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Gladstone Capital Corporation (NASDAQ:GLAD)

F3Q09 (Qtr End 06/30/09) Earnings Call Transcript

August 4, 2009 8:30 am ET

Executives

David Gladstone – Chairman and CEO

Chip Stelljes – President and Chief Investment Officer

Gresford Gray – CFO

Analysts

Greg Mason – Stifel Nicolaus

Vernon Plack – BB&T Capital Markets

Scott Valentin – FBR Capital Markets

David West – Davenport & Company

Operator

Greetings, ladies and gentlemen, and welcome to the Gladstone Capital Corporation third quarter 2009 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Gladstone, Chairman for Gladstone Capital Corporation. Thank you, Mr. Gladstone. You may begin.

David Gladstone

Thank you, Claudia, for that nice introduction, and hello and good morning to all of you out there. This is the quarterly conference call for shareholders and analysts for Gladstone Capital, NASDAQ trading symbol, GLAD. Thank you all for calling in.

We are always happy to talk to as shareholders about our company, and I just wish there were more opportunities but we only do this once a quarter. I hope you'll all sign up for email notices, so if you are a shareholder or planning to be shareholder, get on the email notification list, so that you get the information coming directly from our company to you. And please remember that if you are in the Washington DC area, you have an open invitation to stop by and say hello. We are here in Mclean, Virginia, a suburb of Washington DC. Just stop by and say hello, you will see some of the finest people in the business.

Now let me read the statements that I read each quarter. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities 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 believe the 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 the forward-looking statements, including those factors listed under the caption Risk Factors in our 10-K and 10-Q filings and in our prospectus as filed with the Securities and Exchange Commission. Those can be found on our website at www.gladstonecapital.com and at the SEC web site.

The company undertakes no obligations to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Let us start now with the President, Chip Stelljes. Chip is the Chief Investment Officer for all the Gladstone companies. He will cover a lot of ground. So Chip, take it away.

Chip Stelljes

Thanks, David.

As most of you know, we continue to operate in a very difficult environment through the quarter ended 6/30/2009. The environment did not worsen for us but it didn't really improve either. While there are some new investments being made in the market, the continued instability of the financial and the lending markets combined with the downturn in the economy and the lack of much visibility into the rest of 2009, much less 2010, has made us cautious. We did not close any new investments during the quarter, just ended in the investment activity of 7.6 million, which was entirely an existing portfolio of companies in the form of additional investments or draws on revolver facilities.

During the quarter, we received approximately 55.3 million due primarily to loan sales, but also payoffs, normal amortization, and pay downs on revolvers. This resulted in a net production decrease on our portfolio of 47.7 million for the quarter. Since the end of the quarter, we made about 230,000 in additional investment in existing portfolio of companies. Additionally after the end of the quarter, we sold one syndicated loan that was held in of our portfolio of investments at June 30. The loan had a fair value of 6.4 million of which we received all the proceeds as of August 3.

We continue to see new investment opportunities, we are being contacted pretty aggressively because so many lenders are still not active. Pricing and structure are attractive. Unfortunately, companies that have a positive outlook for the remainder of 2009 and into 2010 are limited, but there are some out there. If we can access more capital, we should be able to find them. The net decrease in investments in the June quarter was 47.7 million from loan sales, prepayments and repayments. This does allow us to further deleverage.

We continue to look at ways to increase yield on the portfolio by refinancing our lower yield and senior loans with third-party lenders while trying to maintain a higher yield in junior debt. Our deal flow is good but we will need to be confident when we understand the economics cycle ahead of those and have the capital to pursue the pipeline of opportunities. At the end of the June quarter, our investment portfolio was valued at approximately 331 million versus a cost basis of 386 million or approximately 86% of cost. We were very concerned that the use of fair value becomes suspect when there are few sellers and few buyers or in some cases no sellers or buyers. Even though the values remain stable this quarter, we still believe the valuations are more reflective of the overall poor market for loans rather than our specific portfolio.

