Gladstone Capital Corp F1Q08 (Qtr End 12/31/07) Earnings Call Transcript

| About: Gladstone Capital (GLAD)

Gladstone Capital Corp. (NASDAQ:GLAD)

F1Q08 Earnings Call

February, 6, 2008 8:30 am ET


David Gladstone - Chairman and Chief Executive Officer


Vernon Plack - BB&T Capital Markets

Kenneth James - Robert W. Baird

John Zimmerman - FBR

Daniel Furtado – Jefferies


Welcome to the Gladstone Capital first quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman and CEO of Gladstone Capital. Thank you, Mr. Gladstone, you may now begin.

David Gladstone

Thank you, Jackie. This is the quarterly conference call for shareholders and analysts for Gladstone Capital, trading symbol GLAD. Thank you all for calling in. We are happy to talk to shareholders and when you are in the McLean area, you have an open invitation to stop by and say hello; you will see some of the finest people in the business.

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 even though they are based on our current plans and we believe those plans to be reasonable.

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

The quarter ending December 31, 2007 was a good quarter for our company in terms of increasing our assets and was another volatile one obviously for the financial marketplace. We invested about $73 million this quarter, of which $58 million was to five new portfolio companies and the remaining $15 million was to existing portfolio companies in the form of additional investments or draws on our revolving facilities that we provide them.

During the quarter, we received repayments of about $4 million due to normal amortization paydowns of our revolvers. This resulted in net production of about $69 million for the quarter.

At the end of the quarter, our investment portfolio was valued at about $414 million and our cost basis was approximately $425 million. Although the portfolio was depreciated, our portfolio was fair valued at approximately 97% of cost. We believe this to be a good indicator of the high quality of investments in our portfolio.

At December 31, 2007, we invested $13.9 million in one new non-syndicated loan and also about $700,000 in an additional revolver draw to our company.

Since inception, we’ve made loans to approximately 125 companies. We’ve been repaid or exited from 60 of those companies and Donya, our Deputy CFO tells me that the average return of the exits has been about 12% for the syndicated loans and about 16% for our non-syndicated loans.

At the end of the quarter, we had two loans past due, one with a cost basis of $2.4 million and the other with a cost basis of $6.6 million. We should have one of them fixed very quickly here and the other one back on track in a quarter or so. So, it’s about 2.1% on a cost basis of the portfolio that’s past due.

To date, all of our investments have had a positive IRR and I hope that’ll be true in the future as well. This all leads us to say that the program we set up at the founding of the company and as we continue to mature, is performing as planned and we don’t have any need to change the strategy.

We have seen a noticeable change in the opportunities coming our way. Banks are calling us to help them with some of the loans that they are making to small and medium-sized businesses and so are the LBO funds. The pipeline is probably as strong as it has ever been in the history of the company. I would say that the market has finally come back our way and we intend to make some good loans during this time period.

Our balance sheet is strong. At quarter end we had approximately $162 million borrowed on the line of credit and we had $266 million in equity so we are less than 1:1 leverage and this is very conservative in the balance sheet of finance companies and the risk profile we believe is relatively low.

On the income statement side for December quarter net investment income, which is before appreciation, depreciation, gains and losses was about $7.3 million versus $5.2 million for the same quarter last year. That’s an increase of about 41%. On a per share basis, net investment income for the quarter was about $0.43 a share for the quarter as compared with $0.42 for the same quarter year ago.

This per share basis is an increase of about 2% and that low increase is attributable to the dilution from the shares issued during the quarter, or in other words an additional 4.7 million weighted average shares outstanding as compared with the same period last year. I think this shows great strength when we increase equity by about 23% and don’t have dilution of earnings.

As all of you know, net investment income is the most important number to us because it’s the number that is closest to our taxable income, and taxable income is the income number we use to pay our dividends so this is the one to watch.

Now let’s switch over to unrealized and realized gains. This is a mixture of appreciation, depreciation, gains and losses. We like to talk about it in two categories; first gains and losses because they are cash items; and then second we’ll talk about appreciation and depreciation, which are non-cash items.

