Is Main Street Capital Showing Signs of a Bad Lender?

Main Street Capital's (NYSE: MAIN  ) fourth-quarter earnings report had little in the way of surprises, but it did reveal two less-than-impressive developments.

The company reported that two debt investments were placed on non-accrual, reflecting the reality that the borrowers couldn't make interest payments necessary to service the debt.

What's wrong?
The two companies in question are Integrated Printing Solutions and Quality Lease and Rental Holdings. Main Street Capital invested $15 million and $39 million in the two companies, respectively.

The conference call gave a few important details about these two non-accruing investments. From this call, we learned that there are two very different problems at both companies.

Integrated Printing Solutions has a bit of a cash problem. The company faces a working capital shortage, which Main Street managers suggest will be fixed, presumably with an additional investment from Main Street, or a third-party. But details were mostly scarce, as Main Street Capital is under a nondisclosure agreement that prohibits it from discussing the matter further.

Quality Lease and Rental Holdings is apparently subject to management turnover, and a legal issue involving noncompete clauses. Legal costs, it seems, have made it difficult for Quality Lease and Rental Holdings to pay interest owed to Main Street Capital.

Taking a haircut
The company expects that it will resolve issues in Integrated Printing Solutions by the next quarter. Given Quality Lease and Rental Holding's problems come from the courts, no timeline is available.

At any rate, the combined writedowns total $22.9 million from their fair value in the previous quarter, or about 1.6% of Main Street Capital's total assets, and 3% of the company's net asset value.

It's still too early to tell how either non-performing asset will impact the portfolio. It's important to remember that no BDC is a perfect lender. Some 26 investments appreciated for a total of $21.2 million in appreciation against $28.6 million in total depreciation in 8 portfolio companies. And while two investments went on non-accrual, one investment moved from non-accrual to accrual. Movements like these happen all the time.

What comes next
Next quarter, investors should closely watch developments at Integrated Printing Solutions, where Main Street Capital has a much more direct role in correcting issues at the company.

Both investments, if eventually fully impaired, would have very little impact on earnings. What's big, however, is whether or not Main Street Capital can rectify its non-accruals.

It's the process that matters, not necessarily the size of the investment. Given that Main Street Capital is invested in the secured debt of both companies, it should have control should they become insolvent, testing its underwriting. All in all, though, this is little reason to sell what has been one of the best BDCs in the industry. 

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