Gladstone Capital Corp
NASDAQ:GLAD
Earnings Call Analysis
Q1-2024 Analysis
Gladstone Capital Corp
Gladstone Capital Corporation reported a consistent performance in a slow deal environment for the first quarter of 2024. Originations picked up, totaling $58 million with a significant portion allocated to support existing growth-oriented businesses. Even as repayments remained modest, the company managed net originations of $37 million and maintained a steady weighted average yield on their investment portfolio of 13.9%.
The net interest income rose by 2.3% to $17.5 million due to decreased borrowing costs and improved originations, which combined with advisory fee credits propelled the net investment income higher by 8.6% to $11.9 million, translating to over $0.27 per share. Overall, the company's returns on equity were impressive, with a quarterly ROE of 19.4% and a 12-month ROE of 14.9%.
With senior debt constituting 73% of the total portfolio, Gladstone Capital exhibited a resilient performance, ending the quarter with only one non-earning asset valued at $6.1 million, a mere 0.4% of assets at fair value. The portfolio's appreciation was a significant factor this quarter, with debt investments and equity co-investments appreciating by $6.3 million and $1.6 million, respectively.
The company forecasts an uptick in new originations and prepayment activity as short-term interest rates are expected to decline, stimulating private equity sponsors to offload seasoned investments. With a conservative leverage position at 83% of net asset value (NAV) and substantial liquidity from their credit facilities, Gladstone Capital is well situated for asset and fee income growth to support shareholder distributions.
Total assets grew to $767 million, and net assets increased to $418 million by the end of December 2023, marking a 2.3% rise in NAV from the prior quarter to $9.61 per share. The company confirmed monthly distributions of $0.825 per common share for the first quarter, and the board will revisit the distribution policy in April. The current common stock price indicates an annual yield of approximately 9.6%.
Gladstone Capital has positioned itself for sustained success as it wrapped up the quarter with favorable financials, a 2.3% quarter-over-quarter increase in NAV, and net investment income growth of 8% from the previous term. With strong portfolio health, modest leverage, and low nonperforming assets alongside a resilient balance sheet, the company appears set for further growth and to competently maintain its distribution commitments.
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Greetings, and welcome to the Gladstone Capital Corporation First Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Gladstone, Chairman and CEO of Gladstone Capital Corporation. Thank you. You may begin.
Well, thank you so much, and good morning, everyone. This is David Gladstone, and this is the earnings conference call for Gladstone Capital for the quarter ending December 31, 2023. Thank you all for calling in. We're always happy to talk with you and share information about this company and your company and we'll get started, of course, and hear from our Assistant General Counsel, Erich Hellmold and he'll tell you some stuff that you need to know before you listen to Bob and go ahead, Erich.
Thank you, David, and good morning. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that are based upon our current plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors in our Forms 10-Q, 10-K and other documents we file with the SEC.
Those can be found on the Investor Relations page of our website, www.gladstonecapital.com, where you can also sign up for our e-mail notification service or on the SEC's website at www.sec.gov. We undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Today's call is an overview of our results, so we ask that you review our press release and Form 10-Q issued yesterday for more detailed information. Again, those can be found on the Investors page of our website. Now I'll turn the call over to Gladstone Capital's President, Bob Marcotte.
Good morning. Thank you all for dialing in this morning. I'll cover the highlights for last quarter and some comments regarding the outlook for the balance of fiscal '24. Before turning the call over to Nicole Schaltenbrand to review the details of our financial results for the period. So beginning with our last quarter's results, originations last quarter rebounded and totaled $58 million, including one new portfolio company and several existing portfolio companies.
Repayments continue to be modest, which combined with portfolio amortization totaled $22 million, so net originations were $37 million for the period. Short-term SOF rates unchanged, so the weighted average yield on our investment portfolio was also consistent at 13.9%. Average earning assets for the period declined slightly resulting in a 1% decline in our total interest income to $23 million for the quarter. Borrowing costs declined with lower average bank borrowings given our equity issuance in the September quarter and debt placement.
As a result, our net interest income rose 2.3% to $17.5 million for the quarter. Higher net interest income improved originations and advisory fee credits lifted the net investment income by 8.6% to $11.9 million or just over $0.27 per share. The net realized and unrealized gains in the portfolio for the period totaled $8.1 million, which lifted our ROE for the quarter to 19.4% and 14.9% for the last 12 months.
