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Golub Capital: Major Change In Secured Borrowings

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NEWS

On July 9, 2018 Golub Capital (GBDC) filed a Form 8-K relating to its secured borrowings.

The filing indicated that a GBDC wholly owned special purpose financing facility had given “irrevocable notice” of its intention to redeem all of its outstanding notes.

The redemption date is July 20, 2018.

“The 2010 Notes would have otherwise matured on July 20, 2023”.

The financing involved is a $350mn face value  on balance sheet securitization, which was initiated in 2010.

Here are the key details from the press release:

The 2010 Notes currently consist of $205.0 million of Class A-Refi 2010 Notes, which bear interest at a rate of three-month London Interbank Offered Rate (“LIBOR”) plus 1.90%, $10.0 million of Class B-Refi 2010 Notes, which bear interest at a rate of three-month LIBOR plus 2.40% and $135.0 million face amount of Subordinated 2010 Notes that do not bear interest. The Class A-Refi 2010 Notes are held by institutional investors and are included in the Company’s consolidated financial statements as its debt. The Company, indirectly through Golub Capital BDC 2010-1 Holdings LLC, a direct subsidiary of the Company, currently holds the Class B-Refi 2010 Notes and the Subordinated 2010 Notes, which are eliminated in consolidation in the Company’s financial statements.
The full SEC filing is attached.

ANALYSIS
Secured Borrowings
GBDC finances itself with two forms of secured debt: traditional Revolvers, secured by portfolio investment assets, and “on-balance sheet” Collateralized Loan Obligations (“CLOs”), also secured with portfolio assets.
Regarding the latter: senior tranches of the CLO are typically placed with third party lenders while more junior tranches are funded by GBDC itself and eliminated in consolidation.
For all the details, we suggest reading page 65 of the latest 10-Q “Debt Securitizations”.
Cheap, Cheap
The principal benefit off on balance sheet securitizations is that the cost of borrowing is said to be lower than most any other vehicle, including traditional secured Revolving Loans.
Controversial 
However, GBDC has been reporting for some time that the SEC has been questioning the BDC’s use of this vehicle for technical reasons in the past 2 years.
The subject was explicitly tackled in the latest 10-Q (see page 84), as evidenced from this extract:

Due to the interplay of the 1940 Act restrictions on principal and joint transactions and the U.S. risk retention rules adopted pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank, as a business development company may be unable to enter into certain types of securitization transactions. We have requested no action relief from the SEC that, if granted, would permit us to once again utilize securitizations in which assets are transferred through GC Advisors, but we cannot provide assurance that the SEC or any other regulatory authority will grant our request, which would permit us to enter into certain types of securitization transactions, on a timely basis or at all. As the reinvestment period for one of our securitizations expired on April 28, 2018, we are looking to expand our secured debt financing facilities, including through an expansion of our existing bank facility.

Although the latest press release does not address the status of discussions with the SEC regarding the use of securitizations, time has apparently run out without adequate resolution and caused the decision to liquidate the vehicle.

(The 2010 securitization was refinanced and extended in 2016, but there will be no repeat).

Pay Off

As a result, and based on outstandings at March 31, 2018 $205mn in debt was outstanding on the 2010 securitization, collateralized by 79 loans with a value of $340mn.

No word has been provided about how GBDC will refinance the debt.

Cash on the balance sheet is not sufficient.

We expect the BDC will draw on one or both its existing Revolvers and/or expand the existing arrangements or enter into a new Revolver.

Lay Of The Land

The $170mn Wells Fargo Revolver was more than half drawn at March 31, 2018 (balance $107mn).

That leaves only $63mn in availability.

Likewise, there is a second Revolver, provided by the Investment Adviser itself, with a $20mn line and no outstandings.

Not Enough

Clearly, GBDC has to undertake some further action to be able to redeem the 2010 securitization borrowings.

That might include – since the end of the quarter – shrinking portfolio size to generate the needed capital.

We don’t know how hard pressed GBDC has been, but we note that the 2010 facility is being called just 3 days before entering its non-reinvestment period.

Double Trouble ?

Besides the unknown about how GBDC will refinance the 2010 securitization, we don’t know the status of a second on balance sheet CLO: the 2014 securitization.

That facility is even larger, with a nominal size of $403mn and outstandings at March 31, 2018 of $246mn.

As recently as March 23, 2018 GBDC refinanced and re-priced the 2014 securitization. See the March 15, 2018 8-K.

However, as the 10-Q indicates, the re-investment period expired nearly 3 months ago:

Through April 28, 2018, all principal collections received on the underlying collateral may be used by the 2014 Issuer to purchase new collateral under the direction of the Investment Adviser in its capacity as collateral manager of the 2014 Issuer and in accordance with the Company’s investment strategy, allowing the Company to maintain the initial leverage in the 2014 Debt Securitization. The 2014 Notes are scheduled to mature on April 25, 2026.

