Goldman Sachs BDC Inc (GSBD) 2015 Q3 法說會逐字稿

Good morning. My name is Brent and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. third-quarter 2015 earnings conference call.

(Operator Instructions)

I will now turn the call over to Ms. Katherine Schneider, Head of Investor Relations at Goldman Sachs BDC, Inc. Katherine, you may begin your comments.

Thanks, Brent. Good morning, everyone.

Before we begin today's call, I would like to remind our listeners that today's remarks may include forward-looking statements. These statements represent the Company's beliefs regarding future events that, by their nature, are uncertain and outside of the Company's control. The Company's actual results and financial condition may differ, possibly materially, from what is included in the forward-looking statements as a result of a number of factors, including those described from time to time in the Company's SEC filings.

Yesterday after the market closed the Company issued an earnings press release and posted a supplemental earnings presentation, both of which can be found on the homepage of our website at www.goldmansachsbdc.com under the Investor Resources section. These documents should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC.

This conference call is being recorded today, November 6, 2015 for replay purposes. With that, I will now turn the call over to Brendan McGovern, our CEO.

Thank you, Katherine.

Good morning everyone, and thank you for joining us for our Q3 earnings conference call. In terms of the agenda for this morning's call, I'll start by providing key highlights for the third quarter and some observations on the credit markets. Jon Yoder will then provide color on our investment activity and portfolio metrics before handing it over to Jonathan Lamm, who will take you through a detailed discussion of our financial results. And finally, I will conclude with some closing remarks before we open up for Q&A.

So with that, we are pleased to report very strong operating results for Q3. Net investment income was $0.57 per share as compared to $0.44 for Q2. Two primary factors drove this 30% quarter-over-quarter increase. First, we generated significant investment portfolio growth, funded by borrowings under our credit facility. The resulted increase in investment income produced very strong NII per share for our shareholders. While we were successful growing the portfolio, average debt to equity in the quarter was just 0.58 times, which was still toward the lower end of our target range of 0.5 to 0.75 times. Second, we produced solid prepayment fee income, primarily resulting from the redemption of our second lien loan to Orchard Brands at a premium to par.

As we announced after the close last night, our Board declared a $0.45 per share dividend payable to shareholders of record as of December 31. In Q3 NII exceeded the dividend by $0.12 per share, resulting in 126% dividend coverage. Even excluding the benefit this quarter from prepayment and fee-related income as well as the reduction and total incentive fees caused by the netting of unrealized losses, dividend coverage was 107%.

Investment activity was strong during the quarter, with gross and net originations of $203 million and $146 million respectively. We also funded $28 million of unfunded commitments that were originated in prior quarters. As a result of this activity, our investment portfolio grew 14% sequentially. Jon Yoder will give more detail on our investment activity later on in the call.

Looking forward, we continue to be comfortable with our capital position. We anticipate further portfolio retainment activity, which, together with our available borrowing capacity, should provide ample capital to fund our pipeline of investments.

A few other highlights to note: we are pleased to announce that the Company favorably amended the terms of its credit facility, which reduced the stated interest rate and extended the maturity date, further solidifying the Company's overall capitalization. The lower rate should positively impact our net interest margin, while the maturity extension further enhances our runway. Also, under the previously announced 10b5-1 plan, Goldman Sachs has purchased approximately 165,000 GSBD shares in the open market. This brings Goldman Sachs' ownership stake to 16.5% of the total outstanding shares of the Company.

Moving on to the market. During the quarter, credit markets expressed significant mark-to-market volatility. For context, the S&P LSTA leveraged loan index was down 1.4% during the quarter, which marked the worst quarterly performance in four years. The US [high yield] market sold off as well, with credit spreads widening by over 170 basis points to approximately 650 basis points. Thus far in Q4 we have see a positive shift in sentiment, with rebounds across both equity and credit indices over the past several weeks. With that said, we believe heightened volatility is likely to persist in the coming quarters as investors grapple with concerns over global growth as well as the potential for less accommodative Fed policy.

