1 Huge Win for Main Street Capital and Triangle Capital

Main Street Capital Corporation (MAIN 0.23%) and Triangle Capital Corporation (NYSE: TCAP) are the outliers of the BDC industry. Since their IPOs in 2007, these two companies have simply crushed their peers in terms of total return.

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One reason is that both run lean operations. Managed internally, these companies hold their expenses to about 20% of revenue, well below most of the industry, which frequently spends as much as 40% of revenue on operating expenses. In addition, internally managed structures provide operating leverage -- more assets under management have resulted in bigger per-share dividends, even as many peers simply grow for growth's sake. 

But that's really just the start. Behind their outperformance is an untold story: these companies benefit from what I call a powerful "economic put."

A gift from the stimulus bill
Before they were public companies, Main Street Capital and Triangle Capital got their start as so-called SBIC funds. SBIC funds raise equity capital from private investors, match it with cheap debt from the Small Business Administration, and then use the combined funds to invest in America's small businesses.

Prior to the financial crisis, SBICs were a very small source of small business financing. SBICs were limited to $137.5 million in cheap debt from the SBIC -- they could never be a big source of funding for BDCs. 

But then the credit crunch and financial crisis unfolded. Credit to small businesses dried up, and the government needed a way to increase small business investment. It did so by increasing the limits on an SBIC's size: the stimulus bill, passed in 2009, increased the maximum available leverage to SBIC funds to $225 million, up from $137.5 million. 

The rush was on
The year 2009 (and 2010, for that matter) could be described as the "year of the SBIC fund." BDCs, burned by fleeting capital during the downturn, had an epiphany: SBA funding was simply the best and cheapest money they could ever get their hands on. Many BDCs would start the lengthy process of filing for an SBIC license during the 2009-2010 period.

Main Street Capital and Triangle Capital, having formed from the IPO of SBIC funds, had a head start on the rest of the industry. They already had the licenses they needed. And with the leverage limits raised from $137.5 million to $225 million, they could start putting money to work quickly.

In addition, their low-cost operating structures helped their shares weather the downturn during the financial crisis. Not only did Main Street and Triangle have access to cheap debt from the SBA, but they also had access to the equity capital necessary to increase the size of their SBIC funds. Most BDCs were trading below book value -- they simply couldn't grow their balance sheets to make new investments.

If you had capital during the financial crisis, finding great investments was like shooting fish in a barrel. When you're the only investor with cash on hand, you have all the power at the negotiating table.

SBICs on the rise again
A bill to increase leverage to SBIC funds is circulating in Congress once again. This bill would make as much as $350 million available to up to two SBICs in common control, up from the current limit of $225 million. One Main Street Capital executive noted that he believes the odds of it passing are 50-50 this year. The CEO of Hercules Technology Growth said that he believes the bill may pass somewhere between June and September of this year. 

For BDCs with SBIC licenses, this means they'll have access to another $125 million in cheap, 10-year financing. And when I say cheap, I mean really cheap. Simply compare the terms of SBIC debentures to debt recently raised by industry bellwethers Ares Capital and FS Investment and you'll see what I mean.

SBICs can simply borrow at lower rates and for longer time periods, with virtually no covenants.

Of course, this is a completely different environment than in 2009 and 2010. Capital is cheap and plentiful, and more BDCs have SBIC licenses than before the downturn. But no capital is as cheap as government-sponsored capital. And having access to it, in substantial quantities relative to your total balance sheet, is a huge advantage.

Furthermore, it's my opinion that BDCs with SBIC licenses benefit from an "economic put," so to speak. If the bill doesn't pass this year, the likelihood of it passing in a downturn is substantially higher. After all, there isn't a single member of Congess who wants to explain why they wouldn't support a bill to increase small business lending at the depth of an economic downturn.