Hi YXI friends,

Welcome to our fortnightly update on Business Development Companies (BDCs). With each update, we focus on the latest price movements and metric comparisons across all of the BDCs in our coverage, plus earnings analysis where applicable.

For those who are new to BDCs, they are private credit companies that lend money to medium-to-large private businesses outside of the banking system.

The art of the deal is the “yield spread” - BDCs can raise capital at fairly low costs (e.g. 6% borrowing rate) due to their high credit ratings. However, they lend to hundreds of private businesses at a much higher rate (e.g. 10%+). As long as they do lots of investments with insignificant number of defaults, they can reward the shareholders handsomely from the yield spread.

Because BDCs lend money at a floating interest rate, their returns have boomed since the Fed’s last rate hike cycle. While we are in a cutting cycle now, the Fed does not seemed rushed to cut rates too soon from here. This, coupled with strong economic growth, is good news for BDCs, even as their investment yields came down in Q4 last year due to the rate cuts. Having a patient Fed in the foreseeable future helps BDC dividend yields stay high.

Another factor to consider is credit spreads. When corporate borrowing activities are low and spreads are tight, it is a headwind to BDC returns. This is because investors are chasing the same deals and are willing to accept lower yields.

Credit spreads have tightened significantly in the past 6 months, which have also dragged BDCs’ latest performances. However, spreads are now already near a 20-year historical low, with less room on the lower side. This means BDCs could see improved performance in the next two quarters should corporate activities start to pick up.

This week, we first compare the BDCs in our universe, and then dive into the latest earnings from Ares Capital (ARCC) and Hercules Capital (HTGC).

Table of Contents

• 1. BDC Key Metrics Overview

• 2. Ares Capital (ARCC)

• 3. Hercules Capital (HTGC)

DISCLAIMER: This newsletter is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.

1. BDC Key Metrics Overview

Latest Price Performance

In the past month, BXSL (Blackstone), FSK (FS KKR), and FDUS (Fidus) have performed strongly with 5% returns. For reference, SPY was down 1.7% in the same period.

Year-to-date, we have seen very decent returns across board, most notably in FSK and FDUS. 9%+ returns almost match their annualised dividend yields.

Price / NAV Premiums

Among our cohort, MAIN and HTGC enjoy the highest premiums, signalling strong investor demand. The industry leader, ARCC trades at 17% premium, which is a rebound from the end of last year.

Dividend Yield on NAV

The dividend yield on NAV shows a BDC’s distribution as a percentage of their net asset value, which differs from the stock price due to the premiums / discounts we mentioned above.

HTGC has the highest dividend relative to NAV, but it’s because it invests in a higher-risk sector (VC-backed companies) which generate higher investment yields.

Annualised Dividend Yield on Stock Price

This chart shows the dividend yield investors get if they bought shares at the latest market price. OBDC, FSK, and GBDC have 10%+ yields, which are handsome given their low risks.

MAIN only offers a dividend yield of 4.7%, less than 30bp above the US 10-year Treasuries. It suggests that investors believe that MAIN’s investments are pretty much as good as risk-free. Personally, I would prefer Treasuries at just a 30bp difference.

2. Ares Capital (ARCC)

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