Golub Capital BDC Inc (GBDC) 2014 Q1 法說會逐字稿

Good afternoon. Welcome to Golub Capital BDC Inc's December 31, 2013 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 Inc's 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 home page of our website, www.GolubCapitalBDC.com, and click on the investor presentations link to find December 31, 2013 investor presentation. Golub Capital BDC's 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 purposes.

I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.

Thank you very much. Good afternoon everybody, and thanks for joining us today.

I'm joined here at Golub Capital by Ross Teune, our Chief Financial Officer, and Greg Robbins, Managing Director. Earlier today we issued our quarterly earnings press release for the quarter ended December 31, and we posted a supplemental earnings presentation on the website. We'll be referring to that presentation throughout the call today.

I would like to start by providing you with an overview of the December 31, 2013 quarterly financial results. Ross is then going to take you through the quarterly financials in more detail, and then I'm going to come back and provide an update on our outlook for conditions in middle market lending, generally over the next couple of quarters.

So with that, let's get started. I'm pleased to report we had another solid quarter and our results were very consistent with the goals that we talked about last quarter. We anticipated that the December 31 quarter would be a heavy originations quarter, and it was.

We planned on increasing our utilization of leverage and we did. And we also indicated that the portfolio was unusually clean from a credit perspective, and as we'll talk about today, it got even more so over the course of the December 30 -- the fourth calendar quarter of 2013.

So with that, with those headlines, let's run through the numbers, starting on Page 2 of the investor presentation. For the three months ended December 31, 2013, we generated net investment income of $13.3 million, or $0.31 a share. That compares to $12.4 million, or $0.31 a share for the quarter ended September 30. Net increase in net assets resulting from operations, what I call net income, or EPS, ended the quarter at $14.8 million, $0.34 a share, as compared to $12.3 million, or $0.31 a share for the quarter ended September 30.

The difference between the two, the $0.34 and the $0.31, is, of course, net realized and unrealized gains on investments, and that totaled $1.6 million for the quarter ended December 31. It related primarily to net unrealized appreciation on several middle market debt and equity securities.

As we'll talk about, we also sold one underperforming investment and we wrote off two nonaccrual investments, all at values that were very close to their September 30 carrying values. As Ross will discuss, the impact of that was that, not only can you see credit quality remaining strong, but non-accruals now stand at essentially zero.

Net asset value per share for the quarter ended December 31 was $15.23, and that compared to $15.21 for the quarter ended September 30. The $0.02 of accretion was attributable to our EPS being in excess of our quarterly dividend, and we're proud to say this is the sixth consecutive quarterly increase in our NAD.

In regards to new investment activity, as I mentioned, we had strong new originations for the quarter, totaled $286.7 million. That includes $25.6 million we invested senior loan fund. Approximately 12% of the new investment commitments were senior secured loans, 71% were one-stops, 7% were second lien loans, 1% for equity securities, and 9% were investments in the senior loan fund.

As you'll see on the subsequent Slide, the portfolio mix continued to shift toward one-stops. So let's look at this a bit more carefully right now.

If we take a look at Slide 4 of the presentation, you can see that one-stops are now up to 59% of the total portfolio. This is consistent with our strategies, we feel one-stops right now are generally offering the best risk/reward in current market conditions. After you take into account portfolio run-off during the quarter and other activities, investments at fair value grew by $155.3 million during the quarter, a 15.1% increase from September 30.

We financed the growth in the investments with debt, and in doing so, we made quite a lot of progress on our goal of increasing our targeted economic leverage to about 1 to 1. For the quarter ended December 31, our economic leverage was 0.9, and that's up from 0.64 as of September 30.

Obviously, regulatory leverage was much lower than that, because of our SBIC borrowings. Regulatory leverage was 0.6 at December 31, so we still have plenty of cushion against the 1 to 1 regulatory limit.

Let's look at Slide 3 of the presentation. On Slide 3, you can see in the tables, $0.31 per share of NII, and $0.34 of EPS. The table also highlights the bump in our net asset value per share this quarter to $15.23.

What I want to point out on this page is we continue to have a very granular, very well diversified portfolio, with 139 different portfolio investments, and an average investment size of only about $8.5 million.

I'm going to now turn it over to Ross, who is going to discuss the results in more detail.

Great. Thanks, David.

I'll start on Page 4 of the balance sheet. We ended the quarter with total investments of nearly $1.2 billion, total cash and restricted cash of $71.7 million, and total assets of just under $1.3 billion. Our total debt was $577.2 million at the end of the quarter, which includes $215 million in floating rate debt issued through our securitization vehicle, $196.3 million of fixed-rate SBIC debentures, and $165.9 million of debt outstanding on our revolving credit facility with Wells Fargo.

