Introduction: Monroe Capital (MRCC), a business development company that we follow. It was just reported yesterday that there was some high level of insider buying in the past 2 weeks by officers, directors, and managers. We believe that MRCC is attractive at the current prices and investors who do not own the stock should initiate a small position. Note that the stock has a very small market cap of $220 million, and because of this, it has been volatile. The best approach is to buy in small amounts and average down on large pullbacks.
Monroe Capital Corporation is a conservatively managed BDC that makes senior loans and has a good track record. The share price has taken a hit recently with the price falling by 21%, from recent highs near $14 to just at $10.8 recently. At the current price, it is a compelling bargain. It pays a dividend of 35 cents per quarter for a yield of 12.65%. Net asset value ('NAV') as of the end of the most recent quarter was $12.95 so that it is now trading at a discount of 22% to NAV.
We will explain in this report the reasons behind this pullback and why the stock is an attractive investment for income investors.
Monroe Capital is a BDC that follows the basic model of making senior loans to small- and middle-sized businesses and using leverage to enhance net investment income. It has had a steady stream of "net investment income" ('NII') covering its dividend, with NII covering the 35 cents quarterly dividend for every quarter since the first quarter of 2014.
MRCC's portfolio is dominated by 77.8% of senior secured loans. Uni-tranche senior loans constitute 10.30% of the portfolio and junior secured loans are at 5.7%. MRCC has a new joint venture (Senior Loan Fund) which is 3.8% of the total portfolio (and consists almost entirely of senior secured loans). Equity holdings represent 2.4% of the portfolio. This investment profile is considered to be a conservative in the BDC world. While first lien secured loans are safest, loans further down the chain, in small amounts and with carefully selected high-quality borrowers, are a good way to boost income.
The portfolio is very well diversified by business and geography. The regions of the country represented evenly. Retail has been struggling over the last couple of years and only represents 7% of the portfolio. Energy, which has also been problematic for some BDCs, constitutes only 0.5% of the portfolio. There are no CLO or CDO holdings.
As of their latest reported results, the weighted average effective yield on MRCC's loan assets was 10% and MRCC just recently closed an offering of notes at 5.75%. That spread will enable MRCC to generate increased investment income from higher leverage that is now permitted under the revised BDC leverage rules.
What About the Recent Underperformance?
Monroe Capital in the past has had a good performance. A growing NAV and producing enough Net Investment Income ('NII') to cover its dividend. However, lately, their earnings have been disappointing to investors. Monroe Capital decided to clean up their balance sheet resulting in some significant write-downs on some of its investments. These write-downs have caused a decline in GAAP earnings.
In a recent article on MRCC, we covered some of the issues. At that time, Monroe Capital was still carrying TPP loans at a fair value of $3.7 million (although that was a significant markdown from their original value) and we highlighted the risk of a total write-off. As of the latest quarter, the TPP position has been written off completely to zero. This company is no longer a risk to Monroe Capital's performance going forward. This is what we call the trivial solution to the problem, but at least any further risk is gone.
The biggest concern to investors was another loan: The Rockdale Blackhawk loan. Rockdale was the subject of considerable discussion at the most recent quarterly conference call. Management's position is that its investment is substantially protected by assets and that Rockdale's only problem is that it is a health care company and one insurance carrier is refusing to pay reimbursement which is creating a cash flow problem.
New Developments Since the Last Earnings Report
Since the last earnings report, MRCC has had additional developments with the Rockdale borrower. Rockdale has refiled for liquidate (Chapter 7 bankruptcy) instead of just reorganization (Chapter 11 bankruptcy). This bankruptcy seems to have been forced by MRCC itself because it appears that Rockdale has been submitting questionable lab work invoices to its insurance company who refused to pay them. At a minimum, the lab work was charged at a higher rate or not even done. Here is a link on the issue.
So, in the next quarter, MRCC will have to take an additional charge for the balance of the Rockdale loan amounting or $0.87 per share reducing the Net Asset Value per share to $12.08, or a write-down equivalent to 6.7% to MRCC's Net Asset Value.
The Good News
Now, all the bad news is out and all the problem loans will be marked to zero. The balance sheet "clean-up" by the management will be done with. This removes a lot of uncertainties going forward.
Factoring in a 100% write-down of the Rockdale loan, this will bring down NAV from $12.95 to $12.08. At the current share price, MRCC would still be attractively priced at 12.6% discount to NAV.
Again, what is the most important thing to note is that these write-downs are non-recurrent and the clean-up is over with. Importantly, all this clean-up will have no impact on the dividends as all these loans were already on a non-accrual basis. In fact, I like the conservative approach of management and writing off the problem loans is the right strategy. Going forward, MRCC is poised to show much stronger results.
For Income Investors, The Dividend Safety is What Matters
As an income investor, what I care about is the safety of the dividend, the outlook of the company, and an attractive entry price. Of course, the higher the dividend, the more attractive the investment becomes. MRCC ticks all the right boxes.
- MRCC currently pays a quarterly dividend of 35 cents a share. Priced at $10.80 a share, this produces a very attractive annual yield of 13%. The dividend amount has been the same since March 2015 and well covered by Net Investment Income ('NII'). Management affirmed its confidence in continuing the dividend at the current level in its most recent conference call.
