Top 5 Alternative Bank Stocks With High Income Potential in 2024
December 29, 2023
Top 5 Alternative Banks With Dividend Yields Up to 16%
The average American doesn’t like the idea of high interest rates. After all, they make it more expensive to borrow money and service debt. But rising borrowing costs are what banks live for.
Not all financial institutions are built the same, though. One niche area that income investors should pay close attention to right now is business development companies (BDCs).
We at Income Investors have nicknamed these firms “Alternative Banks” because they operate much like traditional financial institutions but don’t have brick-and-mortar branches or ATMs. And thanks to a quirk in U.S. tax law, these firms pay out some of the highest-yield dividends around.
In October 1980, President Jimmy Carter signed the Small Business Investment Incentive Act of 1980. (Source: “H.R.7554 – An Act to Amend the Federal Securities Laws to Provide Incentives for Small Business Investment, and for Other Purposes.,” Congress.Gov, last accessed December 21, 2023.)
Overnight, the U.S. government created an industry that was designed to lend venture capital to small and midsized businesses. Since then, BDCs have become indispensable for burgeoning companies.
As mentioned above, BDCs operate much like traditional financial institutions. They borrow money at one interest rate and lend it out at higher interest rates. Their profit, called the spread, comes from the difference between what they receive in interest and what they pay to creditors.
In recent years, dozens of BDCs have popped up to serve different types of customers. For instance, a Texas-based BDC might focus on lending capital to oil and gas companies, while a California-based firm might devote itself entirely to Silicon Valley start-ups.
What Are the Advantages of BDCs for Investors?
BDCs are a financial lifeline for many companies.
And because of tax breaks, they’re a great option for income investors. Traditional financial outfits have to pay the government between $0.25 and $0.35 in taxes on each dollar they make in profit. In contrast, BDCs pay little or no corporate tax on their earnings.
In exchange for this break, BDCs must distribute at least 90% of their ordinary taxable income to their shareholders. As a result, these companies pay out some of the highest dividend yields around.
In early November, the share prices of the best alternative banks got a big boost. That’s when the Federal Reserve said it would keep its interest rates between 5.25% and 5.5%. At the time, the Fed didn’t rule out further rate hikes, but with inflation falling, Wall Street was pretty confident that the Fed was done raising its rates for this cycle.
In December, the Fed again held its key lending rate. It also said its historical interest rate hike policy was likely over. Now, Wall Street analysts think the Fed will announce three 25-basis point cuts in 2024.
A pause in interest rate hikes and the lowering of inflation mean the U.S. economy is probably going to avoid a recession. A stronger economy means many small and medium-sized businesses will be looking to BDCs for capital to help their companies expand. That’s good for investors who own BDC stocks.
Moreover, even though interest rate hikes may be done for this cycle, Wall Street expects that the higher interest rates will stick around for a long time. That, too, could be great for alternative banks.
TriplePoint Venture Growth BDC Corp
TriplePoint Venture Growth BDC Corp (NYSE:TPVG) specializes in investing in companies at the venture growth stage. It primarily focuses on businesses in technology, life sciences, and other high-growth industries. (Source: “Investor Presentation: Quarter Ended September 30, 2023,” TriplePoint Venture Growth BDC Corp, November 1, 2023.)
The company’s sponsor, TriplePoint Capital, has provided more than $10.0 billion in commitments to more than 900 companies around the globe,
When I say that BDCs target small and medium-sized businesses, that doesn’t mean mom-and-pop shops. BDCs typically lend to companies that generate between $20.0 and $100.0 million yearly in sales.
If you can judge a BDC by the companies it invests in (and you should, really), it’s tough to beat TriplePoint Venture Growth BDC Corp. It has invested in some of the tech industry’s biggest names, including Etsy Inc (NASDAQ: ETSY), Facebook, Ring LLC, Shazam, Square, and YouTube.
As of September 30, 2023, the company held debt investments in 54 companies, warrants in 106 portfolio companies, and equity investments in 48 portfolio companies. (Source: “TriplePoint Venture Growth BDC Corp. Announces Third Quarter 2023 Financial Results,” TriplePoint Venture Growth BDC Corp, November 1, 2023.)
The company’s high net investment income allows it to reward TPVG stock investors with very generous quarterly dividends.
Recently, management declared a fourth-quarter distribution of $0.40 per share, for a yield of 15.3% (as of this writing). The company last raised its distribution in the first quarter of 2023, by eight percent from $0.37 to $0.40. (Source: “Dividends,” TriplePoint Venture Growth BDC Corp, last accessed December 21, 2023.)
TriplePoint Venture Growth has declared total distributions of $14.65 per share since its initial public offering (IPO).
In December 2022, the company announced a special distribution of $0.10 per share. That special dividend was part of the company’s estimated undistributed taxable earnings from net investment income, aka spillover income. (Source: TriplePoint Venture Growth BDC Corp, November 1, 2023, op. cit.)
At the end of the third quarter of 2023, its estimated spillover income was $37.3 million, or $1.03 per share.
Oxford Square Capital Corp
Oxford Square Capital Corp (NASDAQ:OXSQ) is a BDC that invests in public and private companies. It invests in secured and unsecured senior debt, subordinated debt, junior subordinated debt, syndicated bank loans, preferred stocks, and common stocks. (Source: “Investor Presentation: Quarter Ended September 30, 2023,” Oxford Square Capital Corp, last accessed December 21, 2023.)
It invests in companies in various industries, including business services, health care, information technology (IT) consulting, insurance, plastics manufacturing, software, structured finance, telecommunication services, and utilities.
Oxford Square Capital Corp concentrates on companies with annual revenues of less than $200.0 million and market capitalizations or enterprise values of less than $300.0 million. The firm invests between $5.0 and $30.0 million per transaction. It seeks to exit its investments within seven years.
