2023-06-21 14:11:49 ET
Summary
- GSBD and MRCC have among the highest dividend yields for the BDC sector, currently over 12%.
- We compare the credit quality of their portfolios to help explain why these companies typically have higher yields.
- One of these BDCs has a relatively safer portfolio, and we provide a list of positive and negative considerations.
- Also, please see the chart at the end of this article comparing the potential impact on NAV per share for each BDC, assuming that 100% of watch list investments (including non-accruals) defaulted with 0% recovery.
Quick Introduction To business Development Companies
Business development companies ("BDCs") invest shareholder capital in privately-owned, small- and medium-sized U.S. companies generating income from secured loans and capital gains from equity positions, much like venture capital or private equity funds. Anyone can invest in BDCs as they are public companies traded on major stock exchanges. Also, many BDCs have investment grade ("IG") bonds/notes for lower-risk investors building a balanced 60/40 portfolio (composed of 60% to 70% stocks/equities and 30% to 40% bonds or other fixed-income offerings).
This article compares portfolio credit quality for Goldman Sachs BDC (GSBD) and Monroe Capital ( MRCC ) which currently have among the highest dividend yields, as shown below, likely for the reasons discussed below. Earlier this month, we discussed FS KKR Capital ( FSK ), PennantPark Investment ( PNNT ), and Prospect Capital ( PSEC ) in the following articles:
- PennantPark: Big Win From Dominion/Fox Settlement
- Better High-Yield Buy: FS KKR Or Prospect Capital?
Please see the chart at the end of this article comparing the potential impact on net asset value ("NAV") per share for each BDC, assuming that 100% of watch list investments (including non-accruals) defaulted with 0% recovery.
Comparing Portfolio Credit Quality
Author's Note: The following information was provided to subscribers of Sustainable Dividends along with a constantly updated full risk profile and rankings for GSBD and MRCC .
Goldman Sachs BDC
During Q1 2023, GSBD's NAV per share decreased by $0.17 or 1.2% (from $14.61 to $14.44), mostly due to marking down its "watch list" investments, including Zep Inc. , MPI Engineered Technologies , Ansira Partners , Professional Physical Therapy , MedeAnalytics , and Wine.com partially offset by issuing shares above NAV. GSBD's NAV per share has declined by 20% over the last five years.
GSBD fully exited its non-accrual second lien debt investment in National Spine and Pain Centers , resulting in a realized loss of $36.3 million or $0.35 per share.
Non-accruals remain low but increased from 0.3% to 0.6% of the portfolio fair value due to adding its "watch list" investment in MPI Engineered Technologies partially offset by marking down some of the others (as shown below).
Ansira Partners is also held by CCAP and BCSF , which previously considered this investment non-accrual. GSBD finally added during Q3 2022.
Professional Physical Therapy is a provider of outpatient physical/hand therapy and rehabilitation services. This investment includes a PIK portion with a near-term maturity date (recently changed from January 31, 2023, to May 1, 2023).
The following table shows most of GSBD's watch list investments that currently account for around 9% of the portfolio fair value (over 11% at cost) and are likely the investments considered "Rating 3" as well as some of the "Rating 2" investments "performing as expected and the risk factors are neutral to favorable." GSBD recently exited its watch list investment in Tronair with a full recovery:
Sales and repayment activity totaled $12.6 million, primarily driven by the full repayment of investments by one portfolio company. We are pleased to note that this full repayment was by Tronair, which was previously a watch list name for us and a position that was a three on our risk matrix. Of note, Tronair was marked at 94 as of quarter-end December 31 and was repaid at par."
Thrasio Inc. is an acquirer of companies that sell through Amazon's third-party platform which has been discussed in previous reports.
Zep Inc. is a cleaning products manufacturer for industrial, institutional, food and beverage, vehicle care, and retail customers which also is held by OCSL that previously marked this investment down from 83% to 70% of cost compared to GSBD currently marked at 60% of cost.
Monroe Capital
The following is an update to " Why Investors Are Selling 12% Yielding Monroe Capital " which suggested that readers should sell their positions which was excellent timing as the stock is lower by 30% compared to the S&P 500 which has returned almost 35% during the same period:
During Q1 2023, MRCC's NAV per share declined by $0.10 or 1.0% (from $10.39 to $10.29) "primarily attributable to a couple specific portfolio companies that saw declining financial performance resulting from larger economic factors, including the rising interest rate environment and inflationary impacts on consumer spending." Its NAV per share has declined by 24% over the last five years:
Also, MRCC has experienced net realized losses of $55 million (around $2.52 per share) over the last five years, partially responsible for the previous 29% reduction in its quarterly dividend (as predicted in previous articles).
The amount of investments on non-accrual status declined from 0.5% to 0.4% of the portfolio fair value but the amount of "watch list" investments accounts for over 21% of the portfolio at cost, 14% of the portfolio fair value, and almost 33% of NAV, which is more than most BDCs (as shown later).
