Golub Capital BDC - Earnings Call - Q1 2020

Transcript

Speaker 0

Welcome to the Golub Capital BDC, Inc. December 3139 Quarterly Earnings Conference Call. Before we begin, I would like to take a moment to remind our listeners that remarks made during this call may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements other than statements of historical facts made during this call may constitute forward looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward looking statements as a result of a number of factors, including those described from time to time in Gold Capital BDC, Inc.

Filings with the Securities and Exchange Commission. For materials the company intends to refer to on today's earnings conference call, please visit the Investor Resources tab on the homepage of the company's website at www.gallopcapitalbdc.com and click on the Event Presentations link. Golub Capital BDC's earnings release is also available on the company's website in the Investor Resources section. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.

Speaker 1

Thanks, Christine. Hello, everyone. Thanks for joining us today. I'm joined by Ross Keeney, our Chief Financial Officer Greg Robbins and John Simmons, both Managing Directors here at Cali Capital. Yesterday in the morning, we issued our earnings press release for the quarter ended December 31, and we posted an earnings presentation on our website.

We'll be referring to that presentation throughout today's call. For those of you who are new to our investment strategy is and since inception has been to focus on providing first lien senior secured loans to healthy, resilient middle market companies backed by strong partnership oriented private equity sponsors. Gregory is going to start today with an overview of GBDC's results for the first quarter of twenty twenty. Ross will then review those results in more detail, and I'll close with an update on our market outlook. Let me just start with the headline.

Quarter ended December 31 was another solid consistent quarter for GBDC. Last quarter, you'll recall that GBDC's reported GAAP results were complicated by onetime noncash accounting items related to our merger with College Capital Investment Corporation or GCIC. We said we expected GAAP net income beginning in the 2020 to more clearly reflect GBDC's fundamental economic performance, and we believe it's us, and we believe it will continue to do so going forward. Our first fiscal quarter post merger results showed strong GAAP EPS in excess of our regular distributions per share of $0.33 a quarter, driven by solid net investment income and $02 per share of net realized and unrealized gains. With that, I'll turn the call over to Gregory, who will begin to go through the details.

Thank you, David. Before I go through the details, please note that in addition

Speaker 2

to the GAAP financial measures in the investor presentation, we have provided certain non GAAP financial measures to make GBDC's post GCIC merger financial results easier to compare to our pre merger results. These non GAAP measures, referred to as adjusted measures, seek to strip out the impact of the merger related purchase premium write off and amortization and are further described in the appendix of our earnings presentation. We will refer to the adjusted measures where appropriate as we think they are better indicators of performance. With that context, let's turn

Speaker 1

to Slide three to look at the results for the quarter.

Speaker 2

Adjusted net investment income per share, or as we call it, income before credit losses, for the quarter ended December 3139, was $0.33 This compares to adjusted net investment income per share of $0.33 for the prior quarter. Adjusted net realized and realized gain per share was $02 This compares to adjusted net realized and unrealized gain per share of $02 for the September. Earnings per share and adjusted earnings per share for the quarter ended December 3139, were $0.35 As we communicated last quarter, we expect earnings per share will equal adjusted earnings per share going forward as any purchase premium amortization should be offset by a corresponding reversal of the unrealized depreciation on the loans acquired from GCIC in the merger. Adjusted earnings per share for the quarter ended December 3139, of $0.35 remain unchanged from the prior quarter. On December 3139, we paid a quarterly distribution of $0.33 per share, an increase of $0.1 from before the GCIC acquisition.

In addition, we also paid a special distribution of $0.13 per share, our fourth consecutive calendar year in which we have paid a special distribution. Absent this special distribution, our NAV per share would have increased this quarter. Primarily as a result of this special distribution, our NAV per share declined to $16.66 as of December 3139, from $16.76 as of September 30. Finally, on 02/04/2020, our Board declared a quarterly distribution of $0.33 per share, which is payable on 03/27/2020, to stockholders of record as of March 6. I'll now hand the call over to Ross to go through more details.