With respect to the portfolio, our portfolio continues to perform well with senior debt representing 73% of the portfolio, and we ended the quarter with only 1 non earning asset representing $6.1 million at cost or 0.4% of assets at fair value. We continue to prioritize our portfolio monitoring in areas where revenue headwinds compare to be most prevalent which seem to be mostly consumer-facing sectors, which is fortunately a small portion of our portfolio.
Depreciation for the quarter of $8.1 million was led by the broad-based appreciation of our debt investments which totaled $6.3 million, while the net appreciation of our equity co-investments contributed an additional $1.6 million. And reflecting on our first quarter of fiscal '24 performance and our near-term outlook, a few comments I'd like to leave you with. Last quarter's deal activity certainly demonstrated the benefit of our incumbent position is supporting growth-oriented businesses across a variety of industry sectors in an otherwise slow deal environment.
PE sponsors are dealing with extended hold periods and continuing to seek ways to creatively grow or capitalize their investments and supporting performing businesses we know well as a low-risk way to grow our assets. That said, deal flow has improved, and we expect new originations to increase along with potential prepayment activity over the balance of the year as short-term interest rates are expected to decline and PE sponsors are expected to bring more -- their more seasoned investments to market to generate liquidity events for their investors.
We ended the quarter with a conservative leverage position at just 83% of NAV and ample availability under bank -- our bank credit facilities. So we're very well positioned to grow our earning assets and fee income to continue to support our shareholder distributions over the balance of the year.
And now I'll turn the call over to Nicole to review detail the fund's -- detailed financial results.
Thanks, Bob. Good morning. During the September quarter, total interest income fell $300,000 or 1% to $23 million based on the small decline in average earning assets. The weighted average yield on the interest-bearing portfolio was consistent at 3.9%. The investment portfolio weighted average balance declined to $658 million, which was down $11 million or 1.6% compared to the prior quarter.
Other income declined by $300,000 and total investment income fell by $500,000 or 2.3% to $23.2 million for the quarter. Total expenses declined by $1.5 million quarter-over-quarter as net management fees declined $1.2 million with higher deal closing and advisory fee credits and $700,000 in lower financing costs from the reduction in average bank borrowings. Net investment income for the quarter ended December 31 was $11.9 million, which was an increase of $900,000 compared to the prior quarter or $27.4 per share, which exceeded the $24.75 per share dividends paid. The net increase in net assets resulting from operations was $20 million or $0.46 per share for the quarter ended December 31 as impacted by the realized and unrealized valuation depreciation covered by Bob earlier.
Moving over to the balance sheet. As of December 31, total assets rose to $767 million, consisting of $750 million in investments at fair value and $17 million in cash and other assets. Liabilities rose with net originations to $349 million as of December 31 and consisted primarily of $253 million of senior notes and as of the end of the quarter, advances under our $234 million line of credit were $85 million.
As of December 31, net assets rose to $418 million from the prior quarter end, with investment appreciation and undistributed earnings. NAV rose 2.3% from $9.39 per share as of September 30 to $9.61 per share as of December 31. Our leverage as of the end of the quarter with the asset growth rose with the asset growth to 83% of net assets. Subsequent to December 31, we had a small $3 million prepayment of a syndicated second lien debt investment. With respect to distributions, our monthly distributions to common stockholders of $8.25 per common share was announced for the month of January, February and March, which is an annual run rate of $0.99 per share.
The Board will meet in April to determine the monthly distribution to common stockholders for the following quarter. At the distribution rate for our common stock and with a common stock price at about $10.30 per share yesterday, distribution run rate is now producing a yield of about 9.6%. And now I'll turn it back to David to conclude.
Thank you very much. Nicole, you did a great job, and so did Bob and Erich, and you all did a good job. So they've informed our stockholders and analysts that follow the company. So with your report that you got a 10-Q filed yesterday to shareholders in this call that we're making at pretty much brought up to date about everything going on. So in summary, it's just another solid quarter. Sometimes that's pretty boring, but it's pretty nice when we have borrowing profitable quarters.
