Golub Capital BDC Inc (GBDC) 2014 Q3 法說會逐字稿

Good afternoon. Welcome to Golub Capital BDC, Inc.'s June 30, 2014, 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 homepage of our website, www.GolubCapitalBDC.com, and click on the investor presentations link to find the June 30, 2014, 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, Donny. Good afternoon, everybody, and thanks for joining us today. I'm joined today by Ross Teune, our Chief Financial Officer, and by Greg Robbins, Managing Director here at Golub Capital.

Earlier today we issued our quarterly earnings press release for the quarter ended June 30, 2014, and we also posted a supplemental earnings presentation on our website. I am going to be, and Ross will be, referring to this presentation during the call.

I would like to start by providing an overview of the June 30, 2014, quarterly financial results. Then Ross is going to take you through the quarterly results in more detail in and then I will come back and provide an update on our outlook for conditions in the middle-market lending environment over the next couple of quarters.

So with that, let's get started and I'm going to start on page 2 of the investor presentation.

I'm pleased to report we had another strong quarter. For the three months ended June 30 we generated net investment income of $0.32 a share, $15.1 million as compared to $0.31 a share or $13.3 million for the quarter ended March 31. Net increase in net assets resulting from operations, what I call net income, for the quarter ended June 30 was $0.35 a share, or $16.3 million, as compared to $0.32 a share, or $14.1 million, for the prior quarter.

Net realized and unrealized gains on investments and secured borrowings were $1.2 million for the quarter ended June 30, so we had another quarter of what I call negative credit losses. The net gain related primarily to unrealized depreciation on a range of middle-market debt and equity securities.

Overall credit quality remains very strong. We will go into that in more detail later in this call. And our nonaccrual rate continues to round to zero. About 95% of our investments have an internal risk rating of 4 or 5, our two highest ratings.

Net asset value for the quarter ended at $15.44, up from $15.41 for the quarter ended March 31, so we had $0.03 of accretion that was primarily due to EPS in excess of our quarterly dividend. I would note this is the eighth consecutive quarter in which we have seen an increase in our net asset value per share. That is something we are proud of.

In regards to new investment activity, we had another strong quarter of new originations. Commitments for the quarter totaled $158.7 million. That includes $3 million we invested in Senior Loan Fund.

Of that amount approximately 18% were in senior secured loans, 79% were in one-stops, 1% were in equities, and 2% were investments in Senior Loan Fund. The overall mix of originations that we saw in the quarter was consistent with the strategy I discussed last quarter, in particular our focus on one-stop investments, as we feel one-stops offer the best risk/reward in the current investment climate.

After taking into account portfolio runoff and other activity, the investments at fair value grew $71.3 million during the quarter, a 5.7% increase from March 31.

On June 5, we closed on a new securitization. We issued $246 million in debt. This is our second balance sheet securitization, provides us with another source of very stable and attractively priced debt financing. Ross will walk you through the details of that debt issuance later on in this call.

The highlights are we have a four-year reinvestment period that runs through April of 2018. The notes mature in April of 2026 and we have a nice interest savings versus the Wells Fargo financed bank facility that this replaces.

Due to the additional debt we raised via the securitization, partially offset by a reduction of debt outstanding on the Wells Fargo revolving credit facility, we ended the quarter with a GAAP debt-to-equity ratio of 1 to 1. When we think of debt to equity, we focus on what I call economic leverage and what I mean by that is we adjust debt outstanding by subtracting out cash.

So if we adjust for cash, our net debt-to-equity ratio was 0.83 times, still below the target level we have discussed in prior calls of 1 to 1. We ended the quarter with an unusually high level of cash and restricted cash, about $120 million in total. This was the result of the new securitization vehicle not being fully ramped with investments at the time of close. We anticipate that we will fully ramp that vehicle shortly.

Calculated per regulatory definitions, our leverage at the end of the quarter was 0.71 times, so we still have a substantial cushion against the 1 to 1 regulatory limit as of June 30.