Speaker 3

Great. Thanks, Gregory. Turning to Slide four. This slide highlights our total originations of $271,100,000 and total exits and sales of investments of $154,300,000 contributing to net funds growth of $155,400,000 or 3.6% during the quarter. As shown on the bottom table, the weighted average rate of 7.4% on new investments this quarter was consistent with the prior quarter.

In addition, the weighted average spread over LIBOR on new floating rate investments of 5.6, the weighted average rate on investments that paid off of 7.8% and the weighted average fee received on new investments of 1.4% were all relatively consistent with the prior quarter. As a reminder, the weighted average rate on new investments is based on the contractual interest rate at the time of funding. For variable rate loans, the contractual rate will be calculated using current LIBOR, the spread over LIBOR and the impact of any LIBOR floor. The top of Slide five shows that GBDC's average investment size remained at $17,300,000 as of December 31 or 0.4% of the total portfolio based on fair value. The bottom of the slide shows that our overall portfolio mix by investment type has remained consistent quarter over quarter with one stop loans continuing to represent our largest investment category at 83%.

Turning to Slide six. Our debt investment portfolio remains predominantly invested in floating rate loans and defensively positioned in what we believe to be resilient industries. Turning to Slide seven. This graph summarizes portfolio yields investment spreads for the quarter. Focusing first on the light blue line, this line represents the income yield or the actual amount earned on the investments, including interest and fee income, but excluding the amortization of upfront origination fees and purchase price premium.

The income yield decreased by 40 basis points to 8% for the quarter ended December 31. This is primarily due to the continued decline in LIBOR over the past few quarters, which continues to impact portfolio yields as LIBOR contracts reset. The investment income yield, or the dark blue line, which includes amortization of fees and discounts, also decreased by 40 basis points to 8.4 during the quarter due to declining LIBOR. The weighted average cost of debt, or the blue line, decreased by 10 basis points to 3.9%, a smaller change than the decline in LIBOR as some of the interest rate contracts on our CLO liabilities did not reset until early twenty twenty. As a result, our net investment spread, the green line, which is the difference between the investment income yield and the weighted average cost of debt, declined by 30 basis points to 4.5%.

Flipping to the next two slides. Fundamental credit quality remains strong with over 90% of the investments in our portfolio having an internal performance rating of four or higher as of December 31. During the quarter, the number of nonaccrual investments increased to seven investments, and nonaccrual investments as a percentage of total investments at cost and fair value were 1.61.3%, respectively, as of December 31. As a reminder, independent valuation firms value approximately 25% of our investments each quarter. Reviewing the balance sheet and income statement on Slides ten and eleven, we ended the quarter with total investments at fair value of $4,400,000,000 total cash and restricted cash of $133,200,000 and total assets of $4,600,000,000 Total debt was $2,300,000,000 which includes $1,100,000,000 in floating rate debt issued through our securitization vehicles, dollars $3.00 5,000,000 of fixed rate debentures and $890,700,000 of debt outstanding in our revolving credit facilities.

Total

Speaker 1

net

Speaker 3

asset value per share was $16.66 Our GAAP debt to equity ratio was 1.06, consistent with recent quarters and within our target range of 0.85x to 1.15x. Flipping to the statement of operations. Total investment income for the quarter ended December 31 was $78,600,000 and total expenses were $45,900,000 Due to the acquisition of GCIC, which closed on September 1639, comparisons to the prior quarter for total investment income and total expenses are not meaningful. Excluding the impact of the GCIC purchase premium amortization, adjusted net investment income per share and adjusted earnings per share of $0.33 and $0.35 respectively, were consistent with the prior quarter. Turning to Slide 12, excuse me.

