Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2020
Business Model: GECC is an externally managed, non-diversified closed-end management investment company registered as a Business Development Company (BDC) and a Regulated Investment Company (RIC). It seeks to generate current income and capital appreciation primarily through debt and equity investments in middle-market companies.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Total Investment Income | $6.43 million | $6.31 million |
| Net Investment Income | $2.65 million | $2.78 million |
| Net Realized Gain (Loss) | ($11.31 million) | $0.61 million |
| Net Unrealized Appreciation (Depreciation) | ($24.88 million) | $4.68 million |
| Net Increase (Decrease) in Net Assets from Operations | ($33.54 million) | $8.07 million |
| Net Asset Value (NAV) per Share | $5.05 | $8.63 (Beginning of Period) |
| Total Net Assets | $50.85 million | $86.89 million (Beginning of Period) |
| Cash and Cash Equivalents | $22.84 million | $4.61 million (Beginning of Period) |
| Total Debt Outstanding | $123.75 million | $124.03 million (Beginning of Period) |
| Asset Coverage Ratio | 141.1% | 150.0%+ (Prior Period) |
Material Changes vs. Prior Period
- Significant Decline in Net Assets: Net assets decreased by approximately $36.0 million (41.5%) from the beginning of the period, driven primarily by a $24.9 million net unrealized depreciation and an $11.3 million net realized loss.
- Realized Losses: The quarter saw a net realized loss of $11.3 million, a sharp reversal from the $0.6 million gain in Q1 2019. This was primarily due to the sale of Commercial Barge Line Company ($9.8 million loss) and Full House Resorts, Inc. ($1.3 million loss).
- Unrealized Depreciation: Net unrealized depreciation of $24.9 million was largely driven by valuation decreases in Avanti Communications Group, Tru (UK) Asia Limited, and California Pizza Kitchen, Inc., attributed to market volatility and the COVID-19 pandemic.
- Expense Increase: Total expenses rose to $3.78 million from $3.53 million year-over-year. This increase was due to higher interest expense ($2.31 million vs. $1.45 million) resulting from the issuance of $45.0 million in notes in 2019, partially offset by a decrease in incentive fees.
- Asset Coverage Ratio Breach: The Asset Coverage Ratio (ACR) fell to 141.1%, dropping below the regulatory minimum of 150%. This limits the Company's ability to incur additional debt or make distributions until the ratio is restored.
Outlook, Risks, and Management Commentary
- COVID-19 Impact: Management highlights that the pandemic has caused significant market volatility and economic disruption. While the Company continues to fund commitments and make new investments, there is uncertainty regarding the duration of the impact on portfolio companies, which may lead to further defaults, restructurings, or valuation declines.
- Interest Rate Risk: Approximately $158.3 million of the debt portfolio bears interest at variable rates based on LIBOR. Significant decreases in LIBOR during the quarter reduced investment income. Management notes that prolonged low rates could further decrease net investment income if not offset by higher spreads.
- Liquidity: As of March 31, 2020, the Company held $22.8 million in cash and cash equivalents, which management believes is sufficient to meet unfunded loan commitments of approximately $21.9 million.
- Regulatory Constraints: Due to the ACR falling below 150%, the Company is subject to limitations on borrowing, distributions, and share repurchases under the Investment Company Act of 1940.
- Subsequent Events: In April 2020, the Company executed several transactions, including the purchase of Apache Corporation bonds and the sale of Finastra Group Holdings and Mitchell International, Inc. at discounts to par.
Investor Verification Checklist
- Asset Coverage Ratio: Verify the current status of the ACR and the Company's plan to return above the 150% threshold to lift borrowing and distribution restrictions.
- Portfolio Valuations: Review the specific valuation methodologies and inputs for Level 3 assets (approx. 57% of total investments), particularly for Avanti, Tru, and CPK, which drove significant unrealized losses.
- Non-Accrual Status: Monitor the status of Davidzon Radio, Inc. and PFS Holdings Corp., which were placed on non-accrual status during the quarter.
- Debt Maturities: Assess the Company's ability to service its $123.8 million in outstanding notes, given the reduced NAV and potential for further portfolio distress.
- Dividend Sustainability: Evaluate the ability to maintain distributions given the breach of the ACR and the significant decline in Net Investment Income and Net Assets.