On ACAS' Results: 2Q2009

ACAS' earnings were a disappointment: NOI shrank to $0.09 per share and SEC-reportable NAV dropped to a dividend-adjusted $7.42 per share. Between realized losses and FAS-157 write-downs, ACAS reported losing $2.52 per share in the quarter.

The $0.09 isn't really the quarter's NOI, though. The $0.09 is what's left of NOI after an accounting exercise in which prior-quarter payment-in-kind ("PIK", or non-cash "payment" of debt) is reversed. Presumably, some PIK notes (interest paid in more IOUs rather than in cash) have become so impaired in value that the "income" that consisted in PIK has been reversed.

ACAS might be required to accept PIK under some of the debts it holds, or ACAS could have the right to accept PIK on more onerous terms than it could stick to delinquent debtors if cash were required. Whether PIK turns out to have value depends on whether the debtor issuing the PIK turns out to be solvent eventually, or not. At present, lots of little debtors look terrible. ACAS' management keeps saying that its experience in the last downturn was that lots of companies recovered, so it'll be interesting to see how much zero-valued debt turns out later to be largely payable. This isn't helpful in the short run -- nonpaying debt doesn't generate cash flow, and insolvent portfolio companies hardly seem candidates for a rich sale -- but is a possible consideration for the longer term.

One poster commented about ACAS' debt-to-equity ratio and the face value of its bad debt. Clearly one wants to see ACAS with a debt-to-equity ratio of less than 1:1, and small single-digit bad debt. In my post comparing ACAS to banks, the fact that banks commonly had a 10:1 ratio was a reason to love ACAS -- as was its ability to earn more than bank interest when its bets went right. Although ACAS has a debt-to-equity ratio that's worse than 2:1, this doesn't mean that ACAS lacks enterprise value any more than banks ordinarily have zero enterprise value despite being much more leveraged.

ACAS' willingness to finance long-term obligations with short-term debt is definitely a point over which one might become concerned. On the other hand, ACAS' short-term financing of long-term obligations at its managed company AGNC has worked wonders even as ACAS' own shares have been slashed 90% in price. ACAS is making a mint at AGNC by financing long-term assets with short-term debt. The principal difference is that AGNC's assets are easily-valued and liquid agency-backed securities that retained their value after FAS-157 when the non-government-backed debt took a henous haircut, and ACAS' assets are illiquid assets that are difficult to value. ACAS' problems, frankly, result from their illiquidity and the consequent lack of clarity in their value.

But the difficulty of valuing illiquid portfolio companies is why ACAS is supposed to be able to make great deals in that kind of asset, right?