Senior Debt Yielding Over 7%

 |  About: MVC Capital (MVC), Includes: FSC, MCC, TCAP
by: Valuematters

With interest rates being so low many people aren't happy with their options in terms of generating investment income and to that point, I am no different. However, those are the rules of the game, as the 5 year treasury rates are under 1% and the 10 year is under 2%. Most of the rates under 5 years are even lower, making generating income even more difficult.

With the risk-free rates being so low this lowers the yields across the board. So if you want to have more than the next-to-nothing short term treasury yields, you could either move into a more risky security, go with a longer dated maturity, or both. Obviously, as you move into issuers with lessor credit quality, you increase the credit risk (i.e. risk of default). As well, as you move into the longer-dated maturities, you increase your interest rate risk (i.e. if rates move up you will see the prices decline).

Investment Thesis

In line with both of those movements noted above, one area I have looked for yield is the publicly traded debt of business development companies (NYSEARCA:BDCS). BDCs pay out most of their earnings in dividends and do typically go to the capital markets for new capital as the need arises (in this sense they are like REITs). They are typically in the business of making loans and other investments to companies that are typically private. Because of the nature of their business and the fact that they pay out most of their earnings as dividends, coupled with the fact that these are generally unsecured debts, I believe that senior debt wont usually result in much payoff (if any) if a default were to occur.

In this space often times these notes wont be rated by the major agencies (or any agency) and while some people would shy away from non-rated notes, I tend to gravitate towards them. Not having a rating on them will certainly keep some investors away, both big and small (big because they could have a mandate to only buy rated securities), which could create an investment opportunity. I believe in the BDC space the biggest risk here will be more of a macro risk and that is the risk that the credit/capital markets close off to these guys at exactly the wrong time. Obviously, there is issuer specific risk (they could make a batch of bad loans and fall short on capital), but I am using the last 5 years as a period to stress test their interest paying ability.

The main idea is finding an issue where the issuer has been able to continue with dividends in bad markets, ideally generates sufficient investment income to cover the interest, and where the issue is yielding a sufficient amount. In a perfect world, I would prefer a maturity of 7 years or less, but that has been a difficult criteria to meet. As such, I am focused on finding something with 10 years or less. That does leave a bit more interest rate risk than preferred, but if rates rise because of an improving economy, this could help offset that impact (as the underlying loans would be strengthening in quality about the same time).

The Investment

Comparatively speaking, one of the better yielding senior debt issues out there is a relatively new issue from MVC Capital (NYSE:MVC), which is a 10 year issue that yields 7.25% at par. It trades under the symbol MVCB (these don't link to It matures Jan 15, 2023, but is callable on or after April 15, 2016. It currently yields a little less than its par coupon, trading at $25.30 per share, and on a yield-to-call basis, it is yielding even less at about 6.75%. Even so, as compared to some other senior debt issues it does have a yield advantage (on a yield-to-call basis, but also a yield-to-maturity basis as well in most cases).

Some of the comparable issues I found are included in the table below, but they include FSCE from Fifth Street Finance (NASDAQ:FSC), MCV from Medley Capital Corporation (NYSE:MCC), and TCCA from Triangle Capital Corporation (NYSE:TCAP). Other than MCC (not a long enough history) these offer some history as to whether the issuer was able to continue their dividend through a difficult market. I believe some of the difference in yields among these is driven by the nature of the return that these BDCs have historically earned (i.e. income vs. capital appreciation).

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MVC as a BDC has historically not been my favorite as it tends to require more capital appreciation than some other BDCs that are more focused on investment income. However, the company maintained its $.12 per share dividend even through the turbulent times of 2008/2009, and even more recently increased that dividend to $.135 per share. In terms of the overall thesis however, you might think MVC isn't a great fit because it traditionally hasn't generated a large amount of investment income (you may be correct). However, with a recent shift in focus and strategy, they are trying to gear the business more towards income flow than capital appreciation and I believe that while this shift will take time, it will create a safer level of interest coverage (and dividend coverage).

As announced in their recent Q1 earnings release the company the company showed a $2.8M increase in total operating income, driven by a strong increase in dividends. Additionally, as a sign of the portfolio repositioning, the company recently sold out of one of its larger positions (Summit Research Labs), which was a mix of equity and debt investments (but much more of the value came from the equity), and then re-invested some of those proceeds into a loan back to Summit. It isn't clear what the terms are of the new loan, but the previous loan the company had to them was at 14% per year.

Another key point from the Summit sale is that the price came in pretty close to the last fair value (Jan 31 2013) the company assigned this investment. As the company trades significantly under its $16.29 net asset value, if they start selling off some of the equity positions close to fair value and then put the proceeds back into higher yielding loans/investments, it could help the company realize an overall valuation closer to net asset value (as well as significantly increase dividend and interest income).


If you want to take the risk of the unsecured debt and are ok with the term length, I believe that as the portfolio repositioning takes place the senior debt would trade more in line with its peers and yield less than it does today. As such, I think at a yield to call over 6.7% (all else equal) MVCB represents a good reasonable option for a fixed income portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not an investment professional and as such nobody, under any circumstances, should rely on anything I write for investment advice.