Golub Capital BDC Inc (GBDC) 2011 Q3 法說會逐字稿

Good afternoon, and welcome to the Golub Capital BDC incorporated June 30, 2011 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 Golub Capital BDC Incorporated, filings with the Securities and Exchange Commission.

For a slide presentation that we intend to refer on the earning conference call, please visit the events and presentation link on the home page of our website at www.golubcapitalbdc.com, and click on investor presentation link to find the June 30, 2011 investor presentation. Golub Capital BDC earnings release is also available on the Company's website in the Investor Relations section.

I would now like to the turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead, sir.

Thank you, Tom. Good afternoon, everybody, and thanks for joining us today. I'm joined today by Ross Teune, our Chief Financial Officer. I hope you have had the chance to review our earnings release and our investor presentation that we posted on the website. I'm going to refer to the presentation, and Ross will as well through the call today.

I'm going to start by giving you an overview of the June 30 quarterly financial results. Ross is going to them take you through the results in more detail, and I'm going to come back and give you an update on our new credit facility with Wells Fargo and the additional SBIC debenture commitments, which we've recently received approval for. So, let me get started.

We had a solid quarter on the period ending June 30 with EPS of $0.31 a share. In addition, we made particular progress on four of the key goals that I outlined in our last quarterly conference call, and I want to review each of those. The first was strong originations. As expected, we had strong originations in net asset growth for this quarter. It's highlighted on page four. You can see our new investment commitments for the quarter were $135.8 million. That is up from $54.6 million in the prior quarter.

If you look at the $135.8 million, $113.8 million were new investments in middle market loan and equities, while the remaining $22 million represented what I view as temporary investments in broadly syndicated loans that we bought shortly after the follow-on offering. After you take into account sales and prepayments, net funds growth was $49.5 million, plus about $11.5 million for our new total return swap. I'll talk more about the total return swap later. We account for that per GAAP on a separate line item, but I think it's best to look at those two numbers together. So $49.5 million plus $11.5 million, or $61 million in what I view as our new investment growth.

Due to our net funds growth, we were able to efficiently deploy most of the capital we raised in the follow-on offering that we completed on March 31. Our deal flow continues to be robust, and we expect solid funds growth in the fourth quarter, as well. But I put a caveat on that, given recent activities in the securities market, and I'll come back to that at the end.

Second key goal was to sustain our strong market position. And our market position proved very strong in the quarter. The latest evidence is that Golub Capital was ranked the number one traditional middle-market book runner by Reuters for the first half of calendar 2011 for senior secured loans of $100 million and less. Our strong market position is a key piece to what allows us to continue to source really good risk-adjusted transactions for Golub Capital BDC.

Third goal that I talked about last time was shifting our asset mix, and we continue to make progress increasing the proportion of unitranche, or one-stop loans and junior debt securities in the portfolio. If you look on page four, you'll see that the percentage of unitranche investments went up from 29% of total investments at March 31 to 35% of total investments at June 30. And the percentage of junior debt investments increased from 13% of total investments last quarter to 16% of total investments at the end of this quarter.

Now, we recognize we still have more work to do on our mix, but we're pleased with our progress this quarter. Our current goal is to keep increasing unitranche junior debt and equity investments so that together, they constitute between 60% and 70% of total investments. That's up from about 53% today.

The shift that we accomplished in our asset mix did have a positive impact on total interest income yields in the portfolio last quarter. If you look on slide eight, you'll see the total interest income increased from 8.3% for the quarter ended March 31, to 8.6% for the quarter ended June 30. We see continued upward potential to move that in the coming quarters.

The fourth goal that I talked about last time was sustaining our high credit quality. Consistent with the past four quarters, we had realized and unrealized gains net of realized and unrealized losses that were positive for the quarter. This is what I called in the past negative credit losses. So we added one additional non-accrual loan during the quarter.

