Gladstone Capital Corporation F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

| About: Gladstone Capital (GLAD)

Gladstone Capital Corporation (NASDAQ:GLAD)

F4Q08 Earnings Call

December 3, 2008 8:30 am ET


David Gladstone - Chairman

Chip Stelljes – President and Chief Investment Officer

Gresford Gray - Chief Financial Officer


Troy Ward - Stifel Nicolaus

Kenneth James – Robert W. Baird

Vernon Plack - BB&T

Henry Coffey – Sterne, Agee & Leach

Leroy Carter – Private Investor


(Operator Instructions) Welcome to the Gladstone Capital Fourth Quarter 2008 Earnings Conference Call. It is now my pleasure to introduce your host Mr. David Gladstone, Chairman for Gladstone Capital.

David Gladstone

This is the quarterly conference call for shareholders and also analysts of Gladstone Capital, traded on NASDAQ trading symbol GLAD. We certainly thank you all for calling in. We're always happy to talk to shareholders about our company and we wish we could do this a lot more often.

I hope you all sign up for the e-mail notices so you get information coming directly to you from the company and please remember that if you are in the Washington DC area, and you have time come by and stop and see us in McLean, Virginia, we’re just outside of Washington DC. You have an open invitation to come by and say hello. You’ll see some of the finest people in the business.

Now I need to read the statement. This conference call may include statements that may constitute forward looking statements within the meaning of the Securities Act of 1933 and the Security Exchange Act of 1934 including statements with regard to the future performance of the company. These forward looking statements inherently involve certain risks and uncertainties even though they are based on our current plans and we certainly believe those plans to be reasonable.

There are many factors that may cause our actual results to be materially different from any future results that are expressed or implied by these forward looking statements including those factors listed under the caption risk factors in our 10-K and 10-Q filings and our prospectuses filed with the Securities and Exchange Commission. That can be found on our Web site at and also on the SEC website. The company undertakes no obligation to publicly update or revise any forward looking statements whether as a result of new information, future events or otherwise.

For those of you who are on the call last time know that we started a new way of reporting to you so that you can hear from some of these great team members that we have here working at the company other than just me. I have no plans of leaving and neither does Terry Brubaker or any of the others but we would like you to hear from some of the talented team members that we have here at the company. We think shareholders should hear from them as well as just me.

We’ll start with the President of the Company, Chip Stelljes. Chip is also the Chief Investment Officer and he will cover a lot of ground for us.

Chip Stelljes

We continue to operate in a very difficult environment from an economic financial sector and investment perspective. Through the third quarter the environment worsened from making new investments because of the uncertainty of the economy. While the longer term prospects in our pipeline remain strong the continued instability of the financial and lending markets made the closing of investments more difficult and time consuming this past quarter.

That being said, new investment production for the fourth quarter ended September 30, improved over the prior quarter with $39 million in new investments closed. Of the $39 million invested this quarter $33 million went into three new portfolio companies and the remaining $6 million into existing portfolio companies in the form of additional investments or withdrawals on revolver facilities.

During the quarter we received repayments of approximately $23 million due to loan payoffs, investment sales and normal amortization and pay downs of revolvers. This resulted in net production increase of $16 million for the quarter. Since the end of the quarter we’ve made about $8 million in additional investments in existing portfolio companies.

Our pipeline continues to be strong; we continue to see a noticeable change in the opportunities coming to us. Banks and buyout funds are calling us aggressively because so many lenders are no longer investing. Pricing and structure continue to improve for us. If we can keep moving we can make some strong loans during this timeframe.

The net increase in investment this quarter was only $16 million due to prepayments and repayments, however, this can be good if it enables us to reinvestment the funds into higher yielding opportunities. We continue to look at ways to increase the yield on the existing funds. Our pipeline of investments as I’ve said is large. We have to convert the opportunities into new investments. We can reach our objectives in the short run but we’ll need to be confident that we understand the economic cycle ahead of us and have the capital to pursue the pipeline opportunities.

At the end of September quarter our investment portfolio is valued at approximately $408 million versus a cost basis of $461 million meaning our portfolio was fair valued at approximately 89% of cost. The depreciation for the quarter was about 4%. We don’t like the lower valuation of the portfolio during the quarter given the strong performance of the underlying investments and remain confident that the de-valuation is reflective of the broader market for loans rather than any substantial change in our portfolio.

