Gladstone Capital Corporation (NASDAQ:GLAD)
F3Q 2013 Earnings Conference Call
August 1, 2013; 08:30 a.m. ET
David Gladstone - Chairman, Interim President & Chief Executive Officer
Melissa Morrison - Chief Financial Officer
Greg Mason - KBW
Casey Alexander - Gilford Securities
Good morning, and welcome to the Gladstone Capital Corporation’s, third quarter ended June 30, 2013 shareholders conference call.
All participants will be in a listen-only mode. (Operator Instructions). Please note this event is being recorded.
I would now like to turn the conference over to Mr. David Gladstone. Please go ahead sir.
Well, thank you Denise for that nice introduction and hello and good morning to all of you out there that have called in. This is David Gladstone, the Chairman, and this is the quarterly earnings conference call for shareholders and analysts of Gladstone Capital, with the common stocks traded under the symbol GLAD and the term preferred shares are traded under GLAD and with a P at the end for Preferred.
Again, thank you all for calling in. We are always happy to talk to shareholders and give an update on our company, and please remember that if you ever happen to be in the Washington D.C. area, you have an open invitation to come by and see us here in McLean, Virginia. Please stop by and just say hello and you will see some of the finest people in the business.
Please take the opportunity to visit our website, www.gladstonecapital.com and sign up for our email notification services. We don’t send out any junk mail, just news about your company and you’ll also find us on Facebook under the keyword The Gladstone Companies and you can follow us on Twitter under Gladstone Comps, that’s C-O-M-P-S after Gladstone.
And now I need to read the statement regarding forward-looking statements. 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 risk and uncertainties and other factors. Even though they are based on our current plans, we believe those plans to be reasonable. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may or similar expressions.
There are many factors that cause our actual results to be materially different from any future results that are expressed and implied in these forward-looking statements, including those factors listed under the caption, Risk Factors that our found in our 10-K and 10-Q filings and in our registration statement as filed with the Securities and Exchange Commission, and all of these can be found on our website, again at www.gladstonecapital.com. They are also on the SEC website.
The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a results of new information, future events or otherwise after the date of this conference call, except required by law of course. Please also note that past performance or market information is not a guarantee to future results.
But first, let me remind the new listeners to Gladstone Capital that the business here is to provide loans, and to a less extent some equity investments in small and mid sized businesses. Now we defined these small and mid sized businesses as one having $20 million to $100 million in revenue and sometimes as low as $3 million and up around $15 million in earnings.
We provide capital to these companies for growth. Sometimes it’s for acquisitions; sometimes its just re-capitalization from a situation they might be in. We make investments in private companies with profitable operations and good management team and we use senior debt, junior debt and equity investments in these small businesses.
During our third quarter ending June 30, 2013, we invested about $10 million in new and existing portfolio companies, while we received $14.4 million in scheduled and unscheduled principal repayments.
We invested $8.8 million in a company called Funko, and that’s a combination of senior debt and equity. Funko headquartered in Lynnwood, Washington is a designer, importer, and marketer of really top culture collectables. This is our first co-investment with our affiliated fund, Gladstone Investment Corporation. Gladstone Investment invested an additional $8.8 million in Funko under the same terms and conditions as ours.
During the quarter ending June 30, 2013, we received $10.5 million in early payoffs at par by three syndicate investments. These pay offs resulted in about $200,000 in prepayment fees.
In addition, in April 2013 we were able to exit one of our long-standing problem investments called Cable -- Kansas Cable Holdings. We had received the net proceeds of around $500,000. Unfortunately, this resulted in a realized loss of $2.9 million, which recorded in June 30, 2013 income statement.
Kansas Cable has been on our non-accrual status for a long, long time, and the sale of the company just sort of moves it along to someone who hopefully can turn it around. We at the time of December 31, 2012 had it valued at $18,000. So, we did a little better than that of course, but at last we’d exhausted all viable strategies to turn the company around and really sold it to a larger cable operator, and I believe the exit was a prudent step, and this investment just moved it along.
Overall, we have net contraction in the portfolio this quarter as compared with the quarter ending March 31, 2013, due to the unscheduled payoff and also some new deals slipping into the fourth quarter ending September 30, 2013.