For the quarter ending December we had a small capital loss of about $6,000 and that’s from the proceeds of our interest rate cap agreement and from the unrealized deprecation report during the quarter ending is primarily determined by our use of the opinion of value of our loans that we receive from Standard & Poor’s Security Evaluation Service or S&P as we call them. It does a good job at setting the price on loans that they price. They have a good experience in this area, because the S&P organization follows thousands of loans. We ask S&P to value all of these loans in our portfolio and especially the ones that don’t have readily determinable market value, and they do that every quarter. We believe we are the only business development company that does this.

S&P gives us an independent opinion of the exact dollar value for each loan that we ask them to review. This eliminates the worry our shareholders may have that we are not writing down poorly performing loans. We think it’s good for shareholders to have an independent party giving them an opinion on the value of loans rather than an advisor or the management company telling you, the shareholders, what it’s worth. Of course, our board oversees this determination of fair value.

So a lot of non-management people are involved in the determining of the value of our product portfolio, and I think this should give you good assurances. Because of this valuation from the independent third party, you’ll see a lot of volatility in the numbers. At this time last year our portfolio was just slightly below par whereas this December our portfolio was valued at a depreciated value due mainly in part to the instability in the loan marketplace. You will see that our overall portfolio has held its value at about 97% of par, further demonstrating our investment quality.

For the quarter ending December our assets had a net unrealized depreciation in total of about $5.4 million as compared to prior year, which was a net unrealized depreciation of about $1 million. From the quarter ending September to the quarter ending December 31, we saw the value of the portfolio change from about 98% of par to 97% of par or about 1% depreciation. As you know, depreciation does not have an impact on the ability of the company to pay distributions to shareholders; all our loans expect two are paying as agreed, but S&P thought there was a need for depreciation in some of these loans so they wrote them down.

When you ask someone like S&P to value your portfolio you should expect some volatility because the techniques being used here is the value of the loan, what it could be sold for on a single date. This is a much harsher technique been used by other funds that use a liquidation analysis which says that if the business that you have made a loan to is sold, would the loan be repaid? If the answer to that is yes, then the loan is valued at par. That technique is called an enterprise value method.

But all these valuations are just guesses and until one tries to sell a loan you don’t really know what its worth, but I think the value that is placed on the portfolio is a fair one.

Bottom line, now we turn to the net increase of net assets resulting from operations. This term is a combination of net investment income, appreciation, depreciation, gains and losses; it adds up everything kind of like adding apples, oranges, and tomatoes together to come up with a number.

For the December quarter this number was about $1.9 million versus $4.2 million last year this time, this December quarter we are about $0.11 a share versus last year $0.34 a share, a decrease of about 68% per share all due to the panic in the marketplace so loans have been written down.

For the quarter that just ended this difference is related to the depreciation of the portfolio at this time; investors should expect this kind of volatility in the portfolio. Paid in kind interest, we talk about this every time; it’s known as PIK interest and original issue discount or OID. This is income you have to accrue for your books for tax purposes and then you have to pay it out but you don’t receive the income until much later, sometimes not at all. We call this kind of income phantom income because the company that’s doing it does not receive the cash but has to payout the phantom income.

We avoid this as much as we can and this is a very important point because there are other BDCs with very large portions of their income from non-cash sources and that non-cash income has to be paid out as dividends even though the money has not been received so they must borrow from the bank to pay their dividends and we strive not to have any phantom income as part of our portfolio. We seek to have the money we receive from the interest payments be the money that we have available to pay dividends. This again is a very conservative to run a business like ours.

During the quarter ending December one of our investments had a provision in their $500,000 loan agreement that gave them the ability to capitalize their monthly interest payment. The PIK interest here is about $4,000 a month; we had about $14,000 in capitalized interest income for the quarter ending December 31, 2007 and none in the prior year period. We referred again to this as paid in kind or PIK interest and its not much here but we had a tiny bit of PIK interest.

Our average loan rating for the quarter remained relatively unchanged. The risk rating system we use for our non-syndicated loans had an average of 7.3 for this quarter versus an average of 7.1 for the same period last quarter. The portfolio is a little risky according to our risk rating model. The risk rating we use for un-rated syndicated loans was an average of 6.3 for the quarter versus an average of 6.1 for the prior year December 31st quarter end.

