Golub Capital BDC Inc (GBDC) 2012 Q4 法說會逐字稿

Good afternoon. Welcome to Golub Capital BDC Inc's September 30, 2012, 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 fact made during this call may constitute forward-looking statements and are not guaranteed of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statement as a result of a number of factors including those described from time to time in Golub Capital BDC Inc's filings with Security and Exchange Commission. For a slide presentation that we intend to refer to on the earnings conference call, please visit the Events and Presentation link on the home page of our website, www.GolubCapitalBDC.com and click on the Investor Presentation link to find the September 30, 2012 Investor Presentation. Golub Capital BDC Earnings Release is also available on the Company's website in the Investor Relations section.

As a reminder, this call is being recorded for replay purpose. I will now turn the conference over to David Golub, Chief Executive Officer of Golub Capital BDC.

Thank you, officer, and good afternoon to everybody. Thanks for joining us today. I'm joined here in New York in our New York office by Ross Teune, our Chief Financial Officer. Earlier today we issued our fourth quarter earnings press release and posted a supplemental earnings presentation on the website. As the operator mentioned, we'll refer to this presentation throughout the call today.

I'm going to start by providing an overview of the September 30, 2012 quarterly financial results. Ross is then going to take us all through our quarterly financial results in more detail. And I'll come back and provide a summary of our common stock offering, the one that we completed in October, and I'll also update you on current portfolio activity and current market conditions. With that, let's get started.

As highlighted on slide 2 of the investor presentation, I'm pleased to report we had another strong quarter. For the three months ended September 30, 2012 we generated net income of $8.7 million or $0.34 a share, and that compares to $5.4 million or $0.21 a share for the quarter ended June 30, 2012. Net investment income for the quarter ended September 30 was $7.8 million or $0.30 a share, as compared to $6.7 million or $0.26 a share for the quarter ended June 30. As you know, for the period of time when we had the total return swap outstanding we've also proceeded to give you an adjusted figure. So adjusted to include net spread payments of $0.1 million, $100,000 from the swap, net investment income was $0.31 per share for the quarter ended June 30, (sic - see press release September 30) that compared to $0.30 per share for the quarter ended June 30.

This is our final statement with respect to the total return swap. As we terminated the swap and that final payment is the end of it so I'm happy to report we won't be continuing to talk about adjusted NII performance going forward. So if we look at NII plus TRS income of $0.31 a share and EPS of $0.34 a share, I want to walk you through the bridge of the $0.03 difference. There are three principal pieces to it. First, we had net realized and unrealized gains on investments of $1.2 million or $0.05 a share comprised of $1.7 million of unrealized depreciation on the investment portfolio and this was across a variety of middle market debt and equity securities. We had a $500,000 realized loss on the sale of one portfolio company investment, an equity investment. The realized loss on this portfolio company equity investment, it was in a company called Strategic Partners, was largely offset by a prepayment penalty we earned on that debt investment, the prepayment penalties in net investment income.

First we had the net realized and unrealized gains on investments. Second, we had net realized and unrealized losses on our Treasury futures contract and that constituted about $300,000 or $0.01 a share. You'll recall that we put in place some Treasury futures to hedge interest rate risk on unpriced SBIC debentures. We priced, or rather the SBA priced the SBIC debentures on September 19 and in conjunction with that we terminated all of the futures contracts. So as of September 30, there are no remaining futures contracts outstanding. This is an interesting one. We'll obviously get the benefit of the lower rates on those SBIC debentures over the life of the SBIC debentures, but for the reason that we hedged the interest rate, we have a small loss on that this quarter. So $0.05 positive good guy on net realized and under realized gains on investments, $0.01 bad guy on net realized and unrealized losses on the Treasury futures. Finally, we had $0.01 loss on the termination of the total return swap.

Turning to slide 3 of the investor presentation. I want to highlight the $0.02 increase in our net asset value this quarter from $14.58 to $14.60 per share. This is consistent with our goal you've heard me talk about many times before of earning our distribution and maintaining a stable net asset value over time with relatively limited quarter-to-quarter volatility. I also want to highlight the degree of diversification and granularity of the portfolio, because I think this is one of the factors that differentiates us from a lot of our competitors. As you can see on the second table of this slide, as of September 30 GBDC had 121 separate investments in portfolio companies with an average investment size of about $5.6 million. This highlights the strength and breadth of Golub Capital's origination platform and our leading market position, which gives us the ability to create a very diversified portfolio.

