The following is from the GBDC Deep Dive that was previously provided to subscribers of Premium BDC Reports along with revised target prices, dividend coverage and risk profile rankings, potential credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all business development companies (“BDCs”).
GBDC Fiscal Year 2019 Fourth Quarter Portfolio Update
On October 9, 2019, GBDC announced that it had originated $130.4 million in new middle-market investment commitments during the three months ended September 30, 2019. Approximately 87% of the new middle-market investment commitments were one stop loans, 10% were senior secured loans and approximately 3% were equity securities. Of the new middle-market investment commitments, $120.7 million funded at close.
On September 16, 2019, GBDC completed its acquisition of Golub Capital Investment Corporation (“GCIC”), with GBDC as the surviving company. Including $2.3 billion of investments acquired from GCIC and factoring in debt repayments, sales of securities, net fundings on revolvers and net change in unrealized gains (losses) at GBDC, total investments at fair value are estimated to be $4.3 billion as of September 30, 2019.
“Upon closing of the merger, GCIC stockholders received 0.865 shares of GBDC common stock for each share of GCIC common stock. The transaction is estimated to be 4.5% accretive to GBDC’s net asset value (“NAV”) per share as of June 30, 2019. The final NAV accretion resulting from the merger will be disclosed when GBDC reports its results for the fiscal year ending September 30, 2019. The GBDC Board of Directors has previously disclosed an intention to increase GBDC’s regular quarterly distributions to $0.33 per share after the closing of the merger, provided that GBDC’s Board of Directors reserves the right to revisit this intention in its sole discretion.”
GBDC Dividend Coverage Update
GBDC has completed its acquisition of Golub Capital Investment Corporation (“GCIC”) and the Board intends to increase the regular quarterly dividend to $0.33 per share. GBDC’s generous hurdle rate of 8% basically ensures dividend coverage especially after taking into account the expected 4.5% increase in its NAV per share.
“Based on GBDC’s NAV per share as of June 30, 2019 and GCIC’s estimated NAV per share of $15.00 as of the June 30, 2019, the accretion to GBDC’s NAV would be approximately $0.72 per share, or about 4.5%. So that equates to roughly two quarters of historical net income per share for GBDC.”
The company paid a special dividend of $0.12/share in 2018 and there is a good chance of continued special dividends as the company continues to grow undistributed income and gains on a GAAP basis. Higher quality BDCs typically support regular dividends with recurring net investment income (“NII”) and pay special/supplemental dividends with additional income and/or capital gains (usually from equity investments), similar to Main Street Capital (MAIN).
“The special distribution is due to taxable income exceeding distributions over the past year. This is the third consecutive calendar year we will have paid a special distribution.”
Many BDCs retain undistributed income and some incur excise taxes rather than pay out to shareholders as they see it as “cheap capital” to reinvest and grow the portfolio. GBDC has chosen to a pay special dividend to avoid excise tax and will raise capital through accretive equity offerings as needed. See discussion from the most recent earnings call below.
Q. “On the special dividend, obviously it’s been a plan for the last several years to pay out the full amount or roughly the full amount of taxable income. I mean, is that going to continue to be your policy, basically avoiding excise tax, going forward, and if you have any thoughts of that, in the context of the GCIC acquisition?”
A. “That will continue to be our policy. That’s our intention. We don’t understand why it isn’t everyone’s policy. You have your choices of BDC manager to pay an excise tax or not pay an excise tax, and you can avoid paying the excise tax by making sure that you have paid out distributions equal to or almost equal to your taxable income. This is not a hard calculus. So, it’s good for shareholders to avoid paying the excise tax. I anticipate we will continue with that same policy.”
On February 5, 2019, shareholders approved the reduced asset coverage requirements allowing higher leverage but management continues to target a regulatory debt-to-equity ratio of 1.00:
GBDC is currently above its targeted leverage and through its third license from the Small Business Administration (“SBA”) the company has access to a maximum of $350 million of SBA debentures. However, leverage will likely decline due to the upcoming merger (discussed later) as shown in the updated projections and discussed by management:
“We said it was GBDC’s current intention to continue to target a GAAP debt-to-equity ratio of about 1.0 times. Although quarter-end GAAP leverage was a bit over our target, our strategy and near-term expectations for leverage haven’t changed. It remains our intention to target GBDC’s leverage at about 1.0 times. We currently anticipate that the proposed GCIC merger will be deleveraging for GBDC. So with GBDC running a bit above target now, we think the combined company will end up with leverage more in line with our target post-closing.”
GBDC’s liquidity and capital resources are primarily from its debt securitizations (also known as collateralized loan obligations, or CLOs), SBA debentures, and revolving credit facilities. On February 1, 2019, GBDC closed on a new $200 million credit facility with Morgan Stanley priced at LIBOR +2.05% and was used to repay its revolving credit facility with Wells Fargo. On September 6, 2019, GBDC amended the facility increasing the borrowing capacity to $300 million. As of June 30, 2019, the company had $41 million of available SBA debenture commitments, none of which was available to be drawn.
For the quarter ended June 30, 2019, GBDC hit its base case projections covering its dividend by 100%. There was a meaningful decline in its portfolio yield and leverage remains higher as shareholders previously approved the reduced asset coverage requirements allowing higher leverage.
“Excluding an approximately $28,000 accrual for the capital gain incentive fee, net investment income for the quarter ended June 30th remained unchanged at $19.4 million, or $0.32 per share, as compared to $19.4 million, or $0.32 per share, for the prior quarter. Consistent with previous quarters, we have provided net investment income per share excluding the capital gains incentive fee accrual as we think this adjusted NII is a more meaningful measure.”
