Business development companies (BDCs) are getting new looks from income-starved investors this year, due in large part to low bond yields.
That’s a plus for exchange traded funds, namely the VanEck Vectors BDC Income ETF (BIZD ). BIZD lives up to the high dividend profile of BDCs, sporting a 30-day SEC yield of 8.13%. There’s no denying that’s high-yield, but as is the case with any asset class sporting a whopper of a yield, investors need to make sure that those dividends are sustainable and the companies offering those payouts aren’t burdened by the obligations.
Specific to BIZD and its 25 holdings, the outlook for BDC finances is sturdy, though dividend coverage is on a case-by-case basis.
“The 2022 sector outlook for business development companies (BDCs) is neutral, given the expectation for relatively stable asset quality, sufficient asset coverage cushions, strong funding flexibility and solid liquidity,” says Fitch Ratings. “Competition in the middle market is expected to continue to pressure spreads and deal structures in 2022, but most rated BDCs are well positioned competitively given expected benefits from affiliations with broader investment platforms.”
In terms of credit outlooks, 14 of the 15 BDCs that Fitch rates carry stable outlooks after the ratings agency lifted those views from negatives earlier this year, citing improvements in asset coverage and “stabilization of asset quality metrics.”
That’s relevant to investors considering BIZD because it implies that the ETF’s components aren’t in imminent danger of credit downgrades, which could weigh on dividends.
“Fitch has also revised the outlook on its ‘bbb’ operating environment score for BDCs to stable from negative, reflecting expectations for relatively stable performance despite the competitive middle market. Sponsors should generally be supportive of portfolio companies given significant equity contributions in deals, which should further benefit BDC credit performance,” according to the ratings agency.
In terms of near- to medium-term issues for BIZD investors to ponder, the climate for new deals for BDCs remains intensely competitive. Likewise, the mix of BDCs’ asset quality remains critical, but there are some positive characteristics for investors to consider, too.
“Key trends to monitor include pricing and terms on new investments given the competitive underwriting environment, potential changes to portfolio risk profiles and divergent asset quality performance, as well as the effects of portfolio growth/mix on leverage and cushions to asset coverage requirements,” concludes Fitch. “Improved access to capital markets has been a positive development for BDCs and should continue to support funding flexibility and liquidity.”
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