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Credit for More Cash in 2020

December 26, 2019

There are two main sources for corporations to fund their debts.

The first is commercial banks for loans. The second is the corporate bond market where larger sums are raised.

But like so many other sectors of the economy and markets, there have been disruptions. And these disruptions are leading to alternatives that are taking a bigger piece of business from traditional banks and investment banks for corporate bond placements.

In the process, investors are being rewarded with opportunities to get paid much higher levels of income with yields running from over 6% to over 8%.

Suffice it to say, these alt-financials are successfully disrupting the US credit markets.

Banks Busted

US banks are being strangled from their core operations of making corporate loans and participating in the capital markets, including trading.

The Dodd-Frank Act of 2010 made it almost impossible for normal corporate and business lending as well as many of the trading activities, including repos. And further regulatory actions through 2016 further imposed troubles for banks.

Even with legislative relief in 2017 and regulatory changes since then, much has been left undone.

And this should continue into 2020. US banks remain an unattractive place to put your money to work in the financial sector.

The way to benefit is to do what worked in 2019. Alt-financials will continue to thrive.

One of the best is Main Street Capital (MAIN), which lends primarily to middle-market US companies.

Main Street is set up under the Small Business Investment Incentives Act of 1980. This act was passed in another time of bank woes.

Back in the 1970s, inflation was out of control, making business loans very difficult to price for banks. The act allowed companies to operate like a commercial lending bank, without traditional corporate income taxes as well as a lot less oversight from financial regulators.

Main Street Capital Total Return—Source: Bloomberg Finance, L.P.

Yielding 6.64% at an annual rate, including regular special dividends, it’s a good performer with a return year to date of 38.3%.

Corporate Bond Cracks

The US bond market did very well throughout 2019. And one of the best segments has been corporate bonds. Low inflation and good demand aided corporate bond prices. But one of the surprise drivers was the lack of supply of new issues for much of the year.

Number of US Corporate Issuers—Source: Bloomberg Finance, L.P.

The result has been a corporate bond market that has a year to date return of 14.5%, well above the general overall US Aggregate Index from Bloomberg Barclays.

Bloomberg Barclays US Corporate Index Total Return—Source: Bloomberg Finance, L.P.

What has taken its place is the rapidly expanding market for privately placed corporate loans that have replaced traditional corporate bond issuances.

These are done without the costs of massive filings as required by publicly traded corporate bonds. This makes them easier and cheaper to get done. And eager buyers are gobbling them up.

Direct lending is now outpacing US corporate bonds, as tracked by Cliffwater LLC (private).

Direct Lending and US Corporate Bonds—Source: Cliffwater, Bloomberg Finance, L.P. & Barclays

This market has done well for 2019, and I see it continuing to outpace corporate bonds and corporate lending.

One of the best ways into this market is in TPG Specialty Lending (TSLX). Structured as a business development company (BDC) under both the Investment Companies Act of 1940 and the Small Business Investment Incentives Act of 1980 (similar to Main Street Capital), TPG Specialty Lending is a leader in the loan market.

It is significantly aided by its association with TPG Group (formerly Texas Pacific Group), a leading global private equity investment group. TPG Specialty is involved in working with origination as well as acquisition of loans that form the core of its loan portfolio.

It yields 8.43% on an annual basis, including regular special dividends. And it has returned 29.5% year to date.

TPG Specialty Lending Total Return—Source: Bloomberg Finance, L.P.

TPG Specialty Lending should continue to generate rising revenues from the developing loan market as the company grabs more of the corporate funding market away from the traditional corporate bond markets.

All My Best,

Neil George
Editor, Income Investor’s Digest & Profitable Investing
Author, Income for Life

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