This graph illustrates our long history of steady growth in NAV per share since our IPO. For historical comparison purposes, we have presented NAV per share both including and excluding special distributions. Turning to Slide 13. The graph on the top summarizes our annualized return on average equity over the past five years, which has averaged 8.6%. The graph on the bottom summarizes our regular quarterly distributions as well as our special distributions paid in each of the past four years.

In addition, it highlights the increase in our quarterly distribution from $0.32 per share for the quarter ended September 30 to $0.33 per share for the quarter ended December 31. I'll turn to Slide 14. This slide provides some financial highlights for our investments in our two senior loan funds. This will be our final reporting on the senior loan funds. As we reported in an eight ks filing on 01/01/2020, we entered into an agreement to purchase the remaining 12.5% of the LLC equity interest in the SLS from our minority interest partners.

As a result, the assets and liabilities of the SLS will be consolidated into GBD's financial statements for the period ending on or after 01/01/2020. The next slide summarizes our liquidity and investment capacity as of December 31 in the form of restricted and unrestricted cash availability on our revolving credit facilities and debentures available through our SBIC subsidiaries. Slide 16 summarizes the terms of our debt facilities as of December 31 as well as our focus on diversified long term and stable sources of debt capital. Lastly, on Slide 17, our Board declared a regular distribution of $0.33 per share, payable on March 27 to shareholders of record as of March 6. With that, I'll turn it back to David for some closing remarks.

Speaker 1

Thanks, Ross. So to sum up, PPDC had another solid quarter. Net investment income was very consistent. Credit was good, although we did see a small uptick in nonaccruals. And the investment portfolio remained well diversified.

I want to close with updates on two topics: first, what our merger with GCIC may mean for the BDC industry and second, an update on our strategy for calendar twenty twenty. Let me start with the merger. The merger with GCIC essentially doubled the size of GBDC, and it did so on terms that we think were a win win win for the company, our existing stockholders and our new stockholders. We believe the transaction represents a potential new growth model for the BDC industry. But it's interesting.

It's a model that we believe will only be available to a small number of BBTs. Let me explain what I mean by this. If you think historically, BDCs have followed one of three principal strategies for growth. The first is the strategy GBDC has pursued prior to the GCIC merger. That strategy involves growing at a measured pace through small, episodic follow on equity raises, time to coincide with periods where the manager expects to be able to quickly deploy the proceeds.

When done right, it's a win win for the company and its stockholders, but it's necessarily slow. The second strategy involves larger follow ons. Some of these that we've seen in the industry have been good for managers but rarely have they been good for existing stockholders. Typically, larger offerings either have caused NAV dilution or earnings dilution or both. The third strategy involves acquiring portfolios.

A few BDCs have successfully created value for stockholders this way, but attractive targets are readily available and the execution risks are quite significant. Our view is that the merger with GCIC represents a potential fourth growth strategy. That growth strategy involves acquiring affiliated private BDCs on terms that are accretive for existing stockholders and compelling for new stockholders. The key to making the math work is that the acquirer has to consistently trade the premium to that. In other words, the strategy isn't available for everyone.

We think better performing BDCs that trade at a consistent premium may get rewarded by stockholders over time because they have access to this new norm of shareholder value creating growth. Which leads me to a logical next question. What enables a BDC to consistently trade at a premium to NAV? And you've heard my answer to this before. We believe the answer is access to a platform with sustainable competitive advantages, which in turn permit the BDC to produce consistent premium returns.

And this brings me to the second topic, what's our strategy for calendar twenty twenty? My answer will be boringly familiar. It's the same one we followed for many years: stay at the top of the capital structure, focus on healthy, resilient middle market companies backed by strong private equity sponsors and lean on the competitive advantages of the Dollar Capital platform. If we look back on 2019, our sponsor relationships, incumbencies, reliability, market leading scale, industry expertise and the breadth of the financing solutions we were able to offer sponsors, all of these helped us win a high proportion of the deals we wanted to win. We expect more of the same in calendar 2020.

With that, let me thank you for your time today and for your partnership. And Christine, if you can please open the line for questions.

