GAIN: On August 9, 2018 GAIN held its annual Shareholder meeting. Two issues were up for vote: a routine approval of an interested Director, which was approved. More importantly, a resolution giving permission to allow the BDC to raise equity below book value for the next year was overwhelmingly approved. The BDC Reporter - which owns the Term Preferred - is not a fan of these "blank cheques". From a practical standpoint, with the stock trading at a 4% premium to book any issuance is likely to be at a premium or thereabouts. Of course, the risk is that the Gladstone organization is not shy to raise capital at a discount at times and should market conditions change a below book issuance between now and next year is not out of the question. The optimistic mood in the BDC sector and at GAIN - which has been on a hot streak - is such that most shareholders - as the vote shows - hardly care. However, conditions and sentiment can turn on a dime (an expression which we use but do not understand). Moreover, as management constantly admits, even the lower middle market is overheated right now and good deals are hard to find. What's more GAIN ha adopted the new lower asset coverage/higher leverage standard as of April next year, giving them plenty of access to capital if needed. This is gilding the lily, but an action many (but not all) BDCs take to have as many options as they can in their pocket to undertake future actions without consulting shareholders.
WHF: The mid-sized BDC put three items to a shareholder vote. Two were routine ( a director approval and the blessing of the independent accountant) and were approved. Also approved - and by a wide margin - was the immediate adoption of the lower asset coverage/higher leverage allowed under the Small Business Credit Availability Act. As discussed on the Conference Call, WHF has set itself an unofficial - and non binding - leverage limit of 1.25x debt to equity. That could grow asset size by $137mn, according to management. That would represent a 27% increase in total assets and a 64% increase in total debt. (When we calculated the numbers, the asset increase was $166mn. We can't account for the difference).
GARS: We are not shareholders in GARS but note that the BDC is actively reminding its shareholders of a Proxy filed July 12 and coming up for a vote on August 14. The only subject is asking shareholder approval to reduce asset coverage/increase leverage under the Small Business Credit Availability Act. The BDC Reporter adds: We don't recommend shareholders for the new proposal, but chances are they will, given what's happened elsewhere on votes of this kind. We note that GARS is already leveraged above 1:1 thanks to its SBIC license, whose debt does not count against the regulatory limit. Moreover, the BDC has not imposed any constraint on itself beyond the new 2:1 debt to equity limit should the approval be received. Technically that will allow GARS to add $193mn in assets and the same in debt to the $393mn of investment assets and $235mn in debt already in existence. At most (and assuming another $10mn increase in SBIC debt-which is also possible) that would take total assets to $596mn on an equity base of $185mn at FMV on March 31, 2018 . Unfortunately to date GARS credit performance has not been reassuring. Realized and Unrealized Losses - virtually all the former - have amounted to ($69mn), equal to 28% of par equity capital. For the type of loans GARS makes, we typically assume 2% in annual average write-offs a year or 10% over 5 years. That suggests (and using a 1.8x multiple for ACTUAL debt to equity) we estimate additional losses could be $56mn over the next half decade. That would reduce book value by ($3.5) per share and (very roughly speaking) income by ($0.30) per share annually. Effectively that would reduce the current value of GARS by a third. The current recurring EPS is $1.24 and the dividend $1.12. The only positive worth noting is that GARS offers to reduce - as many other BDCs have done - its Management Fee to 1.0% for assets over the prior regulatory limit. To our mind that modest concession is not worth the extra risk.
8/3/2018: In advance of filing a Proxy to adopt the higher leverage allowed under the Small Business Credit Availability Act, TSLX published these comments from the latest Conference Call on the subject. The BDC Reporter adds: We are shareholders in TSLX in our Long Term Income strategy. Whether one is for or against higher leverage at TSLX, the discussion held during the IIQ 2018 Conference Call is the most thoughtful we've seen and should help shareholders decide. Given the 1.25X limit; the excellent track record of TSLX to date; the lowered management fee and the relatively cost of debt capital the BDC attracts, we expect to vote YES on the higher leverage, subject to a review of the final Proxy.
SAR: Only item up for vote is re-electing CEO Oberbeck to the Board. The BDC Reporter adds: We are shareholders in SAR. We will be voting FOR Mr Oberbeck's re-election, even if we would prefer - both for SAR and all other BDCs - to see the Chairman role on the Board given to an independent director.
GAIN: The BDC faces the difficult task of getting enough shareholders to vote on this year's shareholder issues to have a quorum. With time running out GAIN has "adjourned" the August 2 meeting, which gives the proxy solicitation firm employed by the Advisor - but paid for by the BDC itself - to get more investors to vote. The BDC Reporter adds: We are not currently a shareholder in GAIN but are shareholders in all 3 Term Preferred issues. The key issue of two on the ballot is getting approval from shareholders to sell stock below book value, a perennial request of the Board and Advisor. This year GAIN is trading at a premium to book so the need for the blank cheque is lower but GAIN is asking anyway. We have voted AGAINST the proposal. As always in these situations, we are against shareholders giving away a key protection of the BDC model (forbidding BDCs from issuing stock below book value) and without any pre concession from the Manager. Moreover, with the new asset coverage rules kicking in within a few months, the risk of GAIN breaching the BDC leverage tripwire (often listed as a reason to allow the Advisor to raise fresh capital at a discount) is very low. Finally, we note that the Board and Advisor have chosen to call a shareholder vote on issuing stock below book but have not given shareholders a direct voice in the decision to adopt the lower asset coverage provisions of the Small Business Credit Availability Act, which will be kicking in - whatever shareholders want - in 2019. Because of provisions in the Term Preferred that require 200% asset coverage, GAIN will be forced to redeem all 3 of its Term Preferred issues and re-borrow in some form in the months ahead at great cost to shareholders. Moreover - unlike some other BDC Managers - the GAIN Investment Advisor has not proposed any fee concession to shareholders as part of the higher leverage to be adopted from 2019.