Golub Capital BDC Inc (GBDC) 2017 Q1 法說會逐字稿

Welcome to Golub Capital BDC Inc's December 31, 2016, 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 the statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance. Our results involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result 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 accompanying terms referred to on today's earnings conference call, please visit Investor Resource tab on the homepage of the Company's website at www.GolubCapitalBDC.com and click on the events presentation link to find the December 31, 2016 investor presentation. Golub Capital BDC's Earnings Release is also available on the Company's website in the Investor Resource section.

Also, as a reminder this call is being recorded for replay purposes. I will now turn the conference over to David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead, sir.

Thanks, Operator. Hello everybody and thanks for joining us today. I'm joined by Ross Teune, our CFO and John Simmons, Director at Golub Capital. Yesterday afternoon we issued our earnings press release for the quarter ended December 31 and we posted an earnings presentation on our website. We're going to refer to this presentation throughout the call today. I'll start by providing an overview of the December 31 quarter. Ross is then going to take you through the results in more detail and then I'll come back and provide some closing remarks and open the floor for questions.

The quarter ended December 31 was another solid quarter for GBDC. For those of you who are new to GBDC, our investment strategy is and since our inception has been providing first-lien senior secured loans to healthy resilient middle-market companies backed by strong partnership-oriented private equity sponsors. As we discussed last quarter, the competitive environment in middle market lending has grown more challenging; and in particular, it grew more challenging over the course of calendar 2016. It went from a relatively lender-friendly environment to the beginning of calendar 2016 to a relatively borrower-friendly environment toward the end of 2016.

We pursued and we continue to pursue a strategy of leveraging the competitive advantages of the Golub Capital platform to sustain strong performance. Advantages such as our leading market position, our long term relationships with private equity sponsors and our ability to deliver compelling buy-and-hold one-stop solutions in size. Let me dive into the details of this quarter's results.

Net increase in net assets resulting from operations, in other words net income for the quarter ended December 31 was $19 million or $0.34 a share compared to $16.1 million or $0.30 a share for the quarter ended September 30. Net investment income, or as I call it income before credit losses, was $16.9 million for the quarter ended December 31 or $0.31 a share as compared to $17.2 million or $0.32 a share for the quarter ended September 30. Excluding a $500,000 GAAP accrual for the capital gains incentive fee, net investment income for the quarter was $17.4 million or $0.32 per share, roughly flat with the prior quarter. Consistent with previous quarters, we provided net investment income per share excluding the GAAP capital gains incentive fee accrual as we think this adjusted NII is a more meaningful measure of income before credit losses.

Net realized and unrealized gains on investments and secured borrowings for the quarter were $2 million or $0.03 a share and that was the result of $0.9 million of net realized gain and $1.1 million of net unrealized depreciation; so we had another quarter of what I call negative credit losses. On December 29, 2016, we paid our usual quarterly distribution of $0.32 per share and we also paid a special distribution of $0.25 a share. As a result of the special distribution, our net asset value per share declined to $15.74 at December 31 from $15.96 at September 30. Excluding this special distribution, our NAV per share would have increased to $15.99 at December 31 as our earnings per share of $0.34 exceeded our regular quarterly distribution of $0.32 per share.

New middle market investment commitments totaled $113.6 million for the quarter ended December 31. Consistent with recent quarters we continue to focus our origination efforts on our one stop product and about 70% of our origination activity in the December 31 quarter was in one stops with the vast majority of the balance in traditional first lien senior secured loans. Overall total investments in portfolio companies at fair value increased by 2.1% or $35.7 million during the quarter after payoffs and sales to our Senior Loan Fund.

Turning to slide 4, you can see in the table the $0.34 we earned from a net income perspective; the $0.32 per share we earned from an NII perspective before accrual for capital gains incentive fee; and our NAV per share of $15.74. As shown on the bottom of the slide, the portfolio remains well diversified with investments in 182 different companies and average size of $8.7 million per investment.

With that, I'll now turn it over to Ross who is going to provide some additional portfolio highlights and discuss the financial results in more detail. As I mentioned, I'll come back to provide market perspective and open the floor for questions after that.

Thanks, David. Turning to slide 5 as David mentioned, we had total investments in middle market companies of $113.6 million and total investments of $122.7 million when including a $9.1 million investment in SLF. Total exits and sales of investments were $93.9 million and net funds growth was $35.7 million.