There are so many loans being sold by banks and hedge funds that the market is more like a fire sale market rather than an orderly one. The use of fair value comes into suspect when there are forced sellers and limited buyers. That being said, we expect most of the portfolio to continue paying as agreed with few problems through the near term. However, we’re watching our portfolio come as revenues and backlog carefully to judge where we think the underlying companies are headed.

At the end of the quarter we had three loans on non-accrual with costs basis of $6.6 million, $6 million, and $0.5 million. We’re in control of two of the three companies and are working aggressively to fix the companies and improve their profitability. Two of these situations required new management as the issues were more company specific and not necessarily due to the tough economy. We now have new management teams in place to help us turn these two around and we’re beginning to see results.

We feel good that we only have three loans on non-accrual out of the 63 companies. On a dollar basis the non-accrual loans have a cost basis of $13.1 million or less than 3% of the cost basis of all loans in our portfolio. Again, a good statistic for such a difficult time.

We continue to concentrate of variable rate loans so that we participate in rate increase and while our rates are variable they often have a minimum rate or floor so that declining interest rates are mitigated. About 71% of our loans have floors, unfortunately 29% of our loans do not have floors and with floating rates down we’ve been generating less income there. At September 30, 2008, we have two fixed rate loans with a cost basis of $13.9 million or approximately 3% of the cost basis of our total portfolio of loans and investments.

To date all of our fully exited investments have had a positive internal rate of return. We may have some losses in the future but as you know we work hard to keep them to a minimum. Another measure of the quality of our assets our average loan ratings for the quarter adjusted and remained relatively unchanged. The risk rating system we use for our non-syndicated loans showed an average of 7.3 for the quarter and for the same prior year quarter.

The risk profile has remained constant according to our risk rating model and to us that’s a good sign. The average risk rating for unrated syndicated loans was 6.6 for the quarter versus an average of 6.0 for the prior year’s quarter so a nice increase there. As for our rated syndicated loans they had an average rating of CCC+ or CAA1 for the quarter and the prior year quarter.

Our risk rating system gives you a probability of default rating for the portfolio with a scale of zero to 10 with zero representing a high probability of default. The risk we see here is staying relatively low. We’re quite satisfied with our current portfolio mix.

In addition to solid quality of assets the quality of our income is also very good. As we’ve discussed before some companies structure investments with paid in kind or original issued discount structures. This generates non-cash income which has to be accrued for book and tax but is not received until much later and as we all know, sometimes not at all. This income is subject to our 90% payout requirement so the company does not receive the cash but has to pay out the income.

We avoided these structures for this reason. This is important because other BDCs derive significant income from non-cash sources and that non-cash income has to be paid out as a dividend even though the cash has not been received. So they must borrow from banks or raise equity capital to pay their dividend. We strive to avoid non-cash income as part of our portfolio. We seek to have the money we actually receive from interest payments be the money that’s available to payout dividends and we think this is the right way to run a business like ours.

One of the acquired investments that we have had a provision in their loan of $700,000 that gave them the ability to capitalize their monthly interest payments. The pick interest here is about $5,000 a month. There were no other investments in the quarter ended September that had a similar provision. We had about $16,000 in capitalized interest income for the quarter ended September 30, 2008, and have non in the prior year period. We have a negligible amount of pick interest and no original discount issues.

Since inception we have made loans to approximately 132 companies. We’ve been repaid or exited from 69 companies. The average return of the exit has been about 13% for syndicated loans and about 16% for non-syndicated loans. We have this month a seven year great track record and hope to continue in this new fiscal year.

Since last quarter the senior and subordinated debt marketplace for larger middle market companies has continued to have tremendous liquidity problems. For a while the market was closed all together there just were no buyers. No there are new transactions and some sales of old transactions. As you know, we buy some of these first and second lien loans when the companies issue them. We’ve got about $77 million at our cost basis in senior and secondly syndicated loans today. This is where most of our variable rate loans without floors exist and these loans have seen their values decline more than some of the others.

The market pricing for the larger middle market loans continue to change. For senior syndicated loans of $200 million or larger last year rates were about 2.5% over Libor. Libor is of course the London inter bank rate which is recognized as the leading indicator of short term corporate rate. Now they seem to be closer to 6% over or more. Because these new loans are the higher spread this causes the old loans to command a lower market price. However, we hold these loans to maturity we should get 100% of our capital back with no loss. All but one of these syndicated loans is paying as agreed.