As for our rating of syndicated loans had an average of CCC for this quarter and the prior quarter December 31. Our risk rating system gives you the probability of default for the portfolio with a scale of zero to ten with zero representing high probability of default and ten of course a much lower rate risk of default. The risk we see here is staying relatively low and pretty much unchanged from quarter-to-quarter. We are quite satisfied with the current portfolio mix.

Most of you know we sold from our shelf registration an additional 2.5 million shares of common stock on October 19, 2007 at a price of $18.70 per share. In November the underwriters exercised this option to buy an additional 375,000 shares at the same price. This yielded us approximately $50.5 million in net proceeds to go to our equity, all of which we used to repay borrowings outstanding on our line of credit and will use that ability to borrow on that line of credit to continue increasing our asset base. So we increased our equity by about 23%, which is a lot.

After December 31st, 2007 we invested $13.9 million in new loan originations and funded additional revolvers of about $700,000. We also received about $675,000 scheduled loan amortization payments. Needless to say we are very pleased with the results for the first quarter of our 2008 fiscal year.

Yesterday on February 5 we closed an offering of 3 million shares of common stock at a price of $17 per share which yielded us approximately $47.8 million in net proceeds, all of which was used to repay a portion of our borrowings outstanding on our line of credit. We do not know if the underwriters of the offering will exercise the over-allotment option.

We now have about $314 million in equity and we will be expanding our line of credit so we can continue to grow our base of loans. If you make the assumption that we have $314 million in equity and we can move our asset base from about $429 million to about $628 million, that’s a 46% increase and that’s very significant.

Since I last talked to you folks last quarter, the senior and sub debt marketplace for large middle-market companies has had tremendous liquidity problems. For a while the market was closed; that is, there were no buyers of senior syndicated loans. But now there are transactions happening and sales of some of the older transactions, but it’s still going very slow and as you probably read in the newspapers, some of the new ones that were going to come to the marketplace haven’t come.

As you know, we have bought in the past some of these first and second lien loans when the companies issued them. We’ve been selling some of those senior syndicated loans to make room for non-syndicated loans at higher rates of interest income. But with the panic this summer and a stagnation this fall, our rates have changed and now the loans are worth a bit less than the face of the loan. So in order to sell them we have to take a small loss. We often weigh the alternative of selling some at a loss with raising money by selling stock. It’s a question we ask ourselves often.

We have about $76 million in our cost basis in senior and second lien syndicated loans. For senior syndicated loans of $200 million or larger, our rates were at about 2% to 2.5% added to the LIBOR; now it seems to be running at about 4% sometimes 5% added to LIBOR. Because these new loans are at a better rate, this causes the old loans to be at a lower market price but if we hold the loans until they mature they would pay off and we should get 100% back on new losses. These syndicated loans are paying as agreed, so we hate to sell them and take a loss. At any rate, that’s the story on that area.

By the way, LIBOR is the London Inter Bank Rate, which is recognized as the leading indicator of short term rates. The norm for LIBOR has traditionally been 5% to 6% range. It’s now running at about 3.2%, so it’s relatively low and the cost to borrow money for most companies has come down some. That’s for larger companies that we help finance, and the demand for these loans in the big capital marketplace by non-bank lenders like hedge funds and bond funds for rated loans is still very, very low. There are very few buyers of these loans today.

For our small companies and their loans the world is certainly different. Small loan marketplace we invest in is not seeing much competition from banks. Many banks have tightened up on their credit standards. Most banks don’t want to make the kind of loans that we make and we are often called by banks to help them; they do the first lien and we do the second.

We have to compete for our loans with other small private lenders like mezzanine loan funds and a few small hedge funds and some of the smaller BDCs. Our loan request pipeline, as I mentioned before, is very strong. It’s stronger than it’s been in the history of the company. We see a very strong outlook as it may materialize into more loans for us as we’ll see what happens next quarter.

Our goal is to be a strong profitable company and not the biggest. We are emphasizing profitability and not growth. We do concentrate on variable rate loans so that we are not hurt by rates if they increase. While our rates are variable we often have minimum in rate changes so that we don’t have any declining interest rates hurt our ability to pay dividends. These are call floors in our business so that the floor is set at a certain level and they don’t go below that, we have floors at 9.5%, 10%.

