Hear Ye. Hear Ye

One of the BDC sector’s favorite BDCs – Main Street Capital (MAIN) provided a brief update on steps being taken in the Covid-19 environment.

Here are the highlights drawn from a Seeking Alpha press release, and the BDC Reporter’s comments thereon.

We’ve written the following in a hurry with one eye on the ever-changing markets, so apologies in advance for any breathless prose.

Plans

Main Street Capital (NYSE:MAIN) says it’s executing its contingency plans in an effort to respond to the significant challenges resulting from the Covid-19 pandemic.

Specifically, it implemented remote work arrangements for its employees on Friday, March 13.

“Our employees are currently maintaining the normal functions necessary to meet our ongoing operational requirements and to fulfill the responsibilities and obligations to our stakeholders,” the company said in a statement.

The BDC is taking all the now-routine steps that most businesses of this type are undertaking.

We’d be surprised if the story was very different at the other 44 BDCs.

Checking In

Main Street said it’s “pleased with the diligence of and proactive actions taken by our portfolio company management teams and we remain confident in the ability of these teams and their employees to respond to the challenges associated with these circumstances.”

From what we’ve heard on recent conference calls – and our own experience on both sides of  leveraged lending – as banker and owner- MAIN has been calling round to its lower middle market portfolio companies asking for updates.

MAIN is less likely to have access to its Upper Middle Market (UMM)  portfolio companies – another drawback of being just one lender amongst many in a large financing, which we’ll discuss more below.

Confusing

In any case, from what we’ve heard from a number of sources, there’s very little companies can usefully report as the conditions are constantly changing and nobody can be certain of being operational as early as tomorrow.

In our own plywood business, where we have a major facility in Sacramento, every day for the last 3 days we’ve seen nearby counties announcing the intention to “shelter in place”.

That’s reduced the ambit of potential business activity but also introduced many unanswered questions about how to operate and with what staff, if at all.

We expect similar uncertainties are occurring across MAIN’s portfolio, so any update is almost immediately outdated.

MAIN’s personnel will – in all likelihood – be in “constant contact” for many weeks to come.

Deep Breath

The good news from a MAIN shareholder standpoint is that the BDC has been through this type of uncertainty before during the Great Recession in its lower middle market (LMM) portfolio.

As both lender and equity partner in most of its portfolio companies, MAIN has a wide range of tools to assist management adapt to the current situation and what might develop.

That includes the ability to advance new monies; waive covenants; defer debt service payments etc. in a more effective manner than any governmental authority can do.

The short term result might be dreadful looking quarterly metrics but these could resolve themselves in short order when the country returns to work, even if the crisis is followed by a recession.

Disclosure

More important than ever before will be clarity; transparency and granularity  from MAIN’s management about the challenges facing their portfolio companies.

Historically MAIN has been one of the more candid players in this regard.

Flexibility

One of the strengths of the BDC model – both in larger and smaller transactions – is the ability to adapt their financing to companies changing needs as they can provide capital in a variety of forms.

Today MAIN may be a senior lender with a warrant position.

Tomorrow, the debt might be converted to equity; a new short term loan advanced for short term needs and a larger equity stake taken.

The BDC model was created to encourage capital sources to work closely with smaller companies to assist in their growth: the origin of “Business Development“.

Like Family ?

Over the years, many BDCs have strayed far from that initial ambition, but MAIN – and many other BDCs – remains closely involved with their borrowers.

Often the relationship is more akin to that of a PE group and portfolio company than an arm’s length lender-borrower relationship.

Both the management of the companies involved and the shareholders of MAIN should probably take some comfort from that close relationship at times like these.

Ready

The company believes that its permanent equity capital as a publicly traded company provides significant flexibility.

It also sees its conservative leverage approach and diversity of debt capital sources as advantages during challenging times.

Main Street says its capital structure includes minimal amounts of near-term maturities, with only $77M, or ~5%, of its total debt capacity of over $1.5B maturing before the end of 2021.

To their credit, MAIN was one of only 4 BDCs that did not adopt the Small Business Credit Availability Act (“SBCAA”) and the higher leverage limits allowed.

Unlike others who sought to defend their investment grade rating by this move, MAIN seems to have been motivated by a conservative approach to balance sheet management born from the lessons of the Great Recession.

Metrics

As of IVQ 2019, MAIN’s net GAAP debt to equity is 0.68x.

More importantly, very little of the financing contains onerous lender requirements as 72% of the borrowings are in the form of SBIC borrowings and unsecured notes.

As the SA article says, very little of the BDC’s debt is due in the short to medium term.

Liquidity, too, still looks good with $55mn of cash at year end. (This number may already be higher).

Overall liquidity at year end was said to be $500mn, according to the latest conference call and 10-K.

Plenty To Go Round

Even if that gross liquidity number is reduced marginally by the dropping value of assets, MAIN should still have hundreds of millions to deploy both into existing investments and any new opportunities.

To put that into perspective, the BDC’s total portfolio had a value of just over $2.5bn before the crisis began.

That suggests – at least to us – that MAIN has the resources needed to point its own “bazooka” at any portfolio company – especially in the LMM – that might need support.

The Other 

Where we’re less optimistic in the short run is that MAIN can proactively protect its interests in the UMM.

At 12/31/2019 MAIN had half its portfolio in so-called “middle market” and “private loans” to companies with EBITDA of $58mn-$85mn, all of which we’re painting with the UMM brush.

Unlike in the LMM,  MAIN can do little to effect the credit outcome of these companies but only work along whichever lenders are in the lead of these transactions.

That does not mean the ultimate credit outcome will be worse but only that MAIN is less in control of its destiny as one of many lenders in a huge financing.

In the long term an argument can be made that the default risk of these larger companies is lower than that of LMM entities whose EBITDA average just over $5mn.

We’re not convinced by that argument – usually made by lenders to larger companies – because it ignores the flexibility groups like MAIN have in navigating treacherous conditions.

That’s harder to do in a loan syndicate to a larger company with possibly multiple layers of financing and an army of lawyers, accountants and government players involved.

However, in the LMM MAIN can make a difference and has a track record of doing so throughout its history.

Isn’t It Ironic ?

The BDC did not have exposure to these larger companies in the last recession.

Ironically, the very success MAIN had ten years ago in the LMM made them so popular and capable of raising  large amounts of equity and debt capital.

As we’ve noted, the BDC has an investment grade rating, which is impressive for a BDC that in the middle of the Great Recession only had $127mn in portfolio assets.

Over the years, and after many successes increasing its dividend and raising equity at a premium, and with only so much bandwidth to invest in the LMM, MAIN turned to the UMM to deploy its excess capital.

We’ll have to see as matters play out over the next couple of years if the strategic shift was a heaven-sent case of diversification or a mistake.

Investor Reaction

Untrusting investors do not appear willing to wait around to find out as MAIN’s stock price has dropped to $16.53, a (63%) drop.

That’s the lowest level in 10 years.

Then MAIN’s regular dividend was (40%) lower than today.

New Ideas

We’ll be inaugurating a new feature after the close today: BDC Best Ideas, where we’ll give prospective investors our unalloyed view on whether individual BDCs are a Buy,Sell or Hold for the longer term.

MAIN, both because of its storied history; unique business model and recent price drop to levels that most shareholders could never imagine, will likely be one of the first names we turn to.

No spoilers here because the BDC Reporter – like everyone else – is having to absorb constantly changing information both about the BDC itself and the overall credit and economic environment.