Goldman Sachs BDC - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning, this is Dennis, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC Inc third quarter 2020 earnings conference call. Please note that all participants will be in listen-only mode until the end of the call, when we will open up the line for questions. Before we begin today's call, I would like to remind our listeners that today's remarks may include forward-looking statements. These statements represent the company's belief regarding future events that, by their nature, are uncertain and outside of the company's control. The company's actual results and financial condition may differ, possibly materially, from what is indicated in those forward-looking statements as a result of a number of factors, including those described from time to time in the company's SEC filings. This audio cast is copyrighted material of Goldman Sachs BDC Inc.

and may not be duplicated, reproduced, or rebroadcast without our consent. Yesterday, after the market closed, the company issued an earnings press release and posted a supplemental earnings presentation, both of which can be found on the homepage of our website at www.goldmansachsbdc.com under the Investor Resources section. These documents should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC. This conference call is being recorded today, Friday, November 6th, 2020, for replay purposes. I'll now turn the call over to Brendan McGovern, Chief Executive Officer of Goldman Sachs BDC.

Brendan McGovern (CEO)

Thank you, Dennis. Good morning, everyone, and thank you for joining us for our third quarter earnings conference call. I am joined on the call today by Jon Yoder, our Chief Operating Officer, and Jonathan Lamm, our Chief Financial Officer. I will begin the call by providing an overview of our Third Quarter results, including commentary on the performance of our portfolio and how we've navigated the economic uncertainty resulting from the COVID health crisis. I'll also provide a recap of our recently completed merger with our previously affiliated business development company, Goldman Sachs Middle Market Lending Corp, which we refer to as MMLC. Jon Yoder will then discuss our portfolio activity in more detail before turning the call over to Jonathan Lamm to walk through our financial results. Finally, I'll conclude with some closing remarks before we open the line for Q&A.

With that, let's get to our third quarter results. Q3 net investment income per share was $0.45 on after-tax net investment income of $18.2 million. Our GAAP earnings per share was $0.80, which reflected both the solid net investment income generated during the quarter as well as net gains in our investment portfolio. The net gains reflected continued improvement in underlying portfolio company performance, coupled with a tightening of market spreads. Net asset value per share increased to $15.49 per share as of September 30th, 2020, an improvement of 2.3% from the end of the second quarter. As we announced after the market closed yesterday, our board declared a $0.45 per share dividend payable to shareholders of record as of December 31st, 2020. This equates to an annualized dividend yield of 11.6% based on net asset value per share at the end of Q3.

Furthermore, our board declared special dividends aggregating to $0.15 per share, which will be payable in three $0.05 per share installments to shareholders of record on each of February 15th, 2021, May 14th, 2021, and August 16th, 2021. Recall that these special dividends were first approved last December when the initial merger with MMLC was announced. Next, I'd like to take a moment to reflect on the overall state of the portfolio. As all of you are aware, it has now been over seven months since the beginning of the COVID-19 health crisis, which caused unprecedented social and economic disruption across the globe as government-mandated lockdowns put tremendous stress and strain on businesses. Against this extraordinary backdrop, we are extremely pleased with the performance and resilience of our investment portfolio, and we want to share some further insights and observations that evidence the strength of the portfolio.

First, revenue at our portfolio companies increased by over 2% year-over-year based on the most recently available data, despite the broad economic upheaval and broader contraction of economic activity. We attribute this solid performance to our focus on high-quality businesses in durable and dynamic sectors of the economy, such as technology, business services, and certain areas of healthcare that have non-discretionary demand drivers, coupled with strong management performance at our portfolio companies. We've observed that healthy companies with forward-looking owners and management teams have capitalized on long-term expansion opportunities in this environment, primarily through M&A, which has further solidified leadership positions. Net debt to EBITDA at our portfolio companies ticked up modestly quarter-over-quarter, but at 5.7x still remains consistent with historical levels. Furthermore, weighted average interest coverage, a measure of cash flow coverage of debt service, remains very healthy at 2.6x.

We know that investors are keenly focused on loan amendment activity as an indicator of any portfolio stress. We did observe that loan amendment activity was elevated in Q3 compared to historical levels. That said, however, the majority of amendments were granted to companies that are performing well or seeking technical relief, in many cases to pursue the accretive M&A transactions I described earlier. This dynamic is giving rise to growth in our pipeline of attractive investment opportunities, which we are well positioned to pursue. In those instances where companies are seeking covenant relief to manage the business impact from the health crisis, we have generally been successful in negotiating for junior equity capital to come into the businesses to support both liquidity and debt service.

In Q3, seven of our portfolio companies received commitments of new junior capital, evidencing the confidence that business owners have in the enterprise value and future prospects of these businesses, as well as the safety and stability of the more senior portions of the capital structures where we invest. Presently, among the 110 companies in our portfolio, just one company is out of compliance with covenants. In addition, we continue to observe that our portfolio companies have the wherewithal to remain current on their cash obligations to us. As a result, payment in kind, or PIK income, represented just 5.3% of total income during the quarter. We believe the demonstrated ability for our portfolio companies to meet their interest obligations in cash is a testament to their underlying health and durability and bodes well for credit performance.

During the quarter, no new investments were placed on non-accrual, and total non-accruals were de minimis at 0.1% of fair value and 0.9% at cost at quarter end. Next, I'm delighted to announce that on October 12th, 2020, GSBD completed its previously announced merger with MMLC. We believe the transaction delivered significant benefits to all stakeholders. For example, the transaction increased GSBD's portfolio yield at cost while at the same time reducing the percentage of non-accrual assets. With $3.5 billion of assets, the company has significant scale, which we believe delivers benefits to all stakeholders, including enhanced access to diversified sources of funding to further strengthen our balance sheet position. To that end, perhaps the greatest benefit of the merger was the substantial deleveraging that occurred.

As of the closing date of the transaction, GSBD's net debt to equity ratio was just 0.93x, down from 1.29x at the end of the third quarter. As a result of this deleveraging, the company is now well positioned to patiently deploy incremental capital and increase net investment income in the current environment. Finally, in connection with the completion of the merger, our board of directors has reauthorized and amended the company's 10b5-1 plan. The amended plan increases the buyback authorization to $75 million from $25 million previously, subject to certain conditions. With that, let me turn it over to Jon Yoder.

Jon Yoder (COO)

Great. Thanks, Brendan. To pick up on some of the comments you made, we are certainly pleased with the stability and resilience demonstrated by our portfolio under adverse economic conditions over the past several months. In part, this strong performance can be attributed to a notable and deliberate shift in our asset composition towards more senior first lien loans over the past several years. To recap our portfolio statistics at quarter end, total investments in our portfolio were $1.4312 billion at fair value, which was comprised of 93.2% in senior secured loans, including 75.5% in first lien, 2.4% in first lien last-out unitranche, and 15.3% in second lien debt, as well as 0.5% in unsecured debt and 6.3% in preferred, common stock and warrants. We also had just under $60 million of unfunded commitments as of September 30th, bringing total investments and commitments to $1.4904 billion.

As of quarter end, the company had 110 portfolio companies operating across 38 different industries. The weighted average yield on our investment portfolio at cost at the end of the third quarter was 7.7%, as compared to 7.5% at the end of the second quarter. The weighted average yield of our total debt and income-producing investments at cost remained at 8.3% at the end of the quarter. During the quarter, we made five new investment commitments, four of which were to new portfolio companies and one of which was to an existing portfolio company, totaling $11.6 million. In addition, we received $24.7 million in repayments, which was driven primarily by the full repayment of investments in two portfolio companies. Overall, both sales and repayment activity was relatively muted this quarter.

As previously discussed, new asset origination was constrained during the quarter as we were operating at the high end of our target leverage ratio going into the merger with MMLC. As we look forward, we see significant incremental operating flexibility afforded by the deleveraging that resulted from that merger transaction. As Brendan mentioned, we expect to be patient and thoughtful going forward as we deploy new capital into new investments. Similarly, while repayment activity slowed significantly during the depths of the crisis, we do anticipate an increase in repayments consistent with the general uptick of transaction activity that we've experienced in private markets in recent months. Already in the fourth quarter, we've received full repayments of two portfolio companies, and a third portfolio company called GK Holdings has agreed to merge with one of its competitors in conjunction with the sale of the combined company to a SPAC.

GK Holdings had been an underperforming asset, and as part of this SPAC transaction, we expect to receive a nearly full recovery of our first lien claim. In the recovery on our second lien claim, we expect to be significantly in excess of our mark as of the third quarter. As a result, we marked up the investment value prior to the closing of our merger on October 9th, and we expect this transaction to close in early Q1 of 2021. I will now turn the call over to Jonathan to walk through our financial results.

Jonathan Lamm (CFO)

Thanks, Jon. We ended the third quarter of 2020 with total portfolio investments at fair value of $1.43 billion, outstanding debt of $920 million, and net assets of $626 million. Our net investment income per share was $0.45, which was unchanged from the prior quarter. Earnings per share were $0.80 as compared to $0.86 in the prior quarter. We ended the third quarter with a net debt to equity ratio of 1.29x versus 1.33x at the end of Q2. Importantly, as Brendan mentioned, subsequent to the closing of the merger, the net debt to equity ratio came down to 0.93x, thus providing the company with incremental capacity to deploy capital into new investment opportunities.

During the crisis, the company maintained a significant amount of cash and cash equivalents directly on the balance sheet, as evidenced by the large difference between our gross and net debt to equity ratios. Subsequent to the closing of the merger, we used a significant portion of that cash to pay down our secured revolving credit facility. In addition, pro forma for the completion of the merger at the end of Q3, the company had approximately $690 million of liquidity. I would also add that as of Q3 2020, our unsecured debt percentage was 56%, but pro forma for the merger, it is approximately 30% due to the high percentage of secured financing ported over from MMLC.

I would reiterate comments made on previous calls that we are keenly focused on ensuring a healthy balance of unsecured debt in our capital stack, as it provides the company with significant financial flexibility, especially as evidenced on our own balance sheet during the crisis. Turning to the income statement, our total investment income for the third quarter was $31.5 million, which was up from $30.6 million last quarter. The increase was primarily driven by an increase in prepayment-related income and amendment fees. Net expenses were $12.9 million for the quarter as compared to $12 million in the prior quarter. Net expenses were up quarter-over-quarter, primarily driven by the lower management fee waiver in Q3.

NAV was $15.49 per share, up 2.3% from the prior quarter, driven by net gains in our investment portfolio as a result of continued improvement in portfolio company performance, as well as from further tightening of credit spreads. The company had $46.6 million in taxable accumulated undistributed net investment income at quarter end, resulting from net investment income that has exceeded our dividend historically. Pro forma for the completion of the merger at the end of Q3, this equates to $0.46 per share. As discussed on prior calls, we believe that the cost of spilling over this income in the form of excise tax is a small price to pay relative to the much higher cost of issuing new equity. With that, I will turn it back to Brendan.

Brendan McGovern (CEO)

Thanks, Jonathan. In closing, we are pleased with the performance of the company under these challenging operating conditions. During the quarter, asset values continued to improve, non-accrual investments remained low, and we deleveraged the company's balance sheet, which gives us great flexibility to navigate the current environment. As a result, we believe the company is on a strong footing to continue to deliver attractive results for all of our stakeholders. As always, we thank you for the privilege of managing your capital, and please don't hesitate to reach out if you have any questions. With that, Dennis, we'll turn it back to you to open up the line for questions.

Operator (participant)

Ladies and gentlemen, we will now take a moment to compile the Q&A roster. If you would like to ask a question during this time, simply press star and then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. If you're asking a question and you are on a hands-free unit or speakerphone, we would like to ask that you use the handset when asking your question. Your first question is from the line of Finian O'Shea with Wells Fargo Securities. Please go ahead.

Finian O'Shea (Director of Equity Research)

Hi, guys. Good morning. Thanks for having me on. First is, Brendan, can you remind us on the special dividends? Were those related to the waivers or just spillover in general or something else?

Brendan McGovern (CEO)

Yeah. Yeah, yeah. Finn, good to hear from you. Yeah, you'll recall when we initially announced the merger back in December of last year and we put in place the fee waiver. The thought we had was that since we're putting in this place the fee waiver, there's incremental earnings that would enter that it would be better to actually put that back into shareholders' hands directly in the form of these specials. Back in December, we announced this 15% aggregate dividend. That's the background there. This is something we've talked about going back since December. No broader change in our dividend policy or chair, but we did think in connection with the merger and giving those fee waivers, better to put that cash back into shareholders' hands.