We now have a grand total of two, as a small exposure. So non-accruals, in total, continue to represent less than 1% of total investments at fair value. And if you look on slide 10, you'll see that the percentage of loans in our two highest quality buckets, those rated four and five, represent nearly 90% of the total portfolio as of June 30.

I want to repeat something I've said in the past on this. We're proud of our credit quality, but we do anticipate a downward migration in our average ratings as the portfolio develops going forward. We actually view the average rating now as being too high for optimal profitability.

So, with our strong asset growth this quarter and the substantial deployment of our new equity capital that we raised in the March 31 follow-on offering, we took some steps to increase our debt capacity. We put into place a five-year $75 million Wells Fargo revolving senior secured credit facility. I'm going to talk more about that in a few minutes. And we applied for and we received approval for roughly $50 million in additional SBIC debentures.

I'm going to come back after Ross' comments and give you some more details on both the new Wells Fargo facility and the debentures. But I'm going to first leave it to Ross to discuss the financial performance for the quarter in more detail.

Thanks, David. I'll be starting on slide three of the investor presentation. As David mentioned, earnings per share for the quarter was $0.31 per share. This was down from $0.33 per share last quarter. Earnings per share for the quarter was consistent with our expectations, taking into account dilution from the additional shares that we issued through the follow-on offering back on April.

Net investment income for the quarter was $0.28 a share, down $0.01 from $0.29 per share last quarter. And net realized and unrealized gains on investments was $0.03 per share, also down $0.01 from last quarter. This is our fourth straight quarter of positive net realized and unrealized gains on the portfolio of investments, or what we sometimes refer to as negative credit losses.

Our net asset value remained unchanged for the quarter at $14.75 per share. And lastly on this page, as noted at the bottom of the slide, the fair value of our loans, as a percentage of principal, continues to trend up and was 98.1% of par value at the end of June 30.

Turning the slide over to portfolio highlights. As David mentioned, we closed on new investment commitments totaling $135.8 million for the quarter, of which $113.8 million was new commitments in middle-market loan and equity securities. This was up significantly from the $54.6 million last quarter. Exits from repayments and sales totaled $79.6 million for the quarter, for overall net funds growth and loan and equity securities of $49.5 million.

As David also mentioned, we invested $11.5 million in a cash collateral account as part of a total return swap transaction. So our net increase in total investments was $61 million. As shown on the asset mix table, in the middle towards the bottom of the slide, we increased the overall percentage of unitranche deals by 6% during the quarter, and the junior debt product by 3%.

Turning over to the next slide, quickly reviewing our balance sheet. Total assets were $547.3 million, which included total investments of $438.6 million and total cash and restricted cash of $73.4 million. Total assets also included a $17 million receivable for loans that we had sold in the secondary market. And the $11.5 million that we invested in the total return swap is listed as a separate line item under the due for broker heading.

Looking at the liabilities, liabilities were $222.3 million, which includes $174 million in floating re-debt that we issued through our securitization. And it includes $48.3 million of fixed rate SBA debentures. As of June 30, 2011 net assets were $320.5 million, and as I mentioned, our net asset value per share was $14.75.

Turning over to the next slide, the operating results. Our net investment income for the quarter was $10.1 million, an increase of 11% quarter-over-quarter. This increase was primarily attributable to an increase in the average investments outstanding. On the expense side, total expenses totaled $4.1 million, which increased 4.8% quarter-over-quarter, and was primarily due to an increase in interest expense, due to higher average debt outstanding, as well as an increase in management fees due to higher average investments outstanding. There was a net gain on investments during the quarter of a positive $568,000, primarily due to continued broad improvement in middle-market loan valuations.

Turning the slide to the portfolio highlights, asset mix page. The chart on the left provides a breakdown of our new originations by product category. For the quarter ended June 30, 2011, 52% of our new originations during the quarter were unitranche and subordinated debt investments, while 48% were straight senior secured investments. The chart on the right provides a breakdown by product of our total investments. And as David previously mentioned, we continue to make progress towards shifting our asset mix from straight senior secured loans to unitranche and junior debt investments.

