Golub Capital BDC Inc (GBDC) 2013 Q3 法說會逐字稿

Good afternoon. Welcome to the Golub Capital BDC Incorporated June 30, 2013 quarter 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 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 to on the earnings conference call, please visit the events and presentations link on the homepage of our website, www.GolubCapitalBDC.com, and click on the investors presentation link to find the June 30, 2013 Investor Presentation. Golub Capital BDC's earnings release is also available on the Company website in the investors release 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. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. Thanks for joining us today. I am joined today by Ross Teune, our Chief Financial Officer, and by Gregory Robbins, one of our Managing Directors. Earlier today we issued our quarterly earnings press release for the quarter ended June 30, and we posted a supplemental earnings presentation on our website. We are going to be referring to this presentation throughout today's call. I'd like to start by providing an overview of the June 30 quarterly financial results. Ross is then going to take you through the results in more detail, and I will come back and provide an update on our agreement with United Insurance Company to co-manage a senior loan fund to invest in middle market loans, as well as to give you an update on current market conditions.

With that, let me get started. As highlighted on slide 2 of the investor presentation, I'm pleased to report we had another solid quarter. For the three months ended June 30, we generated net investment income of $12 million, or $0.32 per share, as compared to $10.4 million or $0.32 per share for the quarter ended March 31. Net increase in net assets resulting from operations, what I call net income, was $12.7 million for the quarter, or $0.34 per share, as compared to $12.3 million or $0.38 per share for the quarter ended March 31, 2013. The $0.02 different between net investment income and net income for the quarter was the result primarily of net realized and unrealized gain on investments of $0.7 million, $700,000, so another quarter of negative credit losses.

Overall credit quality of the portfolio remains strong, and the net gain of $700,000 was attributable not to one but to a large number of small unrealized gains, a couple of unrealized write-downs on middle market debt, and equity investments. Our net asset value per share for the quarter ended June 30 was $15.12, as compared to $14.80 for the quarter ended March 31. That $0.32 increase is attributable to two factors -- earnings in excess of our dividend, and also the accretion from the common stock offering we completed in May.

In regard to investment activity, new originations were very strong last quarter. We previously announced this. Origination commitments totaled $288.4 million for the three months ended June 30. Approximately 20% of those new investment commitments were senior secured loans, 62% were one-stop loans, 16% were second lien loans, and 2% were equity securities. Overall net portfolio growth was also strong, with total investments increasing by $179.4 million during the three months, up 22.7% from the prior quarter. Given the strong portfolio growth this quarter, we were able to very efficiently deploy the capital we raised back in early May.

I want to put today's results in some context, given the exciting macro environment of the last quarter. In May, as probably everybody on this call knows, Chairman of the Federal Reserve Ben Bernanke started talking about the possibility that maybe he would wake up one morning and want to begin to taper bond purchases. This discussion about the possibility of earlier tapering of the fed's bond-buying program caused credit markets to swoon. Treasuries, high yield, even liquid floating-rate securities all fell in value as rates went up and spreads widened. You can see this if you look at virtually every credit asset class's performance in the second quarter.

A couple of examples -- US treasuries, the 10-year treasury was down about 4.7% net for the quarter. The Barclays US ag was down about 2.3% -- that's one of the broadest indices of investment-grade corporate debt, and high-yield bond funds were down, depending on the fund, between 2% and 4% for the quarter. It is gratifying to us to see that our strategy of focusing on very high-quality resilient middle market floating-rate debt was successful this quarter in giving us a very consistent performance despite the choppy market conditions.

I want to touch on one other subject before turning the microphone back to Ross. As we previously disclosed in an 8-K filing, during the quarter we entered into an agreement to co-invest with United Insurance Company of America in middle market senior secured loans, and we're doing that through an unconsolidated Delaware LLC. I'm going to provide some additional details on this agreement after Ross discusses the financial results in more detail.

Ross, over to you.

Thanks, David. I will start on slide 3 of the investor presentation. As you can see on the table, the $0.32 per share we earned from net investment income this quarter, as well as the $0.34 per share we earned from a net income perspective. The table also highlights the nice bump in our net asset value that David mentioned this quarter, to $15.12 as of June 30, up from $14.80 as of March 31. On the bottom of the slide, we saw a modest increase in our average size of our investment this quarter, but the portfolio still remains well diversified, with an average investment size of $7.2 million. Lastly, on the bottom there, the fair value of the total loan portfolio, as a percentage of principal, remains steady at 98.7%.