Asset growth this quarter was principally financed by increased borrowings, higher revolving line with Wells, which increased by just over $136 million quarter over quarter. Total net assets was $666 million, up slightly from the previous quarter, as net income exceeded our dividends paid.

From a GAAP perspective, as David mentioned, our debt to equity ratio was 0.9 times, and we moved closer to our target of 1 to 1 from a GAAP perspective, and calculated for our regulatory limit, our debt to equity ratio was 0.6 times.

Looking at the income statement on the subsequent slide, total investment income for the quarter ended December 31 was $25.6 million. This was up $2.8 million from the previous quarter, or just over 12%. This increase was driven by strong asset growth, as well as an increase in prepayment fees, and discount fee amortization that was driven by higher runoff.

On the expense side, total expenses of $12.3 million increased $1.9 million during the quarter, due to an increase in interest expense, as average debt outstanding increased, an increase in Management fees, driven by an increase in average total investments, as well as an increase in incentive fees, which was driven by an increase in net investment income.

As David mentioned, we had net realized and unrealized gains of $1.6 million during the quarter. This is primarily due to net unrealized appreciation on several middle market debt and equity investments. And last on the page here, net income for the quarter was $14.8 million.

Turning to Slide 7. These charts graphically summarize the breakdown of our new originations end of period investments. As shown on the bar chart on the left-hand side, we originated 12% of our new investments in senior secured loans, 71% in one-stop, 7% in second lien, 1% in equity securities, and the remaining 9% in the senior loan fund. The chart on the right provides a breakdown of our total investments by investment category. This shows the 5% increase in one-stop investments this quarter, with corresponding decrease in both the senior secured investment category and the junior debt.

The subordinated debt, the green bar, if you can see it, as you will see, has nearly disappeared from this chart and now represents only 1% of total investments, as we continue to avoid most new subordinated debt opportunities, and the good subordinated debt that's on our books continues to get refinanced.

Turning to Slide 8, I'll walk you through the changes in our yields and investment spreads for the quarter. First, looking at the gray line, this line represents the interest income or all income earned on the investments, but excluding fee amortization. This line represents the best single indicator of the portfolio's current interest rates.

Due to continued compressed pricing on new investments, the interest income yield declined from 8.9% for the quarter ended September 30, to 8.6% for the quarter ended December 31. We expect to see continued pressure on this line as we originate new loans at current market spread, and some of our older higher-yielding loans continue to pay off.

Including amortization of fees and discounts, the total yield on investments, the dark blue line at the top, the yield was 9.3% for the quarter ended December 31. The decrease in this total yield was consistent with the decrease in the interest income yield, as income from fee amortization was relatively stable quarter over quarter. Looking at the green line, the weighted average cost of debt increased slightly from 3% last quarter to 3.1% for the quarter ended December 31.

Turning to Slide 9 for new investments, the weighted average rate, new middle market investments was 7.2%. This is down from 8.1% the previous quarter. The primary reason for the decline was due to a change in asset mix, as we originate at much lower percentage of second lien investments this quarter. However, a modest decline in rates on new investments also contributed to the decrease.

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 would be calculated using current LIBOR, the spread over LIBOR, and the impact of any LIBOR floor.

As shown in the middle of the slide, the investment portfolio remains predominantly invested in floating rate loans. This has gone up continuously throughout the year and represents over 95% of the total portfolio as of December 31. Overall credit quality continues to remain strong, with non-earning assets as a percentage of total investments on a cost basis at 0.2%, and essentially 0% as -- based on a fair value basis.

Flipping over to Slide 11, looking at our risk ratings, over 90% of our investments at fair value continue to be risk-rated in our four or five category, our two highest categories. And we also experienced declines quarter over quarter in both of our lower risk-rated categories, the two and three accounts. As a reminder, independent valuation firms are valued approximately 25% of our investments as of December 31.

Turning to Slide 12, our Board declared a distribution of $0.32 a share, payable on March 28 to shareholders of record as of March 17.

Flipping to the last slide, we've got liquidity and investment capacity. We had approximately $200 million of capital available for investments as of December 31. This consisted of restricted and unrestricted cash, SBIC debentures, and availability on our revolving credit facilities.

We have $31.8 million of unrestricted cash, and $39.9 million of restricted cash. Restricted cash is primarily held in our securitization vehicle, as well as our revolving credit facility with Wells and our SBICs. That is generally available for new investments that qualify for acquisition by these entities.

As of December 31, subject to leverage and borrowing base restrictions, we had $84.1 million of available borrowings on our $250 million revolving credit facility with Wells Fargo. And we had the full $15 million available on our revolving credit facility with PrivateBank.