I'm now going to turn the floor over to Ross who's going to discuss the financial results in more detail. As I said at the outset I'm going to come back and provide some commentary on the stock offering we recently completed and an update on current originations activity and current market conditions. Ross, over to you.

Thanks, David. I'll begin on page 4 of the investor presentation. As we communicated back in our call in August, we did experience an increase in originations for the quarter ended September 30 with total originations of $113.4 million. This was up from $52.4 million for the quarter ended June 30. On a year-to-date basis, total originations in fiscal 2012 were approximately $428 million, which compares to total originations of approximately $364 million in fiscal 2012. Exits from repayments and sales -- fiscal '11. Sorry. Thank, you David. Exits from repayments and sales for the quarter totaled $70.9 million. This was up from $34.1 million for the quarter ended June 30.

Taking into account other variables, such as net fundings or paydowns on revolvers, net change in unamortized fees and net change in unrealized gains or losses, overall net quarterly funds growth for the quarter was $36.3 million. This represents a 5.7% increase from June 30 and is up 46% from September 30, 2011. As shown on the table at the bottom, our asset mix was relatively stable for the quarter. We had a slight increase in one stop loans to 39% of the total portfolio with a corresponding drop in subordinated debt investments.

Flipping to the balance sheet on the next slide. We ended the quarter with total assets of $734 million. Total cash and restricted cash of $50.9 million. We had borrowings of $352.3 million, which includes $174 million in floating rate debt issued through our securitization, $123.5 million of fixed rate SBA debentures and $54.8 million on our revolving credit facility. Our growth in total investments this quarter was largely financed through an increase in the borrowings on our revolving credit facility, the balance of our debt issued via securitization and through the SBIC debentures was unchanged quarter over quarter. At September 30, 2012, net assets were $375 million, and as David mentioned our net asset value per share was $14.60. From a GAAP perspective, our debt to equity ratio was 0.94 times. Adjusted for the excluding the SBIC debentures, our regulatory debt-to-equity ratio was 0.61 times.

Flipping to the statement of operations on slide 6. Total investment income for the quarter was $16.2 million. This is up $1.4 million from the prior quarter. The growth in total investment income was driven by an increase in average investments as well as an increase in discount amortization. As I mentioned, we had an increase in run-up during the quarter and we also had an increase in prepayment fees. On the expense side, total expenses of $8.4 million increased by about $300,000 during the quarter, which was primarily attributable to an increase in interest expense driven by higher average debt outstanding. The net gain on investments and derivatives for the quarter was just under $1 million, which David provide the detail in his opening remarks.

Turning to slide 7. These charts graphically summarize the breakdown of our new originations and end of period investments. As shown on the left chart, new originations for the quarter were $113.4 million with one stop investments representing 63% of the total. You can see senior secured representing 33% with the remaining 3% investments in equity securities. The chart on the right provides a product breakdown and, again, you can see a modest increase in one stop investments with a corresponding decrease in subordinated debt.

Turning to slide 8. Looking at the spread analysis slide, focus first on the red line. This line represents the interest income or all income earned on investments, excluding amortization of discounts and origination fees. Primarily due to an increase in prepayment and other fees during the quarter, the interest income yield increased from 9.3% to 9.5%. However, if you exclude the prepayment and other fees that we earned during the quarter, the interest income yield would have been fairly flat at about 9.3%. Looking at the top line, the dark blue line. This yield includes the discount amortization and, again, this yield increased as a result of the increase on the red line, but also a little bit more as we had higher discount amortization during the quarter as repayments increased.

Turning to slide 9 for new investments. The weighted average rate at our new middle market investments was 8%. This is down slightly from the quarter ended June 30, and is also slightly below the average of the rate on investment that paid off during the quarter. Again, the weighted average rate in our new investments is based on the contractual interest rate at the time of funding, for variable rates this would be based off of LIBOR, the LIBOR spread and the impact of any LIBOR floor and for fixed rate loans it would be the stated fixed rate. As shown in the middle of the slide, the investment portfolio remains predominantly in floating rate loans, with variable rate loans representing 87% of the total portfolio as of September 30, 2012.

Looking at slides 10 and 11. The fundamental credit quality continues to be very strong with non earning assets as a percentage of total investments on a cost basis at 1.3%, and 0.5% as a percentage of total investments on a fair value basis. As shown on slide 11, portfolio risk ratings remain stable with over 90% of the investments in our portfolio rated a 4 or 5. Happy to report that there were no new non earning accounts added during the quarter. As a reminder, independent valuation firms valued approximately 25% of our total investments as of September 30, 2012.