Turning to slide 4, originations totaled $288.4 million, while exits and repayments and from sales totaled $92.7 million. Taking into account other variables such as net fundings and revolvers, net change in unamortized fees, and net change in unrealized gains and losses, our overall net quarterly funds growth was $179.4 million. Looking at the asset mix at the bottom of the slide, there was no meaningful change in our overall asset mix this quarter. With senior secured loans steady at 33% of the total portfolio, one-stops up marginally by 1% to 50% of the portfolio, and junior debt and equity investments at 17%.

Flipping to the next slide, the balance sheet, we ended the quarter with total investments of $967.8 million, total cash and restricted cash of $34.6 million, and total assets of just over $1 billion. Borrowings were $403.8 million. This consisted of $203 million of floating rate debt issued through our securitization, $164 million of fixed rate debentures, and $36.8 million of debt outstanding in our revolving credit facility. Total net assets at the end of the quarter were $601.5 million. This was up just over $100 million from the prior quarter, primarily due to the common stock offering that we completed back in May. From a GAAP perspective, our debt-to-equity ratio was 0.67 times, however, calculated for our regulatory limit, our debt-to-equity ratio was 0.4 times.

Moving to the statement of operations on slide 6, our total investment income for the quarter ended June 30 was $22.3 million, up $2.2 million from the prior quarter, primarily due to growth in average investments. Included in that, total investment income included $1.6 million of fee amortization. This was down from $2 million from the quarter ended March 30.

In addition to -- in investment income, we had $0.4 million of fee income from prepayment penalties. This was also down from last quarter, when prepayment penalties totaled $0.6 million. The declines in fee amortization and fee income from prepayment penalties was partially offset by an increase in our dividend income this quarter, which totaled $1.1 million, which was up from $0.5 million earned in the quarter ended March 31.

On the expense side, total expenses of $10.3 million increased $0.6 million during the quarter, primarily due to an increase in management fees and incentive fees. As David mentioned earlier, we had a net realized and unrealized gain on investments of $0.7 million, and total net income was $12.7 million.

Turning to slide 7, these charts graphically summarize the breakdown of our new originations and end-of-period investments. As shown on the bar chart on the left-hand side, we originated 20% of our new investments in senior secured loans, 62% in one-stop, and 16% in second lien loans. The chart on the right provides a product breakdown based on total investments, which, again, shows that the overall product mix was relatively stable quarter over quarter.

Turning to slide 8, I will walk you through the changes in our yield and investment spreads for the quarter. I'm going to focus first on the gray line. This line represents the interest income, or all income earned on investments, excluding fee amortization. This line represents the best single indicator of the portfolio's current interest rates. Due to compressed pricing on new investments, the interest income yield declined from 9.5% for the quarter ended March 31, to 9.2% for the quarter ended June 30. Although we have seen some stabilization of rates being quoted on new transactions, we continue -- or expect to see continued pressure on the interest income line as we originate new loans at current market spreads.

Including amortization of fees and discounts, the total yield, or the dark blue line up top, for the quarter ended June 30 was 9.9%. Despite an increase in prepayments during the quarter, the total yield was also negatively impacted by lower discount amortization, due to lower average unamortized fees or discounts on the loans that paid off. Partially offsetting the decline in the total yields on investments this quarter was a decline in our weighted average cost of debt. This is the green line towards the bottom of the slide. The weighted average cost of our debt declined from 3.5% last quarter to 2.9% this quarter.

The decrease was attributable to two factors. First, the current quarter, ended June 30, included the full quarterly impact of the repricing of our class A notes that were issued through our securitization vehicle. The pricing here declined from LIBOR plus 2.4% to LIBOR plus 1.74%. The second factor is the prior quarter included the acceleration of deferred financing fees associated with the $50-million downsize that we did on our revolving credit facility, and those fees being accelerated caused a spike in the quarter ended March 31.

