Golub Capital BDC Inc (GBDC) 2018 Q1 法說會逐字稿

Welcome to Golub Capital BDC, Inc.'s December 31, 2017, 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 unsecurities or 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 the company intends to refer to on today's earnings conference call, please visit the Investor Resources tab on the homepage of the company's website, www.golubcapitalbdc.com, and click on the Events/Presentations link to find the December 31, 2017, investor presentation. Golub Capital BDC's earnings release is also available on the company's website in the Investor Resources 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, Katie, and hello, everyone. Thanks for joining us today. I'm joined by Ross Teune, our Chief Financial Officer; and Gregory Robbins, Managing Director.

Yesterday afternoon, we issued our earnings press release for the quarter ended December 31, 2017, and we posted an earnings presentation on our website. We're going to be referring to that presentation throughout the call today.

The quarter ended December 31, 2017, was another strong quarter for GBDC. We were able to continue our momentum from the prior fiscal year. For those of you who are new to GBDC, our investment strategy is, and since inception, has been to focus on providing first lien senior secured loans to healthy, resilient middle-market companies that are backed by strong partnership-oriented private equity sponsors.

I'm going to start today's discussion by providing an overview of GBDC's results for the first fiscal quarter of 2018. Ross is then going to take you through the results in more detail, and I'll come back at the end for some closing remarks. Then, we'll take questions. So with that, let's get into this quarter's results.

Net -- increase in net assets resulting from operations, in other words, net income for the quarter ended December 31, 2017, was $21.3 million or $0.36 per share as compared to $22.5 million or $0.38 per share for the quarter ended September 30.

Net investment income, or as I'd like to call it income before credit losses, was $18.5 million for the quarter or $0.31 per share as compared to $18.3 million or $0.31 per share for the quarter ended September 30. If you exclude a $0.7 million accrual for the capital gains incentive fee, net investment income was $19.2 million or $0.32 per share as compared to $19.1 million or $0.32 per share for the quarter ended September 30, consistent with previous quarters, we provided net investment income per share, excluding the capital gains incentive via accrual, as we think this adjusted NII is a more meaningful measure.

Net realized and unrealized gain on investments for the quarter were $2.8 million or $0.05 per share, and this was the result of $0.5 million of net realized gains and $2.3 million of net unrealized depreciation. This compares to a net realized and unrealized gain on investments and secured borrowings of $4.2 million or $0.07 per share for the prior quarter.

On December 28, 2017, we paid a quarterly distribution of $0.32 per share, and we also paid a special distribution of $0.08 per share. Excluding the special distribution, our net asset value per share would have increased as of December 31, 2017, because our earnings per share of $0.36 exceeded our regular quarterly distribution of $0.32 per share. As a result of the special distribution, our NAV per share declined to $16.04 as of December 31 from $16.08 as of September 30.

New middle-market investment commitments totaled $142.2 million for the quarter. Approximately 27% of the new investment commitments were senior secured loans, 72% were one-stops and 1% were investments in equities. Overall, total investments in portfolio companies at fair value increased by approximately 2.3% or $38.4 million for the quarter ended December 31.

Turning to Slide 4. You can see in the table the $0.36 per share we earned from a net income perspective, the $0.32 per share we earned from an NII perspective before accrual for the capital gains incentive fee and our net asset value per share of $16.04. As shown on the bottom of the slide, the portfolio remains well diversified with investments in 190 different portfolio companies and an average size of $8.6 million per investment.

With that, I'm going to turn it over to Ross who'll provide some additional portfolio highlights and discuss the financial results in more detail. As I mentioned, I'll come back at the end for some closing remarks, and then we'll take questions.

Great. Thanks, David. I'll turn on Slide 5. This slide highlights our total originations of $142.2 million and total exits and sales of investments of $101.9 million, contributing to net funds growth of $38.4 million for the quarter. Total payouts, which were elevated last quarter, as you can see, returned to a more normalized level for the quarter ended December 31.

Turning to Slide 6. This slide shows that our overall portfolio mix by investment type has remained very consistent quarter-over-quarter with one-stop loans continuing to represent our largest investment category at 80%.

Turning to Slide 7. This slide illustrates the fact that portfolio continues to remain well diversified with an average investment size of $8.6 million. Our debt investment portfolio remains predominantly invested in floating rate loans and there have been no significant changes in the industry classification percentages over the past year.

