The dividends of business development companies, or BDCs, are often incredibly attractive.
In order to avoid corporate taxes, these companies are required to give at least 90% of their taxable income back to shareholders in the form of dividend payouts. As a result, it’s not uncommon to see their dividend yields nearing double digits.
It’s when you get into double-digit territory, though, that you should keep a cautious eye on your investments and look deeper into their financials to see whether there’s anything awry.
That’s exactly what I’m going to do today with the BDC OFS Capital Corp. (Nasdaq: OFS). Shout-out to Wealthy Retirement reader Chris for suggesting the stock!
OFS focuses on investing in mid-level companies to provide them with capital and structure for future growth. It does a good job diversifying across various sectors, including healthcare, tech, industrials, and more. You won’t be seeing any big names in its portfolio, because its focus is mostly on privately held companies with more potential for growth.
OFS’ dividend yield is currently hovering around 15%, which immediately sent up a red flag in my mind. While it’s not impossible to sustain a 15% dividend, it’s definitely difficult, even for a BDC.
The first thing we look at is the company’s net investment income growth. Net investment income, or NII, is the measure of cash flow we use for BDCs, because it tells us how the company’s investments are doing. In the case of OFS, net investment income has been all over the place over the past few years.
There hasn’t been a steady decline, but there also hasn’t been consistent growth. The company’s NII fell from $20.2 million to $16.7 million last year, and this year’s projection of $17.3 million would still be lower than 2022’s figure.
As with real estate investment trusts and master limited partnerships, because of their requirement to pay out the majority of their income, we increase our dividend payout ratio standard for BDCs from 75% to 100%. Even with the higher threshold, though, OFS’ payout ratio is too high. It paid out 109% of its net investment income to shareholders in 2024 and is expected to pay out nearly 113% in 2025.
Finally, OFS is no stranger to dividend cuts. Although it’s made only one cut in the last 10 years, it was a pretty major step. In June 2020, the company slashed its dividend in half from $0.34 per share down to just $0.17.
Although the payout is now back up to $0.34 per share, as it had been for the bulk of the 2010s, it took OFS over three years to increase it back up to that point.
Taking all of this into account, we can see at least four major red flags being waved in front of our faces. There’s a strong likelihood that we’ll have a repeat of 2020 with a cut coming down the line.
Dividend Safety Rating: F
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