Turning to slide 9 for new investments, the weighted average rate on our new middle market investments was 8%. The decline from the previous quarter reflects not only spread compression on new investments, but also a change in the asset mix from last quarter. If you look back at slide 7, we originated a higher percentage of second lien investments last quarter as compared to this 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 is calculated as the LIBOR plus the LIBOR spread, and the impact of any LIBOR floor. And for fixed rate loans it is the stated fixed rate. Shown on the middle of the slide, the investment portfolio remains predominantly invested in floating-rate loans, with floating-rate loans representing over 90% of the portfolio.

On the bottom of slide 9, and onto slide 10, our overall fundamental credit quality continues to remain very strong, with non-earning assets as a percentage of total investments on a cost basis at 0.7%, and only 0.1% as a percentage of total investments on a fair value basis. Our non-earning ratios improved this quarter, primarily due to the transfer of the senior term loan on Pillar Processing back to accrual status.

Looking at slide 11, although we did experience a modest increase in our category three investments, looking at our risk rating chart here, over 90% of our investments at fair value continued to be risk rated a four or five, our two highest product categories. The modest increase in the category three is not a surprise, as we have indicated in the past that we do expect a downward migration to a degree in these statistics. Just a reminder that independent valuation firms valued approximately 25% of our investment as of June 30, 2013.

Quickly on slide 12, the Board declared a distribution of $0.32 a share payable on September 27 to shareholders of record as of September 13.

Turning to slide 13, with respect to liquidity and investment capacity. We ended the quarter with [$12.0] million of unrestricted cash, and $21.7 million of restricted cash. The restricted cash is primarily held in our securitization vehicle, our credit facility, or within one of our SBIC entities, as available for new investments that qualify for acquisition by these entities. As of June 30, subject to leverage and borrowing base restrictions, we had $63.2 million available for additional borrowings on our $100-million revolving credit facility. In regards to our SBIC subsidiaries, as of June 30, we had $3.8 million in available and approved debentures, and an additional $61 million of debentures available subject to customary regulatory requirements.

I will now turn it back to David, who will provide an update on the senior loan fund we co-manage with United Insurance Company, as well as provide an update on current market conditions.

Thanks, Ross. So, as I indicated in my opening remarks, we entered into an agreement last quarter to coinvest with United Insurance Company through what we call Senior Loan Fund LLC, and Senior Loan Fund LLC is going to be an unconsolidated Delaware limited liability company. It's governed by an investment committee, with equal representation from us and United Insurance. All material portfolio company decisions and other decisions are going to be approved by that committee.

As indicated by the name of the fund, Senior Loan Fund is going to invest in senior secured loans in middle market companies. We expect the average investment size per transaction will initially range between $2 million and $4 million. It's going to be capitalized with a subordinated note, and with equity contributions from both United Insurance and from us, as transactions are completed. United Insurance is going to be contributing 12.5% of the subordinated note and equity contributions, and GBDC will be contributing 87.5%. To date, United Insurance has committed $12.5 million to Senior Loan Fund, and we have committed $87.5 million. None of that amount had been funded as of June 30, 2013, but we did fund our first loan in July.

Senior Loan Fund is going to raise senior debt from a third-party; that is our plan. When it has a sufficiently large and diversified pool of investments, we think that the partnership with United Insurance will provide GBDC with an attractive vehicle for investing in lower-risk senior secured loans, and we're excited about its potential over time to be a meaningful contributor to GBDC's earnings. We do want to note, though, that it is going to take some time for Senior Loan Fund to build a large leveraged diversified pool of assets, and so it is going to take some time before our investment in the fund provides a meaningful boost to earnings.

Let me move on now, and talk briefly about current market conditions. As I mentioned in my opening remarks, beginning in late May, the credit markets began to swoon after the Federal Reserve's communication about tapering. In June, and even more particularly in July, we saw a substantial recovery in credit markets from the early May/June swoon, but we expect continued volatility over the coming period. One of the insights that we had in connection with the June swoon was a very simple insight that with rates as low as they are, relatively small moves in rates have very dramatic impact on bond prices.

Let's talk about the impact of this on the middle market. As I've said in the past, although the middle market is insulated from trends in liquid credit markets, we are not immune. And as a result of the downdraft in the liquid credit markets, we have seen some modest improvement in spreads, and in leverage on new transactions. More even than improvement I would say we've seen stabilization. What I mean by that is that the tendency, the trend toward lower spreads and toward some leverage creep has eased somewhat.

