The primary component of Golub Capital BDC's (NASDAQ:GBDC) assets is unsurprisingly its portfolio of loans. Let's take a look at how Golub is structuring its lending, as well as what the risks are for the company.
Investments: Weighted toward senior secured
Golub has been progressively shifting its portfolio toward senior secured and one-stop loans over the past year.
Together, these categories now make up 87% of the firm's total portfolio. This is part of a longer-term trend on Golub's part; subordinated debt investments went from 10% of the portfolio in September 2012 to 2.2% in September 2013, while one-stop investments went from 30.5% to 54.1%.
Why on earth would Golub replace higher-yielding loans with lower-yielding ones?
Golub is sensing froth in the lending market and wants to put its money into secure loans that have a very strong probability of repayment. It's particularly favoring the one-stop loan lately: over 80% of its new originations were one-stop loans, compared to 13.5% senior secured loans.
Wait, what are one-stop loans again?
Considering how important one-stop loans are to Golub's portfolio, let's take a deeper look at some of their risks and rewards.
Golub's one-stop loans have two key qualities. First, they're structured as senior secured loans, meaning they're backed by collateral, and Golub has first priority on the money. In other words, if the specified assets have to be sold to repay the loan, Golub is first in line to collect the proceeds.
The second key quality is that these loans usually let the borrower pay a lump sum at the end of the loan instead of paying interest and principal over time.
The obvious risk to this strategy is if something changes for the worse and the borrower is no longer able to repay or refinance the loan when it comes due. This could be especially risky if communication about what's happening is scarce in the interim.
In other words, Golub does take a risk by offering these loans. The company notes that due to these risks, it's able to extract better monitoring and remediation terms with its borrowers. Obviously, taking a senior secured position also helps. The risk is still there, though, so it's one you should be aware of.
What kind of default rates are we talking about?
In the case of Golub's senior secured and one-stop loans, "non-accrual" rates (meaning that Golub has stopped trying to collect payment on an overdue or defaulting loan) are under 1% if you look at the past year and a half:
One-stop loans don't have a non-accrual rate. That also might be because none came due in these periods, though, so don't get too excited just yet.
You may have noticed that non-accruals are rather significant on subordinated loans. These are, quite simply, riskier loans. They have higher fixed interest rates and, in Golub's case, they generally only pay interest over the course of the loan instead of interest and principal. It's common for subordinated loans to pay interest in the form of cash or "payment-in-kind" interest, meaning that the payment is made with equity or added to the principal, to be paid later on.
Sound risky? It definitely is. Just as with one-stop loans, there's a risk the borrower won't be able to make the lump-sum payment at the end. It's worse in this case because subordinated debt isn't backed by assets which can be sold, and it also carries a higher interest rate so the amount to be paid back is a lot higher. If payment-in-kind interest is used, the risks can be significant.
It looks like Golub took those risks to heart and is reducing this already modest portion of its portfolio even further.