In light of the volatile environment, I would note two important differentiating factors for [ROBDC]. First, unrealized losses are netted against net investment income, which serves to limit the Company's incentive [see] expense, as was the case this quarter. And second, assuming our portfolio companies continue to perform under credit obligations, we believe NII can continue to exceed our stated dividend, providing the opportunity to spill that excess income over into NAV or return it back to our shareholders in the form of special dividends.

So with that, I'd like to turn the call over to Jon Yoder.

Thanks, Brendan.

While we are very pleased with our strong origination activity this quarter, we are even more pleased by the quality of the deals that we saw during the quarter. In particular, we continue to see attractive lending opportunities through our proprietary channels. As we've discussed on previous calls, we source transactions through Goldman Sachs's deep and long-standing relationships with middle-market sponsors as well as from our large network within the family- and founder-owned business community, which often stems from our colleagues in private wealth management. Our ability to see unique and proprietary deal flow from both of these channels allows us to pick and choose what we believe are the best opportunities, and not be beholden to the cycles or fund flows of a single sourcing channel. During the quarter, a number of the most attractive opportunities came from our proprietary relationships with family- and founder-owned companies. In fact, approximately 57% of new originations during the quarter were made to nonsponsored family- and founder-owned companies.

More recently, we've started to see a shift in the competitive environment to provide financing to sponsor-backed companies. Toward the end of the third quarter and into the fourth quarter, the volatility in the public credit markets caused some of the investment banks that seek to syndicate upper-middle-market transactions for sponsors to get hung with deals that they had expected to sell. This caused these banks to pull back from making new commitments. While we are generally focused on the heart of the middle-market and are not competing with these upper-middle-market-focused banks for new transactions, we are seeing signs that all lenders are a bit more cautious and that fewer lenders have meaningful dry powder.

During the third quarter we made new investment commitments of $203 million, including $6 million in the senior credit fund. Our new originations were comprised of 92% in senior secured loans, 5% in common equity, and a 3% contribution to our senior credit fund. Of the new senior secured loans, 77% were first lien and 23% second lien, and all new loans for a floating rate of interest subject to interest-rate floors. These originations were distributed across seven portfolio companies, including four new portfolio companies and three existing portfolio companies.

During the quarter we had sales and repayments of $58 million, resulting in net origination activity of $146 million. The majority of our repayments came from our second lien loan portfolio. Total investments at fair value at the end of the quarter totaled $1.147 billion, up from 1.005 billion as of the end of the second quarter. This represents a 14% quarter-over-quarter increase. Our unfunded commitments were $50 million, representing only 4% of our total investments at fair value and commitments of as of quarter end. Furthermore, 83% of our unfunded commitments will expire by the end of the year.

The weighted average growth yields of our investment portfolio at amortized cost and fair value was 10.7% and 11.1% respectively. The investment portfolio remains focused on senior secured loans, with 93% of investments by fair value in senior secured assets, including 37% in first lien, 26% in first lien last-out unitranche, 30% in second lien, 3% in preferred stock and common equity, and 4% in the senior credit fund, which, as we previously discussed is comprised exclusively of senior secured loans. The portfolio continues to be focused also on floating-rate investments. 88% of our income-producing assets have a floating interest rate, predominantly subject to interest-rate floors. The portfolio remains well-diversified across investments in 40 portfolio companies operating in 27 different industries with no significant industry concentration risk.

Our new originations in the senior credit fund during the quarter were relatively muted, at $5 million in head-on investments to two existing portfolio companies. Notwithstanding the market volatility that persisted through much of the quarter, borrowers were stubborn in acknowledging the new pricing environment. As a result, we felt that the new issue market offered comparatively little risk premium for the super-senior loans that the senior credit fund generally targets.

In the fourth quarter we've started to see better pricing and structure, which we think bodes well for our origination activity in the senior credit fund for the fourth quarter. We had partial repayments of $1 million from the senior credit funds portfolio during the quarter. So as of the end of the quarter, the senior credit fund's investment portfolio stood at $259 million, with 98% invested in first lien senior secured loans and 2% in second lien secured loans. The senior credit fund is also well diversified across 20 portfolio companies operating in 16 different industries. The annualized yield at cost from the senior credit fund during the nine months ended September 30 was 12.5%, up from 12.2% as of June 30.