They increased the net investment income by 8% over the prior quarter. That's really good. It gives good coverage over the current common distributions. Strong portfolio performance and generating net portfolio appreciation increased the net asset value by 2.3% from the last quarter. I love it when that goes up every quarter, and it helps us pay our dividend. For 2023, the whole Glad achieved returns on equity of 14.9%, which compares very favorably with the other business development companies in our peer group. The company is also very well positioned for the coming year as the portfolio is in good shape with modest leverage and very low nonperforming assets and a strong balance sheet to support further growth.
In summary, the company continues to stick with its strategy of investing in growth-oriented lower middle market businesses with good management teams. Many of these investments are supported by midsized private equity funds that are looking for experienced partners to support the acquisition and growth profile of that business which they are invested in. This gives us an opportunity to make an attractive investment paying loans -- on these paying loans that support our ongoing commitment to pay cash distributions. I'm going to stop now and ask the operator to see if there's anybody that has a question for the group here today.
[Operator Instructions] Our first question comes from the line of Kyle Joseph with Jefferies.
Bob, just kind of want to get your thoughts in terms of where spreads have been going in the lower middle market. Obviously, we track public credit markets have been very strong. Obviously, markets tend to be a little bit more insulated or lagged, but just get a sense for spreads you've been seeing on new deals.
Kyle, spreads really have not moved consistent with the overall yields. I would say, as we commented last quarter, there's definitely a lot of capital upmarket from us. And in sponsor-oriented deals, where there is reasonable size, we occasionally will see some pricing compression. In the 50 basis point range. But for the most part, in our initial investments, which tend to be $10 million to $20 million and grow, we don't, at this point, see that level of compression.
Certainly, that leaves interest rates at a relatively high level. So deal flow is not exactly as robust as we'd like, but we're really not seeing much in the way of spread compression today. That's just not where the market is right now. People are obviously expecting those rates to come down. But at this point, we're not seeing that pricing compression.
Got it. Very helpful. And then on credit performance, obviously, non accruals were stable in the quarter, but just to get a sense for top line growth margins, EBITDA growth and how your -- the companies continue to do well in the face of higher rates and ongoing inflation.
Well, it's obviously a mix. As I said, we definitely increased investments in some performing assets on the quarter, which was a big part of our funding and those higher performers are probably looking at 10% to 15% EBITDA lifts. There's certainly some where there's a little bit more headwinds. If you look at the portfolio overall, EBITDA roughly was down slightly at low single digits, 3% to 5%.
There are definitely some sectors where there's more challenge. Those challenges would be in places like consumer-facing business, anything in the restaurant business, anything in discretionary health care certain sectors are more exposed in those cases. I will say that those tend to be the smaller sectors. And where there is some level of headwinds, as I've said in the past, our second lien exposure, which is where it would be most impacted tends to be the larger credits.
And on average, our leverage in our second lien portfolio is significantly below our average for the portfolio. Our second lien leverage average is something under 3. So where we see headline pressure, it tends to be in the smaller credits where we control the credit as the senior lender. So overall, I would say we're still modestly defensive on the consumer side of the businesses. Expecting things to improve. But most of those cases, we are the senior lender and in pretty good shape to manage the underlying portfolio risk profile.
The overall leverage for the portfolio still runs at just under 4 turns of EBITDA. So we've got some cushion in those cases relative to enterprise value.
Got it. Very helpful.
[Operator Instructions] Our next question comes from the line of Robert Dodd with Raymond James.
Congratulations on another excellent quarter. If I can Bob on -- can you give us some more color on the characteristics of the originations? I mean you had $47 million to existing portfolio companies. And I think those were quite chunky in general. I mean like Zupas was reserved at $10 million, and there are several others that were quite large. So I mean, can you give us any color, was that add-on acquisitions by those portfolio companies recapitalization, anything else.
It's a handful of big add-ons rather than sometimes we see more a large number of small ones. So any color you can give us about what the drivers where the size of those follow-ons?
Well, the follow-on is, for the most part, were somewhere in the $10 million to $12 million range. And I think the big ones, Zupas went actually up and down. I mean we -- the company is continuing to grow and expand. We had to bring in another lender since it was getting so large. And once we brought in the other lender, there were additional fundings that happened in the quarter.
So it actually today is still below where we were in the prior quarter. There are 2 other credits that we were in. One was ALS went up and lead point went up. In both of those cases, leverage had gotten very low. In fact, leverage was approaching well under 2. And sponsors looking to take a distribution, looking to reposition and manage their extended hold periods were part of it. One transaction decided not to sell with a very escalated valuation and the -- our loan to value in that case is well under 30%.