Turning to slide 6, this slide shows our quarterly portfolio mix by investment type which has remained very consistent quarter over quarter with one-stop loans continuing to represent our largest investment category at 79% of the portfolio.

Turning to slide 7, this slide illustrates the fact that our portfolio continues to remain well diversified with an average investment size of $8.7 million. Our debt investment portfolio remains predominantly invested in floating rate loans and there have been no significant changes in the industry classifications over the past year.

Turning to slide 8, the weighted average rate of 6.9% on new investments this quarter was down from 7.6% the previous quarter. As we noted on our last call, the increase in the weighted average rate on new investments last quarter was largely the result of a few higher-spread loans originated and not a general market move. As a reminder the weighted average interest rate on new investments is based on the contractual interest rate at the time of the funding. For variable rate loans, the contractual rate will be calculated using current LIBOR, the spread over LIBOR and the impact of any LIBOR floor.

Switching to the graph on the right hand side, this graph summarizes investment portfolio spreads. Focusing first on the light blue 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 up-front origination fees. The income yield decreased by 10 basis points to 7.7% for the quarter. This was primarily due to a $300,000 decrease in prepayment fees.

The investment income yield, or the dark blue line, which includes the amortization of fees and discounts decreased by 40 basis points to 8.1% at December 31 as OID amortization declined by nearly $1 million due to a decrease in payoffs. The weighted average cost of debt, or the green line, remained stable at 3.4% for the quarter.

Looking to the next slide, credit quality remained strong with nonaccrual investments as a percentage of total investments at cost and fair value of 0.3% and 0.1%, respectively, as of December 31. These percentages were unchanged from the prior quarter and there were no new loans added to nonaccrual status during the quarter.

Turning to slide 10, the percentage of investments risk rated a 5 or 4, our two highest categories, remained stable quarter over quarter and they continued to represent over 85% of the portfolio. As a reminder, independent valuation firms value approximately 25% of our investments each quarter.

In reviewing the more detailed balance sheet and income statement on the following two slides, we ended the quarter with total investments at fair value of nearly $1.7 billion, total cash and restricted cash of $71.7 million and total assets of almost $1.8 billion. Total debt was $889.5 million which includes $451 million in floating rate debt issued through our securitization vehicles, $283 million of fixed rate debentures and $155.5 million of debt outstanding on our revolving credit facility.

Total net asset value on a per-share basis was $15.74. Our GAAP to net equity ratio was 1.03 times at December 31 while our regulatory debt to equity ratio was at 0.7 times. These are both up from last quarter and very close to our targets.

Flipping to the statement of operations. Total investment income for the quarter ended December 31 was $33.8 million. This is down $0.7 million from the prior quarter primarily due to lower OID amortization and lower fee income.

On the expense side, total expenses of $16.9 million decreased by $0.4 million from the prior quarter primarily due to a decline in incentive fee expense which was partially offset by higher interest expense resulting from higher average debt outstanding. As David highlighted earlier, we had net realized and unrealized gains of $2 million and net income for the quarter ended December 31 was $19 million.

Turning to the following slide, the tables on the top provide a summary of our quarterly distributions and return on equity over the past five quarters. Our regular quarterly distributions have remained stable at $0.32 per share which is consistent with our net investment income per share when excluding the GAAP accrual for the capital gains incentive fee. As David mentioned earlier, we paid a special distribution of $0.25 per share for the quarter ended December 31 as our GAAP and taxable income have exceeded net investment income over the past few years.

The annualized quarterly return based on net income was 8.6% this quarter and has averaged 8.4% for the past five quarters. The bottom of the page illustrates our long history of increasing NAV over time. For historical comparison purposes, we have presented NAV per share both including and excluding the $0.25 special distribution.

Turning to slide 14, this slide provides some financial highlights for our investment in Senior Loan Fund. The Senior Loan Fund experienced an increase in its return as compared to the prior quarter, but is still below our long-term target of a low-teens return. The annualized total return for the quarter ended December 31 was 7.1%. This was negatively impacted by a decline in the valuation of one investment that is on non-accrual status. Total investments at the Senior Loan Fund at fair value were $333.3 million at the end of the quarter.

Turning to the next slide, as of December 31, we had nearly $100 million of capital for new investments through restricted and unrestricted cash, availability on our revolving credit facility and additional debentures available through our SBIC subsidiaries. Subsequent to quarter end, we received approval for our third SBIC license which will allow us to issue an additional $50 million of debentures. Through our three SBIC licenses, we are now able to issue up to $350 million of fixed-rate debentures which is the regulatory cap for licenses under common control.

