U.S. Markets closed

Edited Transcript of GBDC earnings conference call or presentation 8-Aug-19 7:30pm GMT

Q3 2019 Golub Capital BDC Inc Earnings Call

CHICAGO Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Golub Capital BDC Inc earnings conference call or presentation Thursday, August 8, 2019 at 7:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* David B. Golub

Golub Capital BDC, Inc. - CEO & Director

* Gregory A. Robbins

Golub Capital LLC - MD & Co-Head of the Investor Partners Group

* Ross A. Teune

Golub Capital BDC, Inc. - CFO & Treasurer

================================================================================

Conference Call Participants

================================================================================

* Bill Weisbrod

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Raymond Cheesman

Anfield Group, LLC, Asset Management Arm - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Welcome to Golub Capital BDC, Inc.'s June 30, 2019 Quarterly Earnings Conference Call.

Before we begin, I would like to take a moment to remind our listeners that remarks made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance, or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in Golub Capital BDC, Inc.'s filings with the Securities and Exchange Commission.

For materials 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. 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.

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [2]

--------------------------------------------------------------------------------

Thank you. Hello, everybody, and thanks for joining us today. I'm joined by Ross Teune, our Chief Financial Officer; Greg Robbins and Jon Simmons, both Managing Directors here at Golub Capital. Yesterday afternoon, we issued our earnings press release for the quarter ended June 30, and we posted an earnings presentation on our website. We're going to be referring to that presentation throughout the call today. Gregory is going to start with an overview of GBDC's results for the third quarter of 2019, Ross is then going to take you through the results in more detail, and I'm going to come back at the end for an update on the proposed merger with Golub Capital Investment Corporation, or GCIC.

Let's start with results for the quarter ended June 30, and also, with some headlines. The main headline is that GBDC had another very solid quarter, driven by consistent net investment income and strong credit results. 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 backed by strong partnership-oriented private equity firms.

With that, I'll turn the call over to Gregory.

--------------------------------------------------------------------------------

Gregory A. Robbins, Golub Capital LLC - MD & Co-Head of the Investor Partners Group [3]

--------------------------------------------------------------------------------

Thank you, David. Let's look at the details for the quarter. Net increase in net assets resulting from operations, or net income for the quarter ended June 30 was $19.2 million or $0.32 per share as compared to $17.8 million or $0.29 per share for the quarter ended March 31.

Net investment income or as we call it income before credit losses for the quarter ended June 30 was $19.4 million, or $0.32 per share as compared to $20.1 million, or $0.33 per share for the quarter ended March 31. Excluding an approximately $28,000 accrual for the capital gain incentive fee, net investment income for the quarter ended June 30 remained unchanged at $19.4 million, or $0.32 per share as compared to $19.4 million, or $0.32 per share for the prior quarter.

Consistent with previous quarters, we have provided net investment income per share, excluding the capital gains incentive fee accrual as we think this adjusted NII is a more meaningful measure.

Net realized and unrealized loss on investments and foreign currency of $200,000 or less than $0.01 per share for the quarter ended June 30, was the result of $700,000 of net realized losses and $0.5 million of net unrealized depreciation. This compares to a net realized and unrealized loss on investments and foreign currency of $2.3 million, or $0.04 per share for the prior quarter.

New middle-market investment commitments totaled $157.1 million for the quarter ended June 30, approximately 84% of the new investment commitments were one-stop loans, 14% were senior secured loans, 1% were second-lien loans and approximately 1% were investments in equity securities. Overall, total investment on the portfolio companies at fair value decreased by approximately 1.6% or $32.2 million during the quarter.

Turning to the column on the right at the top of Slide 4, you can see our net income per share of $0.32, or net investment income per share before the accrual for the capital gains incentive fee of $0.32 and our net asset value per share of $15.95 as of June 30.

As shown on the bottom of the slide, the portfolio remains well diversified with investments in 225 different portfolio companies, an average size of less than 0.5% of total portfolio company investments.

With that, I will now turn it over to Ross, who will provide some additional portfolio highlights and discuss the financial results in more detail.

--------------------------------------------------------------------------------

Ross A. Teune, Golub Capital BDC, Inc. - CFO & Treasurer [4]

--------------------------------------------------------------------------------

Great. Thanks, Gregory. I'm starting on Slide 5. This slide highlights our total originations of $157.1 million and total exits and sales of investments of $179.5 million. As shown on the bottom table, the weighted average rate of 8.1% on new investments this quarter was down from 8.7% in the previous quarter, primarily due to a declining LIBOR rate and a modest increase in the percentage of lower-yielding senior secured originations.

The rate on loans that paid off increased slightly to 8.8% from 8.7% the prior quarter, and as a reminder, the weighted average interest rate and 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 of our LIBOR and the impact of any LIBOR floor.

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

Now turning to Slide 7, this slide illustrates that the portfolio remains well diversified with an average investment size of less than 0.5%. Our debt investment portfolio remains predominantly invested in floating-rate loans with no significant changes in the industry classification percentages over the past year.

Turning to Slide 8, this graph summarizes portfolio yields and net investment spreads for the quarter, focusing first on the light blue line. This line represents the income yield for the actual amount earned on the investments, including interest and fee income, but excluding the amortization of discounts and upfront origination fees. The income yield decreased by 20 basis points to 8.6% for the quarter ended June 30, primarily due to a decrease in LIBOR over the past 2 quarters.