Having said that, we are seeing relatively slow deal flow, as we go into the September 30 quarter. New originations in the quarter ended June 30 were very strong; they exceeded our initial expectations. We anticipate that originations for the quarter ended September 30 will be slower than the June 30 quarter. Partly that's a question of what we're seeing in pipeline right now, partly also that is the tendency for the summer quarter to be slower, just as a seasonal factor.

The third factor that I would highlight is we are also particularly focused right now on being extremely selective and cautious. We're focusing primarily on senior and one-stop loans to very high-quality, resilient borrowers.

That concludes our prepared remarks for today. As always, I want to thank everyone on the line for your time and for your continued support.

Operator, if you could please open the line for questions?

(Operator Instructions)

Troy Ward, KBW.

David, you were talking about you being very selective in the current market. Can you provide a little color around that? Obviously, we know that it's a competitive market, but is there any one thing that you are seeing in the market that causes you some worry? Is it leverage, is it structure, is it not getting paid for the risk level? What are you seeing in the market?

We are seeing an increased level of competition, and that competition is taking the form of both price competition and structure competition. We are prepared to be very competitive when it comes to price competition. If we find a deal particularly attractive, we are going to battle it out on the price front.

On the structure front, if the structure doesn't do an adequate job of protecting our interests, we're going to pass. We are seeing an increasing proportion of transactions that either, due to too-high leverage or too-weak structures from a covenant standpoint, or from a structural protection standpoint, don't meet our criteria.

And you say --

By the way, I'd say what's really striking to us -- and I mentioned this last quarter when we talked, Troy -- but I say it probably even more emphatically now, those transactions that we are turning down, they are getting done. They are just not getting done by us.

When you say an increased level of competition, is it the same players just getting more aggressive, or is there new buckets of money coming in?

A bit of both. We are seeing some increase in new entrant activity. We are not seeing a meaningful increase in bank activity, other than in low-leverage transactions and asset-based transactions. I wouldn't say we're seeing a meaningful increase in bank-led activity. It is the usual players, plus a little bit of activity from some new players, or some smaller players who gained access to new pockets of capital.

As you look at the slide deck, on slide 4 --

Let me mention one other thing -- sorry Troy -- one other aspect in answer to your question. I think what other thing that we are seeing is a relatively lighter level of activity then we and the market generally had anticipated. I think one of the things that has driven the competitive activity this year, more so than new entrant activity, more so than new activity from existing players who have gotten access to new pools of capital, has been just a flat-out slow M&A market.

Right, same people fighting over less product.

Right.

On slide four, with your asset mix on the bottom of slide 4 -- now I know it's not a big piece of your portfolio -- but if you look over the last four quarters, five quarters you are showing from Q3 '12 to Q3 '13, your second lien and subordinate have basically flip-flopped. You are doing much more, less subordinated debt and a little bit more second lien. Is that a function of what is available in the market? Or is that a function of you do not like what you are seeing in subordinated debt these days? Or is it just the level of activity?

I'm not sure how to make a distinction between the two choices you gave me, which is what is available in the market and what we like. I think it is a combination of the two. We don't really make a big distinction between subordinated debt and second lien. We view them as, from a risk standpoint, substantially similar. The big distinction is one is floating rate, the second lien is floating rate, sub debt is fixed. In theory, you have a lien in second lien, but you can count me as a skeptic that those security interests are ever particularly helpful in restructuring. In my experience they are very rarely meaningfully helpful in restructurings. I wouldn't want to make too big a distinction between second lien and sub debt, other than the floating rate versus fixed-rate distinction. I would tell you, we just as a generalization, prefer floating rate.

Your answer got to where I was trying to get to. I really wanted to see how you viewed that second lien, the value of that second lien.

Than a couple of real quick ones. What is the average EBITDA in your portfolio?

It is a good question; I do not know the answer. I will have to come back to you on that, assuming that we've got some data that I can share.

One final one. Is the fund -- the Senior Loan Fund -- does it count is a non-qualified asset?

GBDC's investment in a Senior Loan Fund will count toward our 30% bucket.

Great. All right. Thanks.

(Operator Instructions)

Jonathan Bock, Wells Fargo.

David, I am curious as to the actual yield amounts that you are receiving on your senior, your one-stop, second lien sub, just walking that down the capital structure, if you could, in terms of what you're getting and bidding for in this market? Broad brush strokes.

