American Capital (ACAS) has rapidly changed its balance sheet in an effort to split itself into two companies: an asset manager and an asset owner. It sold many of its largest equity investments into a private equity fund it manages, and used its cash to acquire piles of low-yielding, senior floating-rate loans. With an extra helping of leverage, American Capital believes it can generate attractive returns from lower-yielding loans.
The floating-rate loans are central to its spinoff plan, as they are earmarked to be spun off into the BDC when the process is complete.
As of last quarter, American Capital had $2.3 billion of these low-yielding loans, roughly 31% of its total balance sheet. This quarter, its outsize holdings of syndicated loans could come back to bite. As loan prices trade down, American Capital's book value could take a hit this quarter.
Loan prices dip
According to data compiled by JPMorgan, leveraged loan spreads excluding energy issues expanded from roughly 4.3% to 4.8% from the end of the second quarter to Sept. 23. Spreads are also widening in junk bonds, leaping from 5% at the end of the second quarter to 6.5%. The spread is the difference between the yield on a loan or bond compared to a risk-free U.S. Treasury security.
As spreads rise, loan prices naturally fall. The average loan in the S&P/LTSA 100 Index traded at $0.92 on the dollar on Sept. 23, 2015, down from $0.95 on July 1.
This could lead to some rather significant mark-to-market losses in American Capital's portfolio when it reports earnings. A three percentage point impairment to its portfolio of senior floating-rate loans would result in about $68 million of mark-to-market losses. Small as it may seem on a total balance sheet of about $8.1 billion, American Capital earned only $67 million in net operating income last quarter, an earnings measure that excludes capital gains and losses.
While in the long run the quarter-to-quarter swings are simply noise, investors shouldn't be surprised if American Capital's bottom-line earnings, and its net asset value, come in a little weaker in the third quarter.