Looking at slide 12, the Board declared a distribution of $0.32 a share payable on December 28, 2012 to shareholders of record as of December 14, 2012.

Turning to slide 13. Liquidity investment capital remains adequate with restricted and unrestricted cash of $50.9 million as of September 30. Again, restricted cash is cash held in our securitization vehicle and our SBIC entity, and is available for new investments that qualify for acquisition by these entities. In addition, subject to leverage and borrowing base restrictions we had approximately $20.2 million of available capital for borrowings on our $75 million revolving credit facility. In regards to the revolving credit facility, effective October 21, we amended the facility to extend the reinvestment period for another year through October 21, 2013 and also extended the maturity date by two years to October 20, 2017.

In regards to our SBIC we had $26.5 million of available and approved debentures as of September 30, and as a reminder we are in application with the SBA for a second SBIC license. I will now turn it back to David who again will provide some comments on our stock offering and update on market conditions.

Thanks, Ross. As Ross just summarized, although we had approximately $100 million of available capital as of September 30, we did decide to do a small common stock offering in mid-October. We did it because we were starting to see an increase in deal flow, the result of fiscal cliff discussions and anticipations of higher dividend and capital gains tax rates at the start of the year. So we raised approximately $44 million in new capital through the offering. As we've done in previous offerings, a trust organized by Golub Capital for the purpose of awarding incentive compensation to our employees purchased an aggregate of $3 million worth of shares in the offering. We're very proud of the ownership of GBDC by Golub Capital employees and believe that this alignment is part of what lies at the core of our success, fostering the right incentives between our investment team on the one hand and our shareholders on the other hand.

Raising the additional capital proved to be the right decision. We currently have a very strong pipeline of transactions that we anticipate will close before December 31. We anticipate that we're going to have very strong net funds growth for the quarter ended December 31. We're not so positive about the outlook for new deals in the quarter ended March 31, 2013. We've seen this movie before, back in 2010. And what we anticipate's going to happen is that we're going to see a strong push to close deals before anticipated tax increases on January 1, 2013, and this is going to cause a spade of deal closings in December and a relatively low volume quarter in the first quarter of calendar 2013.

Let me also talk about what's going on with spreads and leverage trends in the middle market. We've all seen the trends in the liquid credit markets toward tighter spreads and higher leverage. In middle market land we've been somewhat insulated from these trends but not immune. The trends have started to trickle down to middle-market land, resulting in a degree of both leverage and pricing compression. We continue to search as we always do for the most attractive risk adjusted returns in the market and with that in mind we continue to focus on one stop loans, most of all, and senior secured investments second. As Ross previously highlighted, our investments, new investments in the quarter ended September 30 were predominantly one stops and senior secured investments. We anticipate the same will be true for new investments during the quarter ended December 31.

In particular, we continue to be very cautious about mezzanine and junior debt opportunities. Part of this is a function of what we view as competition induced leverage creep and low pricing. Part of it is a function of our own nervousness about the level of macro uncertainties in the world today. Overall we think this is very attractive time for middle market lending. Our franchise is strong. It's sourcing and underwriting new investments and those are exactly the skills that I think are increasingly important in a credit market like the one that we're in. We're going to continue to use our origination platform to identify and close on high quality loans that we think have a low probability of getting into trouble and focus on producing long-term value for our shareholders in the way we always have, which is by avoiding losing money.

I'm going to stop there and open the floor for questions. Once again, thanks everybody for your time and for your support. Operator, let's start some questions.

Thank you.

(Operator Instructions)

Greg Mason, Stifel Nicolaus.

Great. Thank you. Good morning, David. Just curious about looking at your mix this quarter versus last quarter. Last quarter you did 92% senior secured. This was more of a one stop, yet we saw the average interest rate go from 8.2% last quarter to 8% flat this quarter. Can you talk about what you were seeing, given that you did more one stop this quarter? Was there an enhanced competition, or what was driving that kind of spread compression?

So, let's talk first about what's driving our mix, and then talk about spreads. So, the first category, which is what's driving our mix, we are out in the marketplace right now aggressively seeking to push our mix toward one stops. We think this is an attractive market for one stops, both from a sponsor perspective and from our perspective. And in an environment like we're seeing in calendar Q3 and calendar Q4 of 2012, where reliability, certainty of close is a very important criteria for our clients, one stops are particularly attractive. So, I'm not surprised by the September 30 level of one stops in these numbers, and my expectation is that the December quarter's going to see a continuing high level of one stops.

