Great Elm Capital Corp. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023; filed August 3, 2023. Great Elm is an externally managed business development company (BDC) investing in middle-market debt and income-generating equity, including specialty finance businesses.
Financial results and position
| Metric | Q2 2023 / June 30, 2023 | Comparable period / year-end |
|---|---|---|
| Total investment income | $9.0 million for Q2; $17.4 million for six months | $5.5 million and $11.1 million, respectively, in 2022 |
| Net investment income | $3.4 million for Q2 ($0.44/share); $6.2 million for six months ($0.82/share) | $1.2 million for Q2 2022; $7.1 million for six months 2022 |
| Net increase in net assets from operations | $5.2 million for Q2; $13.4 million for six months | Q2 2022 decrease of $4.5 million; six-month 2022 decrease of $9.6 million |
| Net asset value | $92.9 million; $12.21/share | $84.8 million; $11.16/share at December 31, 2022 |
| Investment portfolio | $236.4 million fair value, excluding short-term investments; $314.6 million including $78.1 million of short-term investments | $225.0 million and $301.1 million, respectively, at December 31, 2022 |
| Cash and liquidity | $3.4 million cash, plus $8.4 million money market funds; $69.7 million Treasury bills | Cash was $0.6 million at December 31, 2022 |
| Debt and asset coverage | $143.7 million notes payable carrying value and $5.0 million revolver; asset coverage approximately 161.5% | $143.2 million notes payable and $10.0 million revolver at December 31, 2022 |
| Cash flows, six months | $13.1 million provided by operating activities; $10.3 million used in financing | $37.5 million used in operating activities; $30.1 million provided by financing in 2022 |
Changes and management commentary
- Q2 investment income rose 63% year over year, mainly from portfolio growth and higher interest rates. The average coupon on debt investments, excluding non-accrual positions, was 12.3% on approximately $217.5 million principal, versus 9.8% on $161.0 million a year earlier.
- Dividend income declined as specialty finance investments distributed less and the company exited certain preferred-equity positions. Other income increased, including approximately $0.8 million per quarter in fees related to revolver extensions.
- For the six months, net investment income was lower than 2022, which included a nonrecurring $4.9 million incentive-fee waiver. Current-period incentive fees were $1.6 million. Realized and unrealized gains also make operating results markedly different from the prior year: 2022 included large Avanti restructuring losses and related reversals of prior unrealized depreciation.
- Portfolio acquisitions were $76.3 million and repayments/sales were $73.2 million in the first half. Weighted average yield on outstanding debt securities was 13.47% at June 30, 2023, versus 12.43% at December 31, 2022.
- Management stated that available liquidity was sufficient for unfunded loan commitments of $11.9 million and that it expects liquidity to meet obligations for at least the next 12 months.
Outlook, risks and unusual items
- The Board set a $0.35 per-share cash distribution for the quarter ending September 30, 2023, funded from distributable earnings. This is unchanged from the $0.35 quarterly distributions declared for Q1 and Q2 2023.
- Interest-rate sensitivity is material: the company estimates a 1% reference-rate increase would raise annual net investment income by approximately $1.4 million, and a 1% decrease would reduce it by approximately $1.4 million, subject to rate floors and assumptions in its analysis. About $136.8 million of debt principal was variable-rate.
- Asset coverage of 161.5% is above the 150% statutory minimum, but leaves limited headroom. The secured revolver also has financial covenants, including a $65 million minimum net-assets requirement.
- Some investments are illiquid and valued using significant unobservable inputs. Level 3 assets totaled $128.0 million; the filing cautions that estimated fair values may differ materially from realizable values. Avanti Space debt positions remained on non-accrual and were valued at zero.
- Portfolio risks include PIK interest, credit deterioration and concentration: specialty finance was the largest industry exposure at $54.2 million, or 22.9% of portfolio fair value. Company-wide risks include credit-market liquidity, portfolio-company performance, interest-rate changes, and maintaining BDC and RIC status. Management reported no material change in risk factors and no material control changes.
- Legal matters include a stayed Delaware action in which a motion to dismiss was granted in part and denied in part in June 2023, and a Texas dispute involving a predecessor-in-interest loan guaranty; the filing does not state a clear quantified loss estimate for these matters.
- After quarter-end, the company sold its Lenders Funding equity for $0.25 million and received repayment at par plus accrued interest on its subordinated note; it retains a commitment under that company’s senior credit facility.
Key facts for investors to verify
- Whether current investment income converts to cash as expected, given accrued and PIK income, and whether portfolio-company distributions remain adequate.
- Upcoming refinancing or repayment plans for the $42.8 million GECCN Notes due June 2024, the $45.6 million GECCM Notes due January 2025, and revolver maturity in May 2024.
- Compliance headroom against the 150% asset-coverage minimum and the revolver’s other covenants.
- Fair-value assumptions and credit performance of Level 3 holdings, non-accrual assets, and controlled specialty-finance investments.
- How the $77.0 million payable for investments purchased at quarter-end settles and affects liquidity; the filing text does not clearly explain the settlement timing in the provided excerpt.
- Whether the announced $0.35 distribution remains supported by distributable earnings and cash receipts.