I’ve previously wrote about how I’ve looked at Apollo’s middle market BDC (also here, here, and here) and how I’ve been looking at CLOs. Linking to these posts forced me to look at them again and virtually all of them made me feel a bit embarrassed as I wrote them no more than two months ago. I’ll chalk it up to learning a good amount in the interim.
I realized the other day that I have been essentially looking at similar assets that have been packaged up in three different wrappers, of which I actually have decent data access to (I don’t have Bloomberg, S&P, etc.). First is the public BDC. The BDC sources virtually all of its new loans from MidCap. While it’s in transition to be a near 100% MidCap portfolio, roughly 90% of its portfolio is aligned with what MidCap does today (and I believe 85% of that portfolio was already MidCap sourced). Second, MidCap releases information for bond investors which one can ask the company for. Third, I found an S&P research report that slipped through the paywall cracks which outlined the basics of a CLO originated and arranged by MidCap.
While all three aren’t exactly apples to apples, they aren’t far from being so. In any case, I lined up their capital structures to compare them:
The major takeaway is the leverage of each structure, with MFIC running at 60% debt / total assets, MidCap at 80% and the CLO at 88% (or 1.5x, 4x, and 7.5x debt/equity). Note that typical broadly syndicated loan (BSL) / large cap CLOs run at 90% / 10x leverage. In any case, if you look at MFIC versus the CLO, you see that the MFIC equity essentially represents a strip of the CLO from AA down to the equity. It should be materially more safe than the MidCap equity let alone the CLO equity. In fact, the co-founder of MidCap essentially confirmed that on the prior earnings call (my first earnings call appearance!) when I asked in too many words if a BDC was the right wrapper for MFIC (BDCs have 2.0x leverage limits and generally trade poorly vs NAV) given how comfortable he was running MidCap at much higher leverage:
Well, so the first question with regard to leverage is that our discussion with regard to risk related to leverage is that 1.5x, 1.6x, 1.4x, it is all splitting hairs. It’s all based on leverage within the AAA or AA of the CLO of this pool of loans if we CLO’d it. And right on MidCap is leveraged higher. And so from a risk perspective, we always felt like that’s very safe.
MFIC 2Q22 Earnings Call Transcript
While I didn’t know hardly anything (in retrospect) about CLOs, one can see in the chart above how the MFIC leverage sits cleanly against the AAA layer of the CLO.
Moving on. Overall one would expect, if you step into a hypothetical that the assets backing each are the exact same, that the return on equity should rise as leverage rises. In reality, they are not the same as the CLO has only leveraged loans I presume (I have no access to the loan tape), where as MFIC and MidCap have a material amount of other ABS loan types in their portfolios. In any case, here is my best guess as to the target ROE for each structure:
| MFIC | MidCap | MidCap CLO | |
| Est. Return to Equity | 9% | 12% | 14% |
As to what each equity slice trades for – I don’t have all of that data, specifically the CLO equity (Woodmont 2022-9). But I do know what MFIC’s equity and MidCap’s equity is trading for.
| MFIC | MidCap | MidCap CLO | |
| Trading Price as % of NAV | 85% | 100% | 100% (?) |
| Adj. Est. Return to Equity | 10.5% | 12% | 14% |
All is to say, this isn’t a recommendation on what to do about MFIC stock. It is just interesting how these different equity slices match up, particularly how an AA down to equity strip (MFIC) can trade at a material discount to NAV (it traded as low as the $10s / 70% of NAV in recent months) while a BBB down to equity strip (MidCap) can trade at NAV at the same time.
Disclosure: My family owns shares in MFIC, this isn’t investment advice. Do your own work.