In regards to our SBIC subsidiaries, as of December 31, we had $28.7 million of additional debentures available subject to the customary regulatory requirements.

In regards to the senior loan fund, subsequent to quarter end, we entered into a $50 million revolving credit facility with Wells Fargo. This facility has a reinvestment period through January 17, 2015, and a final state of maturity date of January 17, 2019. The facility bears an interest rate ranging from LIBOR-plus 1.75% to LIBOR-plus 2.25%, with no LIBOR floor, and depends on the composition of the portfolio. After the reinvestment period, the interest rate increases to LIBOR-plus 2.75%.

With the addition of the third-party credit facility, we expect to fund a larger portion of new investments with this third-party debt, thereby improving our returns on our investment in this fund. I'll now turn it back to David, who will provide an update on market conditions and provide some closing remarks.

Thanks, Ross.

As expected, our deal pipeline in the first calendar quarter of 2014 is slower than it was last quarter. Not to say it's slow. We're still getting some deals done. But the first calendar quarter is typically slow relative to the rest of the year, and I think in 2014, the first quarter will be no exception to that rule.

Our macroeconomic outlook remains very similar to what I've talked about for the last several quarters. We expect calendar 2014 to be a year of continued [bugling] growth, not as good as the economic statistics that came out on calendar Q4 of 2013, and not as bad as some market pundits have been predicting since the stock market started to decline.

We think our credit results this year are likely to stay strong. Certainly, the portfolio is in very strong credit shape right now. We've heard that M&A activity is showing signs of increasing and we're hopeful that it will, but we're not counting on it, and we haven't yet seen it materialize in transaction volume.

Our approach in this environment, I've said this for a couple quarters in a row, it remains very consistent. Our approach is to remain highly selective and to focus on senior debt and one-stops in resilient recession-resistant borrowers that have low-risk capital structures, and that are owned by relationship oriented private equity sponsors.

That concludes Ross and my prepared remarks for today. As always, I want to thank everyone on the phone for taking the time to be with us today, and also thank you if you're a shareholder for your continued support.

Operator, can we please open the line for Q&A?

(Operator Instructions)

Our first question comes from Greg Nelson with Wells Fargo. Please go ahead. Mr. Nelson, your line is open.

Hi. Thanks so much for taking my questions.

David, on the leverage for the SLF, you guys have the credit facility and that's great. Is there a particular kind of advance rate that you guys are getting there? How should we think about leveraging the facility going forward as you guys utilize that credit facility?

SLF is going to be a work in progress for the foreseeable future. What we've said previously and I would say again is our goal is to build a diversified portfolio in SLF, and upon having that diversified portfolio, we'll be very comfortable leveraging it at about a 3 to 1 ratio. Three parts debt to one part equity.

We're not going to get there overnight. It's going to take us some time to build that portfolio to the level of diversification that will enable us to feel comfortable with that level of leverage. The Wells facility is a great start on that, and what it will enable us to do is to earn a good, not great, but a good ROE from here, as we continue to build up that portfolio and look toward achieving our larger goal.

Perfect. Is there a kind of minimum origination level in there that you guys have to reach before you can start pulling down on it?

No, we already have sufficient assets in SLF to be able to draw on that facility.

Okay, great. And then we heard one of your competitors say recently that pricing on -- if you're going to turn to one-stop, has come in. Are you guys seeing that in the deals that you compete in?

Well, I think you can see in our calendar Q4 2013 results as well as in the comments I made earlier about the relative slowness of calendar Q1 of 2014, some of the same themes that you're referencing. We're definitely seeing that there is tremendous interest in the middle market loan asset class right now.

I think it's for good reason, because I think it offers value in a floating-rate form at a time when traditional fixed-income is hard to get comfortable with because of interest rate risk. But when you combine that interest with relatively slow M&A, the natural consequence is going to be a high level of competitive activity, and we saw that in Q4 of 2013 and we're seeing it again in Q1 of 2014.

Sure. And then lastly, you guys mentioned that obviously the yield came down as you guys were originating less. And then secondly, is there a fundamental reason for that? Are you guys avoiding it on a risk adjusted return basis, or is it just less deal flow from your sponsor relationships?

Some people view second lien debt as being very different from subordinated debt. We don't. We think second lien debt is really best thought of as being floating rate mezzanine.

So our views on second lien and non-subordinated debt, we've been pretty vocal about for a number of quarters now. We think that with pricing where it is on second lien and on junior debt, and leverage where it is, we think it's quite difficult to find attractive piece of paper in that category on a risk-adjusted basis. So if you look at our originations over an extended period of time, a portion of our originations that are in senior secured loans and one-stop loans as a percentage of all of our originations, that proportion has continued to grow.

