A Metric-Focused, Intensive Look At Golub Capital

| About: Golub Capital (GBDC)
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This update will provide the metric details of the calendar Q4-12 Golub Capital (NASDAQ:GBDC) earnings release and 10-Q. I will also provide a top down projection of 2013 Total and Net Investment Income (the TII and NII). In part two I will provide the current sector valuations and the valuations for GBDC, and make judgments as to whether GBDC is a buy, sell or hold.

Golub Capital BDC, Inc. became a public company on April 15th of 2010. It began trading at $14.50. It is a spin-off of the Golub Capital group of companies. Golub Capital (the "group"), founded in 1994, has been a top 3 Traditional Middle Market Bookrunner each year from 2008 through 2012 for senior secured loans of up to $100 million for leveraged buyouts (according to Thomson Reuters LPC and internal data, based on number of deals). As of March 31, 2010, Golub Capital (the "group") managed over $4.0 billion of capital, with a team of 48 investment professionals in New York, Chicago and Atlanta.
As of March 31, 2010, on a pro forma basis, the pre-IPO GBDC's net asset value was approximately $254.6 million, or $14.63/share. GBDC's Net asset value was $14.66/share at the end of Q4-12. The dividend for its first full quarter of operations was $0.31/share compared to calendar Q1-13's $0.32/share. At March 31, 2010, the pre-IPO GBDC had investments in debt in 80 portfolio companies, with a total fair value of approximately $293.2 million. GBDC's Q4-12 ending portfolio was $768.342 million.

GBDC Reports Calendar Q4-12 NII of $0.3429 compared to a Div of $0.32/quarter

What They Earned: Golub Capital BDC reported for Q4-12 (or its 1st fiscal quarter of 2013) ending 12-31-12 Net Investment Income of $9.578 million ($0.3429/share). With Total Investment Income of $18.594 million ($0.6656/share) the NII/TII ratio was 51.51%. For the three months ended December 31, 2012, GBDC recorded PIK income of $1.037 million and received PIK payments in cash of $0.332 million. Loan origination fees "received" (as opposed to the amount that was amortized or recognized in TII) were $3.734 million. There was $2.4 million of fee amortization recognized in Q4-12's TII. GBDC had $0.9 million of income from prepayment penalties and other fees in Q4-12. GBDC's Net Increase in Net Assets Resulting from Operations was $9.319 million ($0.3336/share). The ending portfolio of investments was $768.342 million. But the "average earning portfolio company investments" was $663.007 million. This is the first quarter I have noticed this metric in the 10-Q.
GBDC's Net asset value was $14.66/share compared to $14.60 last quarter. Five cents of the NAV rise was due to the public offering done in October. For the 3 months ending 12-31-12, the Ratio of expenses (without incentive fees) to average net assets was 6.37%. Ratio of incentive fees to average net assets was 2.30%. Ratio of total expenses to average net assets was 8.67%. The Ratio of net investment income to average net assets was 9.22%. Portfolio turnover was 83.45%.

Q4-12 Q3-12 Q2-12 Q1-12 Q4-11 Q3-11

Total investment income 18.594 16.219 14.811 14.352 12.477 10.831
Net investment income 9.578 7.791 6.678 7.065 6.342 6.450
Investments @ fair value 768.342 672.910 636.632 613.797 562.046 459.827
Originations 262.200 113.400 25.600 98.400 164.100 164.100
Sales + Repays 145.600 70.900 34.100 43.600 42.900 42.900

TII/share $0.6655 $0.6320 $0.5776 $0.5965 $0.5740 $0.4983
NII/share $0.3429 $0.3036 $0.2604 $0.2936 $0.2915 $0.2963

A more full description of the NII projection process is given in my prior update on BlackRock Kelso Capital.

Run Rate NII Estimate: With approximately 96% of a portfolio of (the current $768 million plus $20 million in projected growth) $788 million having an average yield of 9.7% - forward "interest income" per quarter would be (100% of 768 times 9.7% plus 50% of 20 times 9.7% = 18.624 + 0.051) $18.675 million. New investments are anticipated to be producing income only half of the quarter, which is the reason the income from these investments are divided by half.