Let me now shift and talk about the spread piece. There's definitely been a degree of spread compression in the marketplace, and it's hard to put a finger on exactly how to quantify that. But I would say if you were to look at 2012 from a calendar standpoint, 2012 as a whole, we're probably looking at -- for middle market senior debt and one stops, we're probably looking at between 50 and 75 basis points of spread compression. And I think that's reflected in the chart on page 9, where you see Q2 results at 8.9%, Q3 at 8.2%, and Q4 at 8%. There is some variability on a deal-by-deal basis; not all one stops are the same price. Some have richer spreads than others. The same is true of traditional senior.

The range on both of them probably is up about 125 basis points from low-spread assets to high-spread assets within each of those categories. But I think the reality of our market right now is approximately a 50- to 75-basis-point spread compression from beginning of calendar 2012 to now.

And do you think that will change as we go into the kind of year-end rush of deals wanting to get done before December 31?

I do not see spread compression reversing. I think spread compression is going -- is more likely to continue than it is to reverse.

Great. And then, one additional question kind of on that one stop. We've heard some other BDCs, namely Aries, talk about doing a one stop and then essentially kind of back-leveraging it. Are you doing any of that, or have you thought about doing any of that to combat some of the spread compression that you're experiencing -- that the market's experiencing?

Great question. Yes, we have seen Aries in particular doing more what they call back leverage. Just to elaborate on that for others in the call who aren't familiar with this approach, what they're essentially doing is taking a one stop loan that they've made, and dividing it into two tranches, a first-out piece and a last-out piece. They will then sell the first-out piece to typically a bank, and the spread that the first-out lender will get will be lower than the spread on the loan, and this augments the yield on the loan. The effect of this is really the same as using additional balance sheet leverage. You're just applying the leverage on a loan-by-loan basis as opposed to on a portfolio basis.

We have found, to date, Greg, that we can achieve much more cost efficient leverage on a balance sheet basis, eg, at the portfolio level rather than on a loan-by-loan level. So, we have not been aggressively pursuing these back leverage or first-out, last-out type deals. I do think it can be an effective approach. This is not something I think is universally bad to use. But it's not something that we have been aggressively pursuing, principally because we find that we can achieve cheaper, more flexible leverage at the portfolio level.

Okay. Great. And then one last thing. On slide 8, you showed that the total yield went from 10% flat to 10.5% you said because of some payoffs this quarter. Could you put some numbers around maybe what we should be thinking about as more of the one-time income this quarter from the prepayments that probably aren't part of the longer term earnings run rate?

Yes. This is Ross. Went up 9.3% to 9.5%. As David mentioned, we had a prepayment penalty on strategic partners, you kind of back into the math there. But the prepayment on that deal was about $300,000. That is somewhat of a --

Unusual.

-- unusual or nonrecurring. We will get those obviously from time to time, but that was kind of the magnitude of that prepayment penalty that caused that 20-basis-point increase.

Great. Thank you.

(Operator Instructions)

Jonathan Bock, Wells Fargo.

Good afternoon, and thank you for taking my questions. David, with an expected pick-up in calendar 4Q deal activity, perhaps you could maybe give us a sense of portfolio velocity and perhaps maybe loans that might have a high probability of prepayment, to give us a sense of perhaps what net growth could be. Not in specific terms of dollar amounts, but just a general sense of repayments might be relatively subdued or not?

Sure. So, what we're seeing in the market right now is, we're not seeing an unusual increase in the pace of repayments and prepayments. We are seeing an unusual level of recap activity, and there's some new deals from new M&A in addition. That's continuing apace. The piece of it that has accelerated is recap activity. The recap activity is, in our opinion, very largely a function of anticipated tax law changes. So, if I were to prognosticate, and it is just that, I don't have the ability to give anything other than some broad insights here, my expectation would be that we're not going to see a very large increase in prepayment or repayment activity in the December 31 quarter, and we will see an unusually high level of originations.

And then, getting to your point of recap, so, oftentimes investors might see the potential for a dividend recap as a higher risk loan. And perhaps maybe you could give us some additional color as PE firms choose to take money off the table, how you choose to mitigate the risk of allocating debt capital to a transaction where perhaps a private equity sponsor is going to be a little bit freer, now having capital taken off the table?

Sure. I think that lending in recapitalizations is more complicated, and maybe worth spending a minute on, in terms of the Golub Capital philosophy here. You're absolutely correct that, Jonathan, that all things being equal, that lending to a company whose owner has just taken money off the table is disadvantageous relative to lending money to a company whose owner has just written a check. Having said that, our view is that there are also some very positive attributes about some recaps. Let me give you some.

