Monroe Capital Corp - Another New Filing

(This post is also being published on Seeking Alpha - either as an Instant Blog or real article)


Monroe Capital Corp filed papers to register as a BDC on March 3rd, they just recently filed amended papers on April 19th (N-2/A) for their shelf statement (correcting a typo in the original filing and increasing the fees). This new BDC is a division of Monroe Capital, a smaller private lender that was established in 2004 and currently manages around $440mm. There is an "MCAP" (Mango Capital) traded on the OTC BB, so for this stock, they went with "MRCC" instead (all of the good M tickers are taken). There is a backlog of new BDCs to profile and that raises a concern. We all know from Porter's 5 Forces that Barriers to Entry is a key driver for a company maintaining superior returns. It appears the SEC registration process is no longer a barrier for a number of smaller CLO/PE managers and the potential returns are worth the effort. Will this increased competition hurt some of the other BDCs? Only time and the 10-Qs will tell.


Organization
The company will use Monroe Capital BDC Advisors, LLC (MCAD), an entity formed for the purpose of serving as investment advisor. MCAD will provide MRCC with investment professionals and portfolio selection. Interestingly, they will also use another LLC - Monroe Capital Management Advisors (MCMA), LLC to serve as the administrator. The two entities mean that expenses are split - MCAD will receive the management and performance fees and MCMA will bill MRCC the proportional share of expenses. This setup is slightly different from other external managers and it may result in additional expenses, but there is no way to know how this setup will affect returns.


People in Charge
The investment decisions will be led by Theodore L. Koenig and Daniel M. Duffy. Theodore Koenig is a former lawyer, coming from the defunct firm of Holleb & Coef. After Holleb, he was president and CEO of Hilco Capital. Daniel M. Duffy comes from a more traditional finance background by way of CapitalSource and GE Capital. From what I can find on Mr. Duffy via his old CapitalSource bio:

Mr. Duffy has over 21 years of experience in corporate finance providing both debt and equity capital to companies in a wide range of industries. Mr. Duffy has been with CapitalSource since April 2003. Prior to joining CapitalSource Mr. Duffy was managing director in charge of GE Capital's debt placement team. Mr. Duffy joined GE Capital via its acquisition of Heller Financial where he spent 12 years acting in a number of leadership roles including co-head of the media lending team senior credit officer in corporate finance senior credit officer in equipment finance and team leader in loan workouts. Prior to joining Heller Mr. Duffy received his B.S. in accounting from Northern Illinois University in 1984. 

The filing also mentions that 18 professionals from Monroe Capital will also be supporting the firm. There will be no direct employees.


Fees
This is something interesting to note. In the original filing (glad I did not post this last week), the management fees were stated as 1%, as of the 4/19 filing, management fees are stated as: "calculated at an annual rate equal to 2% of our total assets (which includes cash, cash equivalents and assets purchased with borrowed amounts)." The inclusion of cash and cash equivalents makes this one of the higher management fees. The first part of the incentive fee is 20% of Net Investment Income subject to an 8% annual hurdle rate.
The first, payable quarterly in arrears, equals 20% of our pre-incentive fee net investment income (including interest that is accrued but not yet received in cash), subject to a 2% quarterly (8% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, MC Advisors receives no incentive fee until our net investment income equals the hurdle rate of 2% but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, MC Advisors will receive 20% of our pre-incentive fee net investment income as if a hurdle rate did not apply. The first component of the incentive fee will be computed and paid on income that may include interest that is accrued but not yet received in cash.
The second part is:
The second part is determined and payable in arrears as of the end of each fiscal year in an amount equal to 20% of our realized capital gains, if any, on a cumulative basis from inception through the end of the year, computed net of all realized capital losses on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees.

This is similar to other BDCs like BKCC where a huge liability may be payable at the end of the year and introduce some seasonal earnings into the 10-Q analysis. One other note - Monroe is also looking to pay up to 50% of the fee (pursuant to SEC approval) in MCBDC stock.