Okay, subsequent to June 30, 2013, we funded $1 million in a revolver draw and a follow-on investment in an existing portfolio company. We received about $700,000 in scheduled and unscheduled loan repayments, and also after the quarter ending ,we made a new investment of $8.9 million in Ashland Acquisitions through a combination of senior term debt and equity.
Ashland provides publishing services, including digital and offset printing, warehouse distribution, content services, and marketing services. In addition to that investment subsequent to June 30, 2013, we invested $3 million in one syndicated investment.
Now looking at the quality of the portfolio, in terms of valuation as of June 30, 2013, we had cumulative unrealized depreciation of about $98 million and net increase and depreciation of about $4.7 million from last quarter.
Primary increase in net unrealized depreciation for the quarter ending June 30, 2013 resulted in several portfolio companies’ decreasing financial and operating performance and to a lesser extent a decrease in certain comparable multiples that we use in these valuations that we put these companies through each time.
So, our three non-accrual investments at June 30 had a combined debt cost basis of about $53 million or about 15.9%, almost 16% of the cost basis for all our debt investments in our portfolio, and we had a combined debt fair value of about $6.5 million or about 2.6% of the fair value of all our debt investments in the portfolio at quarter end. And since January 2012, no investments have changed from accrual to non-accrual, so we are in the right direction in that regard.
While the number of our non-accrual investments is higher than we consider acceptable, we were able to decrease the number of non-accruals over the last three quarters from six down to three, continue to work on fixing these and recover meaningful portion of the capital. I think we’ll do a good job in this quarter as well. We remain diligent and focused on managing our current portfolio and feel that we’ve been able to stabilize and improve some of our non-accruals.
We believe the portfolio income quality has been consistently good, especially since the recession, and we generally limit the non-cash sources of income specifically generated from paid [income] (ph) or original issued discounts. Both of these are non-cash income that come into you P&L when you do those kind of things. These have represented less than 1% our investment income over the last three years.
On the other hand we have recognized a high level of other income over the last several years, which is due to success fees, particularly $1.1 million earned in the first quarter of 2013 and combined total of $4 million earned during the fiscal year 2012, all related to portfolio of company’s that existed from early payoffs and at par during those periods.
We didn’t earn any success fees during the past quarter ending June 30, although we expect some in the future. Unlike paid in kind, interest income that comes into your income statement with no cash, success fees are contractually due upon the change of control of the portfolio of the company and generally that occurs through the sale of the company and this is not recognized on an income statement until the cash is actually received.
Therefore this type of income is unpredictable income. We don’t really know when a company is going to be sold and can produce uneven results as you see from time to time in our profit and loss statement.
At June 30, 2013 approximately 44% of our interest bearing debt investments had success fees related to them, and our success fees have a weighted average contractual accrual rate of about 2.5% per annum of the principal balance outstanding.
As of June 30, 2013, we had a current off balance sheet contractual success fee receivables, at an aggregate of about $13.6 million on about $0.65 per common share. That would be owed to us if all of those company’s were sold.
Success fee accruals are not recoded in our income statement or our balance sheet, so this, what I was just talking about are really nimble account. We don’t include success fees in our reported yields, as they are inconsistent and would skew the actually current cash run rate. Due to their contingent nature, there is no guarantee that we’ll be able to collect any or all of them, of these success fees.
I think the future outlook here is really good. We are down to three companies that need the time and attention. That just means it frees our people to go out and buy new investments, and there is an increase competitive pressure in the BDC and investment company marketplace for senior and senior subordinated debt, resulting I think in lower yields than we’ve seen since the recession, and I think the risk profile has gone up as well.
By in spite of this increase competition, we’ve maintained the weighted average yield on our accruing investments of approximately 11.6% in the last several quarters, which doesn’t include any of the success fees that I touched on. We continue to work hard, but fill our pipeline with solid quality deals and I think in the next six to nine months you’ll see a good progress as we go forward.
The market, the loans and companies at the lower end of the middle market, which is where we are, and which we seek investments in our capital and are seeing much more competition, but not from banks. Competition is generally coming from non-bank, other public companies like ours, other BDC’s, some small private funds.
The BDC marketplace in general has experienced slower growth as a result of increased prepayment activity and the low interest grade environment. As you know, a small business, once they have paid a higher interest, once they become strong, they can go to a bank and get a pretty regular loan and reduce their interest cost.
