What’s better than a revolving line of credit from a bank but not as good as a Collateralized Loan Obligation (CLO) ? For Apollo Investment (AINV), the answer appears to be a private placement of senior notes. Apollo Investment is one of the larger Business Development Companies ("BDC"). On Wednesday, the company announced the raising of $225 million in term notes with a maturity of 5 years, and placed with institutional investors (unnamed). The Notes are priced at a fixed rate of 6.25%, with a “make-whole” premium if repaid before maturity.
This is an important development for both Apollo and the BDC industry. In the past, many BDCs had tapped the CLO market to generate low cost financing which matched the maturity of their investment assets. Since the Great Recession, and the closing of the CLO market, medium term financing has been hard to find.
Most of the BDCs, spooked by the way that banks pulled revolving lines of credit during the 2008-2009 period, have been shopping around for longer term financing. For example, every quarter for over a year now David Gladstone reports on the quarterly Conference Call of both Gladstone Capital (GLAD) and Gladstone Investment (GAIN) [GAIN transcripts here] about (so far) fruitless discussions with insurance companies and other lenders about arranging medium term debt.
Golub Capital (GBDC) was able to arrange a CLO consisting of senior debt loan assets a few weeks ago, but that has been the exception to the rule. Specialty lenders such as TICC Capital (TICC) and Hercules Technology (HTGC) have had difficulty arranging any acceptable debt financing at all in the case of the former or expanding existing facilities in the case of the latter.
Most BDCs have been looking to the SBIC [small business investment companies] for long term capital in the absence of other alternatives. At least half the 24 companies we track have arranged or applied or are considering applying for an SBIC license. However, amounts that can be borrowed are capped at $150mn or $225mn. Also, there are guidelines on what type of companies and deals the money can be used for.
Apollo’s breakthrough is a good sign that private sector financing for the industry may be opening up. Nonetheless, it’s important to underscore that this debt is no silver bullet. Yes, the 5 year maturity does a good job of matching the likely maturity life of AINV’s assets with its debt liability. However, pricing is expensive at 6.25%, which is slightly higher than the interest rate charged by the SBIC for 10 year money. Plus the “make whole” provision means AINV is unlikely to be paying down this debt prematurely. Compare the cost to AINV’s Revolver, which is pegged to LIBOR + 300 basis points, or about 3.25%-3.5% (when unused line fees are included). When you consider that yield assets are being booked at around 11.5%, after you deduct out the interest cost and the management fees and other operating costs, the net margin is less than 2%, versus 4.5% for assets financed by the Revolver (which Apollo is also slowly increasing as new lenders are brought on). The incremental earnings per share from the $225mn of assets financed by this debt amounts to less than 2.5 cents. It’s that net margin which pays out dividends to shareholders.
AINV would probably answer that improving earnings is not the point of the exercise. Presumably, the goal is to strengthen the balance sheet, and diversify sources of finance. Still we’d be interested to see what covenants AINV has had to accept, and how easy or otherwise it will be to transfer, add or withdraw investment assets from the secured facility.
Disclosure: Long HTGC. No position in AINV, GLAD, GAIN, TICC