On slide 3 of the investor presentation, you can see in the table the $0.32 per share we earned from net investment income and the $0.35 per share we earned from a net income perspective. The table also highlights the bump in our net asset value to $15.44, as well as the increases we have experienced over the past several quarters.

As shown on the bottom of the page, we had a slight increase in average size of investments but the portfolio remains very well diversified. We have investments in 146 different portfolio companies and the average size of our investments is $8.8 million.

Finally, turning to slide 4, the percentage of one-stops in the portfolio continues to increase. It represented 65% of total investments as of June 30. Junior debt remains a small portion of the portfolio comprising 7% of total investments, and we continue to originate very little new junior debt, reflecting our relatively negative view of market conditions for junior debt and, as I will talk about the end of this call, our cautious macroeconomic outlook.

With that, I am going to turn it over to Ross, who will discuss the results in more detail. Then I will come back with my outlook and then we will shift to Q&A.

Great. Thanks, David. I will start on page 5, the balance sheet.

We ended the quarter with total investments of just over $1.3 billion. We had total cash and restricted cash of $121.2 million and total assets of just under $1.5 billion. As David noted, restricted cash was unusually high this quarter, primarily due to the closing of our second securitization which was not fully ramped with new investments.

So if you look at the balance sheet we had $109.8 million of restricted cash. This cash is generally available for new investments and, as David mentioned, we plan to kind of fully ramp the CLO.

Total debt was $703.3 million, which includes $215 million in floating rate debt issue through our first securitization, $246 million of floating rate debt issued through our second securitization, $208.8 million of fixed rate debentures, and $33.5 million of debt outstanding in our revolving credit facilities.

Total net asset value at the end of the quarter was $726.8 million. This is up about $5 million from the previous quarter, primarily due to EPS exceeding dividends paid as well as proceeds from the partial exercise of the greenshoe in early April relating to the equity offering we completed back in March.

Flipping to the statement of operations on page 6, total investment income for the quarter ended June 30 was $28 million, up $2.8 million from the previous quarter or nearly 11%. This increase was driven by strong asset growth as well as an increase in prepayment fees and dividend income.

On the expense side, total expenses of $13 million increased by $1.1 million during the quarter, primarily due to an increase in interest expense of a like amount. There is an unusual non-recurring item in interest expense I just wanted to point out. The increase in interest expense was partially caused by an acceleration of deferred financing costs associated with our revolving line of credit with Wells Fargo that we downsized simultaneously with closing our new securitization.

As a result of the downsize from $250 million in commitments to $100 million of commitment -- or a decrease of $100 million, we accelerated approximately $450,000 of deferred financing costs. The remaining increase in interest expense was primarily attributable to higher average debt outstanding, increased non-utilization fees, and increased interest rates on SBIC debentures that were pooled at the end of March.

As David mentioned earlier, we had net realized and unrealized gain on investments of $1.2 million during the quarter. This was primarily due to unrealized appreciation on a range of middle market debt and equity investments. And net income for the quarter totaled $16.3 million.

Turning to slide 7, these charts graphically summarize the breakdown of our new originations and end-of-period investments. As shown in the bar chart on the left-hand side, we continue to focus on originating one-stop investments which have comprised over 70% of originations the past three quarters. For the current quarter we originated 18% of our new investments in senior secured loans, 79% in one-stops, 1% in equity securities, and the remaining 2% in SLF.

The chart on the right provides a breakdown based on total investments. This chart shows a 4% increase in one-stop investments to 65% of the total portfolio with that -- with a primary -- with a decrease offset in second-lean investments.

Turning to slide 8, I will walk you through the changes in our yields and investment spreads for the quarter. First, focus on the gray line. This line represents the income yield or the actual amount earned on the investments, including interest and fee income, but excluding the amortization of discounts and upfront fees.

Due to the increase in prepayment fees on new investments, the income yield increased from 8% last quarter to 8.3% for the quarter ended June 30. Excluding the impact of the increase in prepayment fees, the income yield would have remained flat at around 8%.