So we do find some attractive second lien and mez loans. We did make a couple this quarter. And we will -- I suspect we will make more of them in calendar 2014, but not at the pace that we would if the environment for those loans was more attractive.

Great, guys. Thanks for answering my questions.

Our next question comes from Greg Mason. He's with Keefe Bruyette, and Woods. Go ahead.

Great. Good afternoon, gentlemen.

First, on Slide 9 when you have your weighted yield on new investments, the 7.2%. David, does that include your new investments in the SLF, which right now obviously have a pretty modest yield? How is that impacting that 7.2%?

No, that does not include the weighted average rates on the new investments in SLF. So these are just -- it's the weighted average rate on assets that are coming on balance sheet.

What about the -- what about the $25 million investment you made in SLF that I think is what yielding 4% right now if I'm thinking of that right? Is that $25 million -- 4% in that number, or is that just the debt investments this quarter?

This is just the balance sheet debt investments. It does not include the investment in SLF.

I think where you're going, Greg, is that we currently have a bit of a drag as a consequence of a relative new low return on our investment in SLF, because it's not leveraged. And you're right, that's why we were eager to start to ramp it up to put in place the Wells Fargo facility, and to -- going forward from here, start to use debt financing as opposed to incremental equity financing to grow that portfolio.

I think one of the potential sources of earnings growth that we have going forward is a higher level of returns from SLF. But I want to emphasize something you've also heard me say a couple times, which is, we're very optimistic about SLF in the long term. We think it's a great strategic tool for us, but we think it's going to take some time before we get it to the size and scale and leverage levels that we want to get it to.

Great. And then another question on just the funding your liabilities. As you approach target your economic leverage of 1 to 1, and based on our calculations, you should have over $200 million borrowed on your credit facility, kind of a similar size that you did your last securitization, that $215 million.

What are your thoughts about doing another securitization? Do you want to continue to have capital out on the credit facility? Just thoughts on balance sheet construction.

Yes, we're actively thinking about the issues that you just described. I think that the right liability structure for GBDC involves a combination of securitization debt, SBIC debt, and bank debt. And we're getting towards the higher end of the percentage I want to see in bank debt. And that will incline us in coming quarters to look at securitization options as a means of shifting more into that category, and essentially recreating running room for growth through a less utilized bank facility.

Great. And then one last question. You talked about selling one underperforming asset and writing off two non-accruals. If I look through the portfolio, would those be Extreme Fit, KHKI, and Promise?

Yes. Yes, we sold KHKI, what we call Hawk Eye, and we wrote off Extreme, and Promise, which we had valued previously at either zero or very close to zero.

Great. Thank you.

(Operator Instructions)

Our next question comes from Jim Young with West Family Investment. Please go ahead.

Hi. You mentioned your -- the portfolio is shifting toward the one-stop loans because of their best-for-score characteristics. Could you kind of quantify those, the risk/reward that you see in one-stop? And then there's a follow-up.

Would you like me to give you what kinds of rates we're seeing in our portfolio and in the market for senior secured loans and for one-stops today? I just want to make sure I answered the question you want me to answer.

Yes. That's exactly what I'm looking for.

So the market for middle market, traditional middle market senior loans today ranges from LIBOR-plus 400, with a 1% floor at the low end, to LIBOR-plus 5.25%, again, with a 1% floor at the higher end. This is for a good, solid credit, middle of the fairway deal with relatively limited leverage.

And we're able to earn 100 to 150 basis point premium over that when we are doing our GOLD or one-stop product. We take -- we go a little bit deeper into the capital structure, so we're taking a bit more risk.

But as I've explained in prior quarters, what we found is that we have been able to select credits to do our one-top loans, two that have very good credit characteristics. So our fault experience with respect to our one-stop loans is actually slightly better than our default experience on our traditional senior secured loans, which is counter intuitive, but that's what the data is. Does that answer your question, Jim?

Yes, that component of it. And then the follow-up is basically how deep into the capital structure are you going at this stage on average with your new commitments? And how does that compare to the prior quarter?

Leverage on new deals I don't think has moved very much for us over the course of the last couple of quarters. Traditional senior debt, we're seeing in the 3.5 to 4 times EBITDA level in typical transactions. And on GOLDs, we're typically seeing those go to about 5 times.

As I've said in prior calls, everyone has their own approach to underwriting and to thinking about risk. We tend here to be prepared to be very competitive on price, but not to stretch when it comes to working with iffy credits or working with iffy structures. So there are some somewhat more aggressive structures out there that we've seen. Those are not the transactions we choose to do.

Great. Thank you very much.

There are no further questions at this time.

Great. Well thank you everyone again for joining us this afternoon. And we look forward to catching up with you next quarter.

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