Golub BDC Balance Sheet: The Liabilities

Source: Company.

The primary component of Golub Capital BDC's (GBDC -0.81%) liabilities is debt, which is used to finance its portfolio. How is Golub structuring its borrowing, and what are the risks involved? 

The majority of Golub's liabilities are in the form of debt, which is used to finance its portfolio. Golub has a total of $2.20 in assets for every $1 in total liabilities.

Good or bad? Golub is well within the rules for a BDC, which state that the company must have $2 in assets for every $1 borrowed (Golub is allowed exceptions to these rules through a subsidiary, but we won't get into that here).

Of course, any leverage still comes with risks, which we'll get to at the end. First, what are the different types of liabilities Golub is facing? 

Golub's liabilities in a nutshell 
Fully 98% of Golub's liabilities are debts and secured borrowings, so that's what we'll focus on here (the other 2% includes items such as interest payable, management and incentive fees payable, accounts payable, etc.).

Golub's debts fall into four main categories: Debt securitization, SBA debentures, two revolving lines of credit, and secured borrowings. Together, these items together total $590.3 million. By comparison, Golub has $1.3 billion in total assets, of which $1.25 billion is its investment portfolio. 

As mentioned above, this is comfortably within the rules for a BDC.

The debt securitization: What is it? 
The debt securitization is, essentially, notes that Golub issued in a private placement, on which it pays interest. These notes are backed by pieces of Golub's portfolio. It's worth pointing out that Golub issued the notes on the "best" part of its portfolio, namely the most secured assets, and has held onto the rest.

Golub did the same with a more recent securitization, which isn't yet reflected in its financials. As my colleague Jordan Waltham put it, this is a great sign: holding onto the lower-rated pieces of the portfolio shows that Golub believes in its loan book.

As of March 31, 2014, the debt securitization of $215 million was backed by 85 portfolio companies with a fair value of $327.7 million. In other words, for every $1 Golub owes, it has $1.52 in assets for this portion of its debt.

SBA debentures
Golub has a subsidiary that received permission from the US Small Business Administration (the SBA) to act as a Small Business Investment Company (SBIC). The point of this government program is to facilitate and encourage long-term lending to small businesses (and create acronyms). 

The government wants SBICs to be able to finance their activities, so it gives SBICs a guaranteed amount of leverage. To use that leverage, SBICs issue debentures backed by the SBA (a debenture is just a debt instrument that uses general creditworthiness as backing instead of collateral).

It sounds complicated, but it is in essence just another kind of loan. Golub has to pay interest to the government, and there are limits to the amount it can borrow and restrictions on how it can be used. 

Lines of credit 
In addition to its securitized debt and SBA debentures, Golub has two lines of credit. The significantly larger one lets Golub borrow up to $250 million with Wells Fargo. Certain of Golub's assets act as collateral for this credit facility.

The other line of credit is rather insignificant by comparison: $15 million with the option to raise it to $30 million. This credit line is with the PrivateBank and Trust Company, and is also asset-backed.

Obviously, Golub pays interest on both credit lines, and in the case of the small one it pays a fee for any unused portion. 

Secured borrowings 
This category of debt mostly exists because of accounting rules. It reflects a partial loan sale for two portfolio companies, and because that sale didn't meet certain accounting definitions they've had to be treated as secured borrowings. I won't go into more detail here because it's a small portion of the company's debt and I can hear your soft snoring already. 

Remember that leverage is always a risk 
Even though BDC rules allow $1 of leverage for every $2 in assets, it doesn't mean everything will be rainbows and butterflies until the end of time. There is always risk when borrowing is involved, and of course the key risk is not being able to pay what's owed. 

Golub is very conservative in its lending practices, which makes it much more likely that the company will be able to service its debts. But it's important to remember that there's still room for error. For example, Golub might mis-value one of its loans, which could make it seem like it's worth more than it actually is (and thus could make the leverage ratio look misleadingly pretty). 

So if there's a crunch and Golub needs to raise capital, it might not be able to sell that loan for the price it thinks is reasonable, meaning that the "real" leverage ratio in that moment of crisis could look far worse than it does today. 

While none of Golub's loans are due in the next few years, which for now would give it plenty of time to refinance if need be, it's useful to keep in mind that anything can happen in a crunch -- whether it's fueled by economic changes or a problem in Golub's business.

I personally like Golub's balance sheet for a BDC; just remember to take the risks into account.