That being said, we continue to closely monitor our portfolio of companies' revenues and backlog to judge where the underlying companies are headed. At the end of the quarter, we had loans with three companies on non-accrual and a number of companies experiencing problems that may prevent them from making timely payments in the future. We have taken operating control of several of those companies and are working aggressively to fix the problems and improve profitability. On a dollar basis, the loans classified as non-accruing have a cost basis of 10.7 million or about 2.8% of the cost basis of all loans in our portfolio. Our portfolio companies are not immune to the current economic climate, so we expect to have some additional non-performing loans and some write offs before this recession is over, but we are working very hard to keep them to a minimum.

We continue to have a high concentration of variable rate loans so that we participate when rates do begin to increase. And our rates are variable, they often have a minimum rate or floor so that declining interest rates are mitigated. About 83% of our loans have floors, however 13% of our loans do not have floors. And with short-term floating rates at all-time lows, we're generating less income. At June 30, 2009, we had four fixed rate loans with a cost basis of 14 million or approximately 4% of the cost basis of our total portfolio of loan to investments.

Another measure of the quality of our assets is that our average loan rating for this quarter that just ended remained relatively unchanged. Our risk rating system gives you a probability of default rating of the portfolio with a scale of zero to ten , with zero representing a high probability of default and ten representing a low probability. Our risk rating system for our non-syndicated loans stood at an average of 7.2 for this year and 7.3 for the same prior year quarter. The average risk rating for un-rated syndicated loans was 7.0 for this quarter versus an average of 6.5 for the prior year's quarter.

As for our rated syndicated loans, they have an average rating of CCC or CAA2 for this quarter versus an average of CCC+ or CAA1 for the prior year quarter. Overall the risk profile has remained constant according to our risk rating model. And while the risk rating is showing only slight changes in the portfolio, we do see changes that may not be picked up by our risk rating system. Our companies are not immune to the current conditions as I mentioned and we don't want to put all of our trust in a single risk rating system as so many investors did with the rating agencies in the past.

In addition to the quality of assets, the quality of our income continues to be good. As we have discussed before, some company structure investments are paid in time or original issued discount structures. This generates non-cash income, which has to be accrued for books and tax but is not received until much later and sometimes not at all. This income is subject to our 90% pay off requirements, but the company does not receive the cash, it has to pay off the income. So we have all these structures for this reason.

From inception through 6/30/09 we have made loans to 126 companies. We have been paid for exited from 75 companies. The average return on these exited loans is about 8% for syndicated loans and 16% for non-syndicated loans. The returns have dropped some as we booked a loan sales that we announced at the end of last quarter below our cost during this quarter. The senior and second lien debt marketplace for larger and middle market companies showed some signs of improvement, but continues to have liquidity problems. At June 30, we had about 24 million at our cost basis in senior and second lien syndicated loans. This is where we have most of our variable-rate loans without floors and these loans have seen their value declines more than the others. Again during the quarter, we sold a number of syndicated loans.

The market pricing for the large and middle market loans continues to change for senior syndicated loans of 200 million or more. Rates prior to the credit crunch were about 2.5% over LIBOR. LIBOR of course is the London Interbank Offering Rate, which is recognized as the leading indicator of short-term corporate rates. Now the spreads seem to be closer to 6% over or more because these new loans are at a higher spreads or are at a higher rate of the old loan's demand a lower market price. In light of this, we intended to hold our syndicated loans until they matured because we believe ultimately we will recover most of our capital if we did not sell them. But we chose to sell the loans we did at a discount in order to reduce our outstanding indebtedness under the line of credit. Of the remaining syndicated loans, all are paying such as agreed.

In addition to widening spreads over LIBOR, the norm for LIBOR has really been 5% to 6% historically and was approximately 3/10 of 1% on June 30, 2009. So LIBOR is unnaturally low given the emphasis on lowering rates worldwide to spur lending. And the drop in LIBOR has lowered our income. Small loan market in which we invest most of our capital has not seen much competition. Many banks have tightened up their credit standards. The only activity we really see from the banks in our sector is a willingness to make purely asset based loans. We normally compete with others BDCs and private lenders like mezzanine loan funds, a hedge funds, and some of the small business investment companies out there.

Again, our loans request pipeline is still good and if we can access capital and get comfortable with the risks of the economic cycle, it may materialize into more new investments for us as the year proceeds. Again, our goal is to be a strong, profitable company, not the biggest company. And with that, I am turning the presentation back over to David.

David Gladstone

All right, thank you Chip.