In addition to widening spread over Libor the norm for Libor has traditionally been about 5% to 6% with approximately 2.5% at September 30, 2008, about 2% or 2.5% today. A drop in Libor lowers our income but if a loan could be obtained money is relatively low in cost to most companies so still affordable for the portfolio companies. That’s helpful for the larger companies in which we invest.

The small loan marketplace in which we invest most of our capital is not seeing much competition. Many banks have tightened up their credit standards. We have to compete for our loans with other BDCs, private lenders like the Mezzanine Loan Funds, a few hedge funds left in the business and some of the small business investment companies.

Again, our loan request pipeline is strong and if we can access capital and get comfortable with the risk in the economic cycle we see a very strong outlook which may materialize into more investment for us as the year proceeds. Our goal is to be a strong profitable company. Not the biggest company.

With that I’m turning the presentation back to David.

David Gladstone

Now let’s turn to the financials and for that we’ll hear from Gresford Gray our Chief Financial Officer.

Gresford Gray

We’ll begin with our balance sheet, our balance sheet remains strong. At year end we had approximately $151 million borrowed on the line of credit. We have $272 million in equity. We are less than 1:1 leverage. We maintain a very conservative balance sheet for a company like ours. We believe that our overall risk profile is low.

For the September quarter net investment income which is before appreciation, depreciation, gains or losses was about $6.1 million versus $5.7 million for the same quarter last year, an increase of about 7%. On a per share basis net investment income from the quarter was at about $0.29 per share as compared to $0.39 for the same quarter one year ago. This was a per share decrease of about 26% attributable to the dilution from share issuances during the year or in other words, an additional 6.5 million weighted average shares outstanding as compared to the same period of the prior year.

Some of this decline should be removed as the money from our last public offering is put to work. We also have seen Libor fall and for our syndicated loans that has hurt our earnings as well. As rates go back up our income will increase as well. As all of you know, net investment income is the most important number to us because it’s the number that is closest to our taxable income and that taxable income is what we use to pay our dividends.

Now let’s turn to unrealized and realized gains. This is a mixture of appreciation, depreciation, gains and losses. We’d like to talk about two categories in this section. The first category pertains to gains and losses because they are the cash items and then second we’ll turn to appreciation and depreciation which are the non-cash items.

For the quarter ended September we had a realized capital loss of about $701,000 from the partial sale of one loan. The unrealized depreciation, the non-cash item, reported during the quarter was primarily determined by our use of opinions of value on our loans that we received from Standard & Poor’s security devaluation or S&P. They do a good job of giving us their opinion of the prices on our loans. They have good experience in this area because they follow thousands of loans.

We asked S&P to give us opinions of value for all of the loans in our portfolio that don’t have a readily determinable market value every quarter. S&P gives us an independent opinion of the exact dollar value for each loan we ask them to review. This eliminates the worry our shareholders may have that we are not writing down poor performing loans. Because this is a valuation opinion from an independent third party you’ll see a lot of volatility in this number.

At this time last quarter our portfolio was just slightly below par whereas this September our portfolio was valued at a depreciated amount due mainly in part to the general instability of the loan market. You’ll see that overall our portfolio held its value at about 89% of par further demonstrating our investment quality.

For the quarters ended September 2008 and 2007 our assets had net unrealized depreciation of about $19.5 million and $4.9 million respectively. The depreciation was due primarily to the general instability of the loan markets as I previously mentioned and to a lesser extent the use of a modified valuation procedure for the company’s non-control investments.

The change in valuation procedure accounted for about $2.9 million or 6% of the net unrealized deprecation for the fiscal year ended September 2008. As you know, depreciation does not have an impact on the ability of the company to pay distribution to shareholders. All of our loans except three are paying as agreed but S&P thought they were in need of some depreciation due to market conditions.

Now let’s turn to net increase or decrease in net assets resulting from operations. This term is a combination of net investment income, appreciation, depreciation, gains and losses. For the September quarter we had a net decrease in net assets resulted from operations of about $14.1 million versus a net increase of about $0.7 million last year this time.

This September quarter we are at about negative $0.67 per share versus last year at positive $0.05 per share. For the quarter that just ended this difference is primarily related to the depreciation of the portfolio this time versus the small appreciation of the portfolio last time. Investors should expect this kind of volatility in our portfolio.

Now I turn the program back over to David.

David Gladstone

I do want to remind all of our listeners out there that valuations are just the best guess that anybody can make. You could probably ask 10 different people what the value of a loan is and get 10 different answers. All of our valuations are just general valuations even the ones provided by Standard & Poor’s Security Valuation, Inc. In this fire sale market that we talk about the market prices are not reflective of the long term values of these loans but rather the short term sale value.