In light of all the uncertainty in the investment client, we still feel that we have a good market opportunity that we’ll be able to show our shareholders some new quality investments over the next several quarters and generate some good income for them. We believe we have a capital to deploy and the right opportunities are in line for us and our investment strategy and objectives should be fulfilled.
Our experienced portfolio management team is focused on making good conservative investments. As you know we’re probably more conservative than some of the other companies out there, but at this point in time I think we’ll just continue to be able to put good new investments on the portfolio.
And now I’m going to stop and let our Chief Financial Officer Melissa Morrison give her report.
Thank you David and good morning everyone. Yesterday, we released our third quarter’s earnings press release and filed our Form 10-Q, which I hope you’ve had a chance to review.
Starting with the income statement for our third quarter ended June 30, 2013, net investment income remained unchanged at $4.4 million or $0.21 per share as compared to the prior quarter ended March 31, 2013. Investment income increased by 1.5% in the three months ended June 30, 2013 as compared to the prior quarter, primarily due to $200,000 in prepayment fees received on the early payoff of three syndicated investments at par during the current quarter. No prepayment fees were received in the prior quarter.
Operating expenses increased by 3.2% during the current quarter as compared to the prior quarter, primarily due to an increase in professional and other expenses related to receipts of reimbursable deal expenses in the prior quarter.
An incentive fee was earned by our investment advisor during the nine months ended June 30, 2013. However, the incentive fee was partially waived by the advisor for the last two quarters to ensure distributions to stockholders who were covered entirely by net investment income.
100% of common and preferred stock distributions paid in the three and nine months ended June 30, 2013, and over the last two years were covered by net investment income. This highlights our commitment to predict growth and building shareholder value. The focus of the Gladstone Capital Fund continues to be making consistent monthly distributions to our stockholders that will grow over time.
Next, on our income statement are realized and unrealized changes in our portfolio. Realized gains and losses come from actual sales or disposals of investments. During the three months ended June 30, 2013, we have recorded a realized loss of $2.9 million due to the sale of Kansas Cable.
This realized loss was partially offset by realized gains of $500,000, which consisted of $400,000 of escrow proceeds received in connection with the excess of two investments from 2012, and $100,000 unamortized discounts related to the early pay off at par of the three syndicated investments this period.
We had minimal realized activity during the second quarter ended March 31. Unrealized appreciation and depreciation results from our marking investments to fair value on our balance sheet, with the change in fair value from one period to the next recognized in our income statement.
Unrealized appreciation and depreciation is a non-cash event and it’s required by the GAAP investment company rule. From an unrealized standpoint for the June 30, 2013 quarter end, we recorded net unrealized depreciation of investments in the aggregate amount of $4.7 million excluding the reversals related to [sales] (ph) payoff totaling $2.7 million, we had $7.4 million in net unrealized depreciation during this quarter. Our entire portfolio was fair valued at approximately 72% of cost as of June 30 as compared to approximately 75% as of September 30, 2012.
The cumulative net unrealized depreciation on our investments is largely attributable to investments made in 2007 and prior, and we believe it is primarily due to the lingering effects of the recession that began in late 2007.
Our bottom line on our income statement is the change in net assets resulting from operations and is a combination of net investment income, net unrealized appreciation or depreciation, and net realized gains or losses.
For the June 30, 2013 quarter end, the net decrease in net assets resulting from operations was $2.1 million or $0.10 per share versus $2.7 million or $0.13 per share in the March 31 quarter end. The quarter-over-quarter change is primarily due to a larger amount of net unrealized depreciation in the prior quarter as compared to this quarter.
Moving over to our balance sheet; as of June 30, 2013, our third quarter of the 2013 fiscal year, we had approximately $281 million in total assets at fair value, consisting of $255 million in investments, and $26 million in cash and other assets.
We had total liabilities of approximately $100 million consisting of $59 million in borrowings at cost, outstanding on our three-year line of credit, which matures in January 2016, $39 million in term preferred stock, which has a mandatory redemption feature at the end of 2016 and $3 million in other liabilities.
In all, for the quarter ended June 30 we had approximately $181 million in net assets as compared to $187 million in net assets as of March 31 and $189 million as of September 30, 2012. This represents a NAV per common share of $8.60 as of June 30, 2013, as compared to $8.91 as of last quarter and $8.98 as of September 30, 2012.