That is a great report. Now let us turn to the financials and for that we will hear from Gresford Gray, our Chief Financial Officer. So Gresford?

Gresford Gray

Thanks David. We will begin with our balance sheet. Our balance sheet continues to remain strong and at the end of the June quarter, we had approximately $344 million in assets, consisting of 331 million in investment at fair value and the remaining 13 million in cash and other assets. We had about $92 million borrowed on the line of credit and about $250 million in net assets. So we are less than one-to-one leverage. This is a very conservative balance sheet for finance companies, which are usually leveraged much higher.

We believe that our overall risk profile is low. In May of this year, we entered into a new credit agreement for a $127 million revolving line of credit with Key Equipment Finance, which replaced Deutsche Bank as the administrative agent. BB&T also joined the credit facility as a committed lender. The new facility matures on May 14, 2010.

Turning to our income statement, for the June quarter, net investment income was about $5.4 million versus 6.7 million for the same quarter last year, a decrease of about 19%. The decrease was primarily due to a decline in our investment income resulting from the sale of loans during the quarter, lower transaction fee paid by the portfolio companies, which are credited against our base management fees, and the amortization of deferred financing fees incurred in connection with our prior and current credit facilities. Note that we have also seen LIBOR fall as Chip mentioned earlier and the LIBOR continues to remain low

This has negatively impacted earnings from our syndicated loans. If the rates go back up, however, we expect that our income will also increase, all other things being equal. On a per-share basis, net investment income for the quarter was at $0.26 per share as compared to $0.32 for the same quarter last year. This is a per-share decrease of about 19% again caused primarily by the changes I discussed earlier. As all of you know, net investment income is the most important number to us because this is the number that is closest to our taxable income, and that taxable income is what we used to pay our dividend.

Now let us turn to unrealized an realized gains. This is a mixture of appreciation, depreciation, gains and losses. We would like to talk about two categories in this section. The first, gains and losses, because they are cash items, and second we talk about appreciation and depreciation which are non-cash items. In terms of realized losses, for the quarter ended June, we had a realized loss of about $10.6 million, primarily for from the sale of syndicated loans during the quarter. Now turning to unrealized appreciation, for the quarter, we had unrealized appreciation of approximately $4.4 million. This represents a net change in fair value of our investment portfolio, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.

As of June 30, our entire portfolio was fair valued at 86% of cost. The unrealized depreciation of our investment doesn't have an impact on our current ability to pay distribution to stockholders. However, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution.

As explained in our previous 10-Qs, we have made a change in our valuation procedure to value our syndicated loans using a discounted cash flow method, versus the line on third-party indicator bids, when we believe that those bids may not be a reliable indication of fair value because of illiquidity in the marketplace. The marketplace for which we historically obtained indicative bids for purposes of determining fair value for our syndicated loan investments continues to show attributes of illiquidity. Historically, our evaluation procedure specified the use of third-party indicative bids for valuing syndicated loans where there was a liquid public market for those loans and market price quotes were readily available.

However, when there was not an inactive market, the use of these agents/nonbinding indicator bid quotes was deemed to be appropriate and acceptable in accordance with FAS 157. However due to the market illiquidity and the lack of transactions during the quarter ended June 30, we determined the current nonbinding indicative bids for our syndicated loans were not based on transactions within an active or liquid market and could not be relied upon and alternate procedures would need to be performed under liquidity returns to the marketplace. As a result, we have valued our syndicated loans using a discounted cash flow methods for the June quarter, except for the loans we sold at third quarter end, where we used its sale price and not a discounted cash flow value.

Now let us 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. Please note that we're talking about weighted-average fully diluted common shares when we use per-share numbers. This is the most conservative way of stating earnings per share. For the June quarter, we had net decrease in net assets resulting from operations of $0.8 million versus a net increase of 2.8 million last year this time. For the June quarter, this was negative $0.04 per share versus last year a positive $0.13 per share. With the continued uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of our portfolio.

And now I'll turn it back over to David.

David Gladstone

All right. Thank you Gresford. That was a good presentation, very thorough. Hope all of you out there, all you listeners are going to website or leading our press releases and also obtain a copy of our quarterly report called the 10-Q which has just been filed with the SEC. You can get that on our website at www.gladstonecapital.com and also on the SEC website. So a lot of news in there, a lot of information.

