Last week, Medley Capital (MCC +1.02%) reported earnings. In its press release, it broke out the usual numbers. But it also announced two very big initiatives.
First, it announced that it would reduce its management fees, structuring its new agreement for better alignment with shareholders. Second, it increased its current share repurchase program to $50 million.
I thought this was odd. It's almost unheard of for a business-development company (BDC) to enact a repurchase program and slash fees without some outside pressure. So I went digging through the portfolio. Something must be wrong -- it must be making up for something.
Let's learn more about BDCs
I combed through Medley's books, looked at every single one of Medley Capital's investments, and looked for the problem companies -- companies that were marked down this quarter.
In all, I found eight companies compromising $112 million of fair value, or roughly 18% of Medley's book value, that were marked down. As a general rule, companies that are marked down once are often marked down again. Some obviously recover. Some, however, go to zero.
I built the table below to identify companies that were marked down, and to show how their valuations changed from last quarter to the current quarter. Medley investors should make use of the company descriptions that start on page 15 of its annual report to learn more about each portfolio company listed below.
Data source: SEC filings with calculations by author.
An introduction to Medley's watch list investments
Let's start with two of the biggest losers, AAR Intermediate and Brantley Transportation. Not surprisingly, both are described as oil and gas companies. If oil prices remain in the doldrums, these could be a source of future write downs. It's as simple as that.
You can also add Oxford Mining Company and Prince Mineral Holdings to the commodity list -- both are metals and mining firms. Oxford made the list because Medley made what appears to be a $7.5 million add-on investment. With miners performing terribly across the board, it's concerning to see a BDC lend more money to a mining company in the current environment. Is Medley trying to keep a dead company alive? It's a question worth asking.
Calloway Laboratories was the big "surprise," responsible for more than $11 million in losses this quarter. I put "surprise" in quotation marks because Main Street Capital (MAIN 0.67%) also marked its Calloway investment to zero in the current quarter. Main Street Capital reports earnings before Medley Capital, so it was expected that Medley would write it off, too.
It was a matter of time. Calloway's first-lien term loan was paying 17% annual interest, paid-in-kind. That's a definite warning sign that a zero is imminent. Even still, a total loss is always significant. (Lesson: "Secured" and "first-lien" loans aren't necessarily immune from complete losses when things go wrong.)
Reddy Ice Corporation, an investment Medley shares with Goldman Sachs BDC (GSBD 0.77%) also got a markdown this quarter. Somewhat concerning is the fact that Medley marks its position at 79% of cost and Goldman Sachs BDC marks it at roughly 62% of cost. (Fun fact: Reddy Ice reportedly manufactures and distributes 1.8 million tons of ice each year. Cheers!)
Footprint made the list because Medley is starting to write down its preferred equity investment in the company. As a general rule, when BDCs write down junior securities like preferred equity, the safer securities like debt investments get mark downs in the future. This can be a warning sign. Stay tuned.
I'll leave the remaining portfolio company for your own investigation (it's on non-accrual). But it's very clear from a look at Medley portfolio that there are some problem credits in its portfolio. Keep an eye on these -- these companies will likely make or break Medley's 2016 performance.