GBDC has predictably boring quarterly NII of $0.32 mostly due to its fee structure combined with strong portfolio credit quality. My financial projections use a wide range of assumptions but because of the incentive fee hurdle, the dividend is consistently covered by design.
There was a decline in its overall portfolio yield from 8.8% to 8.6% due to new investments at lower yields of 8.1% as compared to 8.8% for the investments paid off.
“As shown on the bottom table, the weighted average rate of 8.1% on new investments this quarter was down from 8.7% in the previous quarter, primarily due to a declining LIBOR rate and a modest increase in the percentage of lower yielding senior secured originations. The income yield decreased by 20 basis points to 8.6% for the quarter ended June 30, primarily due to a decrease in LIBOR over the past two quarters. The investment income yield, or the dark blue line, which includes amortization of fees and discounts, remained stable at 9.2% during the quarter due to an increase in prepayments fees and other fee income.”
GBDC Risk Profile Update
GBDC is a ‘safer’ lower yield BDC for many reasons including strong covenant protections, over 90% of the portfolio in senior secured and One Stop ‘bank quality’ loans and one of the lowest stated portfolio yields in the industry (typically indicating higher credit quality). GBDC’s continued focus on ‘quality over quantity’ has resulted in lower portfolio growth and/or a reduced portfolio yield but dividend coverage has remained stable due to the investor-friendly incentive fee structure.
“Our late cycle investing strategy is a simple one. You have heard me talk about it before and we have stuck with it, staying at the top of the capital structure, partnering with strong sponsors and resilient companies, remaining highly selective on underwriting, leaning in on our competitive advantages, and when necessary, giving up some yield for higher credit quality and portfolio stability.”
New investment commitments totaled $157 million with approximately 14% were senior secured loans, 84% were one stop loans, and 2% were in the SLF and junior debt.
Joerns Healthcare ($1.8 million FV, $3.2 million cost) was added to non-accrual during the quarter. The other three investments that were on non-accrual included Aris Teleradiology ($0.8 million FV, $3.2 million cost), Uinta Brewing Company ($0.8 million FV, $0.9 million cost) and Tresys Technology Holdings ($3.8 million FV, $4.5 million cost). However, one of these investments was repaid in full subsequent to quarter-end which was likely Tresys as discussed next and was marked up by $2.0 million as shown in the following table.
“Flipping to the next two slides, the number of non-accrual investments increased from three to four investments, one of which was fully repaid with 100% recovery on our remaining principal balance subsequent to quarter end. As of June 30, 2019, non-accrual investments as a percentage of total investments at cost and fair value were 0.7% and 0.4%, respectively.”
It is important to remember that GBDC has 225 portfolio companies, so three to four on non-accrual is to be expected. As shown in the previous table, GBDCs ‘watch list’ investments only account for 3.4% of the portfolio fair value which is considered low. Safer BDCs typically have around 3% to 5% of the portfolio that needs to be ‘watched’ including ORCC, TSLX, CSWC, MAIN, SUNS, and PFLT.
Tresys Technology Holdings was reportedly purchased by DC Capital Partners and then merged with Owl Cyber Defense. Owl’s CTO mentioned that the two companies are “very complementary” because Owl is practiced in hardware security while Tresys specializes in software security.
Joerns Healthcare recently filed for bankruptcy and received approval for its restructuring plan that would eliminate $320 million of debt, with existing loans converted into equity and an additional $40 million of new financing to support Joerns’ ongoing operations and continued investments. Joerns will move forward under new ownership composed of its prepetition secured lenders, who have designated as initial board members including Patrick Hayes (Golub Capital). Including the SLF exposure, GBDC had around $8.2 million marked at 62% of cost.
“The successful execution of our restructuring plan significantly enhances our company’s long-term viability and competitive position,” said Joerns Senior Vice President and Chief Financial Officer John Regan. “By reducing our debt load, we can increase our investments in several key growth opportunities and enhance our efforts to continue delivering an exceptional customer experience. This plan confirmation is an important step in our 130-year history to continue our drive every day to fulfill our commitment to be an exceptional company which improves the lives of others.”
Payment-in-kind (“PIK”) interest income remains low with only $1.8 million over the last three quarters accounting for around 1.5% of total income. However, GBDC does not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is not likely to be collectible. One of the investments that I am watching closely is Oliver Street Dermatology that has been marked down over the previous quarters and was partially (1.0%) converted to PIK:
Q. “I saw the — a change to the mark and addition of a PIK component to Oliver Street Dermatology. So wanted to ask what’s going on there?”
A. “I’m going defer discussing a specific situation like Oliver Street. I don’t think it is an appropriate topic for this call.”
PPT Management Holdings has been discussed in previous reports and is also a portfolio investment for CGBD which has marked this investment at 85% of cost (see CGBD report).
GBDC’s net asset value (“NAV”) per share remained stable at $15.95 but has increased 23 out of the last 28 quarters, after excluding the impact from previous special dividends
This information was previously made available to subscribers of Premium BDC Reports, along with:
- GBDC target prices and buying points
- GBDC risk profile, potential credit issues, and overall rankings
- GBDC dividend coverage projections and worst-case scenarios
- Real-time changes to my personal portfolio
To be a successful BDC investor:
- As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
- Identify BDCs that fit your risk profile.
- Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
- Diversify your BDC portfolio with at least five companies. There are around 50 publicly traded BDCs; please be selective.