Poking Around

We’ve diligently reviewed all filings and press releases in recent weeks and found no evidence that the re-investment period has been extended.

We will reach out to the BDC for further information.

However, the BDC Reporter does note that the March 2018 refinancing included a clause that may make future refinancings impossible if there is no relief from the SEC:

..”provide that the 2014 Notes may be further refinanced only so long as (x) (i) a change of law, rule or regulation or regulatory guidance following the date of execution of the Supplemental Indenture (the “Refinancing Date”) would permit a refinancing without resulting in non-compliance with U.S. risk retention regulations, as amended from time to time, (ii) U.S. risk retention regulations are no longer effective or (iii) the “sponsor” (as defined for purposes of the U.S. risk retention regulations) complies with such U.S. risk retention regulations, in each case as determined by GC Advisors LLC, in its capacity as collateral manager to the 2014 Debt Securitization”.

(We did not see this language above replicated in the 10-Q – even though that document was published subsequently –  but we may have missed the disclosure elsewhere in the filing).

This all suggests that the 2014 securitization, too, may need to be unwound before long.

Together, the two securitizations add up to $459mn or 25% of total investment assets.


VIEWS

Confidence

The Investment Advisor of GBDC is top tier: experienced, cautious and thoughtful.

We have very little doubt that GBDC has arranged a solution for its near half a billion dollar problem.

It’s very unlikely the BDC will need to materially shrink its balance sheet to meet its debt repayment obligations.

(If that were to happen, earnings and ROE would be hurt, as would the BDC’s reputation in the market).

The BDC Reporter will be curious to see how GBDC tackles this conundrum.

Forewarned Is Forearmed

On the latest Conference Call CEO David Golub hinted that the machinery was underway to come up with a lasting solution:

…”an update on some moves we’ve made and plan to make in respect of our debt capital structure. On December, we amended our Wells Fargo facility bringing down its interest cost from LIBOR plus 2.25% to LIBOR plus 2.15%. As Ross mentioned in March, we repriced our 2014 CLO and brought the weighted average interest cost down from LIBOR plus 1.87% to LIBOR plus 1.01%, a difference of 86 bps. We still have our 2010 CLO outstanding, and we held off on resetting that facility pending receiving further guidance from the SEC on how, as externally managed BDC, to comply with U.S. risk retention requirements.  We still anticipate receiving greater clarity from the SEC, but it may not arise before we need to address the end of the reinvestment period of that CLO in July. So we’re currently exploring a variety of options for new debt facility as opposed to a new securitization. And we anticipate that if go that route, the new facility is likely to have terms and structure similar to our existing Wells facility”.

Comparisons

The most likely downside here – especially if the SEC continues to frown on GBDC’s on-balance sheet CLO structures – is a higher cost of borrowing.

If – as Mr Golub intimated – GBDC has to switch its secured financing to Revolver debt the pricing is likely to be higher.

Wells Fargo charges GBDC 1 month LIBOR + 215bps or 3.25% all -in at the moment.

Then there’s a “non-usage fee” that ranges between 0.5% and a frightening 2.0%.

Then there are the front-end fees for establishing the facility.

We estimate the full cost is likely to be between 3.75% and 4.00%.

That’s still very good by BDC standards but CLO financing is even cheaper.

The 2014 securitization most senior (and largest tranches) bears a rate of 3 month LIBOR + 0.95% .

(With 3 month LIBOR at 2.34%, that’s an effective cost of 3.25%. Comparing apples to apples by using 1 month LIBOR the all-in would be 3.10%).

Even the more junior tranches were priced only at 3 Month LIBOR + 1.40%-1.55%.

Pro Forma Calculations

We won’t seek to estimate with any specificity the differential in all-in cost between the CLO and Revolvers.

We’ll just show the pro-forma impact of a 0.5% or 1.0% increase in debt cost on $459mn of CLO debt shifting to Revolver or other forms of borrowings.

The range is $2.3mn-$4.6mn annually, which would reduce Net Investment Income Per Share by $0.04 to $0.08.

Putting that into context that could reduce projected annual net Investment Income by 3%-6%.

Unfolding

Nothing disastrous, but a potential set-back if GBDC cannot keep its rock bottom financing cost for a portion of its borrowings.

Not to mention all that time spent in conference rooms negotiating new financing arrangements.

We will learn a good deal more when – as reported in the BDC Reporter’s Earnings Calendar – GBDC files its June 2018 results on August 8 and hosts its Conference Call August 9. 

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