Speaker 0

Thank register for a question, please press the one followed by the 4 on your telephone. You will hear a three tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the 3. And our first question comes from the line of Finian O'Shea with Wells Fargo. Please go ahead.

Speaker 4

Hi. Good morning. Thanks for taking my question. David, just first appreciating the comments on the GCIC merger and the new means to raise capital. Is there any you know, takeaway we should have here on perhaps, you know, timing of of dollar 3?

And then, you know, anything you would do differently, whether it be, you know, size, any new structures of the new BDC that we would think about, appreciate any commentary.

Speaker 1

Sure. So by way of context, for those who aren't familiar with Golub Capital's private BDC. After we created Golub Capital Investment Corp, which recently merged with GBDC, we created a second private BDC, very creatively called Golub Capital BDC three. And Golub Capital BDC three is a public filer, so you can chart its progress through its publicly filed 10 Qs and 10 Ks, and it is in ramp up mode right now. And I can't promise anything about what will happen with respect to Golub Capital BDC three because, as you know from the GCIC merger, there are many factors and many parties that go into figuring out what the appropriate path is for a private BDC.

But what I can tell you is that from my perspective, speaking as the CEO of GBDC, the merger with GCIC seems to me to have been very successful for all parties. And so I think it would be logical for us to look at opportunities to potentially repeat the approach that we undertook with respect to GCS.

Speaker 4

Thank you for the context there. And just a follow on the portfolio credits this quarter. With the two nonaccruals, these were marked at you know, reasonable discounts, say, ish. But put putting the names on non accrual usually means that you've that you've, to some extent, reassessed the the recovery of these credits, and the new marks seem to have moved as much. So with whatever understanding their sensitive situations, is there any context you could provide us there as to the placement on to nonaccrual and the very narrow markdowns?

Speaker 1

Sure. So again, let me first provide some context. So nonaccruals at cost and fair value increased in the most recent quarter to 1.61.3%, respectively. Whenever we think about nonaccruals, we feel a degree of concern, right? I mean we're naturally worriers.

We worry about everything. One of the things we worry about is nonaccruals. I want to make sure, though, that everyone keeps our concerns in appropriate context. So first, this quarter, GBDC continued its strong track record of generating positive net realized and unrealized gains on investments. And that's the metric that we think is, over time, the most important indicator of credit performance.

That's why we focus so much in our earnings presentation each quarter on the chart in our presentation depicting NAV per share over time. A second way we look at credit and overall credit quality is based on risk ratings. And again, in respect of risk ratings, if we look at the most recent quarterly results, I think there's I think they show a great deal of stability quarter over quarter and for many quarters in a row. And the third contextual point I'll make is that latest figures indicate that even with this small increase, we're still in the low end of the range of the industry, and we're in our historical range in respect of nonaccruals and costs. Don't want to make any of this sound like it's more dramatic than it is.

With that said, we're working hard with the managements of the two companies that we put on nonaccrual this quarter. And I can't get into the details of either of the two situations. But what I can say is I'm cautiously optimistic that in respect of both companies, we're on a good path toward good recoveries.

Speaker 0

Our next question comes from the line of Ryan Lynch with KBW.

Speaker 5

Hey, good morning. Thanks for taking my questions. The first one just has to do with Mann Acquisition Company. Is it possible to provide any background what on is the nature of that business? We were having difficulty actually finding any information about what that business actually does.

Speaker 1

I we, as a policy matter, don't talk about specific credits on our earnings calls. Having said that, I believe there is some public information about this company. And Brian, we will get back to you with links to them.

Speaker 5

Okay. That would be helpful. And then obviously, you had Oliver Street Dermatology on nonaccrual this quarter. And then one another investment that got marked down was with Dental Holdings still on accrual status. Those are obviously two different businesses.