Portfolio Composition
The company expects to invest most of the proceeds of the IPOunitranche or junior-secured. The firm
expects to make investments in the $5mm to $25mm range, but maintains that range may drift as the firm's capitalization increases. As per the filing, the initial portfolio will have these statistics:
  •   Loans with a weighted average yield of 7% to 8%;
  •   Emphasis on middle market transactions;
  •   Minimum of 90% senior debt investments (including unitranche debt);
  •   Maximum concentration of 15% in any one industry;
  •   Average loan position of less than $5,000,000; and
  •   Loans with maximum loan-to-enterprise value ratio of between 50% to 70%


Risks
Standard risks are outlined here. The N-2/A has a lengthy list of risks as well that are worth reading.

I will keep everyone updated as this company moves along and IPOs.

TPG Special Situations - New Guy on the Block

On January 14th, TPG Specialty Lending, Inc., the Special Situations division of Private Equity giant TPG Capital filed a 10-12G (Initial Form for General Registration of Securities, aka IPO overview) with the SEC. Judging by available tickers and what other companies have been doing, I assume they are going to go with "TPGM" (TPG Management, there already exists a TPG Capital, the parent) and for the sake of brevity I will refer to them as that for the rest of this post.

Organization
The company will use TSL Advisers (affiliate of TPG Capital) as the investment adviser and enter into an "Administration Agreement" with them. This means TPGM will essentially outsource all functions to them. TSL will provide the new firm with investment professionals, investment decisions, facilities and reporting functions. The new firm will operate very much like other externally managed BDC's such as Ares Capital (ARCC) and Apollo Investment (AINV).

People in Charge
The investment decisions will be led by Co-CIOs Alan Waxman and Joshua Easterly, both former Goldman Sachs employees. Mr. Waxman was the co-founder of the Goldman Sachs Specialty Lending Group (GSSLG) and Mr. Easterly is a former co-head of that group. The statement also stipulates that they have a team of over 20 dedicated professionals. The Board of Directors will be at the time of IPO only 5 people, where at least 3 people cannot be "interested persons" of the Company. The document states that the firm does not intend to ever have any direct employees.

Fees
This is where the filing gets interesting. An externally managed BDC is usually setup by the external manager as a way of increasing fee income. In a way, it is a publicly-traded CLO where the equity can be held by anyone. The manager collects a management fee + a performance fee. TPG Capital will collect a 1.5% management fee of the Company's average total gross assets of of the end of the quarter. Until the IPO, TPGC will not collect a fee and for the first two quarters the fee will be based on the quarter-end gross assets.
The performance fee will have two components. It is best to copy/paste directly from the filing on this one. "(i) Following an IPO, the first component of the Incentive Fee will equal 100% of the excess (if any) of pre-Incentive Fee net investment income over a 1.5% quarterly (6% annualized) hurdle rate, until the Adviser has received 17.5% of total net investment income for that quarter, and 17.5% of all remaining pre-Incentive Fee net investment income for that quarter. No Incentive Fee will be payable under this component for any quarter in which pre-Incentive Fee net investment income does not exceed the hurdle rate for that quarter. Prior to an IPO, the first component of the Incentive Fee payable by the Company will be subject to a reduced rate.

     “Pre-Incentive Fee net investment income” means dividends (whether or not reinvested), interest and fee income less operating expenses, calculated on an accrual basis.

     (ii) Following an IPO, the second component, payable at the end of each fiscal year in arrears, will equal a percentage, which we refer to as the “Weighted Percentage,” of the cumulative capital gains from the inception of the Company to the end of such fiscal year, minus the aggregate amount of any previously paid capital gain Incentive Fees for prior periods; but in no event will be less than zero. The Weighted Percentage will be calculated at the end of each fiscal year of the Company that occurs following an IPO and is intended to ensure that the portion of the Company’s capital gains that accrued following an IPO will be subject to an incentive fee rate of 17.5% and the portion of the Company’s capital gains that accrued prior to an IPO will be subject to a reduced rate. The Weighted Percentage will be calculated in the manner set forth in the Advisory Agreement, the form of which is filed as Exhibit 10.1 of this Registration Statement. Prior to an IPO, the second component of the Incentive Fee payable by the Company will be subject to a reduced rate.