While we believe our overall investment portfolio was stable and continues to meet expectations, today’s markets do move fast and are generally volatile and investors should expect continued volatility in the aggregate value of our portfolio.
From a liquidity perspective, at the time of this call we have about $54 million in aggregate in cash and availability on our $137 million credit facility.
As noted in last quarters earnings call, in January of this year we amended our line of credit to renew the LIBOR floor of 1.5%, which reduces our cost of capital and allows us to be more competitive in the market place. In addition, we amended our line of credit in April of this year to extend the maturity one year from January 2015 until January 2016.
We do have the ability to expand the credit facility to a maximum of $237 million due to the addition of other lenders. We incurred amended fees of $600,000 in January and $700,000 in April of this year for these two amendments. All other terms of the line of credit remain generally unchanged at the time of these amendments.
We believe we have a conservative balance sheet for a company like ours and we believe our overall risk profile is low. We will continue to consider other financing sources as necessary if we feel we need more liquidity for future operational and investment activities. At this time we have the ability to deploy more capital for the right opportunities, in line with our investment objectives and strategies.
Now I would like to cover some of our portfolio statistics. Our portfolio as of June 30, 2013, consisted of loans to 46 companies in 29 states and in 21 different industries. We target to have a portfolio mix of 95% in debt securities and 5% in equity, and currently our portfolio is adding 96% to 4% mix of debt to equity.
We believe we have a very diversified portfolio by industry classification and by geographic region and are not too heavily invested in either one specifically, nor are we invested too significantly in any one particular portfolio company.
Our five largest investments at fair value as of June 30 totaled $86 million or 34% of our total investment portfolio, as compared to the five largest investments at fair value as of September 30, 2012, which totaled $92 million or 34% of the total investment portfolio.
We are constrained in certain concentration limits in our portfolio by our credit facility, as well as the regulated investment company test under the IRS rules, all of which we have historically met and continue to meet as of June 30, 2013.
We continue to manage interest rate risks by targeting our portfolio to have approximately 10% of the debt investments at fixed rates, with approximately 90% made at variable rate.
Our portfolio has consistently had a high concentration of variable rate loans, approximately 89% as of June 30. These variable rate loans usually have a minimum rate or floor so that the effects of declining interest rates as we have seen over the last number of years are mitigated, and when rates begin to increase, we should see higher income. All of our variable rate loans generally have rates associated with the one month LIBOR.
The weighted average floor on our variable rate loans was 2.5% in relation to one month LIBOR as of June 30. These loans had a weighted average margin of 9%, resulting in an all-in weighted average rate of 11.5% on our interest bearing debt as compared to 11.4% as of March 31.
Our proprietary loans had an average all-in rate of 11.2%, while our syndicates had an average all-in rate of 10.1%. The weighted average yield on interest-bearing debt in our portfolio has remained consistent over the last several quarters and was at 11.6% as of June 30, 2013, up from 11.4% a year ago.
In summary, we had a mixed quarter, adding some new income producing investments while receiving funds from several early payoffs that did trigger additional prepayment fees. We look forward to gaining some momentum for the last quarter of 2013 and into 2014, with some new originations to replace the early payoff activity we have recently experienced, in order to increase our income generation assets.
And now I’ll turn the call back to David.
That was a great report Melissa, thank you, and I hope all our listeners read our press releases and review our quarterly reports on Form-10-Q, which is just filed with the SEC. You can access that press release and the 10-Q on our website at www.GladstoneCapital.com and also on the SEC website, www.sec.gov.
I think the news for this company is that we had some production in our portfolio this quarter and the first co-investment, but still experienced a number of pre-payments. Our portfolio yields have remained about 10.6% over the quarter, and in April 2013 we exited one of our non-performing loans and enabled us to focus on our current portfolio and the new investments.
Also in April we are able to extend our line of credit and now it matures in January 2016, so no danger of problems in that area. And subsequent to the quarter end, we invested $8.9 million in the new proprietary investment and $3 million in a syndicated investment. So we are moving in the right direction for our fourth quarter.
The biggest challenge today, like all of the BDC’s, is finding new investments that we believe can survive and survive the next recession is a concern and possibly the fourth coming strong inflation that we are all expecting.
We also need access to long-term capital market place, and we have a great line of credit, very supportive lending institutions and so the line of credit is working fine, and we believe it’s sufficient for the new term. But in order to make long term new investments we will need to raise additional long term debt, long term capital, such as we did in November with the issuance of the our preferred stock.
