shuddacudda

Re-examining My American Capital Strategies Position

I think the notion that generating capital gains which pay part of the dividend is a sign of "weakness" is flawed. Many investment organizations generate both operating income and capital gains. Those who prefer only "operating earnings" should invest in government bond and hold them to maturity.

The ability to build a portfolio from which gains can be harvested is laudable. As a BDC matures, it is natural that some of their earlier investments will begin to payoff.

Also, write-downs are not the same thing as write-offs.

Re-examining My American Capital Strategies Position

Two things you should know -- If you don't already.
1. Management has little discretion to cut dividends.
2. Income from which dividends must be paid can be very different from GAAP earnings since unrealized gains and losses (among other things) are excluded.

Background--

BDCs (Business Development Company) such as ACAS and ALD are also RICs. RICs (Regulated Investment Company) are eligible under Regulation M of the Internal Revenue Service to pass capital gains, dividends, and interest earned on fund investments directly to its shareholders to be taxed at the personal level. The process, designed to avoid double taxation, is called the conduit theory. To qualify as a regulated investment company, the fund must meet such requirements as 90% minimum distribution of interest and dividends received on investments less expenses and 90% distribution of capital gain net income. To avoid a 4% excise tax, however, a regulated investment company must pay out 98% of its net investment income and capital gains. Shareholders must pay taxes even if they reinvest their distributions.

“Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses generally are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual payment-in-kind interest or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.” From ALD 10-K.

Re-examining My American Capital Strategies Position

If ACAS must pay out 90% of statutory earnings (not GAAP) in order to remain a BDC, what makes you think management has the option of cutting the dividend? -- Unless you are predicting a drop in statutory earnings?