- Since its IPO on October 25, 2013 MRCC has outperformed BDCS by over 8% cumulative while yielding, on average, higher than the BDC universe.
- Outstanding balance sheet will provide protection during a downturn, while benefitting from rising rates, as 97% of loans are floating.
- Strong potential for capital appreciation as the market recognizes that this BDC trades well below comparable peers, plus a 9.2% yield!
Monroe Capital Corp. (MRCC), headquartered in Chicago, Illinois, is a business development company (BDC) that invests in lower middle-market companies with EBITDA up to $25 million and revenues up to $250 million located in the U.S. and Canada. The fund invests across a broad range of sectors. It provides senior, junior, and mezzanine debt and equity co-investments for recapitalization, refinancing, acquisition, and expansion capital requirements with an investment size ranging between $2 million and $18 million each. It also makes minority equity co-investments. The BDC is part of the larger Monroe Capital LLC platform.
MRCC uses the larger “Monroe Capital” platform to boost its deal flow and internal operations. This relationship allows MRCC to achieve a level of brand recognition to increase deal flow. MRCC, the BDC, is the public face of the $4 billion assets under management (AUM) Monroe platform. The platform allows the BDC to compete in sponsored and non-sponsored deals and offer better certainty of execution. Moreover, as the only public entity in the platform, the BDC is likely to invest in the highest credit quality and yields of the platform, as its performance is used as an indicator for the other private funds in the platform.
The BDC universe, as a whole, is trading at 1.04x P/Book Value, with MRCC right smack dab in the middle trading at 1.05x P/B. For peers we chose HTGC, MAIN, and GLAD. Though these BDCs are slightly different in nature, they have the highest exposures to REAL first-lien investments. For explanation on this, please see the section below called “Portfolio Composition” because many BDCs are misleading on how they categorize and present investments on their balance sheet. When comparing MRCC to this small group of peers, who have an average P/B multiple of 1.41x, they appear to be trading at a discount.
For the yield and quality of MRCC, we are surprised that it is trading in-line with BDC peers who tend to have riskier balance sheets and higher exposure to fixed asset loans. MRCC is also cheap on a dividend yield metric. They trade above book and can raise equity without shareholder approval (for dilution purposes). We think they have been given a lower valuation due to a bad/dilutive equity offering in 2013. This has caused NAV growth to be stagnant since inception, but if it wasn’t for this dilutive raise, NAV growth would be very healthy and would have grown year-over-year.
If you calculate NAV growth from the beginning of 2014, after the dilutive equity raise, they have grown NAV from approximately $14.00 on 1/31/2014 to over $14.50 at the end of the year. Again, if you were to show NAV growth from their IPO, it would appear to be a flat-liner. MRCC may be yielding a lower valuation compared to peers due to this poor management choice.
The company presented their change in per share NAV from 12/2014 – 12/2016 as shown in the adjacent table:
Though this graph does not tell the entire story of the dilutive raise in 2013, it shows that the company has made progress over the last two years, growing shareholder value. For the credit environment that BDCs have encountered over the past few years, keeping a stable NAV since IPO, is still quite a strong accomplishment, especially having a higher yield, on average, against the BDC universe.
Monroe Capital has not increased their dividend since March 2015, when they increased it by $0.01 to $0.35. Their current yield is 9.19%, trades above the BDC universe average of 8.41%. Since they have not recently grown their dividend, their current and 1-YR future dividend coverage ratios sit at 113.58% and 111.18%, respectively. These ratios have come down and remain well below their BDC peer’s current coverage ratio of 100.01%.
Main Street Capital Corp (“MAIN”), which is internally managed, has a track record of repetitive and outsized realized gains at exit, which has led to its 12.3% GAAP ROE. On the other hand, on 3/31/2017, MRCC has the eighth highest GAAP ROE amongst the BDC universe (a total of 50 BDCs), at 11.5%.
MRCC has had an ROE consistently higher than peers, a material indicator of sector outperformance.
MRCC’s normal target regulatory leverage level is 75%, which embeds a cushion from the actual limit of 100% (1:1x). MRCC utilizes SBA debentures (off-balance sheet) to lever up further as they do not count towards the regulatory debt limit for BDCs. Total leverage (including SBA debt) was 88% at the end of 12/31/16.
We used our proprietary method to estimate, on a fair value basis, MRCC’s true portfolio risk as of 12/31/2016. Their balance sheet consisted of 66.7% first-lien senior secured loans, 12.5% unitranche loans, 14.4% junior secured debt, and 6.4% equity investments. This is a much more secure portfolio than the BDC universe that averages approximately 60% senior debt investments (MRCC’s senior debt is 79.2%, as unitranche is considered a senior debt product). We calculate that the average exposure to “first-lien” loans for the BDC universe is closer to 39.5%, well below MRCC’s exposure. Senior positions in the capital structure of portfolio companies allows the BDC to incorporate beneficial covenants like higher origination fees and prepayment fees. The company has minimal exposure to oil and gas investments. Oil and gas is 1.9% of the portfolio, and other energy-related investments like metals and mining and automotive are under 3.1%, in total. Moreover, its retail investments of 5% of the portfolio are in asset backed lending structures and thus do not represent the current cyclical trend concerns of the rest of the retail space.
The numbers in red are what the company presents its allocation to each category, but we dug into the 10-K and separated the second lien/unitranche loans out of the Stated Secured and placed them into Mezz/Sub debt. Our calculations are in black and are how I think these assets should be grouped. These second lien and unitranche loans react more like sub-debt than senior secured debt in an asset recoverability test. Unitranche has a slightly higher recoverability rate than second lien.
Moody’s data indicates that from 1982 to 2010 the expected recovery rate from first- or second-lien debt differs substantially (as measured by post-default trading prices rather than ultimate recovered dollars) – the first-lien debt expected recovery rate was 60%, second-lien was 28%. A second-lien position has a substantially lower recovery rate in the event of a default than a first-lien