At December 31, 2007 we have three fixed rate loans at a cost basis of about $16.6 million or approximately 4% of the cost basis of our portfolio. We have in place an interest rate cap to cover any fixed rate loans and this is commonly called a derivative. The cap on the rates will help protect us against any increase should rates start to go the other way on our fixed rate loans. We are well protected against future rate increases.

We continue to worry about the cost of oil, the problems in the world especially the Middle East; high oil prices take money out of the pockets of our middle class here in the United States and they don’t have money for restaurants, to buy durable or non-durable goods and they certainly have no money to save for a rainy days so we worry about that.

We are no longer worried about inflation; it may come back in 2009 or 2010 but certainly not here today. The amount of money being spent on the war in Iraq is hurting our economy. We all support our troops. They are the true heroes of this period of history risking their lives for all of us and hopefully they all come home soon.

Even worse than some of the things I mentioned is the pork barrel spending by federal, state and local governments. They are just all out of control. In the 30s, total government spending compared to all spending was about 12%. After the New Deal Roosevelt implemented some very significant government spending and it rose to about 22% of the spending in 1947; and then in 2006, it is now risen to 44% of the national income and it is growing at four times faster than the economy.

Certainly in a few years we will be officially a socialist economy with more than 50% of national income being spend by the government. This excess in taxing and spending on the part of government causes a great deal of dislocation in the economy and it certainly killed the dollar in terms of other currencies like the euro.

The trade deficit with China is still very troublesome and hurting our companies and our country. China continues to subsidize their industries to the disadvantage of our businesses. We wonder how much the impact on a downturn in the housing industry and the related disaster in the home mortgage defaults is going to have on the rest of the economy. No one knows how many of the home mortgages will fail. We originally thought it would be not more than about $200 billion in terms of a problem. Now we have raised that estimate up to about $400 billion. That is enough to cause a slowdown in the economy, but I still believe it is not enough to cause a recession. The Internet bubble was somewhere like a $7 trillion loss of equity and that certainly was a recession.

Home mortgages are backed by a home and there will always be some value to the house; that is very different from the Internet companies that when they got in trouble sort of blew away with zero for equity and many other debtholders.

Also much of the housing trade is out of work and I am not sure the numbers that the government gives us on unemployment are a fair number because many of the workers in the housing business were here without US visas and I am not sure we have a good number on the unemployment rate now.

In spite all those negatives, the industrial base in the US is still very strong; small businesses kept their cost low, profits are not going up as much as they were in the past but they are still going up. Manufacturing is not operating at full capacity so they have room to grow. However, we do see some slowdown in hiring and we do see some backlogs that have come down some, but not anything close to a recession.

Our dividend is $0.14 a month for the first fiscal half of the year. The run rate is about $1.68 per year. We will see our second fiscal half play out and determine at the next board meeting what our directors want to do with regard to our dividend. At this dividend rate and with the stock price at about $16.88 yesterday, the yield on the stock now is 10% and the stock came down as the new stock sale occurred but it really shouldn’t have; we will put the money to work and given the strong pipeline of loan applications, we should be fine there.

The new shares we sold this fall all are fully invested and that’s the reason we have the second offering in January. There was a little dilution to the earnings, as you heard; we actually increased earnings per share after issuing that much equity. I think the same will be true for the money we raised in January. We are generating a good return on new loans and it’s higher than the yield on the stock we are selling and in addition we should be able to borrow up to 40%, 50% of the amount that we are lending to our portfolio companies, and the interest rate is lower on the money that we borrowing so that spread as it is today is a very positive spread and that’s great income to our company.

This is the way that we are going forward. Please go to the website and sign up for email notification service. We don’t send out junk. You can sign up for our newsletter at We have some great job openings for senior and entry level positions, so please send over your resumes.

As far as we can see now, the economy looks okay, but we can only see a couple of quarters out and we want to be careful. We are of course stewards of your money and we will stay the course and continue to be conservative in our investment approach. We have not in the past invested in housing or in mortgages or home mortgages and we don’t intend to do that in the future. So we will continue to be very conservative in our approach.