I do wish the SEC would relax the fair value rule so that those of us in the lending business that are not selling our loans to mark them to the long term value market and not to the short term fire sale marketplace. I can’t understand what value the SEC sees in making us mark our securities to market that can only be classified as a fire sale market.

Also please note that we renewed our credit agreement with the group of banks not too long ago. It was a very difficult time to have a renewal but we’re happy to say that the group of bank increased our line of credit and we’re in good shape as far as the credit lines can do.

Credit markets are our biggest worry today for this fund. We just hope that things get much better as time goes on. When it comes time to renew our credit line again in late spring we do worry a lot about the credit marketplace and how they will impact us and our portfolio companies. If they don’t renew we do have a two year payout under our loan so that wouldn’t be the end of the world and we could also sell off some of our loans and pay them down.

We worry of course these days about oil prices; they’re down now to a $50 a barrel. I never thought I would be happy that $50 was where oil prices are per barrel but certainly better than the $140 or so that we hit at one point in time. We’re also no longer worried about inflation, although inflation is the next worry and it will be back maybe not in 2009 but certainly sometime in the near future.

The amount of money being spent on the war in Iraq is certainly hurting the economy. All the team here at your company supports troops in Iraq and Afghanistan, they are the true heroes in this period of history, they risk their lives everyday for us I hope they all come home safe.

The pork barrel spending by Federal, State and Local Government is very harmful I think. They’ve been out of control for years now and it didn’t really matter whether its Republicans or Democrats they all seem to have the same approach to things. I hope this new administration that comes in will shut down the pork barrel spending and use the money for very constructive projects.

The stimulus spending is certainly dislocating a lot of marketplaces. I’m not sure how this will turn out. It looks like we are partially nationalizing a lot of our businesses by having the Government take ownership positions and over time these partial nationalization or ownerships of our businesses will have to be bought out by raising new equity so we’ll have to see how that comes along as time goes along.

All this spending will mean more taxes on our middle class and middle class certainly can’t stand any more taxes than they have today. That will cause even more dislocations in the economy as we take away spendable income. Trade deficit with countries like China and other nations is just a terrible; China continues to subsidize their industries to the disadvantage of our businesses. They subsidize for example oil and gas prices. China’s high growth rate is slowing down and perhaps they’ll come back into line as that slows down. They have certainly become less of a competitive threat.

We are seeing many of our small businesses build products here in the United States rather than going to China. I think that’s a very healthy sign for our economy. The downturn in the housing industry that we talked about for the last three years is coming. It obviously has come and had a great impact. It’s certainly a disaster in the home business and the mortgage defaults are going to continue to hurt our economy.

Certainly no one knows how many home mortgages will fail but we had originally thought it might be a $200 billion problem it’s certainly been revised up to $400 billion, maybe even more than that. There’s some estimate that put it at $1.2 trillion, I think that’s way off the charts. All of this is enough to slow down the economy. We certainly are not in a depression but has been announced by the economic advisors they’ve declared in a recession.

The housing problem probably will turn around during the next 12 months because housing prices are now falling far enough so that qualified buyers can step up and buy the houses. In spite of all these negatives that we come up with and we talk about the negatives everyday and we certainly see the broadcasters on the news fill our ears with all the negative news. In spite of all of that the US is not in dire straights. The industrial base is still very strong. The only thing that’s hurting us today is a lack of bank lending money to many of the businesses out there.

Most banks have just about stopped making loans. Some of the midsized banks are certainly making loans that is collateralized loans but not a lot. This is just like 1990 in which we had failure in the real estate marketplace and it bled over into all the rest of the marketplace. This time the Federal Government is pouring money into the banking system but the banks are still not lending. In 1990 you’ll remember that the Federal Government just took over the banks and sold off the assets.

I wish the Government would buy some preferred stock in our fund that would be great fund if we could raise some 5% preferred stock. We would certainly turn around and lend it out. We’ve tried to apply for some of the TARP money from the bailout bill but we were told it’s just for banks. I guess they’re going to change that over time giving it to insurance companies like AIG and now of course the auto industry is begging for some of that.

If they really wanted to get the economy started they would put money in small businesses with 80% of all of the jobs increase. I guess the downturn that began last summer is really not going to last much longer. We think the marketplace is stabilizing and will begin to turn up in the next quarter perhaps the second quarter of next year. If that’s true it would be a great time for us over the next two years because two to three years after a recession we normally get the best opportunities.