The big news this quarter of course was the payoff of our primarily lender Deutsche Bank and replacing them with Key Bank as the lead bank and BB&T is a participant. Deutsche Bank was our lead bank but they told us they were not likely to extend our loan and we took a look at that and said, well, we're in pretty good shape, because we have the ability to pay off the loan over a one-year period. But rather than do that, we sold a few loans and KeyBanc and BB&T increased their loan amount so we could pay off Deutsche Bank in May and that ended our relationship with Deutsche Bank.

Our biggest challenge today is debt marketplace for our funds and also for our portfolio of companies. The banks' willingness to provide our line of credit was a great benefit to us but banks are not providing anything more than lines of credits, they're not doing term loans or long-term term loans for us or our portfolio of companies. We have a new line of credit. It is working fine. It will be good until next May and we believe it is sufficient for the near term. However, in reality, we need to raise long-term debt and long-term capital like preferred stock or common stock in order to finance our new investments. Our new investments obviously are long-term debts. We will make long-term investments. So we need long-term liability to go with those rather than short-term liabilities.

For our portfolio of companies, we are certainly worried about them not being able to get anything more than lines of credit and in some cases we have gotten good lines of credit for them, but it is very hard to get term loans, and they need that long-term debt as well. There is a fair number of regional banks that are making new loans based on assets of the business. These asset based lenders are more plentiful now than they were last quarter, even the quarter before, and I think, this is a very good sign that the credit markets are freeing up at least for short-term asset-base loans, but term loans are still hard to find.

On the other front, we're still worried about oil prices. We think they will go up as the economy continues to get stronger and better and that of course put a crimp in everybody's dial. We're currently worried about inflation. I don't think there is any need to worry during this quarter or perhaps the next quarter, but you just can't do what is being done in Washington, that is expand the money supply without inflation coming at some point. Our fear will be concern in 2010 where the government is talking about or projecting now to raise as much as $2 trillion during the next couple of years in government paper. Last week, they sold the most that has ever been sold in one week period, and they got it all off in pretty good shape. So there are still buyers, but one has to wonder how much longer there are going to be buyers for that much federal spending, federal debt sales.

The spending at the federal and state and local governments is still off the charts although now many of the state and local governments are having to scramble and cut back and that is probably a good sign. But the federal government certainly is out of control, looking at the so-called stimulus package it just built with spending goodies for many of the supporters of the new administration and those people who are in favor of putting that stimulus package together. The stimulus spending is dislocating I think a lot of the marketplaces. I'm not sure how this will turn out. It looks like we're partly nationalizing a lot of the banks, insurance companies, and auto businesses and over time, these partially nationalized businesses hopefully will raise equity to take out the government or the remaining government ownership that they have and that would be good, but it is going to be a lot of equity to be raised.

The amount of money being spent on the war in Iraq and Afghanistan is still really off the charts and I don't know if you know it, but the government has on balance sheet names and off-balance-sheet, and it looks like they keep the Iraq and Afghanistan war off-balance-sheet, so they don't recognize that in all of the spending that is going on. We are all in favor of our troops overseas, we are certainly supporters there. They are the true heroes of this period of history. They are obviously risking their lives for all of us and we hope each and everyone of them comes home safely, but we have to recognize that it is still a horrendous expense to our country and to our taxpayers.

All of this spending will remain just mean more taxes and I don't think that people can handle any more taxes. It keeps causing dislocation in the economy by continuing to tax and the government has to sell more debt. This causes inflation and there are just many in Congress who continue to call for increased taxes on the so-called rich and the definition of rich continues to include more and more of the middle class. I just don't see how the middle class can continue to bear more and more taxes.

The trade deficit with China hasn't gone down much at all, it is still just terrible. China continues to subsidize their industries to the disadvantage of our businesses by subsidizing their oil and gas prices significantly so that it is cheap for their local businesses to buy gasoline and oil, whereas our is probably two or 2 1/2 times more expensive here. The downturn in the housing industry and related disaster in the home mortgage defaults continues to hurt our economy. I don't think anyone knows how many home mortgages will ultimately fail, but there is some estimates that put the number at the a trillion dollars. And that is the main cause of this recession, the housing problem will likely turn around this year, because housing prices and mortgage rates are falling enough, so that is bringing back in qualified buyers.