In regards to our investment in our Senior Loan Fund or SLF, in late December, based on approval from both co-managers, SLF recapitalized its balance sheet by redeeming and terminating the subordinated note commitments and replacing this capital with equity commitments and contributions in the like amount. There's no economic impact to GBDC as a result of this simplified capital structure, but it does change the geography of income from our investment in SLF which will now be recorded as dividend income on the income statement as opposed to a combination of interest and dividend income.

Slide 16 summarizes the terms of our debt facilities. And lastly, on slide 17, we have summarized our distributions including the two distributions both regular and special, declared by our Board that David highlighted in his opening remarks. I will now turn the call back to David who will provide some closing remarks.

Thanks, Ross. So to summarize, GBDC had a solid first quarter of FY17. The key drivers were consistent investment income, strong credit and access to the Golub Capital origination platform. Last quarter I talked about the market environment, about how middle market M&A has been slow and how we've seen signs of what I call credit-market inflation and this story continues. We're seeing some continued spread compression, leverage creep and pressure on documentation and terms.

Rather than talk more about that, I thought this quarter I'd focus on a different issue. The issue for this quarter, where's the economy headed? It's an interesting question, so Mr. Market is optimistic. Credit and equity markets have delivered very strong returns in the last couple of months especially post-election. For the three months ended January 31, the total return for broadly syndicated loans in the BSL market has been at an annualized pace of about 8%, a high yield market up at an annualized pace of about 11.2% and the S&P 500 up at an annualized pace of about 31%. But if we take a closer look at the data, indicators are actually pointing in different directions.

Let's talk first about some positive signs. The economy added 227,000 new jobs in January. That's a little bit over trend and the unemployment rate remained low at 4.8%; we saw some improvements in the participation rate. Initial jobless claims have been near post-recession lows; the four week average for the end of January was 248,000. Consumer confidence is high. It's near a 15-year high per The Conference Board Consumer Confidence Index. The NFIB publishes a small business optimism index which is also showing very high numbers, its highest level since 2004.

So that's on the positive side, but on the other hand there's some broader trends that don't look so good. Corporate profit margins seem to be facing headwinds and the headwinds have identifiable sources, rising wages, rising commodity prices, rising debt-service costs as interest rates have ticked up a bit. We publish, as many of you probably know, we publish a quarterly called the Golub Capital Middle Market Report and it looks at the median EBITDA and revenue growth of companies in our middle market portfolio. And for the fourth quarter of 2016, it told us that corporate profit margins are under pressure in the middle market.

Labor productivity growth remained slow. Productivity increased just 0.2% year over year in 2016 and labor costs increased by 2.6%. That's a bad combination. And in many sectors we're seeing an increasing dispersion between winners and losers. The most obvious example of this is retail, where Amazon and Costco continue to do very well, but much of the rest of the sector not so much. Hundreds of store closings announced already in 2017.

So what does all this mean? We've got a situation where Mr. Market is optimistic, but the data, I think the data argues for caution. Maybe this means that we're in a period post-election where increases in consumer spending and increases in business investment are coming but they're not yet visible; or maybe it means that Mr. Market right now is a little exuberant in his optimism. I'm not sure which it is, but here is the good news.

The good news is that at Golub Capital we're well prepared for both scenarios. What do I mean by that? By investing in loans to healthy resilient middle market companies that are at the top of the capital structure, we think we benefit if economic growth accelerates, if Mr. Market is right. In that scenario, we should see acceleration in deal flow; we should see better credit results. If on the other hand, Mr. Market is too exuberant and we go back to a muddling environment, we think we'll see a marked increase in junior debt default rates and we'll be very happy with our strategy of focusing on senior debt in resilient companies. And I'm hopeful that our portfolio will continue to perform reasonably well.

So no matter what scenario develops here, we're going to continue to do what we do which is to aim to sustain our long-term track record of consistent premium returns. Very interesting period we're in right now, very high degree of uncertainty. So thanks for your time this afternoon and for your partnership. And with that, Operator, let's open the line for questions.

(Operator Instructions)

We'll get to our first question on the line of Jonathan Bock with Wells Fargo.

