Golub Capital BDC (NASDAQ: GBDC ) has a strong business, a coherent strategy, and a solid track record. Where can it go from here?
Golub's competitive advantage
Golub has the advantage of being well positioned in its market and of being clear and coherent in its strategy. It lends to private equity-backed firms, focuses on high-quality middle-market companies, and keeps its loans on its books.
As a result, Golub's returns aren't as spectacular as those of its more diversified or yield-seeking peers. They are the type of returns that can weather good lending environments and bad, however.
Based on the company's recent investment decisions, which favor the most secure financings, it doesn't seem like Golub's managers think today's low yields and strong liquidity will last forever.
That means that Golub is looking at keeping the cost of capital low and its loan book solid for the next cycle. Whatever happens next, the idea is that Golub should be able to keep lending at a competitive rate and keep paying out shareholders no matter what happens.
This alone places it in a good position if and when the market turns.
Will the marketplace change?
Commercial lending to middle-market firms is a hot area at the moment. Banks have been forced to back away from the space due to capital requirements and risk exposure issues, so the market has opened up more to alternative lenders such as Golub.
Meanwhile, demand is rising. A Federal Reserve survey in April found strong demand for commercial loans from companies of all sizes, and potential lenders are taking notice. Insurer American International Group (AIG), for example, recently announced that it will be teaming up with private equity fund Oak Hill Capital Management in a $1.5 billion joint venture.
The fund, Varagon Capital Partners, will target companies with $10 million to $75 million in EBITDA (earnings before interest, tax, depreciation, and amortization.) This overlaps quite a bit with Golub's target range of $5 million to $50 million.
How will Golub respond?
I don't know if AIG can definitely lend for less than Golub, but either way we could see a reduced deal flow coming the company's way as more firms enter the space. This could prompt Golub to take on worse deals than it otherwise would.
Until now, Golub has held fast to both its lending strategy and to keeping loans on its books. From a shareholder perspective, this is a great way to ensure due diligence and appropriate loan structures for borrowers because it mean that Golub is, in the words of its founder, "eating its own cooking."
I would get worried if Golub started loosening these standards in the face of competition. In other words, I would be happier to see the company endure lower market share and some extra capital in the short term than watch it begin a gentle slide down the slippery slope of lower standards and risk transfer.
Of course, that territory isn't questionable for everyone. AIG, for its part, is only planning to hold onto $20 million to $100 million of its loans and syndicate the rest. Considering the poor incentives that go along with this type of thing, namely those lower lending standards and a shorter-term focus, it's not a strategy I would be happy about.
The best shot at long-term growth
To be sure, Golub also isn't just sitting around waiting for other companies to take its market share. In May 2013, Golub enacted a co-investment agreement with United Insurance Company of America to establish a Senior Loan Fund, which also enjoys a line of credit from Wells Fargo. This fund will provide enhanced returns on typically low-yielding senior loans; you could call it a way to leverage Golub's credibility.
Golub's advisor is also already one of the largest players in the middle market, so it has a degree of market share protection.
If you ask me, Golub's best shot at long-term growth and ever-increasing market share will come from sticking to its core strategy and keeping its standards high. This way, with every fad and lending cycle, Golub will further develop a reputation as the lender that is always there. If I was a middle-market business or private equity partner, this alone would be worth a lot.
So far, it looks to remain on that course. As always, only time will tell.
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