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BDC Preview: Week Of March 25 – March 29, 2019

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Medley Mania: This week brings the triple merger vote – postponed multiple times – by the Medley companies on March 29. However, chances are there will be much happening even before the digital ballot boxes are opened. Last week we had the sudden – and shocking – resignation of two of Medley Capital’s (MCC) “independent” directors. That’s caused problems for the BDC which needs a quota of disinterested directors to be publicly listed and to meet SEC regulations. We just don’t know by when MCC has to name replacements, and who they might be. Moreover, what role do “independent” directors play now that the votes are almost cast ? And – throwing one more question into the pot – what about the two remaining “independent” directors at MCC ? Are they happy to stay around or will further resignations be coming ?

Just as intriguing will be what happens to the hat thrown in the ring at the last minute – or Friday after the close to be exact – by Marathon Asset Management. The huge firm has asked MCC shareholders to vote AGAINST the proposed merger; adding its name to a very long list of opponents. However, unlike most other players, Marathon is asking MCC shareholders to give them the chance – at a later date – to become the Investment Advisor of MCC (and Sierra Income, too, for good measure) in replacement of Medley Management (MDLY). The terms of the offer are contained in a filing, and were featured on our BDC Reporter Twitter News feed. We won’t go into the details of Marathon’s offer right now. After all, we’re still curious if MCC shareholders will get a final version of the Proxy (Friday’s version was a preliminary version, with some blanks included). We also wonder if MCC shareholders do pronounce a resounding NO to the proposed three-way merger, whether they will want to open the gates to Marathon, and not wait for a broader marketing process, and a better offer. If there’s one thing we’ve learned from the recent lawsuit by FrontFour Capital against Medley’s insiders is that there are numerous potential suitors waiting in the wings for what could b the biggest M&A catch of the year in the BDC sector.

We’ll also be looking out for news about existing and new lawsuits. Medley is seeking to block several dissident shareholders from voting in the election in Federal court  and a disgruntled shareholder is suing them in Delaware Chancery Court, as we covered last week. As the song goes, “some will win and some will lose/some were born to sing the blues”. But whom ? Or will FrontFour sue in Delaware Court for damages, rather than just to stop the vote, at which they failed ? Plus, what happened to the additional disclosures the Delaware Court insisted would need to be added to MCC’s disclosures to provide a fair picture of the unfair process involved in the proposed transaction ? Oh, and what is the word from the SBIC about allowing Sierra Income to acquire MCC’s licenses ? In the past the SBA/SBIC have been sticklers about getting repaid when there’s a change of ownership at a BDC (see what happened at Oaktree Specialty Lending as it shed its Fifth Street Finance persona a little while back – all the SBIC debt was repaid prior to the close).

Keep an eye on MCC and MDLY’s stock price and the four public bonds outstanding, especially the two issued by the latter. Speculators are pouring in, each with a view as to what the ultimate outcome will be. We’ve been watching this strange story unfold for months – if not years – and have no certainty about anything. On Friday the prices of MDLY and its two publicly traded  bonds jumped in price, as did MCC. However, that could readily reverse itself in the week ahead. As Bette Davis would have said on this occasion: “Fasten your seatbelts”.

Market Prices: As readers of the BDC Common Stocks Market Recap already know, the BDC rally that began December 24, 2018 peaked out on February 22, more than a month ago. Since then the sector has dropped by (3.5%). Earnings season has now officially and completely come and gone and investors have not rushed to put more money to work in these vehicles. Even the Fed’s rate pause – which will assuage rising concerns about future affordability of leveraged financing – did not result in any material uptick in sector pricing. Then there was the broad sell-off in all markets on Friday as everyone started to worry again – as they did late in 2018 – about the health of the global economy. That brought all the indices down. Will that sentiment of impending doom continue in the week ahead or will the non-indictment of the President result in more than a passing bump to market prices ? Obviously we don’t know, but the trend of late has been to the downside.

Capital Markets Activity: What happens to BDC prices will be followed by the senior management of several BDCs, anxious to take advantage of what have been propitious conditions through the first quarter of 2019. We’ve had equity raises from Horizon Technology (HRZN) and Stellus Capital (SCM). There may be other candidates who want to follow a similar path. Likewise where unsecured debt is concerned – where conditions are back to as “normal” as possible. Monroe Capital (MRCC), Ares Capital (ARCC) and Prospect Capital (PSEC) have already issued new debt in recent weeks, and others are likely to follow. We’ll be looking out for who that might be. Just as important – but likely to receive less attention – are continuing changes in BDCs secured debt financings. Many BDCs are increasing Revolver sizes and getting permission from their lenders – protected as they are by a first lien interest  in the assets and moderate advance rates – to allow much higher balance sheet leverage. Who gets what from whom will largely decide if a BDC can take full advantage of the Small Business Credit Availability Act and the higher leverage allowed. From what we’ve seen of secured debt changes made to date, the bankers are eager to please and looser covenants may be joined with better pricing in some cases. We’ll be providing more in-depth analysis if and when we hear of new secured debt deals and ry to tease out the longer term implications.

Loose Strings: We may or may not hear more from Newtek Business (NEWT) about last week’s arrest of five employees by the FBI. This is a story that began in October 2017 and included a very public raid by that same FBI on the offices of a recently acquired NEWT subsidiary. Now the BDC is claiming that any misdeeds that might have occurred did so before NEWT came on the scene. For investors, NEWT projected the problem and the remediation undertaken will not have any material impact on the BDC going forward. That might be good news for a NEWT stock price that has been weaker of late after a mighty run-up, as this two year chart shows. The price weakness probably has more to do with concerns about growth prospects for the business than what the FBI is doing but tying up this subject may remove at least one uncertainty where NEWT is concerned.

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