I will now turn the call over to Jonathan to walk through our financial results.

Thanks, Jon.

We ended the third quarter of 2015 with total portfolio investments at fair value of $1.147 billion, outstanding debt of $447 million, and net assets of $704 million. As Brendan mentioned, the Company had very strong net investment income in Q3. Our average debt-to-equity ratio was 0.58 times during the third quarter as compared to 0.35 times during Q2. We ended the third quarter with a debt-to-equity ratio of 0.64 times as compared to 0.43 times at June 30. The increase in ending leverage was attributed to net portfolio growth as we have deployed capital into new income-producing assets. Additionally, we monitor and maintain sufficient capacity under the regulatory asset coverage ratio to fund all of our unfunded commitments and our forward pipeline.

Turning to the income statement: total investment income for the third quarter was $32.9 million. This is up approximately $5.6 million from the previous quarter, or 21%. The income growth during the third quarter was primarily driven by higher average income-producing assets, coupled with higher prepayment-related income, which is comprised of prepayment fees and acceleration of original issue discount. The quality of our investment income continues to be very strong, as our NII is not reliant on origination fees, and non-cash PIK income accounted for les than 0.05% of our total investment income in Q3. As Brandon alluded to earlier in the call, the Company has demonstrated solid earnings power, primarily from high-quality interest and dividend income.

Turning to expenses: total expenses before taxes were $12.1 million for the third quarter as compared to $11.4 million for the second quarter. Quarter over quarter, expenses were up, primarily driven by higher interest expense as a result of higher average debt in Q3. This was partially offset by a reduction in total investment advisory fee expenses, as the netting impact of our NII incentive fee formula, which includes net unrealized losses, resulted in lower incentive fee expense. Our net unrealized losses during the quarter were primarily attributed to the dislocation in the credit markets that we saw in August and September. As you will recall, we've a very strong mark-to-market culture at Goldman Sachs, and the impacts of the broader liquid credit markets will impact the marks in our portfolio. Our supplemental earnings presentation provides an NAV bridge to walk you through the changes to our net asset value quarter over quarter.

Finally, as Brendan mentioned earlier, the Company favorably amended and extended its senior secured credit facility subsequent to quarter end. We are grateful for the continued support that we receive from our lenders. The amendment resulted in a reduction of the stated interest rate on the facility from LIBOR plus 2.25% to LIBOR plus 1.75% or LIBOR plus 2%, subject to certain borrowing base conditions. As of today the stated interest rate is LIBOR plus 2%. The final maturity date was also extended by one year to November 2020. The amended credit facility includes an accordion feature that permits the Company to increase its total borrowing capacity up to $1 billion. We believe these are favorable amendments and should positively impact net interest margin for shareholders.

With that, I will turn it back to Brendan.

Thanks, Jonathan.

Overall, we are very pleased to have produced a strong quarter for our shareholders, driven by solid execution of our strategy. This quarter demonstrated our continued ability to tap into proprietary channels to find differentiated investments. It also demonstrated the earning power of the Company, as we moved into our target leverage ratio and produced very strong per share economics for our shareholders.

Subsequent to quarter end we continued to optimize our financing structure as we lowered our cost of borrowings while terming out the maturity of our credit facility. And finally, notwithstanding a more volatile credit market environment, we continue to feel very good about the backdrop of our investment strategy. We believe that an environment of steady, if unspectacular, growth is conducive to solid returns for our strategy, which is, focus on making secured loans to smaller companies with limited access to capital. As always, we remain disciplined in our underwriting standards, as evidenced by the absence of nonaccruals in the portfolio.

Again, we think you for your support. And now, Operator, we'd like to open up the line for questions.

(Operator Instructions)

Jonathan Bock, Wells Fargo Securities.

This is Joe Mazzoli filling in for Jonathan Bock. Thank you for taking my questions.

The first question relates to the dividend, and of course this was a great quarter. You grew the portfolio, increased leverage, which also appears to indicate spillover income in future quarters. So many folks view the spillover income as an efficient way of kind of increasing the size of the portfolio and potentially increasing the dividend going forward. How do you balance that versus a one-time special dividend? If you could provide some color, please.