Good afternoon. Joe Mazzoli filling in for Jonathan Bock here. David, first could you please remind us again of the thought process behind the special dividend last quarter? Clearly shareholders and the market appreciated the additional distribution, but I think it would be helpful if you could briefly outline your thoughts in consideration of retained capital versus the special just to remind folks.

Sure, so for those of you who were not on last quarter's call, we found ourselves at the end of 2016 in a position where our taxable income on a cumulative basis exceeded the distributions that GBDC had made; and so we had a choice. We could pay a special distribution so that we could bring those two into balance or GBDC would need to pay an excise tax on the difference between its cumulative taxable income and its cumulative distributions. I'm simplifying slightly, but that's the broad picture.

If we chose not to do the special distribution, that excise tax would not be a one-time event. It would be an annual event, so every time we would come to the end of the year and we hadn't paid out enough in distributions to match our taxable income, we would have to pay an excise tax.

And so we came to the conclusion that, from a shareholder perspective, that starting on from behind the 20-yard line this was not a good idea, that if we want to earn an ROE that our investors are satisfied with, starting with a negative number and having to earn more than that, 8%, 8.5% to 9% return that our shareholders are expecting us to make, that this was not good for shareholders. So many managers are reluctant to repurchase shares or to pay out special distributions because they earn fees on capital that they keep within the vehicle.

Our approach is a little different. Our approach is to think about this from the perspective of what's good for shareholders and that led us to the conclusion that the right answer was to pay a special distribution.

Thank you for that. That's very helpful and just a quick housekeeping, now was a portion of the special dividend paid under DRIP or there was a special 100% cash?

This is Ross, Joe. If investors participate in the DRIP plan, they would -- those shares -- that cash would be used to issue additional shares.

Okay, I got you. That makes sense and now a broader question. With frothy syndicated markets, has it become more difficult for Golub and other larger middle-market lenders to compete in the upper middle market? Are there more opportunities that you're seeing at Golub within smaller segments of the market with companies who might not be large enough to access the broadly syndicated solution?

Well I'm not sure I'd characterize any of the markets as frothy. I would characterize it as competitive and I'd say we're seeing a competitive market in small deals as well as in larger deals. The main complaint, if I can use that word, the main complaint I'd use right now about where the market is, is that there are too few high-quality companies pursuing M&A transactions and in need of financing.

So we're in an environment right now where M&A is slow and quality-adjusted M&A is particularly slow. I don't think that's a function of upper middle-market companies versus smaller companies. I think it's true across the board and I don't think we're seeing more competitive pressure in upper middle-market transactions than we are in lower middle-market transactions.

We're seeing competitive pressure across the board and our response to it's really simple. Our response is to lean on our competitive advantages, so we're focused on transactions where we not only like the credit, but where we can provide a compelling value proposition to our private equity sponsor clients. That compelling proposition may be because we're the incumbent lender. It may be because it's a sector where we have domain expertise. It may be because we can provide a one stop in size on a highly confidential basis that serves some need that they have.

There are a variety of different ways in which our competitive advantages can be brought to bear, but it is difficult now where if we were a lender without our competitive advantages, I'd describe today's environment as very difficult. With our competitive advantages I'd describe it as challenging.

That is very helpful and certainly appreciate the value of the one stop over syndicated solution. And just one more question for me, this is a follow-up. But with Massage Envy right, I think we saw the tenor was extended two years and pricing was reduced by 50 basis points. So we see massive repricing in the broader markets, I was wondering if you felt pressure from issuers to reduce pricing on existing loans and maybe to refinance into more issuer-friendly pricing similar to this Massage Envy transaction?

So in the broadly syndicated loan market it's reasonably common for there to be repricing transactions. What that basically means is that the borrower works with its agent bank and an amendment goes out to holders of the broadly syndicated loan that gives those holders the choice between accepting a lower spread and getting repaid at par.

In the middle market, that's much less common. It does happen from time to time but it's much less common so we're seeing most the pressure of what I'll call credit market inflation on new transactions and less on the portfolio. This is one of the reasons why the middle market lags the broadly syndicated market. It's not as responsive to changes upward or downward in spread in short periods of time.

Okay thank you for that and that's it for me. Thank you for taking my questions.

We'll get to our next question on the line from the line of Robert Dodd with Raymond James.

Hi guys. Two questions. One, hopefully easy, the other one a little bit harder and more speculative but first, on the SLF, can you give us any color on the motivation for you wanting to convert the sub notes to equity?