For our portfolio of companies, we worry that they will not be able to get long-term senior loans that they need. There is a fair number of regional banks that are making new loans based primarily on assets of the business and these asset based lender are more clinical than they’ve been in a long, long time, and I think the banks are moving in a direction of doing some longer term fixed rate and variable rate term loans, but still not anything like they were before the recession.
We still have a lot of concerns. The economy is still not in strong recovery. It’s sluggish to say at the least. Some say the growth rate will be between 2% and 3%. Actually it was 1.7% for the last quarter end and that compares with somebody like China that’s at 7% or 8% and the trade deficit with China and certain other nations is just extremely high and unsustainable.
Some feel that China is on the brink of its own debt crises, especially in the building sector, but it’s hard to know since they are not very forthcoming in their reporting. China continues to subsidize the industries for the disadvantage our businesses and they subsidize all prices significant, and this means our companies can’t compete with them and job end up leaving the United States going to Asia.
One of big concerns of course is oil prices. They are a continual risk to the economy. High gas prices for cars and trucks hurts all business in the Untied States and we just need to develop all of our gas and oil that we have here. I noticed the Kingdom of Saudi Arabia is now worried that we will develop that and that their standard of living will go down. I can only hope that we do that.
Everyone has been predicting the Federal Reserves latest policy setting and timing is going begin to move interest rates back up and I think some believe that inflation is here and on the way, even stronger. It’s all due to the government; it continued to print money. The only reason we’ve not seen this turmoil in the global economy is that people all over the world are still buying bonds in the United States and so we can keep printing those bonds and selling them to them.
Spending by the Federal Government has been at unsustainable levels. The Federal deficit today is projected to be over $17 trillion, by their fiscal year ending September 31, 2013 and continues to rise at about $1 trillion a year. The governments borrowing over 40%, 45% of every $1 they are spending today by selling bonds and printing money in essence. So it’s getting pretty scary for a lot of us.
The political conflict in general between the federal government is really affecting the U.S. economy. We can’t seem to get things straight. The recent sequester period is an example of how things are kind of frozen at the government level and I just don’t know when that’s going to come undone and things will start moving towards business again.
We’ve seen taxes go up on all U.S. workers and this just is a undesirable thing to have taxes go up, even more on people. Many of the types of companies we invest in are waiting to see how the new Obama Care is going to increase payroll taxes and affect them.
United States now has the highest statutory corporate tax rate of any advanced economy at 39.1%; higher than both Japan, the United Kingdom and many others. They both Japan and the United Kingdome have recently reduced their rates. The high tax rate is one of the reasons for our company’s outsourced jobs outside the Untied States, so we just continue to hurt ourselves there.
Unemployment in the U.S. is far too high. The number used by the governments don’t indicate who are working part time, but are seeking full time or those who would stop looking all together in our welfare. More realistically, unemployment rate today is somewhere around 14% or 15% by using the old standards or marking unemployment.
Overall, many of the middle market private companies feel that too much regulations are out there around healthcare, financial services, energies, emissions. Its hindering their performance and expanding job growth and that just hurts everyone.
All of these issues are effecting are the investment climate in which we all operate. In spite of all those negations, some or part of the industrial base at the U.S. is seeing some up-tick.
Like most companies, some of our portfolio companies have revenue and backlogs and they were affected more by the rescission than other have. Some of the others that we’ve seen in our portfolio have seen really good increases and a few others have seen spectacular increases. So its very uneven out in the economy today and we just hope that the government will get behind businesses and create more jobs.
Now we have history of earning our dividend and that we pay out. So we don’t pay out more than we earn and we’ve done this all through the recession and the lingering recession. This is the important part of Gladstone Capital, is to distribute our net investment income to our shareholders monthly and consistently. We believe this differentiates us from other BDC's and stocks in general.
In July 2013 our Board of Director cleared our monthly distribution to our common stock holders of $0.07 per common share for each of the months of July, August and September of 2013. And the Board will meet again in October to consider and vote upon the monthly distribution for October, November and December, and so the distributions in October, November and December can’t give you much forecast on that, but probably not going to go up.
Through the date of this call we’ve made about 118 sequential monthly cash distributions to our common stockholders and before that, several quarterly distributions before that. At the current distribution rate the common stock price of about $8.62 yesterday, the yield on the distribution is now 9.7%; a very, very strong return for those who buy the shares today.
