Horizon Technology Finance (HRZN) has a current dividend yield of 10.7%. It is one of 416 stocks with a 5%+ dividend yield. You can see the full list of established 5%+ yielding stocks by clicking here. Horizon’s 10%+ yield towers above most other stocks. The S&P 500 Index, on average, offers just a 2% dividend yield. With a yield of nearly five times the S&P 500 average, Horizon has lots of appeal for income investors. Not only does it have a very high dividend yield, but it also makes its payments each month. Horizon is one of only 29 stocks with a monthly dividend. You can see the entire list of all 29 monthly dividend stocks by clicking here. Horizon’s yield nearly tops the list. It is the second-highest yielding stock on the list of 29 monthly dividend payers, behind only Prospect Capital (PSEC). This article will discuss why Horizon could be an attractive high-yield stock.

Business Overview

Horizon is a Business Development Company, or BDC. These are companies that make investments in privately-held companies. Horizon is a ‘venture lending’ company, meaning it operates similarly to a venture capital firm, except that it makes loans, instead of equity investments. It provides debt financing to early-stage companies across four industry groups:

• Life Science
• Technology
• Healthcare Information & Services
• Cleantech

Life science companies primarily include biotechnology, medical devices, and specialty pharmaceuticals. Technology investments are typically made in cloud computing, wireless communications, cyber security, data analytics and storage, internet, software, and more. Healthcare information includes diagnostics, medical records, and patient management software providers. Lastly, the Cleantech segment is made up of investments in renewable energy, such as alternative fuels, energy efficiency, green building materials, and water technology. A breakdown of Horizon’s portfolio by industry and geography is as follows:

Source: Q1 Presentation, page 13

Horizon views prospective investments through a long-term lens. It invests in companies that have growth potential, strong management teams, superior technology, and/or valuable intellectual property. Transaction size is up to $25 million. Loans made are typically term, bridge, or special purpose, with repayment terms up to 48 months. The loans made can be used for a variety of purposes, including investments in operations, business expansion, research and development, acquisitions, or sales and marketing. As of March 31st, Horizon had a net asset value of $12.11 per share. The share price currently trades at a slight discount to net asset value. Horizon has a sound investment philosophy. It also has a high-quality loan portfolio, that should provide the company with growth going forward.

Growth Prospects

In 2016, Horizon reported net investment income of $17.1 million, or $1.48 per share, for the year. This was an 18% increase from the previous year. Its investment philosophy led to strong results last year.

Source: Q1 Presentation, page 12

However, the company’s performance worsened to start 2017. In the first-quarter, net investment income per share declined by 24%, to $0.29. This is important to note, since Horizon’s net investment income last quarter fell below its dividend of $0.30 per share for the quarter.

The culprit last quarter was weak interest income, due to escalating prepayments that led to a smaller loan portfolio. While fee income rose for Horizon last quarter, interest income declined by 30% for the quarter. New originations last quarter were $26 million, but this was offset by $12 million in scheduled principal payments, as well as $27 million in principal pre-payments. Some of the decline last quarter was mitigated by cost reductions.

Horizon benefited from a 27% decline in total expenses last quarter. Continued cost controls will help, but more importantly, Horizon’s future growth will be fueled by new loans and higher interest rates. One growth catalyst for Horizon moving forward is new investments. The company placed $57.8 million of new loans in 2016. It also made $25.8 million in loans to five companies in the first quarter. Horizon has ample liquidity to continue making investments. It ended last quarter with $49.8 million in available liquidity, which can be used to make loans and grow investment income.

Another growth catalyst for Horizon is rising interest rates. Since its business model is to make loans, Horizon’s net investment income stands to grow if interest rates climb. Persistently low interest rates have restrained Horizon’s interest income, but now that the Federal Reserve is raising interest rates again, Horizon could see a boost going forward.

Horizon is well-positioned to benefit from higher interest rates. As of the first quarter of 2017, floating rate loans comprised 100% of Horizon’s outstanding loan portfolio, up from 96% at the end of 2016. This means Horizon has leveraged itself to a rising-rate environment. The company states that for every 100-basis point increase in LIBOR, it would see annual net interest income increase by approximately $0.07 per share.

Dividend Analysis

On May 2nd, Horizon declared dividends for July-September, at a rate of $0.10 per share each month. The annualized dividend payout of $1.20 represents a yield of 10.7%, based on Horizon’s June 13th closing share price. Including the second-quarter distributions, Horizon has declared $9.62 per share in cumulative distributions since its IPO in October 2010. As a result, investors that bought at the IPO have made their money back from distributions. At that point, investors are playing with ‘house money’. This demonstrates why BDCs are a popular investment for income investors. However, sky-high dividend payouts can be reduced, if the issuing company encounters financial difficulty. Dividend cuts are not uncommon in the BDC space. For example, in October 2016 Horizon cut its monthly dividend payout by 13%, to its current level. That said, Horizon still offers a double-digit yield, which could be very appealing for income investors. And, the new dividend level should be more secure. Horizon’s 2016 net investment income covered its current annualized distribution.

Final Thoughts

Double-digit dividend yields are often a sign of elevated risk. In this case, there is considerable risk that Horizon’s dividend could be reduced in the future, if its investment income deteriorates. However, the outlook for Horizon is generally positive. It invests in technology and healthcare, two stable industries with growth potential. And, Horizon’s interest income would see a meaningful boost, if interest rates go up. As a result, while dividends are never guaranteed, Horizon could be an attractive stock for income investors, thanks to its 10%+ dividend yield.

• For another high-yield BDC with an 8% dividend yield, click here.