Including amortization of fees and discounts, the investment -- income yield on investments, or the dark blue line at the top of the chart, was 8.9% for the quarter. The increase here, again, is due to the increase in prepayment fees as amortization from fees and discounts was stable quarter over quarter.

The weighted average cost of debt increased to 3.3% for the current quarter as compared to 3% to the previous quarter due to an increase in non-utilization fees, increased interest rates on SBIC debentures that were pooled at the end of March, and higher deferred fee amortization.

Turning to slide 9, for new investments, the weighted average rate on new middle-market investments was 7.1%. This is down from 7.5% the previous quarter, primarily reflecting some mix differences quarter over quarter. Our overall sense is that pricing has been relatively flat quarter over quarter.

As the weighted average rate on new investments continues to remain below the weighted average rate on investments that are being paid off, we continue to expect some pressure on the income yield over the next few quarters. Just 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 would be calculated using the 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 investing in floating rate loans with variable rate loans comprising over 96% of the portfolio as of June 30. Overall credit quality continues to remain very strong with non-earning assets as a percentage of total investments at the cost basis at 0.3% and essentially 0% of total investments on a fair value basis.

Flipping to slide 11, the percentage -- flipping two slides over to slide 11, the percentage of investments risk rated of 5 or 4, our two highest categories, remains stable quarter over quarter and continues to represent nearly 95% of our portfolio. The number of investments with a risk rating of 3 also remained stable at just below 5% and the percentage of investments risk rated a 2 or a 1 remains fairly inconsequential at less than 0.5% of the portfolio at fair value.

As shown on slide 12, the portfolio is well diversified by industry concentration. Our highest concentrations are in three industry verticals in which we have meaningful domain expertise. These are in healthcare, retail and restaurants, and software. The portfolio has a low exposure to commodity-dependent and highly cyclical companies.

As a reminder in regards to valuations, independent valuation firms continue to value approximately 25% of our investments each quarter.

Turning to slide 13, this slide provides some financial highlights for investment in Senior Loan Fund, or what we call our SLF. As shown on the table, total investments at SLF continue to grow and now exceed $100 million at the end of the quarter.

In addition, SLF continues to expand the use of third-party leverage with senior leverage increasing from 0.55 times at the end of March to 1.69 times at the end of June. Due to the increased use of third-party leverage, the annualized quarterly return improved from 6.2% the previous quarter to 9.6% for the quarter ended June 30. We anticipate a faster rate of growth in investments at SLF as well as increased use of third-party leverage in coming quarters.

Turning to slide 14, our Board declared a distribution of $0.32 a share payable on September 26 to shareholders as of record as of September 16.

Turning to slide 15, as of June 30 we had approximately $190 million of capital available for new investments. This capital consists of restricted and unrestricted cash, SBIC debentures, as well as availability on our revolving credit facilities.

As of June 30, subject to leverage and borrowing base restrictions, we had [52 point million dollars] of availability under our revolving line of credit with Wells Fargo and Private Bank. In regards to our SBIC subsidiaries, we had $16.2 million of additional debentures available subject to customary regulatory requirements.

As David noted in his opening remarks, we completed a $256 million -- $246 million securitization. These notes consisted of $191 million of AAA Class A-1 notes that bear interest at LIBOR plus 1.75%. We issued $20 million of AAA Class A-2 notes that bear interest rate at LIBOR plus 1.45% and $35 million of AA Class B notes that bear interest at LIBOR plus 2.50%.

As David mentioned, the notes have a four-year reinvestment period that expires in April of 2018 with a maturity date in April of 2026.

I will now turn it back to David, who will provide an update on current market conditions as well as some closing remarks.

Thanks, Ross. So we are now halfway through our last fiscal quarter, the quarter ended September 30, and we anticipate that we are going to have another solid quarter of origination activity. This is somewhat unusual.

Often the summer is a slow period, but not this summer. Our deal flow is partially being driven by a pickup in middle-market M&A activity, but we think more of it has to do with our ability in this environment to win the deals we want to win with sponsor clients that we want to work with. And I will give you some statistics on that.

We think that our strong relationships with private equity sponsors are reflected in the fact that this year and last year over 80% of our deals have been with sponsors we have done multiple deals with previously. We think that we are succeeding in part because of our reputation as a market leader and we think increasingly we are succeeding because we are leveraging our size and scale and our ability to buy and hold large one-stop facilities.

Let me shift and talk briefly about our macro view. I am often asked in various settings, based on the position that we have in seeing a lot of financials, what do we see? How healthy is the economy based on what we are seeing in our underlying portfolio companies?

And our sense is that things are okay. Not great, not bad, okay. Calendar Q2 bounced from a relatively weak calendar Q1. But our sense is that folks were too pessimistic after Q1 that Q1 results were heavily impacted by weather-related issues and that they were also too exuberant about Q2 because we think that the weather-related issues in Q1 pushed some activity into Q2.

So our expectation is that the macro numbers for the rest of the year are going to show a reversion to slow, muddling growth and that perspective is informing our credit and underwriting decisions. So, consequently, we are cautious in the current environment.

We think that this is an environment where competition is challenging. Growth is likely to be slow and it's a time for us to be very selective to focus on the transactions that we really feel conviction about. Well-structured transactions with resilient borrowers and with relationship-oriented P/E sponsors, in most cases P/E sponsors we've worked with before.

That concludes our prepared remarks for today. And as always, I want to thank everybody on the call for taking the time to listen to today's call and for your continued support. Donny, I would ask your help in opening the line for questions.

(Operator Instructions) Greg Mason, KBW.

Great, good afternoon, gentlemen. First, David, could you just talk about the kind of backup that we've seen in the high-yield bond market and liquid markets so far in the third quarter? Has that begun to impact your market at all?

And if it hasn't, how long do you think it has to stay like this before it does start filtering in to your pricing on new deals?

We have not seen it begun to filter in yet. These things do -- quite as your question implies, these things do tend to involve a lag, so you will see impact of changes in funds flows in the high-yield market before you will see it in the broadly syndicated loan market. And you will see it in the broadly syndicated loan market before you will see in the middle market.

So right now we have definitely seen it in high yields. There is a bit of choppiness in the broadly syndicated market, particularly in the heavily liquid names. So if you looked, for example, at what they call the flow names in that market, which are the most easily traded names, there's been about a 1% decline in the price of flow names. Less so outside of the flow names.

I think it's too early to expect to be seeing this in middle-market land, but if we see continued weakness in the high-yield market and the broadly syndicated market, it bodes well for somewhat less pressure on leverage and pricing in Q4. Calendar Q4.

I just want to caution that we don't -- we are not seeing a big change in pricing and leverage today. Ross talked about the fact that in the quarter ended June 30, we saw a lot of relative stability in pricing and in leverage. If you ask me to guess right now, I would be more in the camp of guessing stability than guessing that we are going to see a widening of spreads.

That's great color, thanks. Then one additional question. On the Senior Loan Fund, there is a fellow BDC participant that has a structure that looks a lot like yours. I think it's even the same partner. They are putting about $150 million to work in their senior loan fund. You guys have been averaging about $35 million a quarter since you started yours, much slower pace.

I just wanted to see if you could give us some more color on why that pace and then maybe some color on Ross's comments that you think that pace is going to increase.

We have been focused to date on a strategy of growing our senior loan fund with new issue as opposed to with sales from the balance sheet to SLF. Fifth Street, who I presume is the partner you're talking about, Fifth Street has chosen a different strategy of moving assets from balance sheet into SLF.

I think there is a role for both strategies. We have been exploring potentially using to a degree the strategy of selling assets from balance sheet into our SLF. We actually anticipate that we are probably going to do some of that and that's one of the reasons why we contemplate that our SLF asset growth is going to accelerate in coming quarters.

That's great. Thank you, guys.

Jon Bock, Wells Fargo Securities.

Good afternoon and thank you for taking my question. Tail-end as it results to the SLF, David, there are many pockets within Golub that hold the same loan. And just curious, as you look at the opportunities to go into the SLF in addition to your partner, would it be fair to say that a majority of lower yielding one-stops or just pure senior secured loans that you've done that perhaps maybe aren't necessarily stretched senior investments would end up in that fund?

Maybe in allowing us to bifurcate a bit more as to what's going to be more appropriate for that fund to the extent you choose to sell some balance sheet assets into it.

Yes, I think -- if I understood your question, Jon, you were asking is it our philosophy that it is appropriate to use somewhat higher leverage with more senior assets? And so could we anticipate that to the degree we are choosing assets potentially to move from -- to sell from the balance sheet with our partners' approval and consent into SLF, would we be more likely to do that with senior assets? I think the answer is, yes, we would be.

And I think that is entirely consistent with what I have said before in prior discussions that we have had in respect of H.R. 1800 and in respect of just philosophy on leverage generally. We are more comfortable using higher levels of leverage with senior assets than with other kinds of assets.

Makes sense. I just -- maybe the bifurcation being if you were thinking of one-stop assets or if there was some form of limitation in the indenture that perhaps relegated you to pure first or what we will call very low levered senior secured loans that would go into the fund, or if you had a little bit more flexibility to put in some of the higher-yielding stretch seniors that you might have in your balance sheet.

There are no -- in the debt facility at SLF today there are no restrictions. This is all a series of judgment calls that involve discussions that we have had and will continue to have with our SLF partner.

Got it. Then in terms of risk/reward, we talk about the backup in the more liquid markets. Can you give us a sense of structure at the moment?

We were -- I believe we asked this question two quarters ago. Was your intention to compete on price and not structure? Which obviously we have seen and high-quality deals have gone into the portfolio.

Are you seeing further competition in today's environment that perhaps structures that are getting done are less advantageous? Or is it still as long as you are willing to offer the best price, you will still get the deal on the terms at which you require to make it a decent risk-adjusted opportunity?

I think that in a competitive environment you have competitors who are competing on both price and structure, so there are transactions that have structures that we are not comfortable with and so we pass.

Where we tend to draw a credit line, it tends to be on a structure level as opposed to on a pricing level. There are exceptions. There are deals we passed because price is too low. So all of these factors are important and, ultimately, we have got to reach agreements with our sponsor clients and obligors that the terms that we are offering, both price and structure, are a compelling value.

I think what I meant when I discussed this previously is that from a philosophical standpoint we don't compromise on credit. If we aren't very confident that we are going to be able to sustain our track record of very low credit losses, we would much prefer to not make loans than to make loans the risk of which we don't feel comfortable with.

Okay, great. Thank you so much.

(Operator Instructions) Doug Mewhirter, SunTrust.

Good afternoon, I just had two very quick numbers questions and one bigger picture question.

First, the numbers questions. What was your average total debt to EBITDA in your portfolio of companies? If you have that handy.

Ross, I don't think that's a number we previously released, so we are not going to be able to give it to you on this call because of FD-related issues. But let us look into that and, if we can release that, we will get back to you.

Can you say whether it has been rising, falling, or holding steady over the past two or three quarters?

I would say that over the last two or three years it's been increasing, along with markets generally. I think in the last two or three quarters it has not moved meaningfully.

Okay. And my second numbers question is could you remind me what kind of goals you have with the SLF in terms of capacity on an invested capital basis or -- invested equity basis or on a total capacity to absorb fund loans basis? So would you put in -- are you going to have $50 million invested and $200 million of loans in the facility or something like that? I don't know if you had mentioned that before.

It's a developing strategy; there is no one goal that we anticipate hitting and then stopping. I think the book ends are probably the best way to look at this. So one bookend is we've got to be mindful of our 30% basket, which investments in SLF would fall into. We currently are very, very far away from our 30% baskets, so this is not a big concern.