We will now open up the call for some questions.

Question-and-Answer Session


Our first question comes from Vernon Plack - BB&T Capital Markets.

Vernon Plack - BB&T Capital Markets

David, I was curious in terms of your debt to equity ratio in this type of environment. Any thoughts in terms of how leveraged you would actually like to take the portfolio?

David Gladstone

I don’t think 1:1 is bad in this economy. We have a very nice loan portfolio, it is performing very well so I don’t feel uncomfortable if we can leverage all the way up to 1:1. We never really seem to get quite to 1:1, we get to about 40% or 45%; in essence not quite 1:1 in that situation before we usually need to raise equity, that’s what happened to us as we were coming into December. I don’t feel uncomfortable doing that.

Vernon Plack - BB&T Capital Markets

One other question as it relates to asset quality. We’ve seen asset quality fall a little across the board in this industry which is not unexpected and I was just curious in terms of your thoughts, non-performers are a part of the business and that number will likely go up; what are your thoughts on that, at least for the next 12 months?

David Gladstone

Over the past six years we’ve had non-performers that would come in and we would fix them or sell them or do something to rid ourselves of the problem and I think if you are a good workout team and you have good people in that side of the business, while you will get some non-performers, you are able to fix them and sell them or liquidate them or do something in order to avoid losses.

As you know, we’ve had one loss. I am not sure how many workouts we’ve had over the last six years. There haven’t been that many and the non-performers have certainly been low. We’ve had one loss on one loan, $1 million out of $14 million and we received so much money at the beginning of that period with that loan that we had a positive internal rate of return. I don’t know that we can maintain that over a significant long downturn, but I do know based on my past experience of being through the ‘81 recession, the ‘90 recession, the ‘01 recessions that the portfolio has performed and we did not have anything diminution in our ability to pay dividends. In fact, the two that we had non-performing now didn’t pay interest during some past periods so we do not have a problem meeting our dividend.

We will fix those and move them over and take the money that we get out of them and put it into income producers so it will actually be very positive when we move them across. I just don’t think that portfolio at this stage, again given the fact that this doesn’t seem like big recession, it’s going to have that many problems.

We’ve seen 1990 was probably the worst recession I’ve been through and we would see non-performers ballooned up between 5% and 10%, but losses still remained under 1%, which is the real asset test, is how much did you lose? You may have a problem with the loan but if you can fix it and bring it back to interest paying then the question of losses then becomes pretty low in the priority of things to look at if it’s really low.

So I don’t know, Vernon, this feels like a very mild downturn to me; I don’t see a real recession in terms of government statistics and so I think the asset quality have performed quite well through this next period.


Our next question is coming from Kenneth James - Robert W. Baird.

Kenneth James - Robert W. Baird

Good morning. Could you give a little more detail on your non-accruals, particularly the new one? I’m assuming the other one you mentioned was the one that was previously purchased that’s been around for a couple of quarters?

David Gladstone

The new one is a company that we really didn’t expect that much, the LBO Fund is working it hard and my hope is, we’ve been told at end of February we will some resolution to what’s going on and that’s about all I can say. We don’t like to spend a lot of time talking about them for the simple reason that we have what’s known as confidentiality agreements with these companies and they are private and we are not supposed to spend a lot of time talking about the details.

But it’s a new one, I think we are all covered, I think we will get our money back, and so I’m not that worried about it and we will probably get all of our accrued interest; but who knows. It is a marketplace that you just never know until you have gone through the whole routine of fixing it before you come out the other side and know whether you have made money or lost money.

Kenneth James - Robert W. Baird

It seems like you feel pretty good about a near-term resolution there.

David Gladstone

I do.

Kenneth James - Robert W. Baird

In terms of the levels of originations this quarter and your recent need to raise capital again, can I extrapolate from that that we could be looking at this level of originations to persist here for at least the next quarter or two?

David Gladstone

Well certainly the opportunities are there. As I mentioned in the prepared part of this presentation, the backlog is as strong as it’s ever been. There is still the process of going through the analysis and due diligence of the business that takes up a considerable amount of time and sometimes it goes quickly and sometimes it goes slow. But the bottom line of it is we do have a very robust pipeline. We are having banks call us now that hadn’t call in a while and a lot of small businesses calling us and the LBO funds are calling us.

