Buy these “Private Equity” shares at 10.5% yield

Let’s talk about the “rich loophole” that we can take advantage of and pay dividends of up to 12.5%.

AND NOI won’t ask for your latest tax return or W2. These are perfectly legal “back door” dividends that trade between $10 and $20 a share. Congress has put in a sweet spot where these payers bring in 10.5% to 12.5%.

The secret is in the business development company. BDCs provide capital to small and medium-sized businesses. These firms often invest alongside or after venture capital. They are “a bit” like private equity firms, but accessible to anyone (i.e. we don’t need half a million in liquid assets to invest).

BDCs are structured similarly to real estate investment trusts (REITs). Both were created by Congress. Both were designed to encourage investment in a part of the economy. And both are mandated to pay out at least 90% of their taxable income in dividends.

You already know that REITs offer generous yields. Well, if you like REIT dividends, you’ll love BDCs:

Of course, these double-digit gains are not “sure things.” Big gains often come with big risks. Let’s evaluate each company carefully.

SLR Investment 10.5% dividend yield

SLR Investments (SLRC) is a self-described “for-profit” BDC (but aren’t all BDCs?) that invests primarily in secured loans of privately held U.S. middle-market companies.

This sounds like a normal description for almost every BDC. And it is. But SLRC has focused heavily on specialist niches.

The portfolio is divided into four parts: The traditional “sponsor finance” business, or cash flow lending, makes up only 24% of the portfolio at fair value. Equipment finance (33%) and asset-based lending (31%) make up the larger pieces of the pie; the remaining 12% or more comes from life sciences lending. SLRC’s assets are spread across 800 unique issuers in 110 industries, resulting in an average exposure only 0.1% per issuer.

SLRC is trading at a 14% discount to NAV. That’s not the cheapest you’ll find in BDC-land, but it’s about as cheap as you’re going to get without running into a red flag. Of course, I took a look at SLRC earlier this year when it was trading at a slightly bigger discount, and wondered out loud “is this a bargain — or is it just cheap?”

My concerns? SLR Investment is externally managed, which typically means higher management fees and incentives that limit investor returns. That’s fine when management earns its keep. But SLR lags behind industry ETFs VanEck BDC Income ETF (BIZD)which begs the question, do these external managers add any value?

On the bright side, a large portion of SLR’s portfolio is fixed-rate, meaning these loans will appreciate in value as rates fall. This “fixed-rate pen” stands in stark contrast to many of its competitors, whose investments are almost entirely variable-rate.

From an earnings perspective, SLRC’s 10.5% yield is — believe it or not — bottom 1/3 of publicly traded BDCs. But SLRC is moving further away from its previous period of under-covered dividends; payout coverage remains tight but increasingly manageable. (Unfortunately, the company’s brief love affair with monthly payouts ended last year.)

Nuveen Churchill Direct Lending Corp. 12.5%* Dividend rate

Another company is BDC, which has only been around since 2018 and went public earlier this year.

Nuveen Churchill Direct Loans Corp. (NCDL) is one of the few business development companies that have serious recognition. Like Goldman Sachs BDC (GSBD) AND Carlyle Secured Loan (CGBD)NCDL benefits from its association with a giant financial name. Two, in fact: Nuveen, and its parent, TIAA.

NCDL is a simple play on private credit. The fund’s external manager, Churchill, a subsidiary of Nuveen, invests BDCs in senior secured loans to privately owned middle-market companies in the U.S. The portfolio of about $2 billion currently includes 198 companies. The vast majority of holdings (91%) are first-collateralized loans, although Nuveen Churchill Direct Lending also does second-collateralized debt, subordinated loans, and equity co-investments.

Of course, we don’t have a ton of price action data to analyze, so instead I’d like to look at a few fundamentals and business elements that I’m interested in watching as this new BDC builds a track record of performance:

• NCDL’s Involvement with Nuveen and TIAA should give it greater access to transaction flow than some independent BDCs have.
• It’s currently a healthy portfolio, with just three non-accrual holdings representing less than half a percent of total holdings at fair value. Its positioning in the debt stack isn’t particularly aggressive either.
• NCDL is assuming a conservative 1.0x-1.25x debt leverage, and at mid-year it was around 1.04x. However, CEO Ken Kencel says he expects transaction activity to pick up in the second half of 2024.
• The fees are currently being waived for the first five quarters following the company’s January 2024 IPO. In other words, shareholders are not paying any incentive fees until the second quarter of 2025. That’s a nice benefit in the short term, but we’ll be interested to see how the eventual introduction of fees impacts results.
• Nuveen Churchill Direct Lending began its public life with two sets of dividends – quarterly regular and special. The first was set at 45 cents per share and the second at 10 cents per share for the full year 2024. That’s 10.3% of the regular and 12.5% ​​of the special. Management has established a strong earnings base with the potential for significant incentives.
• While NCDL is an extremely new, small-scale issue, the market doesn’t seem to be second-guessing its value. The stock is currently trading at just a 3% discount to NAV — a value we’d ideally like to see widened before we even jump in.

Crescent Capital BDC 11.5%* Dividend Yield

Crescent Capital BDC (CCAP) is another debt-focused BDC with a penchant for special dividends. However, it was founded in 2015 and has been trading since 2020, giving it a slightly better track record. Crescent benefits from the resources of Crescent Capital Group, a global credit investment firm that specializes in below-investment-grade credit strategies.

CCAP also invests in middle market private companies, primarily in the US, although it has about 10% international exposure spread across Europe, Canada, Australia and New Zealand. It prefers first-line (90) deals with companies in non-cyclical industries (85%), so it is quite defensive.

Worth noting: In March 2023, the company completed the acquisition First Eagle Alternative Capital (FCRD) at a solid 66% premium that was split between CCAP shares, cash from Crescent Capital and cash from CCAP’s advisor, Crescent Cap Advisors. That helped fuel a seven-quarter earnings streak.

To be fair, the deal forced CCAP to halt its series of 5-cent special dividends. Fortunately, not only are special dividends back — they’re bigger. Perhaps even more telling — the company raised its regular dividend for the first time in years, albeit by a cent a share. (That’s also a strange special dividend. Crescent Capital announces its special dividends after the fact; for example, in August it announced a base third-quarter dividend of 42 cents a share but also a supplemental dividend of 9 cents a share second quarter.) Regardless, CCAP currently yields 9.3% at regular rates and 11.5% after special rates.

On top of that, this BDC is trading at an 11% discount to NAV. Although in this case, the market may be pricing in some future volatility. Virtually all of CCAP’s debt holdings (97%) are floating-rate, which could be problematic if the Fed officially moves to cut rates. And that seven-quarter streak of earnings growth? Analysts are modeling an equally long set of quarterly earnings declines over the next two years.

Brett Owens is the Chief Investment Strategist at Contrarian perspective. For more great income ideas, download a free copy of his latest special report: Your Early Retirement Portfolio: Huge dividends—every month—forever.

Disclosure: None