“Cumulative capital gains” means, on any relevant date, cumulative realized capital gains, less the sum of (a) realized capital losses and (b) unrealized capital depreciation on investments, in each case as of such date. "

In normal person terms - this means they will collect 1.5/17.5 (kind of like a hedge fund 2/20 standard), with a quarterly high water mark of 1.5% on the NII + they get a kicker at the end of the year based on Capital Gains.

Portfolio Composition

Like most of the other BDC companies, TPGM will focus on senior secured loans, first and second lien, some unitranche loans (this post does a nice job of explaining), some mezzanine loans, structured equity and even straight equity/warrants.  Most of the equity instruments will be hand in hand with another more senior investment.

Private Offering
Prior to the IPO, the company will have private offering with a number of investors that provided seed capital. The company will structure the private offering like a Private Equity fund where investors will make an initial capital commitment and drawdowns (capital calls) will take place. These initial shareholders will not be able to sell their stock until the restrictions are lifted. The release condition would be for TPGM to have an IPO that results in the Company having a common stock float of at least $75 million or for the fourth anniversary of the private closing to have passed. TPGM has also reserved the right to offer a board seat to a member of the initial private subscription group.

Stated Risks
This could easily be another post, but I will list the main bullet points here

• We are a newly-formed company with no operating history
• We will be dependent on upon management personnel of the Advisor for our future success
• The Adviser and its management have no prior experience managing a BDC
• Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital.
• We may borrow money, which may magnify the potential for gain or loss and may increase the risk of investing in us.
• We will operate in a highly competitive market for investment opportunities
• Even in the event the value of your investment declines, the Management Fee and, in certain circumstances, the Incentive Fee will still be payable (No matter what, TPG will get paid)
• We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code.
• There is a risk that you may not receive dividends or that our dividends may not grow over time. 
• You may be subject to filing requirements under the 1934 Act as a result of your investment in the Company.
• You may be subject to the short-swing profits rules under the 1934 Act as a result of your investment in the Company.
• Potential conflicts of interest could impact our investment returns.
• Our Board may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
• Changes in laws or regulations governing our operations may adversely affect our business.
• The Adviser can resign on 60 days' notice. We may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations. 
• To the extent that we do not realize income or choose not to retain after-tax realized capital gains, we will have a greater need for additional capital to fund our investments and operating expenses.

So there you have it. I encourage anyone who would like to know more about a BDC to read as many 10-12G filings as possible as this provides you with a great look into how the firm was organized (most of these filings have some copy/paste to them) and it provides a number of definitions in it.

American Capital NASDAQ: ACAS

American Capital (stock price of 6.57 as of 10/25/2010) will be the first BDC that I am reviewing. They are one of the oldest and largest of the BDCs. Of note, they are also in a form of zombie status due to certain issues that arose during the financial crisis starting in 2008. Most of the material presented below was taken from the company's webpage www.americancapital.com, SEC filings and news articles found on Google.

Overview 

Directly lifted from the webpage - American Capital (Nasdaq:ACAS), with $15 billion in capital resources under management, is a publicly traded private equity firm and global asset manager. American Capital, both directly and through its global asset management business, originates, underwrites and manages investments in middle market private equity, leveraged finance, real estate and structured products. American Capital and its affiliates invest from $5 million to $100 million per company in North America and €5 million to €25 million per company in Europe. 

The company is headquartered in Bethesda, Maryland and has offices in Boston, Chicago, Dallas, New York in the US and international offices in Hong Kong, London and Paris. Judging by headcount, it appears the main offices in the US are its headquarters and the Dallas office. The company used to have a Pittsburgh office, but that office appears to have been closed over the summer in 2000. Also, it appears that office in Los Angeles and Philadelphia were also closed sometime within the past two years. It was founded in 1986 and taken public in August 1997. The IPO consisted of 7 million shares, up to 645,161 shares offered to the directors, officers and other employees of the company and up to 364,606 shares issued as warrants to the underwriters. An interesting note is that the company currently has over 340million shares outstanding The managers who took the company public (as per the Form N-2) were David Gladstone, Malon Wilkus and Adam Blumenthal. The company had a very successful run up until the end of 2008 when the company's stock price was crushed due to portfolio markdowns that triggered various credit events. If someone was fortunate enough to get out at that time, they would have recognized a Total Return of about 200%. Just in case you were curious, Total Return is equal to the actual rate of return of an investment over a given period of time including interest, capital gains, dividends and any distributions.