With interest rates going up much higher and with the opportunity to pick up some equity type of positions in these companies, I think it will be very profitable -- maybe not a quarter-by-quarter analysis -- but I would say every six months you should expect a pretty good increase.

Again, its very hard to tell. Even though you have a robust pipeline and its bigger than it was last quarter by a quantum amount, there is no way of knowing until you have delved into these companies whether you are going to be able to go forward or not. I would say I’m optimistic that it will be robust but just don’t want to give you a complete projection.

Kenneth James - Robert W. Baird

What about the headwind you have been facing from elevator repayment activity dropped off significantly this quarter; do you think this is a more normalized level, just normal that we would see in the near term or was this quarter do you think especially low?

David Gladstone

Well it was a very nice low quarter and I think you’re going to see that going forward. Obviously the loans that we have on the books that are say, 200 or 300 over LIBOR are not going to be refinanced and the ones, the second liens that we have at much higher rates are not going to be financed easily because the rates have all moved up in that.

So the new loans that we’re putting on the books are substantially higher and that does have a barrier to getting anything refinanced because people don’t want to pay more interest in refinancing; it would cause them to pay a significant amount of interest.

We do have some of those lower yielding loans. The businesses do get sold and when they get sold of course we get paid off and while I’m very delighted to have new money to put out at a much higher rate, then we hate to see anything get paid off. But we will just have to see how that shapes out. I think the payoffs will be substantially less in the coming year than they’ve been in prior years.

Kenneth James - Robert W. Baird

One question on the fees this quarter or the fee credit. Was there any kind of an outsized or extra activity by the management company for portfolio companies that generate fees that were credited back to the fund that made that number a little larger in this quarter?

David Gladstone

There were a couple of things. With all the closings that went on we do get a fee when we close a loan and with all those closings we had about $820,000 of what we call investment banking fees that were credited back. So that’s inside that $2.4 million.

We also had, as you know, our senior syndicated loans we only charge 0.5%. That’s an ongoing thing and that was not that much, about $103,000. The incentive fee that was given back was about $1.46 million so that was a significant part of the giveback and we are projecting that maybe not by the end of this fiscal year, which is September 30, but probably by this time next year we will pretty much have grown out of the giveback for the incentive fee and it should be in a very good position.


Your next question comes from John Zimmerman - FBR.

John Zimmerman - FBR

Good morning, David. Thank you for taking my question. Can you provide a little context or any changes in the motivation for the companies that seek to borrow from you? Have you seen any inflections or the type of customer that’s coming to you to borrow?

David Gladstone

I think the quality is still more or less the same. We’ve been very picky over the period of time as to who we will lend to but the pipeline has not changed that much in terms of what we see. Normally in a downturn or recession period we will see companies that have significant financial problems; for example in 2001 we would see companies that needed to meet payroll in the next month and next week and didn’t have the money to do it or we saw companies that didn’t have any backlog but wanted you to lend to them so that they could build a backlog; and other companies that were in significant problems. We are just not seeing that coming in the door today and so that’s another reason for saying we don’t think there is a recession on the horizon.

The classic for us is the car dealership who comes in who is out of trust on their car loans on their floor plans for their cars and they need to raise money in order to pay the bank; that is they sold the car, but didn’t pay the bank and used the money for operating capital. We are not seeing any of that.

So your question is right on point in terms of what are we seeing? Is it really rugged out there or are we just seeing a lot of good businesses that now can get financing or the cheap money that they got before from banks who were dolling out a lot of money at low rates and at very low terms; very easy terms, kind of like the home mortgage business. Or is this a real downturn in the economy? We are just not seeing it yet, so my perception of the world is maybe of debt jaundice in the sense that we are just not seeing the problems and maybe they’re out there and they’re just not showing up on the doorstep, but I doubt it. We normally see literally thousands of businesses and to date, they’re not these very difficult situations coming in the door.

John Zimmerman - FBR

In that same vein as we’ve talked about banks exiting the space and therefore you garnering with your capital being able to leverage that for incremental opportunities, when we start talking about growing your business and we start talking about expanding your lines of credit, can you talk about the willingness of banks then to turn around and lend to you? I just want to make sure that obviously the vacation of capital just providing an opportunity, but are you too still being able to access the amount of debt in order to meet some of the growth objectives that you’ve set in front us today?

David Gladstone

Well, I can only speak, as you know, Gladstone Investment had its credit renewed in October last year, which was a pretty rough period and so it had its line of credit renewed and didn’t need to raise additional capital, but the bank that was lead there renewed and we are just fine for another year.

In this company we’ve not increased the line of credit beyond the $220 million that we have, but we do have a $30 million request that seems to be approved. We haven’t needed to draw it down quite yet. We do have a couple of banks that are looking to join this syndicate, hopefully that would raise another $50 million to $100 million.

So our goal here is just continue to grow it. I think the banks have not pulled out of the marketplace. They are sticking with the guys that they are in with today but they are just not taking on a lot of new business as far as our type of borrowing.

As far as the other banks out in the marketplace, many of the banks have not gone away from the marketplace, but what they have done is they have tightened their standard. They used to lend 3.5 times EBITDA, they are now lending 2.5. So they have just pulled back as to what they will do in this credit tightening environment.

So I think if you look at what’s going on in the marketplace and couched it in a different term that if the banks are not exiting but there is a flight to quality, and a tightening of the terms and they are charging a little more interest. We had our interest rate go up from about I think it was 80 basis points to 120 and the investment company I think it will go up here about the same amount. So we will have an increase but given the fact that we’ve moved on our senior debt from about 250 to 450, the other day one at 550 over LIBOR, we are maintaining much larger spreads than we had in the so-called profit times when the banks were out there.

I think we are okay as far as being able to borrow. But one never knows and that is another unknown out there and to date we seem to be doing just fine.

John Zimmerman - FBR

As we start looking at the non-accruals, I know that you are senior secured, the market value of those seems to be at about 70% of the cost basis of the loan or par value of the loan. Does that mark in and of itself reflect a recovery rate from S&P and their methodology or does that represent what you might think would be a potential exit value?

I know you don’t take the market value, you take the mark S&P provides, but I’m wondering if you could provide a little bit of context to how we should be interpreting those marks whether it is a recovery value or market value and how to interpret that?

David Gladstone

From my understanding of S&P, this is the value that they believe the loan could be sold for on the last day of the quarter. So they are giving you a sale figure and that doesn’t have any recovery number on it. All of these loans are secured with liens on the assets so I’m assuming they are just looking at their portfolio and saying what are loans trading at today that are similar to this and coming up with a value.


Our next question is coming from Daniel Furtado - Jefferies.

Daniel Furtado - Jefferies

Just an update on your thoughts on the relationship between credit and management fee and dividend? Do you foresee a situation in which you wouldn’t be fully crediting the entire part -- you would not be crediting that fee but still raising the dividend? Or do you have to kind of come true-up on that fee before you issue a dividend increase?

David Gladstone

This is the discussion we had with the board and where we are going on this is some kind of sharing as we go through this period of time. So I can’t give you what is going to happen in the future with regard to the dividend because I don’t read the minds of my board members, but my guess is we will come to some understanding. As long as we are getting back 100% of it, there is no room to play and that is what we did this last time.

But once you got to, let’s say to use an example to getting back only part of it, you could give back a little bit more and have the dividend increase and you could share over a year’s period in the lessening of the need to give back and it would make the dividend go up.

So the answer is, yes, the dividend can go up during this period of time when the incentive fee is not being paid, but it has to go up. It will go up slower than it would if you didn’t have to do that at all.

Daniel Furtado - Jefferies

Understood. I just want to make sure that it is similar at GLAD as at Gain in that the FAS 157 and 159 changes that are about a quarter away, you don’t foresee a meaningful impact to valuations are any more volatility towards value because of these?

David Gladstone

I have got four accountants sitting here and they are all shaking their head no. I am assuming that 157, 159 and all those others are not having any impact on us.


Mr. Gladstone, there are no further questions at this time.

David Gladstone

We thank you all for calling in. We appreciate it and we will do our best to make you happy next quarter. Thank you all for calling in.

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