Turning to Slide 8. The weighted average rate of 7.5% of new investments this quarter was up from 7.3% the previous quarter. This was primarily due to an increase in LIBOR. An increase in LIBOR was also the primary cause for the increase in the weighted average rate and investments that paid off during the quarter. In general, market pricing on new investments remained stable, as the weighted average rate on new investments remained unchanged from the prior quarter at LIBOR plus 6%. 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 current LIBOR, the spread over LIBOR and the impact of any LIBOR floor.

Shifting 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 amount earned on investments including interest and fee income but excludes the amortization of discounts and upfront fees. The income yield increased to 7.9% for the quarter, again, primarily due to an increase in LIBOR. The investment income yield, which includes the amortization of fees and discounts remained unchanged at 8.5%.

Last on this chart, the weighted average cost of debt, or the green line, this increased to 3.9%, again, due to an increase in the LIBOR rate.

Moving 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. These percentages decreased from the prior quarter as 1 portfolio in company investment was liquidated at a value consistent with its mark at September 30.

Turning to Slide 10. The percentage of investments risk rated 5 or 4, our 2 highest categories, remained stable quarter-over-quarter and continued to represent over 85% of the portfolio. As a reminder, independent valuation firms continue to value approximately 25% of our investments each quarter.

Reviewing the balance sheet and income statement on the following 2 slides, we ended the quarter with total investments at fair value of $1.72 billion, total cash and restricted cash of $77.1 million and total assets of just over $1.8 billion. Total debt was $828.3 million, this includes $451 million of floating rate debt issued through our securitization vehicles, $267 million of fixed rate debentures and $110.3 million of debt outstanding in our revolving credit facility.

Total net asset value per share was $16.04. Our GAAP debt-to-equity ratio was 0.87x while our regulatory debt-to-equity ratio was 0.59x. These are both up from the prior quarter, but still below our target.

Flipping to the statement of operations. Total investment income for the quarter ended December 31 was $36.5 million. This was an increase of $1.5 million from the prior quarter, up primarily due to an increase in dividend income received from our investment in our Senior Loan Fund.

On the expense side, total expenses were $17.9 million, an increase of $1.2 million, which were primarily caused due to higher incentive fee expense.

Turning to the following slide. The tables on the top provide a summary of our quarterly distributions and return on equity over the past 5 quarters. Our regular quarterly distributions have remained stable at $0.32 a share, which is consistent with our net investment income per share when excluding the accrual for the capital gains incentive fee. As David mentioned earlier, we paid a special distribution of $0.08 per share during the quarter ended December 31, as our GAAP in taxable net income exceeded net investment income for the calendar year. The annualized quarterly return based on net income was 8.8% this quarter and has averaged 9% for the past 5 quarters.

The bottom of the page illustrates our long history of increasing NAV per share over time. For historical comparison purposes, we have presented NAV per share, both including and excluding special distributions.

Turning to Slide 14. This slide provides some financial highlights for investment in Senior Loan Fund, which showed improved performance with an annualized quarterly return of 11.4% for the quarter ended December 31. This is primarily due to a net gain on mark-to-market valuations.

Total investments at fair value declined by 7.2% to $279.3 million, as we experienced an increase in prepayments and slower new investment activity during the quarter. Due to the decline in total investments held by the Senior Loan Fund over the past few quarters, we downsized the credit facility from $300 million to $200 million, also reduced pricing by 10 basis points to save on unused fees and to improve returns.

Turning to the next slide, we had approximately $150 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 at the end of the quarter.

Slide 16 summarizes the terms of our debt facilities. And last, on Slide 17, our board declared a quarterly distribution of $0.32 per share, payable on March 30 to record -- to holders of record as of March 8.

I'll now turn the call back to David, who will provide some closing remarks.

To sum up, as I mentioned at the outset, GBDC had another strong quarter on the back of a solid fiscal 2017. And that comes despite continued borrower-friendly environment. I want to close with an update on 3 themes that I highlighted last quarter.

First, we said last quarter that we are likely to see continued pressure on pricing leverage in terms, in other words, that we're likely to continue to see credit market inflation. We were right. Trend shows no sign of abating. Industry data suggests spreads were on average about 50 to 100 basis points tighter at the end of 2017 versus the beginning and leverage was about 0.25 to 0.5x higher. Documentation terms remain borrower-friendly and covenant light executions have become increasingly common for high-quality larger middle-market issuers. At the same time, capital continues to flow into our space. By most accounts, 2017 was a record year for fundraising. These factors all suggest us that borrower-friendly market conditions are likely to continue for the near term.

Second, we said last quarter that although the influx of new capital to our market was going to put pressure on everybody's returns that we anticipated increase dispersion, in other words, that some lenders will do a lot better than others. This trend also shows no sign of abating. We continue to see generally solid credit trends in the market, but some of our industry brethren are reporting a striking number of underperforming borrowers, especially our competitors focused on junior debt. Looking forward, we think the new tax law could exacerbate this trend by limiting interest expense deductions to 30% of EBITDA and by eliminating NOL carrybacks. The new tax law has the potential to amplify downturns for highly leveraged issuers with high-cost debt. We expect the winners are going to continue to be large platforms with significant competitive advantages and a focus on first lien senior loans to healthy, resilient companies.

Third observation theme that we discussed last quarter was that we said although the current credit cycle seems long by historical standards, that this time is indifferent. We talked about how this cycle will end the way past cycles have, and our view on this point hasn't changed. In our experience, and with apologies to Ernest Hemingway, credit cycles end in 2 ways, gradually and then suddenly. We're in the gradual phase now. It's too early to tell if the recent surge in market volatility constitutes a turning point, but it's certainly a reminder that conditions can change quickly and unexpectedly. So in short, our outlook is very much unchanged from last quarter, and our plan is also largely unchanged. We plan to stay very selective on new investments to lean in and leverage our competitive advantages and to prepare to play more often when market conditions improve. We think this approach will help us to continue to modulate credit losses into deliver steady predictable earnings in a challenging environment.

Thanks for your time today and for your partnerships, and Katie, if you can please open the line for questions.

(Operator Instructions) And our first question comes from the line of Christopher Testa with National Security Corporation.

David, just curious, we saw one-stop loans fall back down towards 77% after being in kind of the 85% plus range the previous couple quarters. Is this drop-off because M&A has been light? Or because you guys are just kind of backing away from more of the leverage that's being pushed on one-stop loans from sponsors?

I should see neither. We don't run our business to hit a specified target percentage of new investments in a particular category. We look at the opportunities that come in and figure out which of them are attractive credits and drive to win a disproportionate share of those that we see that are attractive. Some quarters that works out without higher or lower percentage of traditional senior secured versus one-stops, it really depends on what's in the market and what our sponsors want. I think what you are seeing this quarter is just [natural] variation.

Okay. That's fair. And just curious with yields where they are. Obviously, you had reduced the credit facility in the SLF, pointing to that being smaller or not a priority of capital allocation in the current environment. I mean, how much would structures in terms kind of have to reverse? I mean, how many more todays, I guess, would we have to see before it becomes conducive for you to be allocating capital to an SLF-type vehicle?

It's a great question. I think the real answer is we don't know. It's not a question of number of days. It's a question of what's it going to take in order to change the way risk is perceived and priced in the marketplace. Right now, we've got in the small niche called middle-market sponsor finance. We've got an enormous amount of capital that's been raised that's waiting to be deployed both by private equity firms and by debt providers. So one could get pessimistic looking at the amount of capital that's ready to be used when you get pessimistic about it taking a long time for circumstances to change. On the other hand, we know from many prior patterns that what typically happens is that volatility in the equity markets, downturn in the equity markets then leads to volatility and a downturn in the high-yield market, which in turn tends to drop capital away from the broadly syndicated loan market, and then when the probably syndicated loan market has higher spreads or lower secondary prices, that, in turn, impacts the middle market. I think we're likely to see that same pattern recur. We're not yet seeing meaningful weakness in secondary prices in the broadly syndicated loan market. So I think we've got some more days like today to -- before we're going to start to see meaningful changes, and I think we should anticipate that there's going to be a lag between the liquid-trading markets and the middle market.

Got it. Is it safe to say that given all the capital that's been raised and everything else that you rightfully pointed out that it's really looking like it's going to take a couple large debt funds just basically imploding for us to see a backup in yields in terms?

I'm not sure I'd go that far. I think there is a substantial amount of capital that is in the middle market that can flow out of the middle market opportunistically into broadly syndicated land and high-yield land. And so I think that a change in risk perceptions and risk-related pricing in those 2 markets will be very impactful on the middle market.

Okay, great. And last one for me. Just with prepayment activity a lot lighter this quarter relative to last quarter. What drove the slight increase in the fee income quarter-over-quarter?

I'm not sure of the answer off the top of my head, but let's get back to you on that.

Yes. And the big increase was the dividend income. Obviously, fee income went from $330,000 to $500,000, so a $200,000 increase. I think that's just an amendment fee and maybe prepayment fee on 1 or 2 transactions. But the big increase was the dividend income which went from $1 million to $2.5 million, and again, that was mostly attributable to increased dividend income from the Senior Loan Fund.

All right, our next question comes from the line of Robert Dodd with Raymond James.

Just one question to be honest(inaudible). David, what's your view on how rates moving are going to impact achievable yields, either in the middle market or your portfolio. I mean, obviously, if I look at the chart on Page 8 of the presentation, right, I mean, we've got LIBOR, again, a year ago, of 1%, now it's at 1.70% on this chart, yet the income yield, obviously, it only moved 20 basis points. Do you think that the level of pricing competition, et cetera, et cetera, and repricings and moves, are those -- is that competitive environment likely to eat up any or a majority, or however, you characterize it of your potential positive exposure to rising rates? Because obviously floating rates portfolio, if rates go up, it should be beneficial and less competition eats it. So if you've got a view on that.

So I don't view these 2 as being as closely connected as your question implies. So there are 2 phenomena and they're both happening. I -- the first phenomena is that LIBOR is increasing. And my expectation is that LIBOR is going to continue to increase. The U.S. economy seems very strong and the Fed appears to be signaling a desire to have some additional increases at the LIBOR forward market certainly indicates that the market anticipates some further debt tightening and LIBOR increases. A separate phenomenon is, Robert, as you pointed out, that we've seen competitive pressure on spreads. And that has caused spreads to come down. I wish I could tell you that I thought that the pressure on spreads was over and that we were entering a new period where we were going to see spread widening. I want to expressly say the opposite. I said in the closing remarks, we talked last quarter about how we anticipated that there was going to be continuing competitive pressure on spreads leverage in terms and that we were right and that, that pressure is continuing. I anticipate that pressure is going to continue for some time.

All right, our next question comes from the line of Ryan Lynch with KBW.

As I look at your [guys'] liability structure, you guys have about $550 million of debt approaching its reinvestment period in 2018. $450 million of that approximately is in securitization debt, and as of now, you're unable to issue anymore. So as you guys kind of envision and plan out 2018, how do you envision the composition of your liability structure looking like 12, say, 12 months from now?

So great question, Ryan. And just to contextualize this for everyone, we have within GBDC, 2 securitizations that we organized before the date that the new risk retention rules became effective. And post the effective date of the risk retention rules, it is no longer possible for an externally managed BDC to issue a new securitization, and simultaneously the incompliance with the '40 Act and with the risk retention rules. We have been in discussions with the SEC about this Catch-22 for some time. And we continue to be optimistic that we're going to be successful in receiving no-action relief from the SEC that will permit GBDC to once again use securitizations. I'm not sure when exactly we're going to get that relief. And the good news is that we have a lot of different potential sources of capital, debt capital to take the place of securitizations if we need to. I prefer to use securitizations. I think that's better for the company and its shareholders. But if we don't have access to that market, we will look at a variety of different other potential sources of debt capital, including an expansion of our bank facility. So I'm -- to summarize, I'm hopeful that we will be able to resolve this issue and issue securitizations again. But in the absence of being able to do so, I think there are other debt facility options that the company has that we'll avail ourselves of in order to extend the reinvestment period of most of the capital that we've got in the BDC.

That's helpful now. It sounds -- as you mentioned, it sounds like you guys are pretty positive or positively positioned and you think you can get the securitization debts refinanced, but if that's not the case and they don't grant you relief and you guys are forced to take other actions, I mean, the securitization debt is very low-cost debt. The credit facility is very low cost as well. I think, it's a little bit higher. Would you guys look to just balloon up your credit facility and put it all that debt on the credit facility? Or would you also look to issue some unsecured debt? And the reason I asked is because if you guys don't want to put everything on a credit facility, which I know most investors don't do that favorably to have that much concentration on credit facility, you would have to think that the debt cost could go meaningfully higher. And again, I know this is all hypothetical if -- only if you guys can't get the securitization debt refinanced.

I think we have other options to create other debt facilities at cost analogous to our current bank facility so that we could achieve our desired goal of reasonable cost, reasonable diversification of lender, reasonable diversification of reinvestment period. I agree with you it would not be -- I agree with you that we could do a better job of that if we get permission to go back to do securitizations, but I don't think it's going to result in enormous increases in debt cost if we can't.

Okay, that's helpful. And then I just had one kind of higher level question. You obviously have a very good pulse on the market. And with tax reform passing, I'm sure you guys are going to evaluate this and get a lot of questions at the year with it(inaudible). But as you guys are working with PE sponsors and borrowers, are you guys getting any indication that those PE sponsors or borrowers are looking to use less leverage because of the interest deductibility? I mean, I know you guys focus on higher-quality companies and one of the things with higher-quality companies is that they can usually have a higher leverage level because they can handle that low because they're positioned very well. So are you seeing any indication in the market that, that PE sponsors are looking to use any bit of less leverage due to the tax reform going through?