In many cases, the recaps that we're involved with are companies that we already know, already have been a lender to, know the management team, know the company, know the industry, have followed for, in many cases, years. In many cases, the recaps are with sponsors who we have a very long-standing relationship with, multiple obligors under their control, a long history of working with them, a long history of successfully seeing their companies repay loans.

In addition, in an environment like the one that we're in, where there's a lot of demand for recap capital, we are, by din of our origination platform, in the position to be highly selective, and we can choose the companies that are particularly strong and resilient. Finally, we can be selective about the structures that we finance. And one of the things we look for is making sure that there's still very significant equity value in the companies, where the sponsor may take some money off the table, but on a loan-to-value basis there's still very substantial value left in the equity of the company. So, there's ample incentive for the sponsor to stay engaged.

All in, I actually think our recapitalization deals tend to be lower risk than our new investments. I recognize there's some vectors that work in different directions when we're evaluating, when we're underwriting these two broad classes of deals, new LVOs on the one hand and recaps on the other. I think our assessment is that the recaps that we do actually have significantly lower risk, not higher risk than average.

That's great color. Thank you. And David, with your focus on the middle market in particular, specialization in lower risk and higher quality senior debt, maybe give us a sense of competition, in particular relative to commercial banks. And whether or not you're starting to see the effects of additional regulation come through the deal line to a point where you're seeing a smaller amount of perhaps commercial bank activity, to the extent there was some in the first place?

You know, we've seen relatively limited bank activity in our space since the financial crisis. The areas where we've seen meaningful bank activity tend to be areas we are not particularly active -- CG asset-based lending and lending on a very low leverage level, generally to non-sponsored companies. Within our space, we have seen relatively limited bank involvement, and we continue to see relatively limited bank involvement. Bank of Montreal is perhaps the only bank I would say is an exception to that rule. We do compete aggressively with BMO from time to time.

And then one last question as it relates to the liability side of the balance sheet. In the BDC landscape today, a number of BDCs have issued retail baby bonds or longer-dated maturity paper, obviously at a higher interest cost, yet obviously that's not the case here. And perhaps you can elaborate on the reasoning of such a decision, and the benefits as well as the risks of perhaps not participating in that market to date?

Sure. I was quoted, in case anyone is interested in seeing it, in a recent Wall Street Journal article on baby bonds, and I'll just elaborate on our negativity about baby bonds to date. There's nothing wrong with unsecured debt. There's nothing wrong with long-duration debt. There's nothing wrong with diversified sources of debt. Count me in favor of all three of those. There is something wrong with high-cost debt.

So, the typical baby bond, when you look through the economics and account issuance costs, has an average cost these days of about 6%. If we were to look at the typical BDC issuing a baby bond, and I'll pick on one that has a 2% management fee just for the sake of this illustration. You would look at that 6% debt cost, plus a 2% management fee, or an 8% cost of capital before there's any return whatsoever to shareholders. So, if we assume that the BDC then turns around and invests the incremental dollar of baby bond proceeds in a new loan at 11%, and we subtract the 8% in interest cost and management fee, that leaves you with 3%. We would have a little bit of incremental expense at the BDC level. We'd have some credit losses that we'd have to account for, and we'd have carry to the, or incentive fee to the BDC manager. So, maybe in a good case scenario that leaves about 2% for shareholders. To our judgment, Golub Capital, that's not an adequate return for the risk for shareholders.

We can see why it's very attractive to managers. In the example I just gave, the manager is actually earning more than the shareholders are on that incremental investment. The manager's earning the 2% incentive fee, and let's say about an additional -- I'm sorry, 2% management fee and let's say an additional 0.5 point to slightly more than that in incremental incentive fees. So, the manager's earning between 2.5% and 3%, and the shareholders are earning less than 2%. So, I can understand why it's good for the manager. We're very focused on producing very high-quality, consistent, predictable returns for our shareholders, and it doesn't fit our model at that cost level.

Appreciate it, and agree with the comments, it's nice to see people focused on net return to shareholders because all too often BDCs choose to run at a higher expense level and issue more equity than is actually needed. Thank you very much.

(Operator Instructions)

It appears there are no further questions at this time. I'll now turn the call back to you. Please continue with your presentation or closing remarks.

Thank you, operator. Again, appreciate everyone taking the time to join us this afternoon. Thank you for your support of Golub Capital BDC, and as always, if you have further questions, please feel free to reach out to Ross or to me at any time.

Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation, and ask that you please disconnect your lines.