Also please know that there’s a very large amount of money sitting on the sidelines. We talked to one hedged fund that had $14 billion, $13 billion of it was in T-Bills and they’re not coming out for a while. When all of that money finally does come back to the market the equity market and the debt market will explode on the upside. I think some of that money will come into our stocks when the banks de-leverage by paying off some of their debt. That really means that the debt holder in the bank has gotten a lot of cash and now they have to do something with the cash to invest it.

There are really billions of dollars of money out there, a lot of it in money market funds for individual investors and that will come back into the market and some of it will come into stocks and others into bonds. We’re expecting ’09 probably would be the big turn around in the stock market.

Our monthly distributions to shareholders still $0.14 per month for the months of November and December it’s been declared we’ll declare a dividend again in January we hope to continue at the $1.68 per share per year. We are working with some changes and I hope this will let us build our earnings and our payouts even more as time goes on.

At this point in time the distribution rate which is $1.68 per year with the stock price trading at $6.99 as it closed yesterday that’s a 24% yield on the distribution and its now very, very high. We really don’t understand why the stock is falling so much other than many of the other BDCs have had to cut their dividend and we’re still committed to continuing our dividend. We have a great portfolio and we just continue to payout our distributions.

Before I forget, we have shareholders meeting that’s going to come up and we’re in need of all of our shareholders. We need to pass one of these items in the proxy. We’re asking shareholders in this company as we did in our other companies to give us permission to sell stock below net asset value if the opportunity arises. We need this flexibility and hope you’ll vote for that item.

We filed a preliminary proxy; it hasn’t been mailed out yet. We hope it will be cleared soon for mail out. You’ll get in the mail and if you could please vote by sending in your proxy or you can look in the proxy and get the proxy number off of it and vote by telephone. Please vote your proxy it cost us a fortune to gather the votes each year so helping us cut down on the cost and really those costs just come out of money that we can pay for dividends.

The net asset value has gone down because of depreciation. I was just looking back the net asset value was $13.41 at the end of ’05 and now we’re at about $12.89. We certainly can’t sell any new shares at $6.99 but if it came back up close to $12.00 we might look to raise a little bit of equity in order to continue to take advantage of all the rich opportunities that are out there for us today and put that money to work at very significant rates.

Please go to our website again, get your notifications directly from us. We don’t send out any junk mail just news about the company and go to and sign up for that distribution.

As far as we can see things look okay for our company. We think the economy is reaching a bottom and we’ll start to gather some strength but we can only see a couple quarters out and we want to be careful we are stewards of your money. We’ll stay the course and continue to be conservative in our investment approach and not go too fast.

I’ll now open it up for questions if we have some questions please operator come on and lead the questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Troy Ward - Stifel Nicolaus

Troy Ward - Stifel Nicolaus

Can you talk about within your credit facility the covenants that are out there? I know the minimum net worth I believe is $100 million plus 75% of all the equity that’s been raised. Can you give us what that number is and also the borrowing base; do you have a borrowing base covenant and where you’re at on that itself?

David Gladstone

The borrowing base covenant we’re covered very well on. As you know we haven’t drawn down much of our line of credit. We are not too far away from net worth covenant. We don’t see busting that, we certainly didn’t break it for September. We’ll be within $20 million or so of that. We’re watching that one closely to make sure we don’t break that covenant. I don’t think we will but if we do we’ll have to negotiate with our lenders to make a change there.

Troy Ward - Stifel Nicolaus

On your facility I don’t know if I heard you right if it weren’t to be renewed if you choose not to renew it at some point in the future did you say it has a one year or a two year wind down?

David Gladstone

It’s a one year tail on it.

Troy Ward - Stifel Nicolaus

Can you talk just a minute about you touched on your dividend policy and I know that’s a backbone to your firm, can you talk about how you view that longer term if NOI doesn’t come up and reach that dividend versus the capital? Secondarily, how you look at your ability to pay dividends versus maybe share buy back?

David Gladstone

I wish we could do share buy back, this would be an excellent opportunity to do so. Unfortunately we don’t want to do that because we think it would not be good for our lender. Our lenders don’t want us to use debt money to buy back equity. We’d love to find someone that would lend us money to buy back and share in that profit some way because it’s a great opportunity.

