American Capital Ltd.’s (ACAS) second-quarter 2011 operating income of 20 cents per share was in line with the Zacks Consensus Estimate. However, results outpaced the prior-year quarter’s earnings of 9 cents per share. The favorable outcome was due to a drop in operating expenses, though partially offset by a decline in interest and dividend income in the reported quarter.
Net earnings for the quarter were $410 million, or $1.13 per share, significantly up from $281 million or 84 cents per share in the prior-year quarter.
Performance in Detail
Total interest and dividend income for the quarter was $131 million, down 5% from $138 million in the prior-year quarter. The weighted average effective interest rate on the company’s private finance debt investments as of June 30, 2011 was 10.5%, up 20 basis points at the end of the previous quarter. Fee income was down 15% year over year to $11 million.
In the second quarter of 2011, total operating income was $142 million, down 6% from $151 million in the prior-year quarter, attributable to lower fee income and interest and dividend income. Operating income was also in line with the Zacks Consensus Estimate.
Operating expenses plummeted 42% year over year to $71 million in the quarter, attributable to a decline in interest expenses, general and administrative expenses, and debt refinancing costs, partly offset by higher salaries, benefits and stock-based compensation expenses. Net realized investment loss was $248 million for the quarter compared with a loss of $320 million in the prior-year quarter.
As of June 30, 2011, non-accrual loans were $255 million, representing 9.0% of total loans at fair value, up from $227 million of non-accrual loans, representing 7.7% of total loans at fair value as of March 31, 2011.
As of June 30, 2011, net asset value (NAV) per share came in at $13.16, up 10% or $1.19 per share from NAV per share of $11.97 as of March 31, 2011. Annualized return on equity in the reported quarter was 38%. Management expects an improvement in the portfolio along with an economic recovery and thereby posts a growth in book value.
American Capital’s asset coverage ratio increased to 376% from 336% in the prior quarter. The company repaid an additional $100 million in debt, strengthening its balance sheet.
Change in Tax Status
American Capital will not qualify as a Regulated Investment Company (RIC) under the Internal Revenue Code (the Code) for its tax year ending September 30, 2011 due to non-fulfillment of Code’s portfolio diversification requirements as of June 30, 2011. Therefore, Subchapter C of the Code will be applicable for American Capital instead of Subchapter M of the Code. Management believes for income tax purposes, American Capital will have a net operating loss for the tax year ending September 30, 2011, which can be carry forwarded in the following tax years.
Major competitors of American Capital, Ares Capital Corporation (ARCC) and Fortress Investment Group LLC (FIG), are scheduled to release their earnings for the second quarter of 2011 on August 4.
Our Take
American Capital’s successful restructuring of debt provided it with sufficient operating flexibility and the company also continues to derisk its balance sheet through a number of initiatives including repayment of debt. However, we believe limited accessibility to capital and increased funding costs have weakened the company’s strategic position in its sector. The resumption of dividend payments is not expected in the near term, given projections for capital losses. Moreover, the improved credit quality of the portfolio is expected to continue along with the economic recovery.
American Capital currently retains its Zacks #2 Rank, which translates into a short-term (1−3 months) “Buy” rating.