- More importantly, management pointed out that Monroe Capital has some 46 cents per share of "undistributed net investment income". This must be distributed to shareholders and provides a buffer in case future ongoing cash generation doesn't fully cover the dividend. Note that in the most recent quarter, the dividend was covered by net investment income of 38 cents - or a 109% coverage. As noted above, "net investment income" has covered the 35 cent dividend for a considerable time, and the dividend coverage remains solid.
For Q3, NII was $0.38 which more than covers the dividend of $0.35. Given that the troubling assets are now gone, we expect positive surprises going forward.
Return to Growth
The decline in NAV that we have seen lately should stop after the Company reports the next quarter. They will have to write-off the Rockdale loan, but this is more than factored in given the low valuations.
Furthermore, MRCC is set to benefit from the liberalized leverage rules for BDCs and plans to do so. In addition, its SLF joint venture is rapidly growing. As of the end of the latest quarter, the SLF portfolio has grown to $134.9 million in fair value, a 42% increase, from the $94.8 million of fair value at the end of the prior quarter.
Insider are Buying, Should You?
It was just reported yesterday on January 07, 2019, by Monroe Capital Corporation the purchase in the open market of more than 45,650 shares of MRCC common stock by officers and directors of the Company and senior management of Monroe Capital Management Advisors, LLC ("MCMA"). This has been taking place over the past two weeks.
- Theodore Koenig, Chief Executive Officer of the Company, and Aaron Peck, Chief Financial Officer of the Company, collectively increased their shareholdings in MRCC by 15,200 shares as disclosed in recent Form 4 filings with the Securities and Exchange Commission (the "SEC").
- Thomas Allison and Robert Rubin, independent directors of the Company, collectively increased their shareholdings in MRCC by 7,700 shares as disclosed in recent Form 4 filings with the SEC.
- In addition, senior management of MCMA collectively increased their shareholdings by approximately 22,750 shares. This included purchases by Michael Egan, Chief Credit Officer and Chief Operating Officer, Tom Aronson, Managing Director and Head of Originations, Kyle Asher, Managing Director and Head of Underwriting of Opportunistic Credit, Carey Davidson, Managing Director and Head of Capital Markets, James Cassady, Managing Director of Operations and Compliance, Alex Franky, Managing Director and Head of Direct Underwriting, Peter Gruszka, Managing Director and General Counsel, Karina Stahl, Managing Director of Finance and Operations, Zia Uddin, Managing Director and Portfolio Manager - Private Credit and Jeremy VanDerMeid, Managing Director and Portfolio Manager - CLO and Loan Trading.
Chief Executive Officer Theodore Koenig commented:
Given all the volatility in the capital markets in the last thirty days, in my opinion, the share price of MRCC does not properly reflect the value of the Company today and presents an attractive investment option, currently paying well over a ten percent annual cash dividend. These recent purchases demonstrate management's confidence in the Company's long-term stability and growth potential."
If we count all the purchases, they amount to $493 thousands or 0.2% of the total market cap of the company. This happened in just 2 weeks, and therefore it is significant.
The selloff in the share price of MRCC is unwarranted. Investors are focused on the declines in NAV due to write-offs of loans that were already marked on non-accrual basis. The cleanup of the balance sheet will be done with, and the bad news is factored in.
Going forward, MRCC has good growth prospects and should see a stable and even an increasing NAV starting Q1 2019. The dividend yield of 13% and its safety makes MRCC an attractive investment. The fact that officers, directors, and management are buying is a great plus in my book and indicates that the worst is behind us and what is left is a clean balance sheet that supports this attractive dividend. Because this is a smaller cap stock and can be volatile, we advise investors not to allocate to MRCC more than 1.5% of the value of their portfolio.
About MRCC's Baby Bond
For more conservative investors, MRCC has issued a "Baby Bond", the Monroe Capital Corp., 5.75% Notes due 10/31/2023 (MRCCL). MRCCL is an attractive bond that currently yields 6%. MRCCL matures on October 31, 2023, and becomes callable on October 31, 2020. Since MRCCL is trading around $24.80/share, below its Par Value (or Call Price) of $25.00 per share, investors would get 6% interest for the period plus a capital gain of $0.2 per share. MRCCL pays a quarterly interest of $0.359375 on 1/31, 4/30, 7/31 & 10/31. This is a lower risk investment, especially with a view that the bond matures in less than 4 years. This is also a good way to place your money for a relatively short period of time. MRCCL goes ex-dividend on January 14 (on Monday next week) and investors will receive the interest of $0.359375 on January 31. As a reminder, "baby bonds" trade like stocks on the normal stock exchange, so you can buy it just like you would buy Apple (NASDAQ:AAPL) stock for example.
A note about diversification: To achieve an overall yield of 9%-10% and optimal level of diversification, at High Dividend Opportunities we recommend a maximum allocation of 2%-3% of the portfolio to individual high-yield stocks like MRCC and a maximum of 5% allocation to high-yield exchange-traded products (such as ETFs, ETNs, and CEFs). For investors who depend on the income, diversification usually results in more stable dividends, mitigates downside risk, and reduces the overall volatility of your portfolio.