CHICAGO (Reuters) – In a frantic search for yields, investors often turn toward relatively unknown products. Business Development Companies (BDCs) are one of latest vehicles to grab investor attention – and money.
BDCs are companies that lend to young, thinly traded and often distressed companies that have credit ratings in the “junk” status. They are as close to a private equity enterprise as you’re going to get in a public company. Yet their high yields come at a price in terms of elevated risk that should not be underestimated, and investors must proceed with caution.
Like Real Estate Investment Trusts (REITs), BDCs must pass through at least 90 percent of their profit to shareholders. Most of their borrowers carry the lowest-possible credit ratings such as BBB-, or are not rated at all. They hold a variety of companies in their portfolios, so some are more diversified than others.
As high-yield vehicles, BDCs have been emerging at a relatively rapid clip in recent years. There were just four of them nine years ago. Now, there are nearly 30, with a total market capitalization of $26 billion, according to Financial Advisor, a trade magazine. That’s peanuts compared with megabanks like JPM Morgan Chase & Co or Bank of America Corp, but they are a growing force in corporate finance.
While regulated, BDCs occupy a useful niche in helping companies grow. Since they can borrow at record-low rates and make money on the spread – the above-market rates they charge less credit-worthy borrowers – BDCs are in a sweet spot now as the economy continues to rebound. They can provide financing to a wide range of companies typically eschewed by mainstream banks. Consider them sub-prime lenders to small- to mid-size companies.