Sure. Thanks for the question, Joe. I think you hit on a number of germane issues here.

If you look at the story of the quarter, we certainly moved into our target leverage ratio. I think you can see that really had a production of very solid recurring net investment income, which is based on contractual obligations from our borrowers. So a very solid base, a very high-quality income. And certainly this quarter, very successful in over-earning our dividend.

As we look at the go-forward and as we look at the continued opportunity for that trend, we view our role here as managers and stewards of capital in a number of different ways. And I think there's a balance between returning capital to shareholders in the form of that special dividend, as well as the opportunity to maintain a stable NAV, or even attempt to grow the NAV by spilling that over to shareholders. So that's the balance that we are striving to strike here.

It's a conversation we're having on an ongoing basis with our Board. I think suffice it to say, in an environment where there is pretty significant mark-to-market volatility, as we discussed during this quarter, we do want to make sure we are mindful of the impact to NAV and the opportunity to again, have a stable, if not growing, NAV. And that is the balance we'll strike.

At this point there's nothing to report with respect to specials. It is an ongoing conversation that we are having with our Board, and we'd invite you to stay tuned on what we do on a go-forward.

Very helpful. Very helpful, thank you.

The next question, just real quick I noticed Data Driven Delivery Systems, very large investment in the quarter. $69 million first lien commitment with a decent yield. Also common equity in connection with it. Given Goldman's private wealth management platform and the unique sourcing abilities, can you provide some color into this deal specifically?

Let me turn that over to Jon Yoder. I think suffice to say it's an investment we are very excited about. But let me turn it over to Jon to hit on some of those specifics.

Sure. So Data Driven is, I think, a great example of our differentiated sourcing. This is a nonsponsored transaction. Generally speaking, as you can see from our portfolio, we are not doing a lot of equity investing. We do view this as predominately a yield-oriented investment strategy and we think that's what our shareholders are looking for.

That being said, this particular investment did hit on a lot of the -- hit on, frankly, all the boxes that we would typically tick in order to consider an equity investment. Specifically it's a very, very fast-growing company. It has a demonstrable, easy to see and quantify value-added service that it provides to a very stable and blue chip customer base.

And I would also say that there are some pretty obvious opportunities for exit as well. It's very likely -- definitely it's a potential to go to both financial sponsors as well to strategics. And so we like the exit dynamic potential as well.

So it kind of ticked all those boxes. We thought this was an attractive one to dedicate some equity capital to. And again, I think you are right, that this is the kind of opportunity that is wholly unique to our BDC in terms of how we go about sourcing deals.

Wonderful. And just one final question. I know you noticed -- or we noticed clearly the loan market is sold off in the third quarter. You guys marked the book correctly. And could you provide an update on Reddy Ice and Securus, as well as Global Tel?

Sure. I will take a stab at that. So I think as you described Joe, we do have a very mark-to-market-focused culture here.

If you look at this quarter specifically, a few things to note. We did not move any of our investments down with respect to our risk rating as of the end up this quarter. So certainly some of the marks that you see we would attributes to the overall market environment.

I spent some time in my prepared remarks describing what took place there. The worst quarter in four years for the loan markets. So we certainly observant of that.

With respect to Reddy Ice specifically, that is a 70 basis points investment. So relatively small investment for our portfolio. Again, marked down this quarter. Really an absence of trading and liquidity in that particular investment.

No material change to the performance of that company. So we would attributes this quarter the changes in that mark to the overall market environment there.

With respect to GTL and Securus, as maybe just for the benefit of the audience here. As of the September quarter we two investments in GTL and Securus that are about 3.9% of the total assets of the portfolio. These are investments that we were attracted to, really based on very attractive market structure.

This is effectively a duopoly market structure. Companies that have historically had very strong cash flow characteristics. And in fact, since we made these investments a few years back, that observation has come to pass. The companies have delevered substantially. So we have second lien investments.

That being said, the last dollar attachment point for those investments is consistent with the overall portfolio last dollar attachment point, which we described as a 4.4 times net debt to EBITDA. So not very high levered companies. What's happened subsequent to quarter end is the SEC has put in place an order.

So there is a regulatory environment which could have a negative impact to those companies' performance on a go-forward basis. As we continue to spend time on those names, we believe even in the worst case scenarios here, there are -- the companies here have very ample cash flow capabilities. We see still solid fixed charge coverage ratios.

We see companies with a number of different levers to pull with respect to their ability to respond to the new regulatory environment. We don't anticipate dramatic changes in those portfolio -- in those company performance attributes until the regulatory regime is really shaken out over the next couple of quarters.

And so again, I think you could see mark-to-market volatility, which we described. But we don't think there is an immediate impact there.

The other piece, Joe, I'd point you, I alluded to this again in our prepared remarks. What we are talking about here, and also in the case with Reddy Ice, is unrealized losses.

And so these are companies that continue to meet their obligations. They continue to perform under their credit applications. And the way our expense structure works at the BDC is we actually take into account those unrealized losses when we calculate the expenses that the company pays for management and incentive fees.

So to the extent there are unrealized losses, those will be netted against the income of the portfolio. And the result for investors in the BDC is reduction of exposes that take that unrealized loss into account. So on balance I think as you roll forward the possibilities there, we are not worried about the overall impact to the portfolio.

Great. That it for me. Thanks, guys.

(Operator Instructions)

Douglas Harter, Credit Suisse.

This is actually Josh Bolton filling in for Doug.

Thanks for taking the question. Pretty significant increase in early repayments this quarter. So I was curious if you could give us some color around maybe what drove that increase?

And also how we should be thinking about prepayments going forward in the fourth quarter, if you have any update. Thanks.

Sure. Thanks Josh. The predominance of the repayments this quarter were a function of our investment in Orchard Brands. So there was a significant repayment early in the quarter that amounted to north of $40 million, [Josh], I think was the number.

So of the repayment activity, Orchard Brands was the super majority. Not much to speak of away from that. It did, as you noted, result in a pretty significant prepayment fee income.

We also alluded to it in our prepared remarks that we do anticipate that early repayments will pick up over the course of the next quarter or two. We've had one repayment that has taken place thus far this quarter, which is Affordable Care, which has already been -- taken place this quarter. As we look through our pipeline, there are a handful of investments that we also believe are candidates that are in the middle of processes potentially for [sponsors] to exit those positions, which we think could also result in prepayment activity.

Whether or not that takes place in Q4 of this year or Q1 of next year remains to be seen. I think timing will play an element there. But we do anticipate, as we discussed, that prepayments will increase.

And just going back to Orchard, that prepayment was the vast majority of the income associated with it. It was over $0.04 a share, just Orchard itself.

Great. Thanks, guys.

Doug Mewhirter, SunTrust.

I have two questions regarding your investment volume. Actually Doug asked my prepayment question. But in terms of the -- that's the outflow. In terms of the inflow.

Obviously you had a very strong quarter this quarter. It was above trend. And you seemed to be hinting that there might be more to come. Is the pipeline sort of maybe better than you expected at this point of the year in the fourth quarter and into the first quarter?

Should we expect above trend inflows for the next couple quarters?

Well, so this is Jon Yoder. I would say we feel fine about our pipeline. I wouldn't draw too many conclusions from one quarter to say that this is -- that one quarter is indicative of a trend.

I would say that overall, as you have heard, we are now within our target leverage ratio. We do expect some prepayment activity. We are still feeling quite good about our pipeline.

But I would categorize us as being in portfolio optimization mode. We are definitely adding some things as some things come out.

Overall I don't think that we are looking to massively grow the portfolio. I think it's really an optimization exercise at this point.

Okay, great. And shifting over to the senior credit fund. You commented on actually some of these bank, these more broadly syndicated deals where the syndications were hung, for lack of a better term.

Maybe this is an ignorant question, but would there be an opportunity for the -- do they fit credit profile, the deal where the senior credit fund could come in and maybe pick up some of those deals that haven't been issued as efficiently for maybe a better price? Or are you operating on a different plane from those kind of deals for the senior credit fund?

We certainly look at all those deals for the senior credit fund. I think what we found was, in the quarter, that a lot of those hung deals were hung for a reason. That they were hung because they weren't structured very well, they didn't have particularly strong covenant protection, they were probably over-levered to begin with.

So we didn't particularly like a lot of those deals. And furthermore we anticipated, and we're starting to see fruits of what we had envisioned, which is as the next negotiations kick off between borrowers and lenders, the lenders are being more disciplined and the new structures are better, leverage levels are lower and covenant protection is better.

And so we kind of, as you saw in the quarter kept our powder a little bit dry and avoided some of these poorer structures. And are now hopefully going to be able to benefit from our patience.

Great. Thanks. That's all my questions.

Derek Hewett, Bank of America Merrill Lynch.

My first question is, given the really, increased market volatility and liquidity exiting the market recently, when are we going to see structurally higher new issue yields? Since I believe that there was roughly, I think, a 40 basis point decline in the weighted average coupon on a quarter-over-quarter basis during Q3.

Yes, Derek, this is Brendan. I'll take that call. So look, I think Jon described the market environment over the course of Q4. There was definitely what we've called internally a bit of a standoff between buyers and sellers where some of the less well-structured, less well-priced transactions were met with a lot of resistance.

It takes a bit of time for that to filter through in terms of borrower recognition of that new pricing environment. And so we do think it's a good healthy environment.

The dynamic that we see is relative to, I would say, the last couple of quarters, certainly the last couple of years. Less capital available into those opportunities and as a consequence, the opportunity for a better balance between the rate structure and other borrower considerations.

If you look at the Goldman Sachs BDC specifically, I think if you look at us over a trendline period, what you see within our portfolio, certainly over the past several quarters, is a dynamic where our portfolio has become more senior over time. The profile today is roughly two-thirds of the book is in some form of first lien investment, be it a last tranche of a unitranche or a true first lien investment.

And not withstanding that, our portfolio yields have been relatively flat. And so certainly this quarter, particularly given our somewhat large investment in DDDS -- Data Driven, there was a shift in the yield of our new originations. Again, as Jon described, I wouldn't look at one single quarter as a trend.

We do think that the environment for the strategy continues to be quite good. And again on balance, when you look at the entire portfolio, we have been able to maintain portfolio yields while in fact becoming more senior in the capital structure for our investments. So we're actually quite pleased with that.

Okay, great. And then one final question, Brendan. Maybe could you give us your thoughts on sector M&A, given that there's been an increased level of activism, at least in the last six to nine months or so? We all kind of know about the more high-profile TICC Capital ongoing issue, but I think there's also some smaller BDCs that have also been in the press where shareholders are starting to get frustrated, given where valuations are.

Right. Yes. Look, I think the M&A question I think is an important one.

It's one that at various different points in time in the history of this space, the analyst community and certainly management companies have been interested in seeing if it's something that will increase in volume. And so in general, that hopefulness has been met with not a lot of activity. And as you look at the market dynamic today, I think what we are seeing is an environment where there have been a number of companies who have been trading at poor valuations for quite a long period of time.

And so it doesn't feel like a one-time dislocation in the market, but rather there has been a persistent period where valuations for many BDCs have been subpar. And for sure that has resulted in, I would say, more vocal shareholder responses and folks looking to managements and boards to be stewards of capital and look for ways to increase shareholder returns. So we are hopeful that will increase opportunities for M&A in the sector.

We are spending, as a management team, a lot of time focusing on the opportunity to see if it's something that we can pursue in a manner that is going to be accretive and beneficial for our shareholders. So frankly we are, I would say, less concerned about the overall market environment and rather looking for opportunities for our shareholders to be beneficiaries of that trend. Certainly when you look at our trading valuations relative to others in the space, I think there could be good opportunities that make sense for all. But at this point of time, certainly nothing to report.

Okay, great. Thank you very much.

(Operator Instructions)

At this time there are no further questions. Please continue with any closing remarks.

Well, thank everybody for your time and attention this morning. We really do appreciate this. And we appreciate your ongoing support.

If you do have any follow-up questions, feel free to reach out to Katherine Schneider and we would be happy to follow up. Have a great day.

Ladies and gentlemen, this does conclude the Goldman Sachs BDC, Inc. third-quarter 2015 earnings conference call. Thank you for your participation.