Our monthly distribution of 7.125% on our current term preferred stock generates about 14.84 monthly or $1.78 per year and the term preferred stock closing price yesterday was about $25.55 on NASDAQ. The ticker symbol there is GLAD with a P after it and the yield is about 6.97% or right at 7%.
So in summery, I think we are moving forward at a good pace and we got to do better than we did last quarter. Although we are still cautions about the economy and we look at each deal and wonder how it will stand up if there is another recession or high inflation.
We think this fund is in great shape to continue its dividend and hopefully in the next 12 months look at increase in the dividend. But we are going to stay the course and continue to be conservative and disciplined in our investment approach, while at the same time striving to deliver shareholder value on our investments.
Again, we are always happy to provide an update on our company and business environment. And with that I’ll turn the call back to Denise, our operator, and take any questions that might be available.
(Operator Instructions). We have a question from Greg Mason from KBW. Please go ahead.
Greg Mason – KBW
Great, good morning. Thank you David. Could you talk a little bit about the two new investments you have made, one in the quarter and one post the quarter, Funko and Ashland. Can you talk about their rates and what they do and why you like those businesses?
Well, Funko has proprietary products that only they do and there’s a huge collection base of people collecting those things that they manufacture. Now, what we liked about it, the management was very strong and over a period of time they’ve been able to go though the recession and problems without any real problems in their company. So, we believed as they continue to expand their base that they will make good money and be able to pay our debt, and we are just very happy to be in that one.
We also put that in Gladstone Investment, it was one that we switched and have both in, because we think the company is going to grow, and we were worried that – in one regard, we were worried that we we wouldn’t be able to satisfy them over the next few years, and so as a result, the two of us thought the equity upside was good and the debt side was strong, so we both went into that.
In Ashland, Ashland is one of those companies that is very interesting. You can have them print a book for you, and they have the machinery to do that, and if you want just one copy of that, they can do it or if you want 10 copies or if you want a 100 copies they can print that on demand, and very quick turnaround for short runs.
So, it’s ideal for collages and say scientific kind of publications that maybe only 100 of a certain book on a very narrow subject and they are only running at about 20% capacity. They were for sale. We helped a group buy them and I think over the next years, they will not only fill up their processing plant, but also be able to grow with some additional acquisitions.
So both of them look like something that we feel like could survive, some kind of economic crash and at the same time could handle any kind of inflation, because they can pass on the cost to their customers. So, those were the basics behind both of those, and both of them were at good strong interest rates. I don’t remember what the rates were exactly. What was?
Funko was at 12% and we also had additional 1.5% pick and then Ashland is at a fixed 12%.
Okay, did that give you a flavor for that Greg?
Greg Mason – KBW
Great, I appreciate the color. And then could you go into the current portfolio. I know Reliable Biopharma has that sub-debt piece, $6 million that’s valued at zero, and BAS is another one that’s had trouble, like $0.10 on the $1. Is there any income coming from those two pieces into the income statement?
What do we have there, both of those on accrual?
Yes, BAS and Reliable are both on accrual.
Let me just touch on something, just so you know it. I know you know Greg the difference, but there may be some folks out there that don’t understand the difference in how these valuations work. On the one hand, we are in deals for the long term; that is we’re making five-year debts, we are in it, and we are saying at the end of 5 years it will be worth a lot of money.
On the other hand, when we do our valuations, it’s on a short term. We ought to determine what its going to be worth in the next three to six months if you had to sell it, and all the mutual funds and closed-end funds, most people are familiar with, such as the ones that might be produced by your firm or someone like Fidelity or Jeffries, generally own publicly traded securities. So determining the net assets value is relatively easy, because the stocks are priced every day, so everybody can look at that and figure it out.
BDC’s are closed in funds and just like many of the mutual funds out there. But BDC’s like ours are required to buy mostly stock and debts of non-public or private companies that don’t trade on any public exchange and thus the BDC board and management has to generally just accept the valuation techniques. We used the generally accepted valuation techniques that are out there, the value of the securities that hold in order to calculate this net asset value.
Because of the imprecise nature of the valuation of product securities and the BDC portfolio, the relationship between the BDC stock price and the number reported a net asset value is always going to be in precise and the volatility of the stock of BDC can close or open that gap, that is the gap between the price of the stock and the net asset value, just at any time.