Turning the page to portfolio highlights, the debt investment spread analysis. I was going to walk you through the changes quarter-over-quarter. I'll first focus on the red line, which represents the interest income yield. The interest income yield represents all income earned on the investments, excluding amortization of discounts and origination fees. As you will see on this graph, our total interest income yield continues to increase, reflecting our progress in shifting the asset mix. For the quarter ended June 30, the interest income yield increased 30 basis points from the prior quarter to 8.6%.

If we look at the blue line, we continue to see volatility from quarter-to-quarter. This includes the interest income yield, plus the amortization, which declined to 9.6% from 9.9% last quarter. This will fluctuate quarter to quarter depending on the overall level of runoff in the portfolio and the related unamortized fees that get accelerated when those investments pay off. Looking at the green line, the cost of our borrowings remain constant quarter-over-quarter at 3.2%.

Flipping the slide to portfolio highlights, selected information. For new investments, the weighted average rate on new investments was 7.8% for the quarter. The weighted average rate on new investments is based on the contractual interest rate at the time of funding. Just for example, for variable rate loans, the contractual rate would be calculated using current LIBOR, the spread over LIBOR on the loan, and then the impact of any LIBOR floor. For fixed rates, it would just be the stated fixed rate on that particular asset.

The 7.8% for the quarter compares favorably to the weighted average rate of 5.7% for investments that were sold or paid off during the quarter. So in summary, we picked up a little over 200 basis points by replacing lower yielding loans with higher yielding new originations.

The middle of the slide, the investment portfolio remains predominantly invested in floating rate loans. And as shown at the bottom of the table, non-accrual loans continue to represent less than 1% of total investments at fair value. As David mentioned, we currently have two non-accrual loans within that category.

Turning to page 10, the portfolio highlights and portfolio ratings. With respect to portfolio Company ratings, our credit quality remains strong, with nearly 90% of the portfolio rated in our four and five category. The percentage of category two and three loans was fairly constant quarter-over-quarter. And as a reminder, for the quarter, independent valuation firms valued approximately 25% of the portfolio.

Turning the slide to page 11, the Board declared a distribution of $0.32 a share, payable on September 28, 2011 to shareholders of record as of September 19, 2011. I will now turn it back to David who will provide some additional details on our overall liquidity and available debt capacity.

Thanks, Ross. As Ross noted in his balance sheet review, our liquidity position at June 30 was solid with about $73 million in unrestricted and restricted cash and cash equivalents. We recently increased our debt capacity to provide additional capital to fund new investment opportunities. I want to give you some details on that.

On July 21, we closed on a $75 million senior secured revolving credit facility with Wells Fargo. The key terms of that facility are as follows. It's got an advance rate of 60% on new first-lien loans, including unitranche loans and 40% for last out loans. It's got a 15-month reinvestment period from the closing date, and after the reinvestment period, principal collections are going to be used to pay down borrowings. It's got a five-year maturity, and the interest rate on the loan is LIBOR plus 2.25% during the reinvestment period and LIBOR plus 2.75% thereafter. It would be our target here to mend this facility to increase it in size and to increase -- and to lengthen the reinvestment period over time.

In addition to the Wells facility, on July 21, we also received approval from the SBA for an additional $51.7 million in debentures. So if you add our currently outstanding debentures of $48.3 million and these newly approved ones, we have authority now for total SBIC borrowings of up to $100 million, of which we have drawn $48.3 million.

Last, on June 17, we entered into a total return swap with Citi. The purpose of the total return swap was to provide us a more efficient way to gain exposure to broadly syndicated loans. Under the terms of the total return swap, we have the ability to recommend purchases of loans subject to Citi's approval rights. The maximum size of the total return swap is $100 million. We're required to fund 20% of the purchase price for each loan, and that's what's in -- what Ross is referring to as the due from broker account.