In spite of all the negatives, the industrial base of the United States still seems to be going along. It is not a disaster. The recession is having an impact on our portfolio of companies and many of the companies we that come in everyday but again it is not a disaster which companies are holding up and going away. The only other thing that is hurting us is – us and our portfolio of companies is the lack of bank lending, that is long-term lending, and I don't know when that will turn around.

Short-term loans by asset based lenders are available as I mentioned before but we just don't have the long-term lenders, the banks are not doing that. This is very similar to the 1990 recession except that the federal government is pouring money into the banking system rather than taking over the banks. In that period of time they took over 1100, 1200 banks. Here they're continuing to lend the money, and keep them propped up, so they're not taking them over. We believe that the downturn that began in 2008 will continue for the rest of 2009. I know the stock market is indicating that the recession has turned around, but one has to go back in history and remember that the stock market has only been 50% right in the past. When the stock market takes off, it is 50-50 chance that the economy has stabilized and turned around.

I do believe the economy is stabilizing and will begin to turn up soon. I'm just not sure if it is this quarter, next quarter, or sometime in 2010. If that is true, and returning around, then we don't have to catch the wave at the beginning of the turnaround. We can catch it much later, but if that is true, we can take advantage of it, we would be in a great time for us over the next 2 to 3, maybe even four years, but our plan right now is to seek long-term debt for our funds. We need to borrow long-term so we can make long-term loans. We are making rounds to some of the long-term lenders such as insurance companies to see if we can raise long-term debt and this is going to take a while. We're not going to be able to do that overnight. But when we announce that we have gotten some long-term debt, you will know that we are back in the marketplace strong making new and better investments.

We need to pay down our short-term debt and replace that with long-term debts. We can't build this company on revolving lines of credit from even from good folks like KeyBanc and BB&T. We have applied for an SBIC license at the SBA. We are – if we are granted the license, then we would be able to borrow, as I say, up to $120 million, which would be very significant for us. It is very attractive terms and under that program, we can borrow money through the SBA for 10 years, interest only, and the rate it is only a few percentage points over long-term treasuries.

At this point I can't say whether we would get the license or not, all I can say is that we have all the paperwork in that they have asked for and we will just have to wait to see if it is two weeks from now or two months from now or if at all if they're going to award us the license. We are also looking at issuing preferred stock or something like preferred stock. It would be very expensive today, so we're trying to figure out if there is a way of issuing something like preferred stock at a reasonable price.

We're not considering issuing any common stock right at this time because stock price is just too expensive for us to do that. And what I might mention is that to raise money today you have to take a big discount and as much as 10% of the current price. So you sell it with a 10% discount, then you pay the underwriters, 5.5% usually, and then there is expenses on top of it. So you end up knocking off 17% of the price. So if you had a $10 stock, you're only getting $8.30. So it hurts a lot to do new stock offerings today. We're hopeful that the retail market place and other parts of the market will come back so that we can issue some stock some time in the future.

As all of you know, our distributions are seven cents per month for July, August and September. That is an $0.84 a year projection we did assuming that we are not making any new investments so the $0.07 should be in good shape. If we make some new investments, we will be able to push the dividend up, but there is no guarantee that we're going to be in that mode in the near term. Obviously, at some point in time, we will get back and start cranking up that part of the business.

The distribution rate in July, the dividend on the stock now about an 8.5% yield at $9.90 that it closed yesterday, so it is still a good distribution, and we hope a lot of folks will step up and buy some more shares and we can move along in terms of raising money. Please go to the website, sign up for email notification, www.gladstonecapital.com. We don't send out any junk mail and you'll get the latest word from the company.

In summary then, as far as we can see economic conditions look like they are changing. We think the economy is reaching bottom. We are starting to gain some strength here we hope as soon as we see enough strength, we will move forward. We just don't know when this bottom is going to be reached, whether it is this quarter or the next two quarters. I think we will be telling about that. We are stewards of your money, we will stay the course and continue to be conservative in our investment approach and in our approach to this very unusual marketplace that we are in.

But now, Claudia, if you'll come back on, we will open it up for questions and we will hear from some of our analysts and shareholders who want to take time to ask us a few questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question is coming from Greg Mason with Stifel Nicolaus. Please state your question.

