Interest rates are rising, and despite chatter that the Federal Reserve may pause in the fall, that will depend on when inflation decides to pause. Based upon current food and fuel prices, that does not look to be anytime soon. Investors can count on 50-basis-point increases in June and July, and most likely, with the Fed beginning the balance sheet runoff, there could be a spike along the Treasury curve this summer.
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So what are balanced growth and income investors to do? The potential for capital appreciation on low coupon bonds is negligible, and with the market possibly primed for a continued big sell-off, risky high-yield or leveraged funds make no sense for those with low risk tolerance. What does make sense is looking at the business development stocks that pay outsized dividends and offer growth potential.

Business development companies (BDCs) are organizations that invest in small and medium-sized companies, as well as distressed companies. A BDC helps these firms to grow in the initial stages of their development or to regain sound financial footing.

Jefferies is very positive on six top BDCs and had this to say about the solid first quarter and prospects for the rest of the year:

Following the robust 2021 for the industry, the macro-back drop has evolved substantially YTD while BDCs generated solid first quarter 2022 results with net operating income upside, some dividend increases, yield expansion and earnings beats. The peer group has sold off since mid-April and while we would be selective, we consider five top companies as top picks.

While all six stocks are rated Buy at Jefferies, it is important to remember that no single analyst report should be used as a sole basis for any buying or selling decision.

AFC Gamma

This is an off-the-radar idea that offers outstanding total return potential. AFC Gamma Inc. (NASDAQ: AFCG) originates, structures, underwrites and invests in senior secured loans and other types of loans and debt securities for established companies operating in the cannabis industry in states that have legalized medicinal or adult-use cannabis.

The company primarily originates loans structured as senior loans secured by real estate, equipment and licenses or other assets of the loan parties to the extent permitted by applicable laws and the regulations governing such loan parties. AFC Gamma has elected and qualified to be taxed as a real estate investment trust (REIT) for U.S. federal income tax purposes under the Internal Revenue Code of 1986.

The company posted stellar first-quarter results that topped both earnings and revenue expectations. AFC Gamma has beaten consensus revenue estimates three times over the past four quarters.

Investors receive a 12.28% distribution. Jefferies has a $26 price target on the shares, and the consensus target is $24.58. The stock closed on Wednesday at $17.84 a share.

This is another top BDC that posted outstanding results for the quarter and has solid upside potential. Apollo Investment Corp. (NASDAQ: AINV) is a closed-end, externally managed, non-diversified management investment company specializing in private equity investments in leveraged buyouts, acquisitions, recapitalizations, growth capital, refinancing and private middle-market companies.
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The company provides direct equity capital, mezzanine, first lien secured loans, stretch senior loans, unitranche loans, second lien secured loans and senior secured loans, unsecured debt, and subordinated debt and loans. It also seeks to invest in PIPES transactions.

The fund also may invest in securities of public companies that are thinly traded and may acquire investments in the secondary market and structured products. It prefers to invest in preferred equity, common equity/interests and warrants and makes equity co-investments and also may invest in cash equivalents, U.S. government securities, high-quality debt investments that mature in one year or less, high-yield bonds, distressed debt, non-U.S. investments or securities of public companies that are not thinly traded.

Apollo also focuses on other investments such as collateralized loan obligations and credit-linked notes. The fund typically invests in construction and building materials, business services, plastics and rubber, advertising, capital equipment, education, cable television, chemicals, consumer products/goods durable and nondurable and customer services, direct marketing, energy (oil and gas), electricity and utilities, aerospace and defense, wholesale, telecommunications, financial services, hotel, gaming, leisure, restaurants, as well as environmental industries, health care and pharmaceuticals, high tech industries, beverages, food and tobacco, manufacturing, media (diversified and production), printing and publishing, retail, automation, aviation and consumer transport, transportation, cargo and distribution.

The company primarily invests in the United States. It primarily invests between $20 million and $250 million in its portfolio companies. The fund seeks to make investments with stated maturities of five to 10 years.

Shareholders receive a 10.00% dividend. The Jefferies price target on Apollo Investment stock is $15. The consensus target is $13.16, and Wednesday’s closing share price was $12.42.

Ares Capital

This is a favorite BDC across Wall Street. Ares Capital Corp. (NASDAQ: ARCC) is a leading specialty finance company that provides one-stop debt and equity financing solutions to U.S. middle-market companies, venture capital-backed businesses and power-generation projects.

It originates and invests in senior secured loans, mezzanine debt and, to a lesser extent, equity investments through its national direct origination platform. The company’s investment objective is to generate both current income and capital appreciation through debt and equity investments primarily in private companies.
Top Wall Street analysts believe the strength of Ares Capital’s origination platform, sizable balance sheet and ample liquidity position it favorably in a very competitive investing environment. Some believe that with the current tight spread environment, the company has the scale and industry relationships to continue to make competitive, high-credit-quality investments.