One's dental, one's dermatology. But I know there's been some concerns around, you know, health care, in particular health care roll up strategies. So are either one of these businesses part a health care roll up practice? And are there any sort of similarities of that we could look across at these two different businesses that are potentially pressuring both of them?

Speaker 1

They're really entirely different businesses. One is and one is not a physician practice roll up. I described the issues that each of them are confronting as idiosyncratic and specific to them. I do think your preface is right, which is that there are pressures on health care roll up strategies in general that we're seeing across the industry in middle market land as well as in broad and syndicated land. And I've talked about this on prior calls.

I think it's fair to say, in my opinion, that health care roll up strategies are harder to execute than people thought a few years ago.

Speaker 5

Okay. And then one question, kind of a higher level question. As you guys roll into 2020 and as conversations come along with sponsors, obviously, '20 is a big election year, which always draws a significant amount of uncertainty surrounding that time period. Have you had any conversations or have you heard sponsors talk about potentially trying to to to move forward deal activity and get deals done before the election? Have you heard any of those discussions?

Speaker 1

I've heard a lot of discussion about the election, divisiveness of American politics right now, about concerns that folks in private equity have about some of the negative commentary about private equity that has been coming out in some of the campaigns. I have not heard anything along the lines of what you're describing, which is a desire by private equity firms to push up the schedule of M and A activity that in an effort to get done before the election happens. Wouldn't surprise me if we see some of that phenomenon happen later in the year. But I think it's right now, Ryan, it's we're too early. M and A processes don't take twelve months to move along.

A typical M and A process is four to six months. So I think we're too early to see that kind of pattern even if we are going to see it later in the year.

Speaker 5

Okay. That's helpful. And then one more. In November, you guys provided a $1,600,000,000 facility to risk strategies. Just recently, you guys provided another $1,600,000,000 unitranche facility to MRI software.

Those are obviously very big wins for your firm and your platform, broadly speaking. Can you just talk about how you were able to win those deals and secure those financings? And also, what were maybe the thought processes of maybe those two companies to choose a partner like Golub versus, obviously, the size of those deals, there's other avenues, particularly the broadly syndicated loan market, I would assume that they could have tapped. Why did they choose the Golub platform versus going to the more traditional broadly syndicated loan market route?

Speaker 1

Sure. So both risk strategies and MRI were one stop executions. So in both cases, the sponsor made a decision that they thought that a one stop was preferable to a traditional first lien, second lien broadly syndicated approach. Sponsors historically have preferred one stops for a variety of reasons, including scalability, flexibility, capacity to more gracefully handle expansions by acquisition, ease of closing a smaller number of parties involved, which facilitates changes down the line, reasons along those lines. Until relatively recently, one stops were a middle market product and not a larger market product.

And what's happened, Brian, over the course of 2019 is that's changed. In 2019, we tracked twenty three one stop executions in excess of 500,000,000 And Golub Capital has been the clear market leader in these executions. We let co led 13 of the 23. So we let or co led more than all of our competitors combined. The capacity that we built to lead these transactions is unmatched in the industry.

We combine both the capacity to hold a significant portion of these larger one stops, and we have a capital markets capability to bring in partners. And I think what we've done is, over the course of 2019, is proven for sponsors in larger transactions that one stop executions are worth considering as an alternative to the traditional first and second. I think what we're also seeing is as sponsors do try one stops in these larger executions, they're finding that they like them. And so in my opinion, we're at the beginning of the adoption curve. We're not even remotely close to the conclusion of the gaining of market share of one stops.

And I think we at Golub Capital are very well positioned to maintain our leadership as this larger one stop market grows. And I believe that's a very good thing for shareholders in GBDC because we're strong believers that these one stops represent very good riskrewards for investors.

Speaker 5

Well, that's helpful color. And yes, there's no doubt that Golub has been kind of the premier player in some of these large one stops. So then and I definitely see the benefits for GBDC shareholders to be able to access that very unique deal flow. So those are all my questions today. I appreciate the time.