Under the terms of the swap, the way the economics work is that cash flows due to Citi are interest on the amount funded to purchase the loans at LIBOR plus 1.2%, plus GBDC owes them any capital depreciation on the underlying assets. If there any during a quarter and cash flows due GBDC are all interest received on the underlying loans, plus any capital appreciation on the underlying assets. Again, this is measured periodically.

Let me just move on and talk about a few closing comments before opening the phone for questions. At the risk of stating the obvious, in the last six weeks, in fact, in the last four days, we've seen an unusually high degree of volatility in both the securities markets and in the political world. European debt crisis, the US debt ceiling drama, the recent S&P downgrade, financial markets gyrating between risk on and risk off. For investors, these have truly been in the words of that ancient Chinese curse, they've been interesting times.

Our goal, as a Company, is to stay boring, even in interesting times. And we're really pleased that for the June 30 quarter, we stayed true to this mantra. We stayed focused. We did what we said we were going to do. We grew our portfolio with high quality risk reward assets, and the portfolio continued to perform well. We're planning on continuing that mantra of looking to stay boring in interesting times.

With that, I want to open the line up for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Joel Houck from Wells Fargo. Please go right ahead.

Thanks, good afternoon, David and Ross. How are you?

Good, Joel.

Good, Joel.

Just on a total return swap, if you look in the Q, it looks like the language implies that the vast majority of loans originated by Golub. Is that the case? And how -- where are the other loans that are in the total return swap, and what degree of control, if any, do you guys have on what gets put in there?

We have full control on what goes in there, subject to Citi's having approval rights. Basically, what we did was we took a chunk of loans that were on the balance sheet directly, and those loans are now in the total return swap.

This portfolio has been very carefully selected. It's not a Citi portfolio. It's a Golub Capital portfolio. And I view this as a much more efficient way for us to hold an exposure to broadly syndicated loans than the on balance sheet approach that we've been operating with previously.

There's no question it makes terrific financial and economic sense, so that's helpful. In terms of the accounting, is the -- is everything, both the income as well as the capital gains and losses flow below the line on this TRS?

Good question. So, Ross, correct me if I have the technical accounting wrong on this, currently we show the TRS in two places. On the balance sheet there is a gain-loss that is in the investments accounts. And there is a cash collateral account representing the cash collateral. So, from an income statement standpoint, we would show gains or loss on the position through our investments account. Ross, from an income statement standpoint. Am I correct in saying that would be in unrealized?

Yes, there's unrealized and realized activity, but it all flows below the line in that net gain or loss on the income statement.

Okay, but the interest and fees you received, less the -- what you pay to Citi, that cash component, is that also go below the line?

That's also below the line as well, correct.

And so it's all -- it all flows in to the net change in unrealized depreciation or appreciation on investments?

That's correct.

Okay. Thanks, guys.

Thank you very much. We'll proceed to our next question from the line of Greg Mason from Stifel Nicolaus. Please go right ahead.

Good afternoon, gentlemen. Real quick --

Greg, having trouble hearing you, can you speak up a little bit.

Sorry, it's Troy Ward. Following up on one of Joel's questions about the assets coming off of your balance sheet and the TRS. Can you speak to the level of prepayment activity that you anticipate outside, obviously, of what you saw this quarter coming out of TRS. And will you have any additional assets coming off your balance sheet into the TRS fund?

The -- so, let me answer both of those questions. In respect to the first one, which is what repayment activity do we anticipate seeing in the portfolio outside of the TRS? My expectation, based on market conditions right now is, that we're going to see some slowdown in repayment activity. It's been running at a relatively high rate over the course of the period since our IPO. My expectation is in the context of a challenging securities market that the degree of refinancing activity's going to slow, and so we're going to see more repayments that are the result of new deal activity.

