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American Capital Ltd. Finds a New Way to Make a Buck

As an investor, I have the utmost respect for the asset management business. It has all of the attributes of a great business: residual revenue, scalability, and little to no required investments to grow the business. Asset managers can be cash machines for their owners.

American Capital Ltd. (NASDAQ: ACAS  ) has a great business in American Capital Asset Management, the company behind American Capital Mortgage (NASDAQ: MTGE  ) and American Capital Agency (NASDAQ: AGNC  ) . As the asset manager, it earns big annual fees for managing other people's money.

American Capital Ltd. wants to extend its reach into asset management by creating a new company, American Capital Senior Floating Ltd. (NASDAQ: ACSF) to capitalize on investor interest in floating-rate funds.

The new fund by the numbers
According to an SEC filing, American Capital suggests the new fund can earn 6.5% on total assets in its new leveraged loan fund.

Source: SEC filing.

After leveraging the fund, paying interest on borrowings, and management fees back to American Capital Asset Management, the fund could yield as much as 7.87% per year. This is based on expense assumptions laid out on page 12 of its new filing.

For investors, the fund would be a winner by any measure. It would yield significantly more than the $6.5 billion PowerShares Senior Loan Portfolio (NYSEMKT: BKLN  ) , which yields just 4.4% per year. The difference is due in part to leverage -- PowerShares doesn't leverage its fund -- and a difference in underlying holdings. American Capital's fund currently holds riskier CLOs at a weighting of 15% of total assets. PowerShares simply holds the largest leveraged loans in its ETF.

Source: SEC filing.

Why this matters for American Capital Ltd.
In recent months, rates have risen, and American Capital's mortgage REITs have traded below book value ever since. Thus, asset growth is muted, and in fact, management fees paid back to American Capital are in decline because of the poor performances of American Capital Agency and American Capital Mortgage.

American Capital Senior Floating Ltd. provides a mechanism for American Capital to benefit from rising rates. In 2013, floating rate funds took in more than $50 billion of assets as investors moved to floating-rate funds to earn higher yields as rates have headed higher.

If American Capital can capitalize on the trend, its new floating rate fund could provide substantial new cash income to the parent company. American Capital Asset Management will earn 0.8% in management fees on total assets and receive up to 0.75% in shareholder's equity in expense reimbursement.

Thus, for every $1 billion in assets under management, American Capital would stand to add $20 million in revenue every quarter.

American Capital intends to take the new company public "as soon as practical," with an IPO valued at $150-$172.5 million. We'll have a better idea of how important this new fund is to American Capital after its IPO. If it goes off to trade above net asset value, American Capital could grow assets under management quickly with secondary stock offerings, just as it grew its mortgage REITs. That would bode well for American Capital shareholders.

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Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

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