There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, realized losses, fee structures including "total return hurdles" taking into account capital losses, changes to portfolio yields, borrowing rates, the amount of non-recurring and non-cash income including payment-in-kind ("PIK"). Most BDCs have around 2% to 8% PIK income and I pay close attention once it is over ~5% of interest income. Higher amounts of PIK are typically a sign that portfolio companies are not able to pay interest expense in cash and could imply potential credit issues over the coming quarters. The amount of PIK interest income for MRCC remains around 15% of total interest income for Q1 2023:
BDC Valuations and Comparing Watch Lists
Author's Note: The following information was provided to subscribers of Sustainable Dividends along with updated target prices and suggested limit orders (for making purchases) for GSBD and MRCC .
There are very specific reasons for the prices that BDCs trade driving higher and lower yields mostly related to portfolio credit quality and dividend coverage potential (not necessarily historical coverage). BDCs with higher-quality credit platforms and management typically have higher-quality portfolios and investors pay higher prices. This drives higher multiples to NAV and lower yields.
Please note that many investors consider MRCC to be a "trading" position (compared to "buy-and-hold") as well as a "Tier 4" mostly due to the combination of the following:
- Higher operating expense ratios
- Continued NAV decline of 24% over the last five years
- Continued realized losses, including $1.19 per share in 2021 and $0.10 per share in 2022
- "Watch list" investment previously over 21% of the portfolio at cost
- Need for relatively higher leverage to cover the dividend
- Higher payment-in-kind ("PIK") income, which increased from 9% in Q3 2022 to almost 15% of total interest income for Q1 2023
- Previous dividend reduction of 29% (predicted in previous articles)
The following chart shows the potential impact on NAV per share for each BDC, assuming that 100% of watch list investments (including non-accruals) defaulted with 0% recovery. This is the worst-case scenario for this group of investments. It's important to note that the chart only takes into account watch list investments and any changes to other positions will also have an impact (positive or negative). The largest NAV declines over the last four quarters were mostly BDCs with larger amounts of watch list investments.
Subscribers who believe the economy is headed for a "hard landing" with a deep, broad, and/or extended recession should focus on the BDCs closer to the top left corner .
As mentioned earlier, MRCC's watch list investments account for over 21% of the portfolio at cost and around 33% of NAV, which is more than most BDCs , as shown below. This is likely one of the reasons why the stock consistently trades 20% to 30% below its previous NAV per share.
Clearly, GSBD has a lower-risk portfolio compared to MRCC but not compared to what I would consider the "safer BDCs." As mentioned in previous articles, I was looking to trim my GSBD position and repurchase once dividend coverage and credit quality improve. On Feb. 25, 2022, I sold 33% of my shares at $20.00, reducing GSBD to my smallest position (as shown below, currently under 3% of my portfolio). I will reassess my position after the company reports Q2 2023 results in early August 2023.
The following are many of the positive considerations for GSBD, most of which were discussed earlier:
- Potential upgrade if there is continued progress with dividend coverage (without the need for fee waivers) and reduced amounts of watch list investments
- Consistent historical dividend coverage (mostly due to waiving/not paying incentive fees)
- Lower expense ratio mostly related to previous fee waivers but also due to its base management fee of only 1.00% (among the lowest in the sector)
- Recent equity offering reduced leverage
- Undistributed taxable income ("UTI") of around $0.78 per share
- 44% of borrowings are unsecured (flexible) with the nearest maturity in February 2025
- Investment grade ratings by Moody's (Baa3) Stable
- "Total return" hurdle or "look back" provision when calculating income incentive fees to protect shareholders from capital losses
- Relatively lower non-accruals at 0.6% of portfolio at fair value
- First-lien investments account for almost 93% of the portfolio fair value
- Diversified portfolio with 133 portfolio companies
- Recently exited its watch list investment in Tronair with a full recovery
- The amount of "watch list" investments as of March 31, 2023, was around 9% of the portfolio fair value (11% at cost), which is slightly better than average
- The amount of investments considered "Rating 3" to have "risk has increased materially" and/or "out of compliance with debt covenants" from 15.6% to 3.3% of the portfolio over the last 10 quarters
- Over 99% of the portfolio debt investments at variable rates (good during higher rates)
- During Q4 2022, GSBD received exemptive relief from the SEC, allowing joint transactions with its affiliates
The following are many of the negative considerations for GSBD, most of which were discussed earlier:
- One of the few BDCs not to increase its regular and/or pay supplemental/special dividends over the last two years (as predicted in previous reports).
- Historical dividend coverage was reliant on fee waivers
- The potential for a dividend reduction to $0.40 per quarter with lower portfolio yield.
- Recently marked down its watch list investments in Zep Inc. , MPI Engineered Technologies , Ansira Partners , Professional Physical Therapy , MedeAnalytics , and Wine.com.
- NAV per share has decreased by almost 21% over the last six years.
- Its 'watch list' investment in MPI Engineered Technologies was added to non-accrual.
- National Spine and Pain Centers was previously on watch list but exited during Q1 2023, resulting in $0.35 per share of realized losses.
- Net realized losses of $185 million or $1.70 per share over the last 10 years.
- Slightly higher-than-average leverage.
For further details see:
Safer 12% Yield: Goldman Sachs BDC Or Monroe Capital