Let's start at the top of the capital structure, with new senior secured debt. New senior secured debt that we are doing, in middle market traditional loans, which range from about LIBOR plus 450 at the low end to LIBOR plus 525 at the high end, typically with a LIBOR floor of 1% to 1.25% and a couple of points up front.

As we look to one stops, I would add 150 to 250 basis points of premium to that. Second lien positions -- that market is a little bit challenging to make generalizations about, but I'd say typical second lien deals right now are in the range of a LIBOR plus 8, again with a LIBOR floor, 100 to 125 basis points; and again with some fees up front.

Subordinated debt today, as low as 11, as high as maybe 13, but those are pretty hairy.

Appreciate that.

One common theme that investors have been focused on vehemently is the potential for spread compression to limit NOI growth, best case; and at worst case, cause NOI to decline. To the extent -- I'm just looking at simple math -- if one were more focused on an L plus 450, plus 100 basis point floor, in light of both the cost of debt at 2.9% and 2.5% on an average as a percentage of assets to run the business, fees and G&A -- maybe give us a sense as to what you think about, in terms of trying to either grow NOI in this environment, or the latter -- trying to protect the stream to make sure one is not taking excessive risks in new investments they are making.

I think it is a great question.

I have said for several quarters now that I think BDC is more focused on higher-yielding assets; they're going to face a very devilish dilemma of either moving up the capital structure and cutting their dividends or taking risks that we're not comfortable with. I think in our case, we are operating at a return on equity level that is sustainable in today's market environment. I think we even have some ability to expand our ROE, particularly by increasing modestly our use of leverage. At the end of the quarter, we were operating with a debt-to-equity ratio of -- just checking my number -- Ross, 0.67, is that correct?

0.67, yes.

That is actually under the target that we have spoken previously about.

I think we have some opportunities in a stabilized environment to increase our ROE, even when I think among our competitive brethren, the opposite may be the case. If we get into an environment in which spreads continue to compress from current levels, it raises a number of questions. One question would be, are these new investments still attractive from a risk reward standpoint? The answer is no, our answer is going to be to shrink.

If the answer is yes, then it is going to raise questions like, well, can we reduce our cost of financing these assets? In other words, can our cost of debt contract along with our spreads on our assets? Are there other steps that we can take in order to improve our ROE by shifting our mix again in the context of having an attractive risk return. There may be an opportunity to shift our mix more toward one-stops as an example.

I think it is a hard question, Jon, to answer in hypothetical, but I hope the guidance that I've given you illustrates the way in which we would think about that kind of environment.

We absolutely appreciate investors that are very focused on limiting risk, because generally that is where people end up getting snagged.

One question, as it relates to the SLF, a few technical ones -- what is the fee, up-front fee sharing arrangement between United and GBDC? Up-front origination fees, I should say.

The Senior Loan Fund will participate in any up-front fees that are earned. We don't have the same accounting policy that I think you are thinking of, that [Aries] has, where we treat those up-front fees as earned and as income in the period in which the new loan is made. We view that as being income that is appropriately amortized over the life of the loan. So we would anticipate that Senior Loan Fund would use that same treatment.

Fair. David, I guess the question is -- if you do a loan and you have an up-front fee of $10, do you split that $10 50/50? Or do you split it according to the proportion of capital that is in the fund?

The latter.

Then, finally, one question on the average investment size of $2 million to $4 million. My guess is that this would be more, this Senior Loan Fund would be more targeted towards direct originations across the broader platform. Do you also believe that there might be a portion of this fund that would invest in more liquid and syndicated type of transactions, given your experience with the asset class?

I definitely think that we will look at club -- what we call club -- which basically means transactions where we are not necessarily the lead. We will look for opportunities with our partners at United in the broadly syndicated market, and to the degree we think there are interesting opportunities there, we may pursue it. That is not part of our current plan.

Okay. Thank you very much.

There are no further questions at this time. I will now turn the call back to you, sir.

Thank you. Again just want to express my appreciation to everyone on the call. We very much appreciate your partnership and should you have questions that occur to you post this call, please feel free to reach out to either me, or to Ross. Take care everyone. Goodbye.

Ladies and gentlemen the does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines. Have a great day.