Golub Capital BDC’s Income Statement & Opportunities

Source: Company.

Golub Capital BDC's (NASDAQ: GBDC  ) income and expenses are tied, as you might expect, to its lending portfolio. While Golub doesn't offer the high yields of some of its competitors, its income statement is a demonstration of its conservative strategy -- and with the addition of a senior loan fund last year, we might see additional growth from this understated BDC.

Income and expenses
Golub makes money primarily from the interest it charges through its financing activities, and to a lesser extent from fees and dividend income. Golub also earns when its investments and secured borrowings increase in value. 

Golub's expenses are also primarily related to the management of its portfolio: interest and debt financing, management and incentive fees to GC Advisors (Golub's external manager), and other professional and administrative fees and expenses. 

With nearly 99% of income coming from interest and over 41% of expenses tied to financing, management fees, and incentive fees, it's a pretty straightforward picture. 

Here's a quick look: 

Investment Income

(in thousands)

Percentage of total income

Interest income

$ 24 977.00

98.9%

Dividend income

$ 262.00

1%

Fee income

$ 21.00

0.1%

Total income 

$ 25 260.00

 

Expenses

   

Interest and debt financing

$ 4 540.00

18%

Base management fee

$ 4 185.00

16.6%

Incentive fee

$ 1 656.00

6.6%

Professional fees

$ 640.00

2.5%

Administrative service fees

$ 742.00

2.9%

General and administrative 

$ 145.00

0.6%

Total expenses

$ 11 908.00

47.1%

Net gains (losses) on investments

   

Net realized gains on investments

$ 87.00

 

Net unrealized appreciation on investments

$ 662.00

 

Net change in unrealized (appreciation) on secured borrowings

$ (12.00)

 

Total net increase in net assets 

$ 737.00

2.9%

Net increase in net assets

   
 

$ 14 089

55.8%

As noted, Golub also makes money from portfolio appreciation. I would, however, tend to disregard the unrealized gains, or at least take them with a grain of salt (which is also easy because they're such a small proportion of the income statement). 

The reason we like interest income and ignore unrealized gains
Most of Golub's assets are not valued based on market prices. Why?

When there isn't a liquid market for something, it's not simple to determine the market price.

Instead, these assets are valued based on internal valuation procedures, which take into account any available market data and, according to Golub, might require a significant amount of judgment or estimation. This means that "gains" in the form of unrealized gains aren't that informative -- they'll give you an idea of the value, but to know the numbers with certainty requires the asset to actually be sold.

On the other hand, interest income is interest income: Golub knows how much it's going to get, and those payments are consistent. If a borrower doesn't pay, the amount that was previously recorded as income for that loan is subtracted. 

Thus, the fact that the vast majority of Golub's income comes from interest payments, rather than portfolio appreciation, is a nice feature of the income statement. 

This income is stronger still because of the types of loans that Golub makes. Close to 90% of Golub's assets are in the form of senior secured and one stop loans, which are both backed by collateral.

In other words, these are very conservative loans, with a very high likelihood of payment. 

Future powerhouse? Golub's senior loan fund
In May of 2013, Golub partnered with United Insurance Company of America to co-invest in senior loans. What does that mean? 

As my colleague Jordan Wathen has pointed out, senior loan funds are special because they employ leverage on low-risk, low-yield investments. 

This means that by borrowing funds from its credit facility through Wells Fargo, Golub can enhance the returns on the senior secured loans it makes in the senior loan fund. The weighted average interest rate on those loans is, as of March 31, 2014, 5.5% -- by adding leverage, Golub can increase this quite a lot.  

Right now, the senior loan fund is a small but growing part of Golub's portfolio. It's an interesting strategy, because it allows Golub to stick to what it knows best (conservative lending), while potentially giving investors a significantly higher rate of return. I'm looking forward to seeing how it changes the characteristics of Golub's income statement as it grows.

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