Monroe Capital: Rising Non-Accruals Threaten Current Dividend

Overview - Monroe Capital (NASDAQ:MRCC) is a small business development company with a market cap of $160 million, focusing on lower middle market companies in the US and Canada [1] - The company has seen its share price decline over 50% since its inception in 2012, but high distributions have kept total returns positive [1] Dividend and Income - MRCC offers a high dividend yield of 13.5%, which is attractive for income-focused investors [3] - The current dividend of $0.25 per share is fully covered by net investment income (NII) of the same amount, indicating a lack of cushion for potential future challenges [18][30] - There are concerns about the sustainability of the dividend, with expectations of a possible cut due to rising non-accrual rates [3][18] Portfolio Composition - The portfolio consists of nearly 100 companies, with an average weighted yield of around 12% [5] - Approximately 82% of the portfolio is in first lien senior secured debt, providing some risk mitigation [5] - The portfolio has significant exposure to real estate (16%), healthcare and pharma (13%), and service-based businesses (11%) [6] Financial Performance - Recent Q1 earnings reported an adjusted NII of $0.25 per share and total investment income of $15.2 million [10] - Total assets increased to $527.4 million, but net asset value (NAV) per share decreased to $9.30, indicating potential issues within the portfolio [10][11] - The non-accrual rate reached 2.1%, which is concerning given the company's smaller portfolio size compared to peers [12][13] Market Conditions - The current high interest rate environment has negatively impacted the growth of portfolio companies, particularly in the real estate sector, where commercial real estate lending decreased by 47% year over year [8][9] - Despite higher interest rates typically leading to increased net investment income, the strain on borrowers has limited growth in share price, NAV, and NII [9] Valuation - MRCC trades at a discount to NAV of over 20%, which is higher than its average discount of 16.1% over the past three years [23] - The average Wall Street price target is $8.42 per share, suggesting a potential upside of over 13% [23] Conclusion - The combination of high non-accrual rates, stagnant dividend growth, and declining NAV suggests that MRCC is facing significant challenges [30] - The company has not increased distributions since a cut in 2020, and the current dividend is barely covered by earnings, limiting reinvestment opportunities [19][26][30]