In Q1-12 fees were $0.600 million. In Q2 fees were $0.516 million. I do not have a stat for Q3, but I will use $0.5 million for a guesstimate. Q3-12 was the end of the GBDC fiscal year - and BDCs typically do a poor job of providing quarterly details when reporting their fiscal year-end in numbers. In Q4-12 fees were an atypically high $3.7 million. I want an annual run rate for this projection. With a total of $5.3316 million for the last four quarter, my run rate fee income projection is $1.329 million.
This produces a TII total per quarter of (18.675 + 1.329) $20.004 million. This compares with a consensus analyst revenue estimate for Q1-13 of $18.990 million with a high of $19.670 million and low of $18.470 million. Q4-12 TII was $18.594 million.
GBDC had a secondary offering in the third week of the quarter. 11/13ths of the 4.5 million January offering plus the Q4-12 ending share count of 28.605 million would produce a Q1-13 weighted average share count of (3.808 + 28.605) 32.413 million.
The division of those shares into the projected TII produces a $0.6171/share projection. This quarter's NII/TII percentage was 51.2%; while it was 48.04% in Q3-12; 45.08% in Q2-12; and 49.22% in Q1-12. Using a projection of approximately 50% of TII that falling to NII, the NII/share estimate would be $0.3086/share - and an annual run rate of $1.2343/share. The dividend is currently $1.28/share. This looks bad. But this is before future portfolio growth in factored in.
The Q1-13 equity raise of $72 million could produce portfolio growth of $144 million before another share offering is needed. GBDC has already reported Q1-13 portfolio growth of only $20 million. That leaves $124 million of portfolio growth potential. That growth could produce - using the current trend of 8.3% yielding investments - another $2.573 million in revenue per quarter. That would raise NII by $1.2865 million per quarter or $0.0389/share when leverage is fully deployed. This would produce NII/share projections by quarter for 2013 of $0.3086 + $0.3200 + $0.3300 + $0.3475 = $1.3061/share.
For those who prefer a spreadsheet presentation of the math that produced in Q1-13 projection, the above is re-told in the data below.

Total Investment Income Calculation
Metric Fee Income ---------- Interest Income ---------- Totals
Formula average for last 4 quarters portfolio times yield / 4 Sum of components
Numbers 1.329 788 million times .097 / 4 + half of 20 million times .097 / 4 20.004

Net Investment Income Calculation
Metric NII/TII Ratio NII NII/share Result
Formula average for last year TII times NII/TII NII/ share count
Numbers 50% .50 times 20.004 10.002 / 32.413 $0.3085/share

This projection compares to the current quarter's $0.3429/share - where $42.5 million of net new investments did not generate income for some portion of the quarter, but fee income was atypically high and the share count was lower. The full year consensus analyst 2013 EPS estimate is $1.29 or $0.3225/share/quarter - with a high estimate of $1.30 or $0.325/quarter and a low estimate of $1.27 or $0.3175/quarter.

What They Own: GBCD's the weighted average annualized investment income yield (which includes interest income and amortization of fees and discounts) was 11.2% and excluding amortization was 9.7%. At 12-31-12, GBDC had investments in 129 portfolio companies. The investments in these portfolio (I am using 10-Q numbers) companies consisted of $248.890 million (32.4%) of senior secured loans; $363.560 million (47.3%) of "one stop" loans; $41.446 million (10.6%) of second lien loans; $49.607 million (6.4%) of subordinated debt; and $24.839 million (3.2%) of equity investments. Second lien loans included $14.7 million of loans structured as first lien last out term loans.

Annualized interest income yield (excludes amortization of fees and discounts) by security type:

12-31-12 12-31-11

Senior secured 7.3% 7.5%
One stop 9.1% 8.7%
Second lien 11.2% 11.2%
Subordinated debt 14.0% 13.9%

Asset Mix of Portfolio Q4-12 Q3-12 Q2-12 Q1-12 Q4-11

Senior Secured 33% 41% 41% 37% 37%
One Stop 47% 39% 37% 41% 41%
Second Lien 11% 7% 7% 7% 7%
Subordinated Debt 6% 10% 12% 12% 13%
Equity 3% 3% 3% 3% 2%

Originations During Q4-12 GBDC originated $262.2 million in new middle-market investment commitments. Sales and repayments on investments for the same period totaled $145.6 million. The 10-Q specified that total asset sales were $14.0 million. The weighted average interest rate on new investment was 8.3% based on the current LIBOR rate. The weighted average interest rate on sales and payoffs was 8.2%,

What They Owe: With Long-term debt of $400.450 million and shares outstanding of 28.605 million, the Debt/share was $15.6395 and the Debt/NAV ratio was 106.68% (a percentage which includes SBA debt). GBDC has a .63x debt to equity on a regular basis. While the balance sheet in both the earnings release failed to provide details on total debt, the 10-Q does. GBDC has loans of $174 million from AAA rated "Debt Securitizations" at a cost of 3.2% and a maturity of July 2021; $135.000 million in SBA debentures (at an average interest rate of 3.4%); and $91.450 million from a credit facility with a cost of LIBOR + 2.25% until October 21st of this year. After October, the cost will be LIBOR + 2.75% until October of 2017. For Q4-12, the effective annualized average interest rate on GBDC's total debt outstanding was 3.4%. The average debt outstanding in Q4-12 was $338.768 million.

That 3.4% cost of debt capital is really low compared to other BDCs. That should translate into GBDC having an advantage. I focus on the NII/TII ratio which includes all expenses. And GBDC failed to produce a quarterly NII/TII ratio that was above - or better than - the BDC sector average in any single quarter of calendar 2012. What could be the cause of that? I took a close look at similar externally managed BDCs where I could find numbers for both base and incentive management fees. GBDC had Q4 incentive fees that almost equaled the base fee - which is slightly high for incentive fees. With it being the fourth quarter, there were several BDCs that would make good comparisons for which I lacked reported numbers. Here is what I found.