For us in terms of the dividend we’re running at about $0.42 a quarter as you know this quarter was probably our lowest quarter at $0.29. That’s about a $0.13 difference. That roughly works out to about $2.7 million per quarter that we have to borrow and pay out. I’m hoping that’s the lowest number that we’re at anytime soon. If it is we’ll be fine. We have a $300 million line of credit and it’s in good shape. We’re working hard to get the deals that are on Libor with no floors.

Some of that sold and put into new loans as you know the math there I think I’ve explained it before we’re running about $0.89 so if you sold our loans and I’ll round it off to $0.90 to make it easy. If you sold $1 million loan and got $900,000 in you’ve thrown away the $1 million that’s earning in round numbers maybe 4% or 5% range today so you’re making $50,000 in that case.

Then you put the $900,000 to work at minimum 10% today so you’re making $90,000 so there’s a real step up every time we move dollars from one place to another. It’s just that we hate to take the hit on the sales of the loans. We’ll just have to see how we work that out.

We also have the three loans that are not paying today and I think at least two of those will be fixed over the next year and come back in as interest payers so that will help the dividend. Right now we’re still committed to the $0.42 a quarter, $0.14 every month, so as a result there’s no worry about being able to meet that payout.

Troy Ward - Stifel Nicolaus

The BDC model as a whole, we’ve seen in this very turbulent time that maybe some weaknesses in the model have been exposed with the inability to issue preferred in the mark to market in such a difficult market. Can you talk whether or not you think you’re going to get relief from any of those? I know there in Washington there’s been a lot of talking about potential relief to mark to market or the preferred. What is your assessment of those?

David Gladstone

You can issue preferred there’s no problem with issuing preferred it just counts as debt.

Troy Ward - Stifel Nicolaus

Which doesn’t really help.

David Gladstone

It would certainly be long term versus short term so it would help in that perspective. We wish we could find somebody that would like some preferred stock in our company because we would gladly trade off some long term preferred for short term debt that we have on our portfolio in our company. We don’t know what the SEC will do. My guess is that they will not give relief but that’s just a guess. We probably couldn’t raise preferred stock at any decent rate today anyway so I’m not sure that’s a solution for the current problem.

Every time I turn around somebody tells me that the BDC model is broken and doesn’t work and all of this kind of stuff. I think it goes back to, I’ll use my analogy and that is when I’m driving and the speed limit is 45 mph I see people whizzing by me at 55 or 60 mph. When you do that and you violate the law you can pay consequences, you’re going to have problems you have a high probability of something going wrong that you didn’t expect to go wrong even accident or policeman pulling you over and giving you a ticket.

There are the same things, the laws of lending and investing and when you go outside those and violate those laws you run the risk of something bad happening and you run a higher probability of default or higher probability of loss. I don’t think the BDC model is busted I think some people took some risks that they shouldn’t have taken and are now paying the consequence for it.

We always see this in a heated marketplace. Many of the analysts that followed our stock criticized us pretty bitterly for not being aggressive and not reaching for deals and we wouldn’t do that. As a result we’re still in relatively good shape compared to our peers and I think our portfolio will continue to stand up in ’09. I don’t think the BDC model is broken I think some people violated the cherished laws of lending and investing and are paying the consequence for it.


Your next question comes from Kenneth James – Robert W. Baird

Kenneth James – Robert W. Baird

In your request in your proxy to be able to offer stock below net asset value did you put any kind of restrictions on that as such can’t be a certain percentage of the outstanding shares or it can’t be raised more than ‘x’ percentage below NAB are you putting any language in there like that?

David Gladstone

No, we didn’t. We’re hoping that you folks will trust us. As the largest shareholders of Gladstone Capital I’m not in a position to want to dilute myself down dramatically so we’re asking you to trust us to use our best judgment on that.

Kenneth James – Robert W. Baird

Do you keep any aggregate portfolio statistics on EBITDA revenue for the company and have you seen a dramatic drop off since September 30. You talked about the portfolio performing pretty well but it seems like things have changed pretty materially just in the last 45 days or so. I’m wondering if you could comment on just the most recent near term timeframe.

David Gladstone

We haven’t closed the books on November yet but for closing the books in October we haven’t seen a great deal of change. Some of the businesses we have some that are much more positive. They’re continuing to grow and we have others that have seen some of their backlog fall off. We’ve gone out to all of our businesses and told them to hunker down and stay strong; we’ve been telling them that for some time. Sometimes they listen to us and sometimes they don’t.

