SLR is attractive for income investors as a high-dividend stock.
Net investment income fully covers the dividend, albeit only barely, but still the dividend payout appears to be sustainable at the present level of NII. However, if there is a significant downturn in the performance of the company’s portfolio, the payout would almost certainly be at risk.
Investors should also keep in mind that BDCs often issue new shares to cover dividend shortfalls, and SLR could go that route if it is slightly short of covering its dividend.
SLR’s distribution coverage is very tight right now, even after last year’s dividend cut as NII remains at suppressed levels. As a BDC, it will always pay out most or all of its income to shareholders, so coverage will likely never be particularly strong. With portfolio growth should come additional net investment income, which should in turn, offer better dividend coverage.
Should rates remain very low, or move even lower, the dividend could be at risk. That’s because many of the company’s investments are done with floating rate interest rates. When interest rates decline, SLR’s income will likely decline as well, and income should rise as interest rates due. The company has invested for future growth, although shareholders have yet to reap rewards from those investments, and future growth is partly dependent on rates moving up.
Investors interested in high-yielding BDCs could find Solar Senior to be an attractive stock. While this is not an appropriate investment for those seeking dividend growth, the nearly 8% yield is appealing for those strictly seeking high levels of income right now. Investors would do well to understand the risks of the company’s floating-rate portfolio, but if rates move in a favorable direction for Solar Senior, the rewards could be significant.