- This article uses my ‘optimal leverage’ analysis to assess dividend coverage for Medley Capital.
- The BDC industry is experiencing yield compression and 7 out of the 26 BDCs that I cover have recently cut dividends.
- I will use this series to project which BDCs are less likely to cut dividends in the future.
Over the next few weeks I will be assessing dividend coverage for each BDC in an effort to uncover companies that have the potential to sustain or increase current dividends. I will also be using this information to update my latest "BDC Rankings: May 2014". For more details regarding this series and for the dividend coverage results for Ares Capital (NASDAQ:ARCC) please see "Part 1".
I have recently downgraded Medley Capital (NYSE:MCC) to a 'Hold' due to the potential for dividend coverage issues partially due to its falling portfolio yield and the analysis included in this article.
Over the last five quarters MCC has seen its portfolio yield decline from 13.9% to 13.5% and is still higher than the average BDC (closer to 11.7%). Historically MCC has had a debt-to-equity ratio between 0.50 and 0.70.
Other income is mostly origination and prepayment fees that can be lumpy from quarter to quarter but I have used the average from the previous quarters. MCC has an average base management fee of 1.75% of total assets and its incentive fees are the standard 20% of income and gains, but for projection purposes I use core net investment income ("NII") that excludes incentive fees related to capital gains.
The following table shows the most recent quarter along with various levels of leverage using a stable yield of 13.5% to determine the impacts on dividend coverage. I have also included the information from the most recent equity offering on April 28 of 6 million shares raising almost $80 million in net proceeds. Each of these scenarios assumes a full quarter of benefit from interest income but also a full quarter of interest expense, management and incentive fees.
These scenarios assume the highest level of efficiency and actual results could be lower because there will always be some turnover in the portfolio (that could drive higher fee income) but keep in mind that this also assumes average amounts of other income. If MCC's higher than average portfolio yield continues to decline there could eventually be a lack of coverage from NII in the coming quarters.
Side by Side Comparison:
For the side by side comparison I will be using the amount of equity as of March 31, 2014 (or most recent) along with a debt-to-equity ratio of 0.80 and current portfolio yield to project income and expenses tracking the following metrics:
- Dividend coverage (using a debt-to-equity 0.80)
- BDC expenses (as a % of available income)
'Available income' is total interest and fee income less interest expense from borrowings and is the amount of income that is available to pay management expenses and shareholder distributions. BDCs with lower expenses can pay higher amounts to shareholders without investing in riskier assets.
The following table compares the results for MCC to ARCC and I will continue to add BDCs in the following articles. As you can see ARCC has a slightly lower cost structure and better dividend coverage. It is also important to point out that MCC has a higher portfolio yield that could decline more than other BDCs.
For more details including some of the potential variances to this methodology for assessing dividend coverage please see "Part 1" of this series. Investors should only use this information as a starting point for due diligence. See the following for more information: