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Golub Capital: Portfolio Update

BDCs:
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On June 7, 2017 Golub Capital (GBDC) issued a press release providing portfolio data from the IIQ 2017. We provide the brief details involved, and analyze what was to be expected and what not. Moreover, the BDC Reporter discusses GBDC’s Dividend Sustainability, and comes to a conclusion. 

DETAILS

GBDC undertakes these press releases quarterly. The amount of data involved is relatively limited. Here is everything of importance included:

  • Originated $241.9 million in new middle-market investment commitments during the three months ended June 30, 2017.
  • Approximately 88% of the new middle-market investment commitments were one stop loans, 11% were senior secured loans and approximately 1% were equity securities.
  • Of the new middle-market investment commitments, $235.0 million funded at close.
  • Total investments at fair value are estimated to have increased by approx  3.9%, or $67.4 million, during the three months ended June 30, 2017 after factoring in debt repayments, sales of securities, net fundings on revolvers and net change in unrealized gains (losses).
  • Total investments at fair value held by Senior Loan Fund LLC are estimated to have decreased by approximately 8.1%, or $28.4 million, after factoring in debt repayments, sales of securities, net fundings on revolvers and net change in unrealized gains (losses).

ANALYSIS

Only one surprise in this short list of new information. We’ll get to that in a second.

The origination level was high after the IQ 2017 of “only” $106mn. However, that was to be expected as the BDC has more capital to invest, and the first quarter is typically a slower period.

After last quarter when GBDC booked a preponderance of “senior secured loans”, the BDC reverted to principally adding “one stop loans” to the portfolio, its lending structure of choice.

As usual, equity was a tiny portion of investments made. GBDC is above all else a lender.

Unlike Hercules Capital (HTGC) yesterday, GBDC informed shareholders of what its total portfolio looks like in size terms (if you do the math): increasing from $1.734bn to just over $1.8bn.

The metrics seems to suggest pay-offs continue at a very high level as the Refinancing Of Leveraged Corporate America continues.

Now For The Surprise

We noted that the Senior Loan JV with RGA Insurance Company saw a material drop in assets.

Unless we’ve missed something that change in fair market value is likely due to new originations not being able to keep up with repayment activity.

GBDC has been emphasizing – most recently on the IQ 2017 Conference Call – its interest in growing the JV over time.

This is probably a one quarter aberration caused by the dog-eat-dog lending environment, but bears watching.


OUR VIEW

We are loath to draw any serious broader conclusion from press releases such as this one, which are no substitute for what is disclosed in quarterly filings.

What’s happened in bad debts ? Or to the portfolio yield ? Or the cost of borrowing as LIBOR has risen and the Fed has raised rates ?

All that will have to wait till revealed in August.

Tight

We would only point out how tight already are GBDC’s recurring earnings per share (even if we adjust in their favor for extraordinary fees expensed last quarter) to its dividend.

Both are at $0.32 as of the IQ 2017.

Moreover, the BDC is highly leveraged on all fronts: both on balance sheet and in the JV, notwithstanding this quarter’s mini-shrinkage.

Place that in the context of “spread compression” and a business strategy where the BDC likes to keep risk low, and will trade one for the other.

Vs Track Record

On the other hand, GBDC has been masterful in keeping to a very stable earnings and NAV narrative in earlier periods.

We don’t want to presume to say GBDC might not be able to keep up its track record, which has helped the larger sized BDC become an investor favorite.

Beloved

How favored ?

CEF Advisors data shows GBDC’s stock trades at a 20% premium to book, the 5th highest of all the BDCs they cover, and yields just 6.7%.

GAAP vs Tax

We’ve been doing this BDC crystal ball gazing for some time and know there’s a difference between GAAP Income and Taxable Income.

We don’t know where GBDC stands in regards to the latter, especially after the latest capital raising.

Maybe there’s more room here than shows up at first glance.

Watch List

However, we’re still putting GBDC on our Dividend Rating Watch List with a Negative Outlook (we’ve always wanted to sound like the rating agencies).

That means we’ll be paying special attention to the possibility that sometime in the next 12 months GBDC might have to “cut its coat according to its cloth”.

Or, more prosaically: cut its distribution.

We’re not making that call yet, but to be useful, if that is going to happen,  investors will want to know earlier rather than later.

No Immediate Change

Given the price level of GBDC, trading not too far off its all-time high, the market remains optimistic that all will be as it was before.

So are we. For the moment.

What Is The Right Thing ?

However, we’re relatively confident if spread compression and the occasional bad loan caused earnings to drops marginally GBDC would not materially change its risk profile to “chase yield”.

As CEO David Golub himself has said, we are late in the cycle and risks are increasing for lenders.

Is the need to keep shareholders – hooked on a stable distribution even as they see market yields dropping and credit quality weakening – going to trump the caution necessary to avoid trouble ahead when the cycle turns ?

We hope not for shareholders sake, even if some don’t realize the Faustian bargain they’re making.

About Us. And Them

Generally speaking the BDC Reporter prefers to see a lower distribution and an improved credit profile, but in these Go-Go Days most investors care inordinately about the yield alone.

Where will GBDC – already using effectively more leverage than BDC rules originally anticipated – come out when lower income inexorably meets higher distribution needs coming the other way ?


FULL DISCLOSURE

We have no position in GBDC.

We have the stock on our Income Portfolio Watch List, which only includes currently the top third of the BDC table by risk.

Unfortunately GBDC trades at a whopping 50% premium to our Fair Value price for the stock.

Even if we believed GBDC could skate through the Next Recession without any loss in NAV or distribution (we assume a 10% erosion on both scores), it’s still 20% too expensive.

We may be “watching” GBDC for some time to come…

Is GBDC over-valued ?

Maybe not for you, but for us the price is just too rich, even though we like their business model and performance to date.

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