Greg Mason – Stifel Nicolaus

Thank you and good morning. David, as we look through the Q last night, you have a table in there that shows your operating earnings by month of roughly $0.10 in April, $0.09 in May, and $0.07 in June. Is that June monthly rate of $0.07 kind of a good run rate going forward after the new facility and some of the assets sales you have had?

David Gladstone

Well, hard to say. I think we will be better than that but that is a good proxy for your analysis.

Greg Mason – Stifel Nicolaus

Okay. And then when you talk about the SBIC license, am I remembering this correctly that you would have to fund say the first half of it with your own capital, and if that is the case, I would assume that you would be looking at some of those capital raising that you talked about to fund that, is that correct?

David Gladstone

Yes, could be. We can also continue to do some sales of our loans. We can – we also have a fairly large amount of repayments due in the next 18 months. So we may be able to fund it out of cash flow. Hard to say at this point, but you are right, we have to do exactly what you said. We have to put up the money first and invest it and then draw down money from the SBA.

Greg Mason – Stifel Nicolaus

Okay, great. And then you talked about in your Q that you have done $24.7 million of investments to existing portfolio of companies over the last nine months. Are your equity sponsors and equity owners also kind of stepping up and supporting portfolio companies in this time?

David Gladstone

Depends on which one. Some of them are not in very good shape so we have had to take over recently one of the companies and we now really are the owner of it. But generally speaking, those portfolio of companies have had their sponsors put up more money and in some cases for example one week ago where the individual who is starting as the president there put up money himself. So we had – that was a good sign obviously. But generally speaking, the answer is yes, and occasionally it is no, and we have to do the work.

Greg Mason – Stifel Nicolaus

And then one last question and I'll hop back into the queue, on your new facility, you said you adapted FAS 159 which is mark to market your liabilities, could you talk about why you chose to adopt 159 today when yields seem low and spreads seem high, continue to discuss 159 and why you chose that?

David Gladstone

Yes. 159 is really based on something for the future. We're doing it for all of our liabilities because quite frankly it is kind of silly to have the asset side of your balance sheet going up and down and your liabilities remaining stagnant. So in our estimation, all companies should be looking at both their asset and their liabilities. If one is growing up, the other one should be going up or down, and there should be some relationship to that, so that if your assets are going down, hopefully your liabilities are going down as well, and you get a balance out of.

We see we could whipsawed obviously but he goal here is if we are able to layer on some long-term liabilities, then 159 will have an impact. 159 really doesn't have an impact to short-term revolving lines of credit. So you shouldn't see any change in that valuation, but we're hopeful that somewhere in the future that we will be able to layer in some long-term debt and we will be able to value it based on 159.

Greg Mason – Stifel Nicolaus

Great, thank you very much.

David Gladstone

Next question?

Operator

Our next question is coming from Vernon Plack with BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Thanks very much. And David, I know that I might get a little bit more color on the fair value adjustments that you took in the portfolio this quarter. If you exclude reversals, it looks like net depreciation was about 4.8 million, can I assume from some of your earlier comments that that is just the result of lower cash flows from your portfolio of companies?

David Gladstone

Well, it has to do with a lot of things. One of course is that when you value notes, you have to price them based on what everyone else is pricing based in the marketplace, so you do get a comparison and you can have many of our loans trading down even though they are paying as agreed and they are in reasonably good shape. So yes, it is due some to lower earnings in the companies but also due to the marketplace that keeps changing and bouncing around.

Vernon Plack – BB&T Capital Markets

I think you mentioned that 83% of your loans have floors on them and just trying to get a sense the floors are obviously good protection now but I'm wondering how far up do rates actually have to go before you lose the benefit of the floor? Rates are so low right now, and with the floors in place, but how much higher does LIBOR have to go before it actually has an impact on the rates on these investments?

David Gladstone

No, it would have – in some cases it has to go up dramatically. We would four floors, 4% floors, so you have to move quite a bit before we are going to see an impact on that.

Vernon Plack – BB&T Capital Markets

Okay, thanks very much.

David Gladstone

Okay.

Operator

Our next question is coming from Scott Valentin with FBR Capital Markets. Please state your question.

