I touched yesterday on the insider buying among business development companies. These investment funds have seen share prices weaken during the past year as they have been kicked out of both the Russell 2000 and S&P indexes because of accounting concerns, fears of higher interest rates and a few dividend reductions. There is not a lot of enthusiasm for these direct lenders to middle-market companies. That is except for the directors and executives who run the show at business development companies. Insider buying has been persistent for some time and shows no signs of abating anytime soon.
Short-term concerns are masking what looks to me to be a huge long-term opportunity for the BDCs. The vast majority of buyout and acquisition activity is in middle-market companies now, and there is a huge vacuum created by the general de-risking of bank loan portfolios. At a recent private-equity conference, Kohlberg Kravis & Roberts (KKR) CEO Bill Janetschek said, "We see an immense opportunity. You see a lot of the local banks not willing to lend to the middle market. So we are the source of capital. Private-equity lenders, and the business development companies that work with them are rushing to fill the void. Since BDCs pay out 90% of their earnings this is a real opportunity for yield starved investors in my opinion."
Fifth Street Finance (FSC) has seen its share price sliced by about 9% so far this year. The company missed Wall Street estimates and committed the cardinal sin of reducing its dividend payout. The cut made sense to me, as it has at other BDCs in the past few months. They are matching the payout to cash flows, and a reduction in payout is warranted. Borrowing the dividend or raising equity capital to continue a payout would be far worse than trimming the dividend a bit. In the earnings press release, Fifth Street CEO Todd G. Owens said, "One important initial step is moving to a more conservative dividend policy and setting distributions at a level that is covered by sustainable net investment income."
Insiders at Fifth Street don't seem to be too concerned. If anything, they are pretty excited about buying at the reduced price. Leonard Tannenbaum, the previous CEO, recently spent $7.8 million to buy more shares of the company, and three other directors have also made open-market purchases this year. The shares appear to be a bargain at about 80% of asset value, and even after the dividend reduction, they yield 10.14%.
Pennant Park Investment (PNNT) is another middle-market lender that is seeing strong insider buying. Pennant has a portfolio of 66 companies with an average investment size of $20.3 million and has an average yield on debt investments of 12.5%. The company is prepared for higher rates as 67% of its loan portfolio is in variable rate loans that will benefit if rates do go up over the next year. Four insiders -- including CEO and founder, Arthur Penn -- have combined to buy more than $1.1 million of the company's stock during the past three months. Pennant shares trade at 88% of asset value and yield 12.08 %.
Solar Senior Capital (SUNS) also invests lends to middle-market leveraged companies where insiders like what they see developing in this market. Business is pretty good as CEO Michael Gross pointed out in the recent earnings release, saying, "Despite being highly selective in the face of continued frothy credit markets and elevated repayments, we grew the portfolio over 20% in Q4 and ended the year with a well-diversified portfolio of excellent credit quality and no direct exposure to the energy sector." He has backed his enthusiasm up with his cash as he has been a consistent buyer of the stock, most recently spending $225, 000 to buy shares. In December, he made almost $900,000 in open-market purchases. One other director also has made a purchase of more than $200,000 in recent weeks. The shares trade at 93% of asset value and yield 8.64% at the current price.
I'm not suggesting you have a portfolio of all BDCs, but adding a few of these high-yielding vehicles where insiders have skin in the game to an income portfolio could significantly boost yields.