And this net asset value, the other thing about it is that its determined once a quarter and those numbers can get stale pretty soon. So we just want to warn everybody that buying stock in a BDC, be careful not to put too much weight on the net asset value or the valuations you see in there, as compared to the price of the shares. That’s just the way things work in our business. And if you look at the past, we’ve had pretty good recoveries on those that have gone down.
I’m sorry, I got off the track here and you probably have another question, Greg.
Greg Mason – KBW
I appreciate the color and the comments there. Just sticking to those two, I definitely can appreciate that it’s difficult to market these illiquid investments. With those two being particularly very low at zero and $0.10 on the $1, are you saying you do think that ultimately they will recovery par and that’s why you are accruing the income there or those just seem to be kind of dramatically low marks versus the rest of your portfolio, which is I think you said marketed at $0.75 on the or something like that.
These techniques that we have to use which are, I’ll say they are generally accepted techniques in the business, are just mandated by GAAP, and so as a result we really don’t have the ability to say. But wait a minute, this is a short-term valuation, what is this thing going to be worth over the next three to five years. And so as a result of being able to value them with short-term techniques, you end up depressing them.
And so if you for example take a company that has missed a payment or they have mispayments, but has some kind of problem in its revenue, just obvious revenue techniques that comes along such as we have in reliable, where one of its customers, in fact two of its customers have some problems that they will recovery from and that you know that this company is very well integrated with those two major customers and that they are income is going to come back over time.
And you look at that on today’s marketplace, you’d say well, I wouldn’t pay anything for that note. But I can tell you, I believe that if someone told me, go out and market this whole company, I think we’ll recovery, but there’s no way to sort of say that other than from experience. So you drop back to these techniques that are used today by all of the BDC’s and you come up with some pretty lousy numbers for a company like that.
Greg Mason – KBW
Great. I appreciate the color. Thank you David.
Okay, next question please. Denise, it sounds like we are finished. Denise, are you still on?
I apologize sir. We have a question from Casey Alexander from Gilford Securities. Please go ahead.
Casey Alexander - Gilford Securities
Good morning. Did the CFO give the percentage of fixed rate loans versus floating rate loans in the portfolio?
I know we have it.
We did. Yes, so this is Melissa, the CFO. Yes, so we are at 89% as of June 30, of variable rate loans.
Casey Alexander - Gilford Securities
Okay, great. Okay, thank you. Secondly, I know you reduced the incentive fee to make sure that net investment income covers the dividend and I’m sure that shareholders appreciate that, but it can’t be lost on shareholders that despite your issue with valuations at NAV hit a record low. So why not cut the incentive fee completely to help support NAV until such point in time that you can get NAV back to an acceptable level, because clearly there is some relationship between the stock price at NAV and clearly NAV is at a record low.
Yes, I keep hearing this and I think it comes from the fact that most people believe NAV is an absolutely precise number, when in essence its imprecise to say at the least. I’d rather run the company the way we are doing it now, and when needed have the incentive fee give back, just to make sure. That’s kind of a way of making sure that shareholders get their dividend.
And you are right, since September ’06, we’d given back in terms of incentive fees about $13.5 million. So it’s not light and I hope shareholders appreciate that and at the end of the day it’s just a way of making sure and from my perspective that shareholders get their dividend. Just saying we are never going to collect another incentive fee doesn’t seem to be the right thing to do either. It doesn’t give.
Casey Alexander - Gilford Securities
I beg to differ, because since the end of 2009 you lost $3.50 of NAV, which is by my calculation close to $70 million. So how is it justifiable to take incentive fees when you are loosing principal.
Well, you say loosing principle I think you are talking about depreciations. So lets see if depreciation turns into appreciation as time goes on.
Casey Alexander - Gilford Securities
Well, I don’t think that you have the potential in your portfolio right now for $70 million or unrealized appreciation.
And there’s no way I can convince you that without sitting down and going through every deal.
Casey Alexander - Gilford Securities
Okay, thank you.
(Operator Instructions). I show no further questions at this time, so I’d like to go ahead and turn the call back over to management for closing remarks.
Okay. Thank you all for tuning in. We appreciate the questions that have been asked and hopefully next quarter we’ll have some additional good news. That’s the end of the call.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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