Another is we want to look at running SLF over time with sufficient scale to be able to achieve real efficiency in our debt financing costs. So that means at a practical level, unless market conditions change, that we are going to want to run it at a size where we can have one or two securitizations underlying the Company. A typical securitization minimum efficient scale is about $300 million of assets.

So I guess where I am headed is I think about this in stages. Stage one is to get this to $350 million to $400 million of assets at a roughly 3 to 1 leverage ratio with the goal of then reducing our financing costs through a securitization. And at that point we would revisit and think about whether it makes sense to grow it further.

Again, just at the risk of stating the obvious, when I talk about SLF, I don't mean to be implying that we are the only ones making decisions with respect to it. We are not. All decisions at the SLF level are -- all meaningful decisions are joint decisions.

Thanks, that's a very comprehensive answer. My last question regarding the one-stop. Obviously you are a major participant leader in that one-stop market and so you have a lot of visibility into what's going on.

It is widely known that banks have pulled way back from middle market lending. There have always been a lot of thanks, though, sort of floating around the one-stop market popping up here and there. Do you think -- has their activity just in the past year, calendar year-to-date or over the past 12 months, has that stabilized or are they still sort of leaking out of the market? Or have some of them come back in?

I don't think there has been a meaningful change. You see a little bit of change in terms of the cast of characters, but in terms of overall level of involvement and relevance, I don't think there has been a meaningful change. I think we have seen a fairly dramatic pullout over the course of years and I don't sense a change in that.

Okay, great. Thanks. That's all my questions.

Jon Bock, Wells Fargo Securities.

One more question, and this is an item that has affected a number of BBC managers. If you look at the recent equity issuance that has occurred in the space, it is -- in some cases shareholders are describing that as problematic.

At best, in some cases for BDCs it's a push on an earnings basis. At worst, it's a complete degradation of shareholder value given that the manager is not going to be able to reinvest at spreads that are appropriate to cover their required rate of return on the equity issuance.

David, looking at where we are at today with what you are putting on the books, to the extent that you were able to raise equity, where would you fall in that spectrum? Would it be safe to assume that one could earn shareholders more by issuing equity today or not?

And if the answer is it's the push, what does it look like in terms of --? How would you consider raising new equity if new shareholders wouldn't get a chance to benefit?

I'm going to answer the last question first because I think it's easy for us. I have often said this in the context of our new equity issuances that they have to be good for new investors, old investors, and the manager or we shouldn't do them. That's our philosophy. It's been our philosophy since day one.

In the current environment, we have adapted a number of strategies in an effort to improve our ROE in the context of a challenging environment. One of those strategies has been to increase our focus on one-stops where we see a particularly attractive risk/reward. One of our strategies has been to use some incremental leverage and to focus on reducing our cost of leverage. A third strategy has been to develop and to ramp up our senior loan fund.

Not among our strategies has been the issuance of large amounts of equity. We have been very sparing in our equity issuances. We have done small equity issuances that have been non-dilutive even in the quarters in which we have done them. And I think what you should anticipate as investors going forward is that we are going to continue to use the same philosophy and the same approach, the same way of thinking going forward.

I will add one other point, Jon, which is something that I have said before. It puzzles me why investors can simultaneously be focused, and I think appropriately focused as you just were in your question, on asking management teams about accretiveness of share issuances and at the same time routinely approve BDC proposals to issue shares below book. BDCs can't issue shares below book unless their shareholders approve it.

We have consistently said, and we will continue to consistently say, that we are not going to ask. We don't think it's the right thing to do, but we are consistently puzzled by the fact that these proposals routinely pass by wide margins.

We will remain as perplexed as you are, although I would say the more that people understand the harm that comes through poor issuance of equity the better off the entirety of the space is. Might not be good for some managers, but good for us all. So thank you for taking the question.

We have no further questions at this time.

Once again thanks, everybody, for joining us today. As always, if you have any questions that you would like to discuss, please feel free to reach out to me or to Ross at any time.

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