Investors receive an 8.45% dividend. The $24 Jefferies price target is higher than the $22.29 consensus target. Ares Capital stock closed at $19.51 on Wednesday.
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Capital Southwest

Based in Dallas, which has been a hub for activity, this is another top BDC that offers long-term growth potential. Capital Southwest Corp. (NASDAQ: CSWC) specializes in credit and private equity and venture capital investments in middle-market companies, mezzanine, later stage, mature, late venture, emerging growth, buyouts, recapitalizations and growth capital investments.

It does not invest in startups, publicly traded companies, real estate developments, project finance opportunities, oil and gas exploration businesses, troubled companies, turnarounds and companies in which significant senior management is departing.

In the lower middle market, the firm typically invests in growth financing, bolt-on acquisitions, new platform acquisitions, refinancing, dividend recapitalizations, sponsor-led buyouts and management buyouts situations. The investment structures are Unitranche debt, subordinated debt, senior debt, first and second lien debt, and preferred and common equity. The firm makes equity co-investments alongside debt investments, up to 20% of total check and only makes non-control investments. It prefers to invest in Industrial manufacturing and services, value-added distribution, health care products and services, business services, specialty chemicals, food and beverage, tech-enabled services and software as a service (SaaS) models.

Capital Southwest seeks to invest in energy services and products, industrial technologies, and specialty chemicals and products. Within energy services and products, the firm seeks to invest in each segment of the industry, including upstream, midstream and downstream, excluding exploration and production with a focus on differentiated products and services, equipment and tool rental, consumable products, and drilling and completion chemicals. Within industrial technologies, it seeks to invest in automation and process controls, handling and packaging equipment, industrial filtration and fluid handling, measurement, monitoring and testing, professional tools, and sensors and instrumentation.

Within and specialty chemicals and products, the firm seeks to invest in businesses that develop and manufacture highly differentiated chemicals and products including adhesives, coatings and sealants, catalysts and absorbents, cosmeceuticals, fine chemicals, flavors and fragrances, performance lubricants, polymers, plastics and composites, chemical dispensing and filtration equipment, professional and industrial trade consumables and tools, engineered solutions for HVAC, plumbing, and electrical installations, specified high-performance materials for fire protection and oilfield applications. It may also invest in exceptional opportunities in building products.

Shareholders receive an 8.59% dividend. Jefferies has set a $27 target price. The consensus target is $26.64, and shares ended trading on Wednesday at $22.28.

FS KKR

This very well-known name on Wall Street is offering a solid entry point at current levels. FS KKR Capital Corp. (NASDAQ: FSK) is a BDC specializing in investments in debt securities. It seeks to purchase interests in loans through secondary market transactions or directly from the target companies as primary market investments.
FS KKR Capital also seeks to invest in first lien senior secured loans, second lien secured loans and, to a lesser extent, subordinated loans or mezzanine loans. In connection with the debt investments, the firm also receives equity interests, such as warrants or options, as additional consideration. It also seeks to purchase minority interests in the form of common or preferred equity in our target companies, either in conjunction with one of the debt investments or through a co-investment with a financial sponsor.
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On an opportunistic basis, the fund may invest in corporate bonds and similar debt securities. The fund does not seek to invest in start-up companies, turnaround situations or companies with speculative business plans. It seeks to invest in small and middle-market companies based in the United States. The fund seeks to invest in firms with annual revenue between $10 million and $2.5 billion. It seeks to exit from securities by selling them in a privately negotiated over-the-counter market.

The company posted stellar quarterly results, announced a huge stock buyback and raised the $0.65 per share dividend to $0.68.

Shareholders receive a 12.57% dividend. The price target at Jefferies is $25, while the consensus target is $23.06. The shares closed on Wednesday at $21.64.

Oaktree Specialty Lending

This lower-priced BDC stock offers investors the ability to buy more shares. Oaktree Specialty Lending Corp. (NASDAQ: OCSL) specializes in investments in middle-market, bridge financing, first and second lien debt financing, mezzanine debt, senior and junior secured debt, expansions, sponsor-led acquisitions, and management buyouts in small and midsized companies.

The fund seeks to invest in education services, business services, retail and consumer, health care, manufacturing, food and restaurants, construction and engineering, and media and advertising sectors. It invests between $5 million to $75 million principally in the form of one-stop, first lien and second lien debt investments, which may include an equity co-investment component in companies with enterprise value between $20 million and $150 million and EBITDA between $3 million and $50 million. The fund has a hold size of up to $75 million and may underwrite transactions up to $100 million. It primarily invests in North America, and the fund seeks to be a lead investor in its portfolio companies.

Investors receive an 8.88% dividend. Jefferies has an $8.50 price target. The $8.14 consensus target also compares with Wednesday’s close at $7.04.

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While the Jefferies price targets are not sky-high, combined with the strong dividends, the total return possibilities for all these companies look to be very solid. Given the segment also has been somewhat out of favor, this year the risk-reward also looks compelling, especially given the strong results that all six of the companies have reported so far.

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