Scott Valentin – FBR Capital Markets

Good morning. Thanks for taking my question. David, maybe just talk about credit quality, pretty large concentrations in broadcast and in printing and publishing, just curious with the economy being so weak and advertising falling back, what you're seeing in those two segments?

David Gladstone

We are seeing a slowdown in both segments. Obviously advertisers in magazines and publications are down and the same thing for broadcasting. The difference in broadcasting and printing versus say some other business is that they have the ability to lay off a lot of people and they can shrink their expenses along with their income. But we are hopeful that in the next 12 months those will all come back up. We have seen for example some of the print folks cut way back and be able to continue to have very positive cash flow even though they had outlined has changed pretty dramatically.

The radio stations have held up reasonably well. We have got some that held up as well as we would like but generally speaking, local broadcasting folks are part of the local economy as opposed to a national economy. They don't get hit quite as bad as say some of the national network radio systems would but generally speaking you are right. Those are two weak areas but at this point in time we are seeing payments come in and we're grateful for that.

Scott Valentin – FBR Capital Markets

Okay. In terms of the portfolios size, you mentioned I think this quarter it was just reinvestment in existing portfolio of companies and you want to get more comfortable with the economic environment. But at what point do you start getting concerned about the dividend and coverage ratio, things like that, I mean how much of that drives the decision whether to grow the portfolio or not?

David Gladstone

If the question is will we go out and put a lot of deals on the books in order to jack up the income, the answer is no. We're going to play it safe at this point in time and right now based on our projections, we don't need to do anything to cover the seven cents per month that we are paying, so we're in good shape now. Should half a dozen companies or maybe a dozen companies have real problems, then of course the $0.07 would be in jeopardy. We are no seeing that today, so we don't have any forecast that we're going to have to cut the dividend.

On the other hand, if this is a turnaround, and say in the fall, we are able to land a couple of long-term loans for our company and then turn around and start put money out, it will mean that we can crank up the earnings and hopefully crank up the dividend. It is all dependant on which way you view the economy and we haven't gotten comfortable enough at this point in time to say the world is ready to go on another spending spree and everything is going to be okay.

So we are still on a hole more than ready to put new money out. And we also want to protect our existing companies so we don't want to use up our money from our revolving line of credit for new deals and not have money for existing companies. We are tending to work with our existing companies and help them buy other small businesses so that they can continue to grow and prosper in a time that we're in now. So I don't know Scott, it is one of those first periods of time in which it is just not a clear signal out there that everything is ready to turn around.

Scott Valentin – FBR Capital Markets

Okay. And just one final kind of industry question, yesterday there was an interesting transaction announced in the BDC space, I was curious if that is consistent given your experience, is that consistent with where we are in the cycle, and can we expect more of that as an opportunity to go out and take advantage?

David Gladstone

Well, we looked at the transaction and decided not to go forward. That is all I want to say about it. But I think there are opportunities out there, probably not through us. We are not very excited about buying portfolios that are really you have got to spend a lot of time and a lot of energy in a very short period of time in order to buy a portfolio under duress. And it just lends itself to mistakes and so as a result I don't think you will see us buying a lot of companies. I know we have been approached by a couple of others and we have not gone forward with them. So you wouldn't look for us in the bidding war that may go on out there.

Scott Valentin – FBR Capital Markets

Okay, thanks very much.

David Gladstone

Next question?

Operator

Our next question is a follow-up from Greg Mason with Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

Thank you. I was wanting to know, David, if you could give us a little more color on EBITDA trends in your underlying companies. You said they have been negatively impacted but are you seeing that EBITDA trends are still declining rapidly, are they starting to level off, just any more color you can give us on the direction of your portfolio and your take on the economy?

David Gladstone

Well, chip is working that everyday, Chip?

Chip Stelljes

Yes, I would say that if you looked at history here that we saw some pretty negative adjustments through the March quarter. I would say some stability in April and May. June seemed to be better and July seemed to be flat to better. So as I said in the very beginning, it didn't – situations aren't getting any worse, they don't seem to be getting a lot better. We are tracking upstairs, we are tracking backlog, we are tracking order rates and inventory build etc. You know I would love to stay that we're seeing a dramatic improvement but we are not. But we're not also not seeing a continued drop-off in performance overall in the portfolio.

