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Goldman Sachs BDC: Convertible Debt Issue Graded

  • The second Business Development Company (“BDC”)  in so many days has announced  its intention to issue institutionally-placed unsecured Convertible debt.
  • Following a similar announcement from New Mountain Finance (NMFC), Goldman Sachs BDC (GSBD) followed suit on September 27th, after the close.
  • The main terms of the GSBD offering are an interest rate of 4.5%, a maturity date of 2022 and a conversion price of $24.49, 10% above the already high stock price.
  • With over-allotments, GSBD will be raising $110mn, and initially use the proceeds to repay its Revolver.
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  • BDC activist says: “The Convertible was a popular form of capital raising a few years ago, but fell out of favor with institutional investors after BDC stock prices dropped sharply and across the board in 2013-2015, but has regained favor in recent weeks.
  • TCP Capital (TCPC) recently issued $140mn of Convertible Debt on terms almost identical to the GSBD issue, after successfully issuing and converting to equity an earlier issue in June of this year.
  • With a seven month rally in BDC stock prices still underway, expect to see more issues like these. Benefits to the BDCs include a lower cost of debt than without a conversion feature, no dilution of existing shareholders as conversion to equity set at price above Net Asset Value and relative ease of placement with institutional investors”.
  • Adds: “The downside is that debt is still more expensive than borrowing under Revolvers, which may reduce earnings marginally and that the issues-unlike straight publicly traded Unsecured Notes-are usually not pre-payable before maturity”.
  • Also: ” Technically, the Convertible Debt-if not converted-does not increase BDCs total assets under management as the new debt only replaces existing borrowings. However, the unsecured nature of the debt capital and  the absence of material covenants or any borrowing base calculation prevalent in Revolver financing, may encourage BDC lenders to ramp up total leverage closer to regulatory limits. “.
  • “In the case of GSBD, Debt To Equity was at 0.7x at the end of June. The BDC Reporter will be interested to see if that ratio increase to 0.8x or 0.85x in the next couple of quarters. That’s a possible $100 mn increase in Total Investment Assets, or about 9%. GSBD-as expressed in their latest press release-have indicated previously that they seek to keep debt to equity under 0.75x, but this may change”
  • Concludes: “As the BDC Activist pointed out yesterday regarding the NMFC Convertible offering, the benefits to shareholders of this type of debt offering are not cut and dried. In the short term funding costs increase if the Convertible just replaces the Revolver. If there is an incremental increase in Total Assets, much of the benefit of higher income goes to management and incentive fees, incremental operating expenses and servicing the obligation. When credit losses are factored in, the net benefit to shareholders, expressed as a  Return on Equity, may be in low single digits or even negative.”
  • “With that said, the economics of the GSBD transaction-thanks to the newer BDC’s relatively favorable management fee arrangement, low operating expenses, and the impressively priced 4.5% interest rate-suggest this capital raise may be “accretive” to shareholders, both before and after bad debts are taken into account, if GSBD can maintain its relatively good credit record established to date”.
  • “As an aside, note that GSBD has struggled with two under-performing borrowers in recent weeks, including Hunter Defense Technologies (covered by BDC Credit Reporter as early as May 2016) and NTS. According to the IIQ 2016 GSBD press release, the latter appears to be getting back to Performing status. (On the other hand, Hunter has gotten the restructuring treatment that so many BDCs are fond of employing when a borrower gets into trouble and is only coming off non-accrual because the investment therein has been converted into a non-income producing form).  Still, at June 30, 2016, non-performing assets (i.e. no money rolling in) were equal to 6% of “investment assets at cost”, which was a material percentage of equity capital at par: 10%. That’s just a reminder that even Goldman Sachs has to contend with pesky bad debts, and the outcome may not always be favorable.”
  • Concludes: ” Still, to end on a positive note, IF  everything goes to GSBD-and the institutional investor’s- expectations, and the new debt is ultimately converted to equity, all shareholders of the BDC will benefit from new equity capital raised at a $6 premium-or 32% above Net Asset Value, and more than 20% above the price at which GSBD first came public. Nothing ventured, nothing gained, and this seems a pretty good approach by GSBD. “
  • Final Grade: B