Finian O'Shea (Director of Equity Research)

Oh, okay. Thanks. Just on GK, obviously a good outcome for Borrowing. I think that was at least on partial non-accrual. Will you have a restore amount of income next quarter? Any color there? I suppose just on the mark, you had that marked down to, I think, 70 or so or below. Just for sort of context, did it improve? Did it recently get out of any duress or was any color on how? Go ahead.

Brendan McGovern (CEO)

Yeah. Yeah. Thanks, Finn. I'll give you a little bit of background here on the goings-on with GK. This is a business that does IT educational training types of services and had been in the process of, frankly, a lot of it in classroom, but some of it online as well. It had been underperforming for quite some time. Our marks coming into at the end of Q2, we have a position in both the first and the second lien. The first lien, I think we had marked somewhere around the $0.50 on the dollar context, then $0.52. The second was on non-accrual. We had that marked lower at around $0.25. What's happened in the context of COVID, the company has made some strides in moving their offerings to the online domain, but that's been a process there.

The real value proposition here was merging with one of their big competitors and the SPAC capital is coming in to effectuate that merger here. On the combined basis and thinking of the synergies that inure to the company, the value that was offered to the, in this case, to the debt holders of GK was effectively getting a full recovery on the first lien and a significant recovery back to the second lien. In the context of that announcement, which was after September 30th, but before the October 9th closing of the merger, post the quarter, we did mark up those positions in conjunction with that merger. That deal will close in the first quarter of next year. The character of our investment will be a cash take-back as well as some take-back paper, which will be performing debt.

Very, very good outcome and I think really indicative of, I would say, one, conservatism on thinking through marks and also just the valuation opportunities in an environment here where there's a lot of capital looking for good opportunities. Very good to be the beneficiary of that.

Finian O'Shea (Director of Equity Research)

Okay. No, that's helpful. Then just one, I'm just doing really quick math here. I could be wrong. I think it's something like $6 million. And that helps and that brings your NAV up around $0.10 even after the closing cost. Yeah, yeah. Is there anything else going on or?

Brendan McGovern (CEO)

Yep, yep. Yeah, let me take you through a little bit of the bridge. Jonathan Lamm can chime in as well if I get something wrong here. Again, going back to the timing of the merger, we closed the merger on, I believe, it was October 12th. If you think about that process there in a NAV for NAV deal, what we did was a full bring down of the NAVs of both GSBD and MMLC at the time of that merger, which was effectively October 9th, the Friday before that weekend. What we did was look across the portfolio, look for any incremental news. The GK news was obviously significant, which engendered that markup. In addition, in both GSBD's and MMLC's NAV, we included the income that had been generated in that sub-period into the NAVs.

Of course, that will end up getting distributed in dividends. When you look at that at the ending $15.57 NAV as of October 9th that we just described, a lot of that is the GK Holdings and part of that is that sub-period of income.

Finian O'Shea (Director of Equity Research)

Okay. Thanks, Brendan. That's all for me.

Brendan McGovern (CEO)

Thanks, Finn.

Operator (participant)

Once again, ladies and gentlemen, if you would like to ask a question, please press star and then the number one on your telephone keypad. Your next question is from the line of Robert Dodd with Raymond James. Please go ahead.

Robert Dodd (Director of Equity Research)

Hi, guys. Morning. Congratulations on closing the merger. Brendan, if I can go back to your comments on loan amendments, I mean, most of them, it sounds like were for technical, to your point, so they can maybe go do add-on acquisitions, but there were some that were not. Can you give us any kind of of those that weren't, were those concentrated? I don't want to say concentrated if they weren't. How many of those were in kind of those more legacy, lack of a better term, more difficult positions at GSBD versus were any of them in the more traditional assets that also overlap with MMLC? Were they in positions that now have obviously shrunk as a piece of the portfolio? Can you give us any color on that?

