Hi YXI friends,

Golub Capital (GBDC) reported a disappointing Net Investment Income earlier this week, followed by its shares dropping by almost 2.3% lower on the day, a near 3-standard-deviation move.

What led to the lower NII in Q1? What are the main concerns for GBDC going forward? For those who are seeking high yields from private credit, let’s find out together in this article. I think GBDC’s report sets the tone for the rest of the BDC cohort in this earnings season.

Table of Contents

• 1. New Investments In Q1

• 2. Net Investment Income

• 3. Dividends

• 4. Price Analysis

• 5. Rating: Equal Weight

• Tools I find helpful:

• A quick “Thank You”

DISCLAIMER: This newsletter is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.

1. New Investments In Q1

GBDC’s investment portfolio has increased to $8.7 billion in fair value, spanning across 386 companies. GBDC is mostly focused on core middle market lending, with its specialty being the One Stop loan.

Overall Portfolio Breakdown

New Commitments

In Q1, GBDC committed $1.18 billion of fresh capital to new investments, while having exited $450 million of previous positions.

Among the new deals, 2% was in the First Lien Senior Secured and 96% in a One Stop loan.

2. Net Investment Income

Net Interest, Net Income, Net Investment Income (NII)

In Q1 FY2025, we note that Net Interest Income was up by $14 million from a year ago, but $17 million lower than Q4 FY2024. This is due to a simultaneous squeeze in the interest income (lower by $5 million QoQ) and in the interest expense (higher by $12 million).

Yield Spread Tightening

Because BDC lending is usually based on a floating rate, the “3-month SOFR” (not always), the interest they receive on investments decline as the Fed cuts interest rates. In Q1, GBDC’s portfolio yield decreased by 80bp to 11.2% due to the drop in SOFR.

At the same time, GBDC’s cost of debt only declined by 60bp to 6.2%. Moreover, a higher proportion of the GBDC’s own debt financing is in fixed rates. This means the net investment spread declined with the Fed rate cuts.

It should be noted, the investment income yield has not stopped falling for the next quarter. In January, the new deals were priced at 9.4% yield on average, likely squeezing the net investment spread again.

However, the Fed paused rate cuts in January, and I personally believe that the bar for another rate cut is pretty high for H1. Therefore, before getting too pessimistic, I would want to watch GBDC’s performance without the Fed cuts in the next two quarters.

A Rise In Fees

While the tightening spread explains some of the drop in Net Investment Income, there was also a $5 million rise in the management incentive fee from $13 million in Q4 to $18 million in Q1. For colour, the management charges 1% on gross asset excluding cash as the management fee, 15% on the NII that exceeds the hurdle rate of 6% annual returns, and 15% of cumulative net realised capital gains each year.

(A super quick, not sour, comment - given BDC investment is essentially a carry trade between the low cost of borrowing of the BDC and the high yield of investment returns, the incentive fee is like money dropping from the sky, as long as they keep making new deals without getting too many non-accruals).

The NII Drop

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