Main Street Capital Earnings: Good Enough

Main Street Capital (MAIN +3.89%) reported generally OK results in the first quarter. The company worked out one troubled investment it shares with Gladstone Investments (GLAD +2.66%), among other business development companies, while reporting a mixed bag of ups and downs in its portfolio.

This quarter by the numbers
A BDC's net income is equal to its operating income plus its capital gains or losses. I like to break these two measures apart, as I think the separate statistics give investors a better understanding of how a company performed in terms of recurring operating income and more volatile below-the-line gains and losses.

Source: Company IR, SEC. 

A simple rule is that operating income serves as a good measure of earnings and dividend-paying power over the short-term, but over the long haul, a BDC's capital gains and losses are just as important. Like many BDCs, Main Street recently felt the impact of investment impairments on its book value, which fell about 3% per share year-over-year.

Movers and shakers
We're getting further along in the credit cycle, and BDC balance sheets are starting to show it. Where non-accrual rates were once near zero, they are now creeping up into the low single digits. A handful of Main Street's smaller investments are showing some issues, just as others rise in value, partially picking up the slack.

This quarter brought some more certainty to portfolio company Targus, a small investment on Main Street's books, but a frequently appearing stain on balance sheets across the industry. Gladstone Investments' filings note that Targus was restructured in the first quarter, resulting in new debt and equity securities for creditors which included Gladstone and Saratoga, in addition to Main Street Capital.

Some of Main Street's lower middle-market investments are headed in the wrong direction. The combined valuations of Mid-Columbia, Houston Plating, L.F. Manufacturing, and Gulf Manufacturing fell by about $6 million (or roughly $0.12 per Main Street Capital share) this quarter. This group was previously identified by looking at the dividend income laggards in Main Street's full-year 2015 results, and will be important to watch going forward.

But just as some companies were marked down, others were written up. Portfolio companies GRT Rubber and Travis Acquisition enjoyed a combined $5.3 million increase to their carrying values this quarter, or about $0.11 cents per share.

The ups and downs across Main Street's entire 198-company portfolio net out to about $0.26 per share in realized and unrealized capital losses this quarter. As for its outsize positions in energy-related investments, it appears the easy losses have been accounted for, though it remains something of a wait-and-see issue as to whether those just barely hanging on can live long enough to see higher energy prices return. 

Big win: More low-cost capital
Main Street Capital makes its money primarily from the spread between what it pays to borrow, and what it charges its own borrowers. Thus, reducing its funding costs are every bit as important as maximizing its investment returns.

The company announced getting the green light to add a third Small Business Investment Company (SBIC) license under its umbrella, which will enable it to borrow up to $125 million in 10-year debt financing at rates that were as low as 2.5% in March. That's the benefit of being on the good side of the Small Business Administration, whose SBIC program is a boon for BDCs that invest in small businesses. (Believe it or not, 10-year money from the SBIC is actually less expensive than what Main Street is currently paying on its bonds that mature in less than four years.) 

Main Street Capital earned its dividend from net investment income, and reported relatively minor changes in its portfolio value during the first quarter. Given worse performance from many of its peers over much longer time frames, its first quarter performance was simply good enough to keep investors happy.