It is our experience over a really extended period that our loans average a roughly three-year weighted average life. So my expectation would be in the near term that we see that lengthen out a bit, probably end up between three years and four years. So that would put us at an annualized rate of repayments on the middle-market portfolio of between 25% and 33%.

With respect to your second question, are there other assets that we anticipate pulling off of the balance sheet and putting in to the TRS? Not material.

Okay, and then I think I saw $46 million in the 10-Q came off of the balance sheet into the TRS. Is that correct, and what was the timing of that? When were those sold out of the balance sheet?

You are correct that we sold roughly $46 million of loans in June. And that a corresponding portfolio was purchased into the total return swap at that time. So that's all reflected in our June 30 financials.

Okay and one last one just on the environment. You saw -- you've seen any big changes, maybe as much as intra-quarter or post quarter, specifically in the market and maybe the spreads on unitranche and subordinate debt?

We're in the process right now of having our market digest recent events. And I think it's important for me in the context of answering your question, Troy, to point out the obvious, which is today, with what debt markets have been doing over the course of the last week, I think the answer to your question in part is we don't know yet. My expectation is that we're going to see an environment where there will be some modest widening of spreads on middle-market senior, and probably a somewhat more pronounced widening of spreads on middle-market subordinated debt. It's very early to be prognosticating.

Great. Thanks, David.

Thank you, very much.

(Operator Instructions).

And our next question comes from the line of Dean Choksi from UBS. Please go right ahead.

Good afternoon, gentlemen. I have a question on the total return swap. How does that impact your leverage calculation? If you could just talk about the numbers we should be looking at there?

Sure, under GAAP, the total return swap is accounted for as a derivative. So it shows up on the balance sheet, as I mentioned earlier, in two ways, as a cash collateral account that's called due from broker, and in a market-to-market of the position that's in our investments account. Those are the accounts that are then factored into the leverage calculation.

So in terms of the go-forward period, it is a $100 million total return swap in total. So we have a relatively small amount of incremental assets that we can build in that facility under its current terms.

And is that how it would be treated for the RIC -- I guess the BDC leverage test?

Yes. GAAP and RIC.

Thanks, and just on the line, the new credit facility. Did you mention what unused facility fees or any origination fees were on that line?

Yes, we can. There was the usual, which is to say that there were both those fees. There was a fee upon creation of the facility, and there is an arrangement under the facility for Wells Fargo to get compensated for unused amounts. We will get back to you with the specifics on it. The unused calculation is a little bit complicated.

Okay and the final question is, you've done a good job freeing up some balance sheet capacity with the TRS and then acquiring some new sources of debt capital. What can we infer about the pipeline of new deals? Granted these things were done in the weeks past, and the markets have changed a little bit, but how should we think about the big growth opportunities going forward?

So, going into the September 30 quarter, our pipeline was strong, and we were anticipating a robust quarter. I think to give you an honest answer today, I would tell you my guess is that we're going to see at least a significant chunk of that pipeline shift to the right because of the higher degree of uncertainty that's in financial markets right now. So, I still think it will be a solid origination quarter, but I think there's no question that we're going to see some shifting to the right of closings relative to what I would have anticipated as recently as a month ago.

Thank you.

Thank you very much. Our next question comes from the line of Ross Haberman, from Haberman Management Corporation. Please go right ahead.

My questions have been answered. I appreciate it. Thank you very much.

Thank you.

(Operator Instructions).

We have a question from the line of Greg Mason and Troy Ward from Stifel Nicolaus. Please go right ahead.

Thanks, guys, a follow-up a little more on this TRS. Can you talk about what your expectations are for your ROEs in this vehicle? And then to follow-up some more, to make sure we get this accounting stuff right, as it comes below the line, is that going to be an unrealized or a realized impact when the actual cash transfers, either from you or to Citigroup?

When the cash gets transferred it does show up as a realized event. There's a quarterly waterfall, and so when the netting of the cash takes place, that shows up as a realized gain or loss.

