- This article uses my ‘optimal leverage’ analysis to assess dividend coverage for Golub Capital BDC.
- The BDC industry is experiencing yield compression and 7 out of the 26 BDCs that I cover have recently cut dividends.
- I will use this series to project which BDCs are more likely to increase or cut dividends in the future.
Over the next few weeks I will be assessing dividend coverage for most of the 26 BDC that I cover in an effort to uncover companies that have the potential to sustain or increase current dividends. I will also be using this information to update my latest "BDC Rankings: May 2014." For more details regarding this series and for the dividend coverage results for PennantPark Investment (NASDAQ:PNNT), Hercules Technology Growth Capital (NYSE:HTGC), FS Investment Corp (NYSE:FSIC), Ares Capital (NASDAQ:ARCC), TCP Capital (NASDAQ:TCPC), THL Credit (NASDAQ:TCRD), New Mountain Finance (NYSE:NMFC) and Medley Capital (NYSE:MCC) please see:
- Part 1: Ares Capital
- Part 2: Medley Capital
- Part 3: TCP Capital
- Part 4: THL Credit
- Part 5: New Mountain Finance
- Part 6: FS Investment Corp.
- Part 7: Hercules Technology Growth Capital
- Part 8: PennantPark Investment
Golub Capital BDC (NASDAQ:GBDC) is a component in my suggested 'Risk Averse' portfolio. Over the last five quarters, GBDC has had declines in its portfolio yield from 9.5% and 8.0% and just short of covering its dividend with core net investment income ("NII").
GBDC has a higher than average debt-to-equity ratio that is currently 0.82 but after accounting for its SBA debentures that are excluded from BDC required leverage ratios, it is closer to 0.54. As of March 31, 2014, GBDC had $22.7 million of additional debentures available through its SBIC subsidiaries. BDCs with lower yielding investments need to use higher amounts of leverage to cover dividends. Solar Senior Capital (NASDAQ:SUNS), Fifth Street Finance (NASDAQ:FSC) and PennantPark Floating Rate Capital (NASDAQ:PFLT) all have lower yielding portfolios and have been short of covering dividends in the past.
As discussed in "Management Fees for Externally Managed BDCs" GBDC has one of the more investor friendly fee structures with a base management fee that is calculated at an annual rate of 1.375% of average adjusted gross assets at the end of the two most recently completed calendar quarters but excludes cash and cash equivalents so that investors do not pay a management fee on idle funds. Incentive fees are a standard 20% of pre-incentive fee income and gains, but for projection purposes I use core NII that excludes both income and incentive fees related to capital gains.
The following table shows the results for the most recent quarter along with projections at various levels of leverage and using a stable portfolio yield of 8.0% to determine the impacts on dividend coverage. Each of these scenarios assumes a full quarter of benefit from interest income but also a full quarter of interest expense, base management and income incentive fees.
These scenarios assume the highest level of efficiency and actual results could be lower because there will always be some turnover in the portfolio (that could drive higher fee income). This analysis implies that the current dividend is sustainable but GBDC needs to use higher amounts of leverage and the dividend could be at risk if its portfolio yields continue to fall.
Side by Side Comparison:
For the side by side comparison I will be using the amount of equity as of March 31, 2014 (or most recent) along with a debt-to-equity ratio of 0.80 and current portfolio yield to project income and expenses, tracking the following metrics:
- Dividend coverage (using a debt-to-equity 0.80)
- BDC expenses (as a % of available income)
'Available income' is total interest and fee income less interest expense from borrowings and is the amount of income that is available to pay management expenses and shareholder distributions. BDCs with lower expenses can pay higher amounts to shareholders without investing in riskier assets.
The following table compares the results from the previous table for GBDC to PNNT, HTGC, FSIC, TCRD, TCPC, ARCC, NMFC, GBDC and MCC. As you can see GBDC has a lower than average 'operating cost as a percentage of available income' but it also has a much lower than average portfolio yield which is why it has not been able to fully cover dividends. At this point I believe TCPC, HTGC and FSIC have a much higher potential for dividend increases than the average BDC. I will continue to add more companies in the following articles.
For more details including some of the potential variances to this methodology for assessing dividend coverage please see "Part 1" of this series. Investors should only use this information as a starting point for due diligence and to learn more about GBDC please see "Golub Capital BDC Articles" or for more information on BDCs see the following: