November 25, 2009: We listened to Gladstone Capital ‘s (ticker: GLAD) IIIQ 2009 Conference Call, which we found disconcerting. We’ve copied out some interesting extracts from the Call. Here are our main conclusions:
- Gladstone is still de-leveraging its balance sheet by selling off assets and not undertaking any new deals (except small advances to portfolio companies). This has a lot to do with the next point below.
- Matters are not resolved with the Company’s lenders. Gladstone would prefer to match the long term nature of its investment assets with term debt from an insurance company or Preferred stock (which no other BDC has yet issued). However, the Company is saddled with a traditional Revolving Line of Credit which expires shortly. Failure to extend the Revolver or to find new sources of capital could yet cause Gladstone Capital to face a liquidity crisis as the business already faced this year when Deutsche Bank bailed on them.
- New business activity in the lower middle market seems to be anemic, but that may be influenced by Gladstone’s de-leveraging status.
- GLAD’s credit trend remains on a downward slope with more non-accruing loans than in the prior quarter and more than a year ago. The Company seems to be hinting that we should expect more troubled loans in the next couple of quarters.
- Our guess is that Gladstone’s earnings will drop in the fourth quarter of 2009 due to the continuing sale and repayment of assets. This may put pressure on GLAD’s dividend as earnings have been roughly equal with the distribution. Lenders will not be happy to allow distributions to exceed earnings even if management should seek to as has been their modus vivendi in the past.
- Given all the above it’s not surprising that the Gladstone Capital stock price is 27% below its 52 week high, and 20% off its recent highest level of $9.50 on October 14, 2009.
- We’re waving a Red Flag for Gladstone Capital, which means that we’re concerned that the dividend is in jeopardy.
Extracts:
BUSINESS ACTIVITY: “Through the quarter ended 9/30/2009 that environment did not improve materially. While some new investments are being made in the market, the continued instability of the financial and lending markets combined with continued downturn in the economy and the lack of real visibility heading into 2010 has just made us cautious.
But we did not close any new investments during the quarter just ended, and the investment activity of $1.7 million was entirely in existing portfolio companies in the form of additional investments or draws on revolver facilities.
During the quarter, we received net payments of approximately $11.3 million, due to loan sales, payoffs, normal amortization and pay-downs of revolvers. This resulted in a net production decrease in our portfolio of $9.6 million for the quarter.
Since the end of the quarter, we made about $1.6 million in additional investments in existing portfolio companies. Additionally, after the end of the quarter, we sold two syndicated loan that were held in our portfolio of investments at September 30. These syndicated loans have aggregate fair value of $2.7 million of which we have received all proceeds.
BAD DEBT INSIGHTS: “At the end of the quarter, we had loans with five companies on non-accrual, and a number of companies experiencing problems that may prevent them from making timely payments in the future. We’ve taken operating control of several of these companies and are working hard to fix the problems and improve profitability.
On a dollar basis, the loans classified as non-accruing have a cost basis of $10 million or about 2.8% of the cost basis of all loans in our portfolio. Our portfolio of companies are not immune to the current economic climate, and therefore we may have some additional non-performing loans and some write-offs, but we need you to know that we are working hard to keep them to a minimum”.
LIQUIDITY: “[Loan] spreads seem to be closer to 6% or more over LIBOR. Because these new loans are at higher spreads, the old loans are coming in [at a] lower market price. In light of this market, without regard to any changes in prices, we had intended to hold our syndicated loans until they mature, because we believe ultimately that we will recover our capital if we did not sell them, but we did chose to sell them, some of them, a number of them at a discount in order to reduce our outstanding indebtedness under the line of credit. Of the remaining syndicated loans all are paying as agreed.”
…” We borrowed about $83 million on the line of credit and had about $249 million in net assets”.”
…”Subsequent to September 30, we reduced the size of our credit facility by $20 million, from $127 million to $107 million. We are in good standing with our line of credits from KeyBanc and BB&T. We’re required to review KeyBanc’s participation [NOI] from $100 million to $75 million by December 31, 2009, and as of today, we have reduced them to $80 million and have the ability to reduce them the additional $5 million today”.
…”
By the way we are having discussion with our lenders now about our renewal of the line of credit, stay tuned for that… However … we need to raise long-term debt and have long-term capital such as the issuance of preferred or common stock in order to finance new investment.Our new investments, as you all know, are long-term, so we need long-term liabilities to go along with that.
[LATER:" I am hopeful that during this quarter, we can find some long-term debt from some two or three institutions and raise $25 million to $50 million of long-term debt; that would help us a lot as well"].
We can’t rely on a short-term line of credit for making long-term investments. This will take us while to get that in place, and we have applied to the SBA for an SBIC licenses and if the SBA grants the license, we’ll be able to borrow up to $120 million on very attractive terms.
…So it would be very advantageous if the government will let us have an SBIC license, but we still don’t know if we’ll receive it. We thought we are in line and we’re hopeful that they will get through us soon and issues us the license.
[LATER IN RESPONSE TO A QUESTION: "Our hope is to get the license for Gladstone Capital, this company soon, and make a success of that so that SBA would like us to get the license for GAIN as well].
We’re also looking at issuing some preferred stock or something similar to preferred stock, but today it would be very expensive if we do find a way to issue preferred stock or something like that in a good price range, then we’ll certainly consider it and that would help us to generate long-term capital that we could use to make investments and we had looked at some convertible preferred stock and that may work for us as well, as we continue to look at that.
We are considering issuing common stock, but certainly not at this time.
MARKET CONDITIONS: “The small loan market in which we invest most of our capital is not seeing much competition. Banks have tightened up their credit standards. Probably most banks are only willing to make purely asset-based loans”.
…”There are a fair number of regional banks that are making new loans based on primarily on the assets of the business. These asset based lenders are more clinical than they were last year of course, and we hope to get banks to finance all of the lines of credit for our portfolio of companies”.
PRICING OF NEW BUSINESS:
“The pricing has all moved back up. If you look even at the marketplace that you can view, the senior syndicated loan market place, you are watching transactions, they are priced out at in the positions that we would be taking in 10% and 12% current pay.
We think that we can get those kinds of rates quite easily, with equity options as well. So the market place is back where it should have been all along, because that’s where the risk reward we are taking to in terms of pricing deals.
The pricing in the market place is not the problem anymore, as it was two years ago. Pricing was a problem, you could find plenty of deals, but the pricing was still behind that, you didn’t feel like the risk reward ratio was there.
REALIZED LOSSES OR GAINS: “For the September quarter, we had a realized loss of about $12.1 million, primarily due to the write-off of one loan and the sales of syndicated loan”
IMPACT OF RECESSION: “We’re very happy to have moved away now from Deutsche Bank which placed us in a very difficult position, when Deutsche Bank decided not to renew our line of credit. They did this to a number of other people in our industry and other industry. So, it’s not just us that we are damaged; they damaged a lot of other companies as well.