No. We're seeing some increased attention to tax structuring, tax planning by everybody. I think that includes individual investors and institutional investors. It's appropriate in the context of the major tax law change for everybody to look at all their activities and figure out whether their ways in which they can adjust their practices to optimize their results given changed tax rules. We're seeing a lot of that, but I'm not seeing signs that, that will result in less borrowing.

All right, and our next question comes from the line of Jonathan Bock with Wells Fargo Securities.

Joe Mazzoli filling in for Jonathan Bock. The first question relates to bank competition in the middle market. We've seen just in the new year, large unitranche deals like Mr. Eye Doctor (sic) [MyEyeDr.] finding lower cost options in the syndicated market. So David, I'm really kind of curious if you could provide some color around the various segments of the middle market where Golub could opportunistically step into. Are you seeing more value kind of, I guess, lower end of the middle market is not appropriate, but may be deal sizes of $100 million to $200 million versus kind of larger $500 million plus where those issuers could easily find solutions, potentially in the syndicated market.

Well, let me reframe your question. If you're saying is it the case that larger middle-market borrowers, say, $40 million EBITDA and up borrowers, are today seeing conditions that for them are very attractive in the broadly syndicated loan markets, I would say you're absolutely right. And we've had a number of obligors, including MyEyeDr., who were able to refinance debt facilities with us by using debt facilities that are broadly syndicated facilities with meaningful savings to the obligor. And I think that's a reflection of the market we're in. We continue to find some of those larger borrowers for whom we are a very high value-added lender because of other attributes that our debt facilities have that may justify somewhat higher pricing, they justify somewhat more extensive covenants. Those other attributes include better scalability, better speed, better confidentiality, variety of others. So we continue to operate in, in an environment in which we've got to find opportunities that our competitive advantages matter in. That's our biggest challenge right now. We've got to lean in on our competitive advantages and identify situations where our financing solutions are compelling. If you're asking is that harder today? You bet.

That's very helpful. And no doubt that the partnership that the Golub provides is certainly very valuable. The next question is -- so this is -- the investment community certainly appreciates GBDC's NOI comfortably covering the dividend quarter-after-quarter, but what is also very interesting and notable about GBDC is that GAAP EPS is fairly consistently also above the dividend, and in most cases, above NOI. So I think much of this is or quite a bit of this is related to consistent modest equity gains. So if you could just kind of remind us what percentage, if you had to estimate of new investments, have equity co-investments as part of the deal?

What percentage of new investments. I -- I'm -- I don't want to give an off-the-cuff answer to that in terms of the proportion of the new platforms that we invest in. I can tell you if you flip to Page 6 of the presentation that equities represent 3%, 4%, of the aggregate portfolio. And that number has been pretty steady over an extended period of time. My guess, if you ask me, what proportion of the 180 companies that we have, do we have equity positions in, it'd be about 1/3. And I can get back to you with that exact number.

Okay. That's very helpful. And yes, I certainly know equity is not a core strategy, but there is additional kind of kickers are certainly very valuable. And then the next -- the final question. This is really kind of more [traumatic], but I'm curious, your thoughts here. We just saw, I think today, KKR management announced that the board was going to evaluate potentially converting into a C corp. Because with the tax changes, the benefits of the partnership were not as substantial given the lower corporate tax rate. I'm curious if you think this might be something that BDCs could consider, especially given that -- for example, maybe if the leverage bill doesn't come through, and in a platform like Golub, who focus on more senior secured opportunities wanted to put more leverage on the portfolio.

I think that -- as I mentioned earlier that the changes in tax that are rising from the tax bill are currently being studied by tax lawyers and tax accountants and management teams all over the country. And I don't think that's a process that's going to end anytime soon. Many companies that are pass-throughs that have, as shareholders, not many nontaxable entities are coming to the conclusion that they're better off being C corps. The fact that BDCs have the capacity to not pay tax so long as they distribute their income, puts BDCs in a starting position that's pretty favorable. So I think what any BDCs thinking about becoming a C corp would need to consider is the disadvantage that doing so would create for nontaxable investors relative to the advantage that it would potentially create for taxable ones. I think this is a challenging area where I'll be the first to say, I don't have all the answers yet.

(Operator Instructions) All right, it appears there are no further questions at this time.

Great. Well, thank you, Katie, and thanks, everyone, for listening today. As always, we appreciate your time and your partnership. If you have any questions that we did not cover today, please feel free to reach out to Gregory or Ross or to myself. And we look forward to talking to you next quarter.

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.