So most of those were probably positioning by -- on the part of the sponsor. Those were the only notable ones. There were a couple of others that were in the couple of million dollar range. But it turns out that I think there was total 6 investments in the portfolio at that point of any consequence above $1 million that was represented most of the total dollars of those fundings. It just happens to be a case where strongly performing assets were -- we were opportunistic in putting out additional capital to those companies.
Nobody wants to take their company to market when the interest rates are where they are and some of the buyers are kind of on the sidelines right now.
Got it. Got it. Understood. I mean that goes on to the follow-up. I mean, you mentioned it in your prepared remarks as well, like deal flows, you're improving, you're expecting there's going to be more activity later in the year. And you also position for portfolio growth over the rest of the year. What's your comfort level that the portfolio is going to be up from here by year-end given you talked about maybe prepayment activity accelerates as well.
I mean can you give us some more thoughts on how you think the increase in prepayments combined with increase in deal flow, how that's going to work out to ballpark what your portfolio could look like at year-end up flat? Any color?
Prepayments is probably the toughest thing to predict. I mean, at this point, there's probably 2 or 3 decent-sized investments that we see likely to prepay. And if those prepayments come in, it's somewhere between $10 million to $25 million, maybe $30 million, the pace of growth originations we are virtually going to be pressed to outpace that. I think in the past, we've generally targeted to grow somewhere in the range of $20 million to $25 million a quarter.
So if we're seeing similar amounts of prepayments, it's going to take 2 or 3 deal closings a quarter to get that number back up. That's not unheard of in the market where we're playing. When you're dealing with unitranches in the range that we're talking about, $20 million to $25 million deals are normal and 2 or 3 deals a quarter is also fairly normal. So I think if you look back at our origination history when the deal market was running doing [ $200 to $250 ] in gross originations per year is certainly doable.
So I think putting on 25 net conservative is a conservative number for us to continue to grow the assets. Is that going to happen every quarter? I'm sure it's not. But I will also say, we're feeling pretty good where we are and given our current capital base. We tend to slide in above the SBICs, which cap out around $20 million for the most part, and we tend to slide in below the large-scale billion-dollar funds which really don't want to put out anything less than $40 million.
So if it's a ZIP code of $20 million to $40 million, we are in pretty good shape to be competitive on that profile. And there's obviously a few other guys that are out there. But that's the size deal that we are, I think, pretty well positioned to continue to originate. And the mix may change a little bit. I expect with rates coming down, we may look at a little bit more second lien paper which will negate some of the compression in spreads likely to happen as rates come down.
But for the most part, I think 25 plus or minus in net asset growth a quarter is still a track record that we've averaged and a track record, I would expect for the balance of '24.
Our next question comes from the line of Mickey Schleien with Ladenburg Thalmann.
Bob, following the common share issuance in the September quarter, the balance sheet leverage has been running a little bit below your target level. Is that purposeful because of your view on the economy or something else? Or do you expect your leverage to climb towards your target level as you invest your liquidity?
Mickey. I think there's 2 factors there. One, we were flattered to have institutional buyers coming to the stock in the volumes that they did. We've always had a long-term strategic objective to increase the institutional holding and the float in our shares, and when they showed up, we felt it appropriate to take that advantage. And you will note that our institutional share count probably doubled as a result of that issuance.
So strategically, it was good for the investor base and the flow in the stock market for us. We took advantage of it. I think the second is we wanted to be in a position where we were strong relative to our capital base. Bank market conditions were a little unsettled in the summer. So we felt going long on the equity gave us a little bit more strength in that viewpoint.
Lastly, I would say, yes, we are going to increase our leverage as the spreads probably start to contract with interest rates coming down. We're obviously skewed very much towards a fixed cost of capital right now. Having a strong equity base will allow us to put on assets and optimize our capital structure and allow us to continue to maintain the level of dividend coverage that we're going to look for to try to continue to maintain the dividend level at or above where it is today. So we'll grow into that leverage level with higher assets over the course of the next 12 to 18 months.
That's very helpful. That's it for me.
Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Gladstone for final comments.
Okay. Thank you very much. I appreciate you all calling in. I wish we had a few more questions. We like it when you ask questions, but we'll wait for next quarter to get some more questions. That's the end of this conference call.
Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.