American Capital Ltd. Just Got A Killer Deal

A quick look at American Capital Ltd. and it's new plan to invest in senior floating-rate loans.

Jun 30, 2014 at 3:47PM

Bargain

Source: Taxcredits.net

American Capital Ltd. (NASDAQ:ACAS) is in the midst of what many believe to be a massive transformation from asset owner to asset manager.

During this transition period, American Capital is piling up cash. Historically, cash on the balance sheet was immediately used to fund share repurchases. Now, however, repurchases are off the table, as further buybacks would violate rules on insider ownership and stock-based compensation.

So what's American Capital to do with all that cash? Invest in senior loans, apparently.

New firepower
In the first quarter, we learned American Capital invested $199 million into liquid, senior floating-rate loans. These loans aren't typically what you'd find in a business development company. The borrowers are larger and more established, and the yields are low -- just 4.5% on average, according to the company's latest filing. That's roughly in line with the yields reported from the S&P/LTSA U.S. Leveraged Loan 100 Index. 

Although these are low-yielding assets, American Capital can still generate a respectable return. We learned on Monday that the company obtained a new credit facility from Bank of America at a rate of LIBOR + 1.6%.

This may be the cheapest credit facility of any BDC. The pricing, though, is obviously the result of the fact senior floating-rate loans are lower-risk investments. Pricing would be much higher if it were secured with middle-market debt investments. (Its other credit facility, secured by riskier assets, costs 3.5% per year.)

Back of the envelope returns
Going quickly to potential returns, let's do some quick back of the envelope expectations for this new credit facility.

First, what we know: the 1-month LIBOR sits at 0.15%, and American Capital's senior floating-rate loans had a weighted average yield of 4.5% in the first quarter. Assuming 1:1 leverage, we get a return on equity of 7.25%, before any credit losses.

Based on discussions from the previous conference call, however, there's potential for greater than 1:1 leverage in this particular vehicle. Leverage of 1.5:1, for example, would boost returns on equity to 8.625%; again, this is before any credit losses.

Respectable returns given bottom line weaknesses
American Capital's biggest problem is that although it's asset rich, it's income poor. The bulk of its equity assets were generating very little income. Those are now largely off its balance sheet.

Reinvesting the cash raised from asset sales into floating rate loans should help headline earnings. After all, using a baseline 7.25% return on $750 million of equity levered at 1:1 adds roughly $13.5 million in quarterly interest income.

Last quarter, the company reported a total of $16 million in net operating income, a figure which excludes the impact of unrealized and realized gains. Once American Capital is fully invested in senior floating rate loans, net operating income would likely double from the first quarter of 2014.

The last word
Deploying capital in senior loans will help net operating income, which has been in decline for quite some time. The real question now is one of permanency: Will senior loans forever be part of the American Capital balance sheet?

Will these assets eventually become a new, publicly traded fund from which American Capital can draw management fees, much like American Capital Senior Floating Rate (NASDAQ:ACSF)?

Or is this just a way to bridge the gap and spruce up earnings while American Capital transitions from an asset owner to asset manager?

I don't know -- there's no way to know. But one thing is for certain: American Capital got a great deal on this credit facility, and, for the first time in a long time, net operating income should finally be on the rise once again. 

Top dividend stocks for the next decade (Hint: It's not ACAS)
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers