These “Alternative” Banks Yield Up to 18.6%
July 12, 2018
Little-Known Funds Yield 9.2%+
You may have sensed a lingering disturbance in the investment world, and a vague, unsettling feeling that a better way to make money is hiding just out of view.
While you collect meager yields in bonds and dividend stocks, connected insiders earn higher returns on some V.I.P. investment.
I have some news: these deals do exist. And while they don’t get much attention in the press, ordinary investors can now earn yields as high as 18% from this same group of little-known funds.
Let me explain.
If you want to make a lot of money right now, you need to be lending to the “sweet spot” of the U.S. economy. I’m talking about profitable, mid-sized businesses—those too large for typical bank loans but too small to go public.
For lenders in this niche, business is booming. So much, in fact, that several institutional firms have gotten into the game. Over the past few years, private equity firms KKR & Co Inc (NYSE:KKR), Blackstone Group LP (NYSE:BX), and The Carlyle Group LP (NASDAQ:CG) entered into this space. Even Goldman Sachs Group Inc (NYSE:GS) launched a competitor for their favored clients.
To raise money, they have set up a type of investment vehicle called business development companies (BDCs). These publicly traded firms work like “alternative” banks. They lend cash to businesses, collect interest payments, and pay out the profits to shareholders. And thanks to a number of advantages, these funds pay out exceptionally large yields.
BDCs are notable for charging high interest rates. Thanks to new regulations following the 2008/2009 financial crisis, banks have dialed back lending to small- and mid-sized businesses. As a result, the remaining lenders pretty much have the entire sector to themselves. With little in the way of competition, BDCs can force borrowers to pay dearly for access to capital.
Moreover, business development companies enjoy low default rates. They generally lend to companies with $10.0 million to $75.0 million in annual earnings before interest, taxes, depreciation, and amortization (EBITDA)—in other words, real companies with real cash flow. BDCs don’t hand out money to fledgling startups with no sales.
To protect themselves further, loans come with strict conditions. Typically, most firms demand senior status. So, if something goes wrong, they get paid before other creditors see a single cent. Deals also get done on a floating-rate basis, which provides protection if interest rates rise.
For these reasons, I frequently highlight business development companies to my paid subscribers. These lucrative lending deals have generated yields in the high single-digits to the mid-teens. From time to time, you can lock in interest payments as high as 20%. That’s pretty impressive when you consider that U.S. government bonds pay out only two or three percent right now.
|
Company |
Yield |
Market Cap |
|
Ares Capital Corporation |
9.2% |
$7.1 Billion |
|
FS Investment Corporation |
9.8% |
$1.9 Billion |
|
Monroe Capital Corporation |
10.2% |
$277.3 Million |
|
Prospect Capital Corporation |
10.7% |
$2.4 Billion |
|
Medley Capital Corporation |
18.6% |
$187.4 Million |
(Source: Yahoo! Finance, last accessed July 12, 2018.)
Of course, above-average yields come with above-average risk. Poorly managed BDCs get greedy and load up their portfolios with risky loans. A spike in interest rates can also send share prices plunging.
For this reason, prospective investors have to do their homework.
Top BDCs protect their shareholders with strict lending covenants. Moreover, as mentioned earlier, they only lend to established, profitable businesses and they minimize risk further through floating-rate loans.
Therefore, you really need to dig into the loan books before pulling the trigger on one of these stocks. For investors willing to do the extra legwork, business development companies make for a tidy income stream. While this small industry might have once been the purview of Wall Street’s elite, there’s no reason why ordinary investors can’t get in on the action.