Brendan McGovern (CEO)

Yeah. No, good question. I'll just reiterate some of the comments I made up front. Like I said, loan amendment activity was elevated. The majority of that, like I said, was really companies going on offense looking for incrementals, looking for flexibility to pursue those acquisition opportunities and incur debt and the like, which is, we think, a positive event. I don't want to leave you with the impression, Robert, that there was a lot of those other companies that were seeking incremental capital. I think I noted that in those cases where we were offering up flexibility, really pleased that it was in partnership with the sponsors and the owners who were willing to provide junior capital. That's consideration for giving flexibility. It really speaks to the evidence of the value there.

As I sort of catalog in my head those names, I don't think there's any significant lack of overlap. I think those are names that are really across both of those vehicles as we've been co-investing those vehicles for the past many years.

Robert Dodd (Director of Equity Research)

Got it. One second. And then just on the other one, I mean, obviously, now leverage is down. You've got capital. You've got liquidity. What are you seeing out there? Not just in opportunities, obviously, M&A activity, etc., private equity activity is up, will lead to more repayments as well, potentially. But in terms of terms that you're seeing there, in terms of the type of industries, obviously, you want the more tech defensive, the kind of businesses that produce up revenue in a recession. So are you seeing the right kind of industries and what are the terms that are available in the market right now?

Brendan McGovern (CEO)

On the industries, absolutely. I think as we look at the prospective environment, we're going to continue to focus on those industries where having had the ability to observe how they performed in a very stressful economic environment and seeing the resilience, we're very pleased with the sectors where we've been active and the sectors that we've avoided. Think of oil and gas, retail, and other troubled areas. We've done a nice job of missing those. We will definitely continue to focus on those areas of technology and business services and healthcare that definitely feel more resilient. The good news is, by virtue of having been quite, quite active there over many years, we feel like we've got excellent access to those opportunities, both on new deals as well as those add-ons that I talked about in the context of M&A.

On terms, look, it's a dynamic environment for sure. We've all observed what's going on in the broader public markets, and there's typically a lag with private markets. Things have definitely tightened. I wouldn't say we're back at pre-COVID levels by any stretch of the imagination. Relative to, call it the summertime or September, as we've been getting more active, certainly new opportunities have tightened. We think there are still opportunities to do transactions that are in the part of the capital structure that we prefer, that are in names and industries that we prefer, that can be accretive to the overall portfolio yield. That's where our focus is.

Robert Dodd (Director of Equity Research)

Got it. Got it. Just on, I mean, obviously, now, in many cases, the opportunities that do come up, you have the data of how they performed, to your point. You know how these companies now performed during COVID. Does that mean you're going to have more appetite for doing some junior deals? By junior, I mean second lien, I don't mean males, but what can you say?

Brendan McGovern (CEO)

Yeah. No, we haven't changed our orientation. We've not gotten more active in junior capital. I think you can certainly envision an environment. Look, we've talked about this since the early days of the Small Business Credit Availability Act. Markets are dynamic. There certainly can be points in time when the supply, meaning the lenders that are willing to offer that junior capital, diminishes relative to the demand, which could give rise to outsized opportunities. We are always mindful of that. I don't think we're quite there yet in terms of seeing that flip to being quite, quite obvious. It is something that we will certainly consider if and when those opportunities do arise. As you know, Robert, there's a relationship between the ultimate balance sheet leverage and your assets mix as well.

As we sit here today, I think our focus will continue to be on the margin, on first lien deals, and we're using the incremental debt capacity we have in the company to finance those assets. Could that change? Absolutely. I don't think I'm sitting here today signaling any change in that profile. We're certainly eyes wide open to the possibilities.

Robert Dodd (Director of Equity Research)

Got it. Thank you for answering my questions, Jess.

Brendan McGovern (CEO)

Thank you, Robert.

Operator (participant)

Once again, ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. If you've previously pressed star one, go ahead and press it again to make sure that your question is registered. At this time, there appear to be no further questions. Please continue with any closing remarks.

Brendan McGovern (CEO)

Great. Thanks, Dennis. Thank you, all of you, of course, for joining us for the earnings conference call today. Obviously, a lot going on in the world. Would be always eager and happy to answer any questions. Feel free to reach out directly. We look forward to chatting soon. Have a great weekend.

Operator (participant)

Ladies and gentlemen, this does conclude the Goldman Sachs BDC Inc third quarter 2020 earnings conference call. Thank you for your participation. You may now disconnect.