Company NII/TII Management/TII Interest/TII Debt/NAV

ARCC 44.53% 31.53% 18.61% 57.48%
FSC 51.29% 15.47% 7.54% 56.38%
GBDC 51.52% 26.14% 16.11% 106.86%
MCC 54.28% 24.90% 13.08% 45.23%
PNNT 55.16% 29.35% 9.39% 52.50%
PSEC 59.75% 24.76% 9.88% 47.64%

It is not the management fees that are the source of the NII/TII ratio problem. Those numbers led me to the interim conclusion that the advantage GBDC has with the low percentage cost of debt is lost due to its atypically high debt to NAV ratio. This would explain why GBDC's NII/TII ratio was better in 2011, when it Debt/NAV ratios were lower. If this answer is correct, then GBDC's NII/TII under performance is not going away. This high level of leverage also explains why GBDC will not issue higher cost publicly traded baby bonds - as many BDCs have done. GBDC has a better than average quality of portfolio that produces lower weighted average yields. GBDC can not afford to carry higher cost debt and maintain a decent net interest margin. The cost of the increased leverage is an addition factor in that decision. The high cost of leverage could also explain the shift in GBDC's portfolio away from senior secured loans and towards higher yielding one stop loans.

Sensitivity to interest rate changes: Assuming that the consolidated statement of financial condition as of December 31, 2012, were to remain constant and that GBDC took no actions to alter our existing interest rate sensitivity, the following table shows the annualized impact of hypothetical base rate changes in interest rates. The data is in thousands.

Change in interest rates Increase (decrease) in interest income Increase (decrease) in interest expense Net increase (decrease) in investment income
Down 25 basis points $ (52) $ (664) $ 612
Up 100 basis points 449 2,655 (2,206)
Up 200 basis points 6,495 5,309 1,186
Up 300 basis points 13,272 7,964 5,308

Portfolio Quality Metrics The total fair value of non-accrual loans was $2.493 million (0.32% of the portfolio) as of 12-31-12, while the cost of non-accruals was $8.676 million (1.15% of portfolio). At cost, $5.182 million of the non-accruals were in senior secured loans, $0.403 million in secured second lien loans, and $3.091 million in subordinated loans. Non-accruals include loans to Extreme Fitness, Prommis Fin, and Pillar Processing.
BDCs frequently renegotiate loans that are on non-accrual. There are footnotes of zero fair value loans - where other loans to the same company have fair values that are close to book values - to companies that include Affordable Care, Consona Holdings, and Road Infrastructure Investment. The 10-Q notes that GBDC had realized losses of $2.1 million primarily as a result of the sale of a non-accrual portfolio company. One can see that non-accruals for calendar Q4-12 (fiscal Q1-13) did not fall by that write-off amount. I am also left to wonder if the shift to higher yielding investments could lead to higher non-accruals in the future.
Calendar Q3-12 had similar non-accrual footnotes of zero fair value loans where there were other existing loans not noted as non-accruals. These were to PC Helps Support, PMI Holdings (Papa Murphy's) and PowerPlan Consultants. Only the loan to PMI was absent in the Q4-12 list of loans. This makes the loan to PMI the number one candidate for that non-accrual sale. The Q3-12 fair value of that loan was $2.709 million at the end of Q3-12.

Information on non-accruals from the conference call:
There were "two valuation adjustments during the quarter, one up, one down, both on non-earning accounts. There was a $1.3 million valuation increase on Pillar Processing. This increase was attributable to an improvement in the company's trailing 12 months EBITDA. In addition, since we restructured this debt in July, 2012, the company's been current with all interest payments. And we have also received some significant principle repayments from liquidation of receivables. The unrealized gain on Pillar was offset by an unrealized loss of $1.1 million on Extreme Fitness as this company's financial performance has continued to decline. There were not any other notable valuation adjustments for the quarter."

Non-Accrual Investments by fiscal Quarter Q1 2013 Q4 2012 Q3 2012 Q2 2012 Q1 2012

Non-accrual investments at amortized cost (000s) $8,149 $8,910 $9,666 $7,328 $11,416
Non-accrual investments / Total portfolio at amortized cost 1.1% 1.3% 1.5% 1.2% 2.0%
Non-accrual investments at fair value (000s) $2,493 $3,222 $4,243 $2,801 $5,442
Non-accrual investments / Total portfolio at fair value 0.3% 0.5% 0.7% 0.5% 1.0%

GBDC per share operating metrics
GBDC has a current dividend of $0.32/share/quarter
Total Investment Income $18.594 million (divided by 27.934 million average shares = $0.6656/share)
Interest Expenses = - $2.995 million (- $0.1072/share)
Base Management Fee = - $2.468 million (- $0.0884/share)
Incentive Fees = - $2.394 million (- $0.0857/share)
Total Investment Expenses = - $9.016 million (- $0.3228/share)
Net Investment Income $9.578 million ($0.3429/share)
Realized appreciation = $0.094 million ($0.0034/share)
Unrealized appreciation = - $0.353 million (- $0.0126/share)
Net Increase in Net Assets Resulting from Operations = $9.319 million ($0.3336/share)

In part two I will provide the current sector valuations and the valuations for GBDC, and make judgments as to whether GBDC is a buy, sell or hold.

Disclosure: I am long ARCC, MCC, PNNT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.