Garrison Capital Inc. Management Continues to Execute

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Garrison Capital reported solid fourth-quarter results on Thursday. Net income, which includes unrealized and realized gains/losses on investments, was $0.40 per share, which compared with our estimate of $0.31. Net investment income (NII) was $0.32 per share, below our $0.35 target, as higher-than-expected expenses more than offset the 18% upside to our net interest and fee income.

Portfolio migration to the higher-yielding (9.0%-plus yield) core portfolio from the transitory portfolio, which seems to happening faster than previously anticipated, and slightly higher prepayment fees drove the upside to our investment income estimate. The investment portfolio grew 4.3% from the prior quarter, to $429 million, which was slightly below our $433 million estimate. Originations of $92 million ($82 million in core portfolio) were mostly offset by repayments of $51 million in its transitory portfolio and $25.6 million in its core portfolio.

Garrison announced a first-quarter dividend of $0.35 per share (9.8% current yield), which will be paid on March 28 to shareholders of record as of March 21. We forecast Garrison’s NII to exceed the dividend, with full management fees but partial incentive fees, in the March and June 2014 quarters. The company stated that it will waive management and incentive fees to the extent necessary to assure this through June 2014. We forecast Garrison’s NII to fully cover the dividend, with full management and incentive fees, in fourth quarter 2014.

Garrison’s IPO was in second quarter 2013. Management is highly focused on protecting book value, which is a key reason for the management and incentive fee waivers.

Core assets have an average yield of slightly more than 11% and the transitory portfolio average yield is only 7.5%. Incremental core portfolio direct originations generate yields of about 12%. New club originations generate yields above 11% currently. The core portfolio represented 68% of the investment portfolio as of December 31, up from 57% of loans at September 30 and 48% at June 30. We expect the core portfolio to represent over 90% of assets by mid-2014. The increase in core portfolio assets should materially increase earnings.

We raised our 2014 estimate primarily to reflect higher interest and fee yields, driven by the faster ramp-up of the higher-yielding core portfolio, offset partly by higher operating expenses. Our NII EPS estimates go to $1.44 from $1.41 in 2014. We reduced our 2015 NII estimate from $1.50 to $1.48 on higher operating expenses, which more than offset our higher asset yield forecast. If the M&A environment were to improve, we believe Garrison’s asset yield would likely increase faster than we forecast. In addition, upside to our 2015 estimates could come from obtaining an SBIC license, which we believe is likely.

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