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Not investment advice. Educational reading. See Disclaimer.
L.4 · INTERMEDIATE · 2 MIN

Yield Decomposition -- Is the Dividend Safe?

BDC yield comes from three sources: portfolio yield (interest income on loans), leverage amplification (borrowing to buy more loans), and special / supplemental distributions (lumpy gains). The metric to focus on is dividend coverage = Net Investment Income (NII) divided by dividend paid. Below 100% means the dividend is being subsidized.

Quiz · 5 questions ↓
§ 01

If NII does not cover the dividend for two or more quarters, the dividend will likely be cut. Watch coverage every earnings release.

§ 02
ComponentHow to read itHealthy range
Portfolio yieldWeighted avg interest on loans10-13% on debt portfolio
Leverage (debt/equity)Amplifies NII (and risk)0.9x - 1.25x debt/equity
NII / dividend coverageCore safety metric>= 100% sustained
Special distributionsLumpy realized gainsBonus, not core
Return of capital (ROC)Dividend > earningsRed flag if recurring
§ 03
Open ARCC's latest earnings press release and find 'Net Investment Income per Share' -- compare to dividend per share. Coverage above 100% = safe.
§ 04

Coverage of 80% means the BDC is paying out more than it earns. The shortfall is funded from prior reserves, leverage, or return of capital. One quarter is acceptable; two or three consecutive quarters of sub-100% coverage almost always pre

§ 05
BDC reports: total investment income 12%, operating expense 3%, interest on own debt 3%, resulting NII yield ~6%. Dividend yield: 10% at current price. Sustainable?
Five questions · AI feedback

Sit with the ideas.

A BDC paid a $0.40 quarterly dividend but earned only $0.32 of NII per share. What does this tell you?

Why:

Other lessons in this course.

  1. 01What is a Business Development Company?
  2. 02Reading a BDC's Schedule of Investments
  3. 03NAV and Premium / Discount
  4. 04Yield Decomposition -- Is the Dividend Safe?— reading now
  5. 05Non-Accruals -- The #1 Credit Metric
  6. 06Leverage and Regulatory Limits
  7. 07Manager Quality and Alignment
  8. 08Building a BDC Watchlist
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