Originally this post was going to discuss the investments, management, loan issues (zombie company) and other major factors, but as I was writing them up, I realized it was a small novel to complete all of that information. So, I will space out the posts and add more meat to each section. The first section I will cover is the ACAS Investment mix and changing strategies. The firm's portfolio has changed quite substantially since the IPO in '97, so there will be some interesting charts.

What is a BDC?

If you have stumbled onto this blog via Google or some other link, then most likely you have a basic idea of what a Business Development Company (BDC) is. Just in case you do not, here is a quick overview of a BDC.

A BDC is a closed-end, may or may not be diversified investment management company that has a class of its shares registered under the Securities Exchange Act of 1934. BDCs were established as a part of the Investment Company Act of 1940 Section 54 (page 105 on that link if you are curious).  They were established in part to spur investment in smaller business after the Great Depression that banks were not willing to provide. The main points of the law establish what a BDC may and may not do.

Some key examples - a BDC must maintain an asset coverage ratio of 200%. Most other publicly traded funds (mutual funds) must maintain a coverage ratio of 300%. What is an asset coverage ratio? Typically it is defined as a ratio of debt to total assets. This means if all of the firm's debt/liabilities came due at this exact time, would they be able to cover them? So, if a firm issued $10m in Equity, they could also issue $10m in Debt. This is also referred to as their debt to equity ratio.

Investment Restrictions - A BDC must have at least 70% of its portfolio invested in eligible portfolio companies. What is an eligible portfolio company? One, it must be a company that is organized and has its principal place of business in the USA, sorry foreign issuers. Two, it must be a non-investment company unless it is a SBIC (small business investment company) that is wholly-owned by the BDC. Finally, it must be a company that does not have a class of publicly traded securities. In plainer English, an eligible portfolio company is a small to medium-sized (rarely large) non-public business.

Investment Types - Most likely a BDC will extend some form of debt financing to a portfolio company. This financing comes in all shapes and colors, from a Senior Secured Loan all the way down to Common Equity. If you do not know what those are, Investopedia may be a decent help or you can wait for my next post.

Managerial Assistance - A BDC is expected to offer significant managerial assistance to a portfolio company. The reason for this is because a BDC is there to help a company thrive. The managerial assistance may take the place of balance sheet restructuring, recruiting and hiring a managerial team and exploring mergers and acquisitions (or divestitures) for the company.

Taxation - A major reason for a company to be organized as a BDC is to be classified as a “regulated investment company” (RIC). As a RIC, the company avoids having to pay corporate taxes on capital gains and investment income that is distributed to shareholders.  To be a qualified RIC, the BDC must distribute at least 90% of the above to shareholders in the form of dividends. If at any time a BDC fails to comply as an RIC for the year, they will be subject to corporate taxes as a regular "C corporation" under US Tax Code.

Dividends - Due to the Taxation treatment above, BDCs will tend to pay out most of their Net Investment Income in dividends to shareholders. The reason why NII is used is because it represents the money that a BDC is taking in from interest payments, capital gains or dividends (from a portfolio company). If a BDC overpays their dividend (shortfall - Dividend Amount > NII per Share), that means the company had to either sell assets, issue equity, take on more debt or some combination of the three. Other times a BDC will underpay their dividend. The reasons for underpaying are varied, but include times when a BDC is anticipating a dividend shortfall in the future or making a significant asset purchase.

There you have it, the quick overview of what a BDC company is. In my next posts I will expand on these topics and then begin an analysis of each BDC company. I plan on going in alphabetical order by ticker symbol so anyone hoping for a TCAP review may have to wait awhile.