Nontraded BDC sales on a tear despite closing of first fund

Role of nontraded REITs raises concern amid volatility

By Bruce Kelly

Nov 28, 2012 @ 2:59 pm (Updated 8:04 am) EST

nontraded REITs, nontraded REITS, investing

Nontraded business development companies continue to enjoy strong sales from independent contractor reps and advisers, even though the industry's biggest fund recently closed.

The funds — called nontraded BDCs — raised almost $592.4 million in the third quarter, according to Michael Stubben, president of MTS Research Advisors. In the previous quarter, independent reps and advisers sold $820 million, a milestone for the relatively new product.

Nontraded BDCs became popular in 2009 with the launch of the first such fund, FS Investment Corp. Its success spawned many other funds. Nontraded BDCs invest primarily in the debt of private companies.

After raising $2.6 billion, FS Investment Corp. stopped selling to new investors in May. Its parent company, Franklin Square, is raising money for two other nontraded BDCs.

“BDCs have raised $2.0 billion year-to-date” and are on pace to double their roughly $1.2 billion in sales last year, he said. He added that the record sales of the second quarter were spurred largely by the closing of FS Investment.

One question about the product is the role of nontraded real estate investment trust sponsors. A number of nontraded REIT sponsors have BDC offerings, and some in the market question whether real estate managers have the knowledge and background to invest in a potentially volatile area such as private-company debt.

“Investors are having a hard time finding yield, and we fulfill that need,” said Deryck Harmer, senior vice president of CNL Financial, an alternative investment manager with a long background in real estate.

Real estate sponsors are working with outside managers to launch nontraded BDCs. For example, CNL Financial teamed up with leading global alternative asset manager KKR & Co. LP last year to launch Corporate Capital Trust.

“The key to our platform over the last five to seven years is working with best-in-practice partners on unique products,” Mr. Harmer said. “We don't have a team of real estate people running Corporate Capital Trust.”

Technically, BDCs are closed-end funds regulated under the Investment Company Act of 1940. Congress created them in 1980 in response to what had been a perceived crisis in the capital markets in the 1970s, with the intent to provide access to capital for small and growing companies.

BDCs invest in the debt and equity of small to mid-market companies, with the instruments ranging from the senior secured level to below investment grade or “junk,” an asset class typically not available to retail investors.

A BDC must invest at least 70% of its assets in eligible companies, which effectively means that they serve private or very thinly traded public U.S. companies.

Nonlisted business development companies

Rank Company 3Q '12 equity raised ($M) 3Q '12 invested assets ($M) 3Q '12 offering price Current net asset value Current dividend yield 3Q '12 dividend payout ratio
1 FS Investment Corp. II $206.4 $193.5 $10.05 $9.00 7.25% 95%
2 Corporate Capital Trust $178.6 $598.4 $10.95 $9.78 7.00% 149%
3 FS Energy & Power Fund $167.0 $455.8 $10.25 $9.18 6.20% 90%
4 Business Development Corp. of America $31.8 $102.0 $10.60 $9.44 7.81% 81%
5 VII Peaks-KBR Co-Optivist Income BDC II $4.6 $2.3 $10.00 $8.81 7.35% N/A
6 Sierra Income Corp. $3.9 $18.1 $10.00 $8.97 8.00% 202%
7 HMS Income Fund $0.1 $16.5 $10.00 $8.90 7.00% 73%
N/A = not available

Source: MTS Research Advisors