Speaker 0

Thank you. Our next question comes from the line of Robert Dodd with Raymond James. Please go ahead.

Speaker 6

Hi, guys. Just going back to credit, if I can, for a second with the nonrecourse. Mean, obviously, yeah, one one, dermatological practice, one, industrial floor cleaner. Like, I mean, completely different parts of of the country, completely different businesses. You know, is there anything thematic between the two, like, you know, the same sponsor or anything like that?

I mean, my opinion is sometimes if I can identify a theme, that means any potential spreading of of credit deterioration and not just in your book, but in general can be can be constrained. Idiosyncratic can sometimes turn into something much more broad based. So any color you can give on on on that front, it'd be really, really interesting.

Speaker 1

Robert, as I said earlier, don't if there are common themes or threads across the portfolio companies in our portfolio that have experienced some credit weakness in the recent period, I'm not seeing it. From my vantage point, what I'm seeing is idiosyncratic issues that are very different from credit to credit.

Speaker 6

Okay. Got it. I appreciate that. I mean, it's tough. On the kind of the pricing environment out there, if I can, I mean, not in your book per se, but in the broader market, I mean, January was incredibly competitive again?

And and, you know, you know, we've got forward curves on on LIBOR continuing to decline slightly, but spreads don't seem to be widening in response. And if anything, we've seen LIBOR floors seemingly coming down in in the broad market. So where do you think the the the risk reward is is evolving right now? And, obviously, you know, to put words in your mouth, you're gonna say one stop. But, but but more broadly, it seems like that the pricing environment, with the forward curve having the shape it is, I would have expected maybe spreads and some other things to be moving in a more favorable direction.

I think this was discussed on the call last quarter, but we just so far have not seen that. So do you think there's anything that's going to really get the spread environment to move in a more favorable direction given the direction of LIBOR?

Speaker 1

I don't think LIBOR changes are likely to drive meaningful changes in spreads. I think we're likely to see meaningful changes in spreads come as a consequence of changes in the credit environment and, in particular, in response to changes in perceived risk of go forward defaults and recoveries. So right now, we're in an environment in which the economy, particularly The U. S. Middle market economy, continues to look very strong.

And we reported that in our Gallup Capital Middle Market Index results in early

Speaker 5

As

Speaker 1

long as we continue to see economic activity as robust as we're seeing and associated with that, a reasonable expectation of continued salutary credit environment, I think we're likely to continue to be in the kind of spread environment that we've been in for the last couple of years. These spreads, historical standards, are not terrible. They're not as good as you and I would buy, but they're not terrible. And the job for us as credit managers is to be very selective and pick credits that we have conviction are likely to pay us back.

Speaker 6

Got it. Got it. I appreciate that color. And one last one, if I can. On given given now what you the the combined entity is is two x the size roughly and and one of the the the discussion points at the time of the initiating the merger was, you know, accessing, you know, maybe the institutional bond market, etcetera, etcetera.

What can you tell us about where do you think you can drive the cost of capital, debt capital for the BDC versus where it is right now? Obviously, it's pretty attractive right now, but do you think you can move that in any material way lower as a result of the overall size and the bond market out there right now, which seems to be pricing debt pretty nicely for BDCs?

Speaker 1

As I mentioned last quarter, one of our activities post merger is to look carefully at the right hand side of the balance sheet and to explore all of the potential avenues that are available to us to optimize the debt capital structure of GBDC. That expressly includes looking at bond issuance. That expressly includes other strategies as well. Too early for me to give you a rundown on what we've concluded on that front, but but we are we are actively looking at that.

Speaker 6

K. Appreciate it. Thank you.

Speaker 0

Thank you. And there are no further questions at this time.

Speaker 1

Thank you, Christine, and thanks, everyone, for joining us today. As always, we appreciate your time and your questions. If you have any issues that did not come up on today's call that you'd like to talk about, please feel free to reach out. And in any case, we look forward to talking to you again next quarter.

Speaker 0

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.