The company’s high net investment income helps it pay reliable distributions to OXSQ stockholders.
As of this writing, Oxford Square Capital Corp pays monthly distributions of $0.035 per unit, for a yield of 14.51%. In November, the company’s board announced that it would be continuing to pay dividends of $0.035 per unit for at least the first three months of 2024. (Source: “OXSQ Dividend History,” Nasdaq, last accessed December 21, 2023.)
Monroe Capital Corp
Monroe Capital Corp (NASDAQ:MRCC) is an alternative bank that provides senior, unitranche, junior secured, and subordinated debt financing and minority equity investments, primarily to lower-middle-market companies in the U.S. and Canada.
Its average loan per company is $5.2 million, and its largest loan was $30.0 million. (Source: “Investor Presentation: Q2 2023,” Monroe Capital Corp, last accessed December 21, 2023.)
The firm’s $515.4-million investment portfolio is diversified across industries including banking, business services, health care, high tech, media, and pharmaceuticals.
Monroe Capital Corp went public in October 2012 and paid its first quarterly dividend in December of that year. The company hasn’t missed a payment since then. (Source: “Dividends and Distributions,” Monroe Capital Corp, last accessed December 21, 2023.)
In early December, the company’s board declared a distribution of $0.25 per share, for a yield of 14.39%.
PennantPark Investment Corp.
PennantPark Investment Corp. (NYSE:PNNT) is a private equity fund that focuses on investing in U.S.-based companies that are owned by middle-market private equity sponsors that have track records of supporting the companies in their portfolios. (Source: “Investor Presentation,” PennantPark Investment Corp., last accessed December 21, 2023.)
Why middle-market companies? The U.S. middle market includes nearly 200,000 companies, generates $10.0 trillion of revenue annually (one-third of the U.S. economy), and is the world’s fifth-largest economy on a standalone basis.
PennantPark Investment Corp. invests between $10.0 and $100.0 million across the capital structure (senior secured loans, subordinated debt, and other types of investments). It chooses companies that have $10.0 to $50.0 million of earnings before interest, taxes, depreciation, and amortization (EBITDA).
As of September 30, the firm’s debt portfolio consisted of 96% variable-rate investments and four percent fixed-rate investments.
As of that date, PennantPark’s investment portfolio included 129 companies, with an average investment of $7.8 million. The industries that PennantPark targets include aerospace and defense; business services; consumer products; financial services; gaming and leisure; health care; hotels; insurance; and telecommunications.
The firm’s high cash generation resulted in increases to PNNT stock’s quarterly distribution in each quarter of 2022 and the first three quarters of 2023. (Source: “Dividends and Distributions,” PennantPark Investment Corp., last accessed December 21, 2023.)
On August 9, the company declared a third-quarter distribution of $0.21 per share. That payout represented a five-percent increase over its second-quarter dividend and a 40% increase over its 2022 third-quarter dividend.
If you look at PennantPark stock’s dividend history, you’ll notice that its distribution plunged in November. Technically, it didn’t. That month was when PennantPark Investment Corp. switched the frequency of its distributions from quarterly to monthly. And frankly, most shareholders would rather get paid monthly than quarterly.
As of this writing, PNNT stock’s payout stands at $0.07 per month, for a yield of 12.77%.
Trinity Capital Inc
Trinity Capital Inc (NASDAQ:TRIN) is a BDC that provides term loans and equipment financing to growth-stage companies. (Source: “Third Quarter 2023 Investor Presentation,” Trinity Capital Inc, last accessed December 21, 2023.)
A growth-stage company is defined as having active equity sponsors, earning annual revenues of up to $100.0 million, and being past its risky early-development stage.
Trinity Capital has a successful track record of serving a multibillion-dollar, under-served, niche market. Since its inception in January 2008, the company has made 309 investments and 179 exits.
As of the third quarter of 2023, Trinity Capital Inc had $1.3 billion of assets under management. The company’s investment portfolio comprised approximately $840.0 million worth of secured loans, $223.2 million worth of equipment financing, and $52.7 million worth of equity and warrants across 187 portfolio companies.
Trinity Capital’s partner portfolio consists of companies in sectors including chemicals and fuels; clean technology; commercial services; consumer and retail; energy and efficiency; health care; Internet of Things; semiconductors and hardware; and software. (Source: “Meet Our Partners,” Trinity Capital Inc, last accessed December 21, 2023.)
Thanks to the company’s outstanding performance, it has been able to increase its base dividend for 11 consecutive quarters.
In October, it paid a quarterly cash dividend of $0.54 per share, for a yield of 13.07% (as of this writing). That payment included a base dividend of $0.49 per share and a supplemental cash dividend of $0.05 per share. (Source: “Trinity Capital Inc. Declares Cash Dividend of $0.54 per Share for the Third Quarter of 2023,” Trinity Capital Inc, September 13, 2023.)
That was up from a July 2023 payout of $0.53 per share, comprising a base dividend of $0.48 and a supplemental cash dividend of $0.05 per share. In October 2022, Trinity Capital paid $0.60 per share, comprising a base dividend of $0.45 per share and a supplemental cash dividend of $0.15 per share.
The Lowdown on Alternative Banks
Economic tailwinds have made alternative banks increasingly compelling. In just a year and a half, the Federal Reserve raised its interest rates an unprecedented 11 times to a target range of 5.25% to 5.5% (its highest range since 2001).
The Fed is done raising its rates for this cycle, and analysts forecast that it will cut its rates by 25 basis points at least three times in 2024.
Despite the expected drops, borrowing costs are expected to remain well above their pre-pandemic levels for years. That’s bad news for people with credit card debt and mortgages, but it’s good news for BDCs.