When volatility comes into the marketplace as it is today you need to be just very careful and I think most of the portfolio of companies that we work with understand that and have been doing that so I don’t expect any dramatic change in the portfolio.


Your next question comes from Vernon Plack - BB&T

Vernon Plack - BB&T

I wanted to talk just a little bit more about the minimum net worth requirement on your credit facility. I’m calculating and it looks like $248 to $250 million and with your net asset value around $272 million right now it appears you’re about $24 million away from that. I’d like some comments particularly given the fact that the broader markets have really taken a hit since September 30, E rated paper broadly speaking is down 20% to 25% and DD paper is down 20%.

It’s hard for me to see despite the issues with fair value accounting if you had to mark your portfolio today to fair value how you would not be in violation of that minimum net worth covenant.

David Gladstone

We’ve done the calculations as well and we just don’t know at this point in time what certainly December 31 is going to be. We don’t have to make that calculation on a monthly basis so we’re all looking at that and we’ll certainly sit down with our lenders if we look like we’re going to break that covenant and negotiate some kind of agreement around that. At this point we feel okay about it.

I think the marketplace is a lot different. Some people have not been marking down their markets the way we have and my guess is that we’ll come down by something if it’s more than $24 million as you mentioned then obviously we’ll have a discussion with our lenders if that’s the necessary thing. The difference with us and some of the other lenders is that we do have plenty of cash flow to pay the interest on our debt. Some of the others were getting close to 1:1 coverage or even not covering their ability to pay their interest on their debt. I think we’re in a different position than those folks.

We’ll just have to wait and see. We’ve had no discussions with our lenders about possible flunking that test. That’s the only one that we’re close to.

Vernon Plack - BB&T

I think you mentioned and I may not have caught all of this but I think you briefly mentioned near the end of your comments that you were working on some changes as it relates perhaps to distribution and/or the payment.

David Gladstone

The only thing that I mentioned there is that as you remember we give back all the incentive fees. We haven’t earned that much incentive fees and we were trying to figure out a way long term to solve that problem as well. That was the thing that we talked about.


Your next question comes from Henry Coffey – Sterne, Agee & Leach

Henry Coffey – Sterne, Agee & Leach

In listening to you talk a lot of the issues I had on my mind have been addressed already but in listening to you talk there isn’t the TARP but there is the SBA and I’m wondering as you look at your overall set of portfolio companies if that’s an opportunity you’d be willing to revisit given the diversification and the loan sizes and everything else you’re doing and you’re experience in this area it seems like it might be a great market for you to start looking at. It is permanent debt obviously you couldn’t fund existing assets with it but it is a potential. I’m wondering what your thoughts are in that area?

David Gladstone

We already own an SSBIC that helps disadvantaged small businesses. We are also applying to the SBA for a regular SBIC. It would avail us to $120 some we understand they’re going to raise that so we’ll most likely we don’t know for sure. We put our application in and we’re going through the process. We assume that we’re good debt by SBA to borrow that money and if so we would have that money available to growth the asset base as well as the income base.

There are a lot of rules and regulations with that but as you know between the group here we’ve all operated by the SBICs at different times in our careers so we’re pretty familiar with that. We’re doing down that path and hopefully we’ll have some news for everybody in the next quarter.

Henry Coffey – Sterne, Agee & Leach

Would that be inside of Glad or would that be?

David Gladstone

It’s inside of Gladstone Capital.

Henry Coffey – Sterne, Agee & Leach

What about any thoughts on ever combining some of the existing funds that are also out there so build up asset size and maybe simplify the funding equation?

David Gladstone

We’ve got different lenders and different investors in those and so we haven’t gone down that path yet. People keep calling us up and wanting to know if we’re going to buy any of the other BDCs and the answer has always been no to that. We’re not a consolidator of the BDC industry. It’s always a thought. We have looked at some other alternatives for raising equity but they’re all very expensive at this point in time and very difficult to get done as well.

It may be better for us to just continue our payout, work our portfolio, build our net investment income back up to the $0.42 a share and go from there. This isn’t a time, I don’t know how you feel about it but we don’t normally don’t like this increase our assets very much during a deep recession like we’re in now. We like to know that we found bottom and we probably won’t know that until two or three months, maybe even several quarters after it’s happened where the bottom is actually hit.

If this is the bottom today this quarter we probably won’t know that until the second quarter of next year. The next two to three years after a period of time when we found that bottom is usually the greatest period for us. We’re not sitting on the sidelines we’re closing one or two, three deals every quarter now so we’re perking along at a slow pace, very careful. That’s probably the best way of operating in this current recession period.