And will that happen like at the very end of each quarter, or will that be inter-quarter? When is that waterfall is calculated?

It doesn't occur at the end of each fiscal quarter, it's inter-quarter. I don't have the exact waterfall date, but I can get that.

Great, and then David your expectations of ROE on this TRS facility?

My expectation is a low double-digit yield.

Great, thank you.

Thank you very much. Our next question comes from the line of JT Rogers with Janney Montgomery Scott. Please go right ahead.

Good afternoon, guys. Just wanted to get a sense of what you thought the willingness was on the part of private equity sponsors to do new deals, given increasing macro economic concern. And obviously, recent events will take a while to filter through. Wanted to get a sense of what you guys are potentially seeing, maybe not this next month, but three months or four months or six months out?

It's a great question. It's a question we've spent some time in an internal deal meeting this morning talking about -- I think the answer is we're not sure yet. Our sense is that the fundamental dynamics that have led us to anticipate relatively high levels of middle-market M&A, by which I mean a group of buyers who have a lot of money to spend. Sellers where there's some pent-up demand. Those still remain, but one of the ingredients that we've talked about before that was an underpinning of increased middle-market M&A activity was reasonably predictable EBITDA and an expectation that it's directionally getting better.

So, I think those last two are the two pieces that are more in the category of question marks at the moment. I think that if securities markets stabilize and we see this as a slowdown, but not as a new downturn, then there will be a relatively quick recovery in middle-market M&A markets. But I think in the near term, we're likely to look at a world where a significant number of the transactions in progress get delayed.

Great, thanks a lot. That's really helpful. And then obviously credit quality has been very good, but broadly speaking, what trends are you seeing in portfolio Company fundamentals? And is there top-line growth; is there cash flow growth? Just trying to get a sense of the actual fundamentals of your current portfolio, and may be some of the deals you've been look at recently.

Obviously, every credit is unique, but I would say in terms of generalizations, we're seeing continued strong profit performance by our obligors. We are not seeing signs in our obligors performance that indicates a double-dip downturn. It may be that the securities markets are forecasting something that's coming, and results are a lagging indicator. But, we are not seeing securities markets responding to something that has already happened. At least not in our Companies. We're seeing continued solid profit performance.

Great, thanks a lot.

Thank you. We do have another follow-up question from the line of Joel Houck from Wells Fargo. Please go right ahead.

Actually two follow-ups. One, can you get a sense for the average coupon in the TRS?

These are the loans that we started out with and a few that we bought since that are at the low end of our range of typical pricing. So, these would be loans that would be in the double-D and B-2 range within the broadly syndicated world. So, I don't have an average to be able to give you, Joel, and I don't want to pick a number. But these would be, I would say, consistent with typical single-B and double-B broadly syndicated names.

That's good enough. We can guesstimate from there. And then the second follow-up was, what are the implications for taxable earnings, ordinary income or otherwise, for the TRS if everything has come in from a realized gain prospective? Can you retain those or are there still payout requirements under BDC/RIC rules?

I don't know the answer to that off of the top of my head. I will tell you as a dividend policy matter, that we intend to continue to have our dividends track to EPS. So, we are not really focused on above the line, below the line, the way that some other BDCs are.

In fact, you've heard me give long speeches in how I don't really believe in the distinction. At the end of the day, what shareholders get is EPS, not NII. And some other BDCs like to play hide the ball and say, our credit losses that happen between those two don't matter. We manage the EPS, so, I'll get back to you on the technical matter, but I wanted to answer the question from a philosophical standpoint. Shareholders and analysts should look at our EPS. And our EPS passes that best indicator of our future dividend growth.

Great, thank you very much.

Thank you. And, Mr. Golub, we have no further questions at this time. I'll turn the call back to you.

Well, thank you everyone for joining us on this call. And as always please feel free to get in touch if you have any further questions. We appreciate your partnership.

Thank you. Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask you to disconnect your lines. Have a good day, everyone.