David Gladstone

And that goes regardless of industry almost right now that heavy industries we are in some companies that are related to metal bending and all kind of products that are produced in the metal area, and those have seen a flattening out and actually seen some activity that would indicate that things are turning around. In the more service-oriented areas, we have seen some changes in that, that seem to say that we flattened out. But we just need a couple of more months or maybe even a quarter to confirm that. After it is confirmed and we start to see things going well, assuming we have got some long-term debt, then I think we can turn on the jets and start to take of doing lots of new deals.

Greg Mason – Stifel Nicolaus

Okay. And then as we look through the portfolio, we noticed like there is two or three companies that have debt pieces at zero fair value but you are still accruing, can you talk to us how that accounting works on those investments, with the zero value that is still accruing the payment you are receiving?

David Gladstone

Yes. You can say to yourself that a company is in – if you had to liquidate it, you would probably get nothing, but it is – because it is a service company, so you're looking at both liquidation value as well as payment value. And it a tricky thing to do and what we do is try to err on the side of ultra conservatism and making sure that we don't overvalue something. So for us, it is just I don't know, it is a habit we have gotten into early in the game. Most of my career, we played the game in a more conservative manner, sending the signal that if this company had to be liquidated or if it was had to be sold today, it wouldn't be worth very much. And that is what we have tried to do. But again people are paying as agreed and as a result of that we tell you that we're getting the money in but at the same time we're telling you that if we had to liquidate it, it would be worth nothing.

Greg Mason – Stifel Nicolaus

And one last question just to make sure I heard right, you said kind of the average LIBOR floor in that 83% of your portfolio has floors is around 4%, did I hear that correctly?

David Gladstone

That is right. There maybe a…

Chip Stelljes

Yes. I think we ran it a while back and we thought it was about 4%, but we ought to rerun the numbers. You probably ought to also remember that we have got a floor built into the line of credit as well, so you have got some matching feature there.

Greg Mason – Stifel Nicolaus

Got it. Okay. Great. Thank you, gentlemen.

David Gladstone

No other question?

Operator

Our next question is coming from David West with Davenport & Company. Please state your question.

David West – Davenport & Company

Good morning. David, I wondered if you could just talk a little bit about your comfort factor in terms of utilizing your current line of credit, fully understand why you don't want to the long-term assets and fund them with a short-term facility, but at 37%, I think as of the end of June, you're probably lower today, is there a level that you feel comfortable with in terms of borrowing under the current line of credit?

David Gladstone

Yes. We're about – we are very aggressively at 92 million drawn on the 127. I think as we approach $50 million, we would certainly feel more comfortable at that level. You know the biggest problem in the world right now is having confidence that your banks will be there for you. We have gotten thrown a real curve with Deutsche Bank and we're happy that KeyBanc and BB&T stepped out, but we are one of those groups that while we love KeyBanc and BB&T, as I told them, they could be bought tomorrow by Deutsche Bank, and so as a result we would be back in the same position we were before.

So we're just trying to do two things there, first of all, as I mentioned before, get long-term debt, but second of all, to diversify our lending base just as you would expect us to do. And right now, we have KeyBanc in for a fairly large amount. I think BB&T is in their comfort zone, but I would like to get KeyBanc pay down to an amount that I felt comfortable with and that's probably needs to get the line of credit paid down to around $50 million. And two ways of doing it, raise long-term debt, pay off the short-term debt, have collections from our portfolio of companies as we expect to do, and pay it down, but we need to get a position where we feel that the banks would not have a problem in continuing their loan.

I don't want to run into the same problem that so many of the BDCs have run into and as we ran into in April and May in which you got a problem with the banks running for the door saying they want to get out of the credit and not being able to either replace them or pay them off. So we're going to take it very conservatively in this company and get it paid down either with long-term debt or with pay downs from our portfolio.

David West – Davenport & Company

Very good, thank you.

David Gladstone

Next question?

Operator

I'm showing we have no further questions at this time.

David Gladstone

All right. Last chance to hit the phone for one more question, anybody out there?

Operator

(Operator instructions).

David Gladstone

All right. That is the end of this conference call. We thank you all. We will see you again next quarter.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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Source: Gladstone Capital Corporation F3Q09 (Qtr End 06/30/09) Earnings Call Transcript
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