Henry Coffey – Sterne, Agee & Leach

Its good to hear your voice and it seems that you’re more optimistic than I’ve seen you be in a long time.

David Gladstone

We’re just waiting for the final turn and as soon as it goes we’ll put on the jets and take off.


Your next question comes from Leroy Carter – Private Investor

Leroy Carter – Private Investor

When you say Libor are you using the 30 day, 60, 90 what are you using?

David Gladstone

We’re using the 30 day Libor.

Leroy Carter – Private Investor

The three loans that are bad haven’t a couple of them been under the $9 million rate a year or so ago or are these new?

David Gladstone

No, they’re all old.

Leroy Carter – Private Investor

In your opinion how much of that $13 million do you expect to recover over a couple years?

David Gladstone

I think we’ll get it all.

Leroy Carter – Private Investor

What would the difference be in your book value if instead of marking to the market everyday you could use a permanent investment type of thing? I’m not saying that right but I think you understand what I’m asking?

David Gladstone

What do you mean by permanent?

Leroy Carter – Private Investor

In other words, they make you market the loans or the debt that you have mark to the market everyday today. Now what they’re trying to get changed or some people are trying to get changed if you keep the loan until maturity you would be marketing it at a much different figure.

David Gladstone

That’s exactly our point.

Leroy Carter – Private Investor

What difference would that make in your book value?

David Gladstone

It would make a huge difference in book value. The book value would go up pretty dramatically. I don’t know what that number would be because we don’t run it. The SEC requires us to give you one number in terms of our valuation and not equivocate and say well it should be this or it should be that. As a result we don’t go out and calculate other numbers. I can tell you that if people let us mark to maturity kind of value it would be a whole different world.

Leroy Carter – Private Investor

On current leverage Chip mentioned it but I think, what is it about 1.4 on your current leverage.

David Gladstone

You mean how much money have we borrowed?

Leroy Carter – Private Investor

In other words $1 equity to how much debt?

Chip Stelljes

We’ve got about $150 million outstanding on the line of credit and about $272 million of net worth. Obviously less than the 1:1 requirement.


Your next question comes from Troy Ward - Stifel Nicolaus

Troy Ward - Stifel Nicolaus

You said something interesting there about if you’re interested in consolidating the industry and it seems you sound like you pretty much discuss that out of hand. What are the hurdles and why do you dismiss it out of hand what would the hurdles be to do some consolidation in the BDC space. Do you think any of that will actually happen?

David Gladstone

The smaller BDCs may seek some refuge in larger BDCs but at this point in time the larger BDCs don’t seem to be in a position to do any consolidating. I would say that most of us, including us, don’t have the currency to do that kind of consolidation unless you’re going to take on one of the turn around BDCs that have problems and their stock is trading at a very low rate much lower than ours.

We’re not in the business of buying turn around; we’re not turn around artists per se. We do a good job in our own portfolio when there’s a problem but taking on somebody else’s problems and trying to fix them is just not what we do. We’re not a distressed debt player is a better way of saying it. For us it’s a matter of personal preference.

Some of the deals would have to be done on a hostile take over kind of thing and while there have been some hostiles in the business [NVC] was a good example of that. We’re just not interested in hostile take overs, it’s not in our chemistry here as a group we’re not comfortable. It takes a lot of cooperation from all of the owners and in management of the BDC.

I think most of the BDCs today while they’re going through some agony are quite content to be masters of their own universe and run their own businesses and really don’t want to combine with anybody else even the smaller ones have a desire to remain independent, run their own show rather than being a part of a big organization.

For us it’s the human part of it that is we don’t want to do it. There’s the human part of it is probably most of the BDCs don’t want to do it then there’s the regulatory hurdles of getting there. I think all of that makes if very difficult for somebody to roll up or combine the BDC industry. If we had a Hank Paulson who comes in and says you’re going to merge with so and so I think that would a whole different world. There isn’t that kind of regulator of the BDC space.


We have no further questions at this time. I’d like to turn the floor back over to management for closing comments.

David Gladstone

We thank you all very much and we do want to mention that today is the birthday of our Chief Operating Officer, Terry Brubaker and so we’re wishing him happy birthday today. With that we’ll call it quits and thank you all for calling in. That’s the end of this conference.


This does conclude today’s teleconference you may disconnect your lines at this time and we thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!