Was there any -- because obviously there were unfunded commitments on the sub notes and it's debatable whether that applies to the equity or not in the same way. So was there any push on from either your lenders, the SEC, anything like that about obviously economically to you doesn't matter which way you structure it, but was there any outside factor that triggered the decision to restructure that?

Two reasons why it was useful to do. One is just simplicity. Simple is always better than more complex. And the second is that there's some tax advantages to investors who are taxable to eliminating the subordinated debt. It reduces, this is highly technical, but it reduces something called QII and basically puts distributions from GBDC into a position of generating less tax for shareholders.

Okay, got it thank you. The second one, when we look at the market obviously it is has rallied. Some of that might be driven by economic over-exuberance, perhaps. Some of it may be by -- obviously the expectation that tax rates may change, lower taxes, higher profits maybe, right because we're talking about moving and maybe moving interest deductibility as well, but allowing people to expense capital expenditures up front.

So when I look at industries, obviously one that was last quarter or two quarters ago, we were talking about a software company, low capital intensity, high leverage, good loan. But hypothetically, if the tax rate comes down, but they lose the interest deductibility, but don't have a lot of capital expense, what does that do? Without necessarily focusing on that investment, what does that do to interest coverage for some of these businesses if the tax code gets really shaken up and deductibility of interest versus capital expenditures really moves around. Any kind of feel on that? Obviously very speculative, I understand that.

So I'm really tempted to say I don't know and leave it at that, but I think you aren't going to let me. So clearly this is speculative. I don't think anyone really knows where the discussions about tax reform are going to head right now.

My understanding of the discussions about changes to interest deductibility are that they would be prospective not retrospective and so that existing debt securities or loans would not be subject to the new rules. So if I'm right on that, then the question really becomes how much are companies worth in a new tax regime and how will sponsors in this new regime finance those new companies? I think there's a potential for some change on both of those fronts.

So if a company is going to end up being negatively impacted by the two vectors that move in different directions, the first being elimination of deductibility of interest and the other being lower tax rates. And those do work in opposite directions and I think in some cases companies will actually benefit, leverage companies will benefit from the combination of those, but let's assume that a company is going to see its after-tax cash flow reduced by the combination, then I think its value will go down. So we'll see some diminution in the entity value of companies that fall in that category.

Then the question becomes if a sponsor by such a company will the lack of interest deductibility change the way that they choose to finance the company. We've spent a lot of time thinking about this and our conclusion is that the sponsor is likely to see more things stay the same than to want to change things, because from a sponsor's perspective they are seeking to achieve some targeted rate of return. If debt becomes more expensive because it isn't deductible, that might argue for replacing that debt with more equity.

But if you replace it with more equity, you actually hurt your returns even more because the equity is higher cost than even the higher cost debt. So I think sponsors are going to look at a post-tax reform world and make decisions that are obviously calculated carefully based on the new math of that post-tax reform world. I think in the likely scenarios in leverage-lending land, we're probably not going to see much change.

Okay thank you for that. Thanks a lot.

(Operator Instructions)

We have a question in the queue from the line of Christopher Testa with National Securities.

Hi, good afternoon guys, thanks for taking my questions. Just wondering if you could provide some color on how much the leverage multiples have gone up on one-stops, for now compared to last year at this time? Just how many more deals are effectively falling out of the funnel from sponsors being aggressive in the market at this point?

So hard question to answer because, as you know, the leverage levels on new transactions are very transaction-specific. But I would say if you look at broadly at market trends that we've seen leverage creep in the quarter to half-turn range over the course of the last 12 months.

Okay, great and just wondering also, if you could just talk about how the potential repeal of the DOL, the fiduciary rule; that seems to be put on hold at least. How do you foresee that impacting private fundraising, David, because it seems like that was a big issue for a lot of the private fundraising for BDCs over the past year.

So I think I'm really the wrong person to ask that question. I think you'd probably be better off asking that question of Franklin Square or one of the other firms that are very active in the brokerage channel. The fiduciary rule or absence of the fiduciary rule will have no impact on Golub Capital.

Thank you very much. And we seem to have no other questions queued up at this time. I'll turn it back to you.

Well just reiterate what I said before. Thank you, everyone for tuning in for today's call and thank you for your partnership. If you have any questions over the course of the quarter, please feel free to reach out to me or to Ross and we look forward to talking to you again next quarter.

Thank you very much. Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation and you may disconnect your lines. Have a good day, everyone.