The investment income yield, or the dark blue line, which includes amortization of fees and discounts, remained stable at 9.2% during the quarter due to an increase in prepayment fees and other fee income. Weighted average cost of debt or the aqua blue line remained flat at 4.2%, despite the decreasing LIBOR rate, primarily due to the timing of 90-day LIBOR reset date on our CLO liability.

Moving to the next 2 slides, the number of nonaccrual investments increased from 4 to 3 investments, one of which was fully repaid with 100% recovery on our remaining principal balance subsequent to quarter end. As of June 30, nonaccrual investments as a percentage of total investment at cost and fair value were 0.7% and 0.4%, respectively. Fundamental credit quality as of June 30 remained strong with over 90% of the investments in our portfolio having an internal performance rating of 4 or higher as of June 30 as shown on Slide 10. As a reminder, independent valuation firms value approximately 25% of our investments each quarter.

Reviewing the balance sheet and income statement on Slides 11 and 12, we ended the quarter with total investments at fair value of $1.9 billion, total cash and restricted cash of $110.7 million and total assets of just over $2 billion.

Total debt was $1 billion, which includes $562.9 million in floating-rate debt issued through our securitization vehicles, $299.5 million of fixed-rate debentures and $184.7 million of debt outstanding in our revolving credit facility.

Total net asset value per share remained at $15.95. Our regulatory debt-to-equity ratio was 0.78x, although our GAAP debt-to-equity ratio was 1.09x, slightly above our target of about 1x GAAP leverage.

Flipping to the statement of operations, total investment income for the quarter ended June 30 was $42.1 million, an increase of $0.3 million from the prior quarter, primarily due to higher fee income. On the expense side, total expenses were $22.7 million, an increase of $1 million from the prior quarter. Excluding the $700,000 reversal on the capital gains incentive fee expense in the prior quarter, expenses were relatively flat quarter-over-quarter.

Flipping to the following slide, the charts on the top provide a summary of our quarterly distributions and return on average equity over the past 5 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.

The annualized quarterly return based on net income has averaged 7.7% for the past 5 quarters. The bottom of the page illustrates our long history of steady increases in 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 our investment in Senior Loan Fund. The annualized return for the quarter was 0 as net investment income at SLF was offset by unrealized losses on a few portfolio company investments. SLF investment at fair value at June 30 declined by 9.3% to $153.8 million from March 31.

The next slide summarizes our liquidity and investment capacity as of June 30, in the form of restricted and unrestricted cash, availability on our revolving credit facilities and debentures available through our SBIC subsidiaries.

Slide 16 summarizes the terms of our debt facilities, and lastly, on Slide 17, our board declared a distribution of $0.32 a share payable on September 27, to shareholders of record as of August 19.

We moved the record date for this distribution only to be a bit earlier to pursue the shareholder meeting date and anticipated closing of the merger in September. No other changes are being made to the distribution, including the payment date. We expect to resume our normal kind of record dates with our next distribution in December.

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

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Ross. So to sum up, GBDC had a strong third fiscal quarter of 2019. Net investment income was very consistent, credit was good, borrower diversification increased further and our balance sheet remained finely tuned. I want to close with a quick update on the proposed merger with GCIC.

First, where does the merger stand? The process achieved an important milestone in mid-July, when the joint proxy statement of GBDC and GCIC was declared effective by the SEC.

On July 15, GBDC and GCIC filed their joint definitive proxy statement, votes are currently being collected from stockholders of both companies and are due by the special stockholders' meetings of each company, which are both scheduled for September 4, subject to stockholder approvals and satisfaction of all other conditions precedent. Our current expectation is that the transaction will close in September.

As a reminder, the GBDC Board of Directors, myself included, has unanimously recommended that stockholders vote in favor of the transaction-related proposals. So a note for stockholders who have not already done so, please vote.

Next, I want to highlight why we believe the merger with GCIC is compelling for GBDC shareholders. 7 reasons, I'll be quick. First, the transaction is expected to be immediately accretive to GBDC's NAV per share, based on GBDC's NAV per share as of June 30 and GCIC's estimated NAV per share of $15 as of June 30. The accretion to GBDC's NAV would be approximately $0.72 per share or about 4.5%. So that equates to roughly 2 quarters of historical net income per share for GBDC.

Second, because the transaction will be accretive to GBDC's NAV per share, the transaction offers the potential for some additional value creation assuming GBDC continues to trade at the approximately 15% premium to NAV that GBDC has traded at on average over the past 3 years.

Third, the combination of GBDC and GCIC would create the 5th largest externally managed publicly traded BDC by assets, based on the fair value of the holdings of each company as of June 30. Fourth, the increased market cap following the merger is anticipated to improve trading liquidity and lead to broader analyst coverage. Fifth, we expect the portfolio of the combined companies to look familiar, though it will look a lot like stand-alone GBDCs, given the 98% overlap between the 2 portfolios. Six, we expect the combined company to have better access to the securitization market given the combined company's greater opportunity to optimize its debt capital as a consequence of its increased scale. And seventh, we expect some operational synergies from eliminating redundant expenses.

In short, we believe the combined GBDC, GCIC maintains all the elements that have made GBDC successful and gives it a number of additional advantages.

In particular, we think the increased scale of the combined company will deliver benefits, including incremental earnings power to support the GBDC board's announced intention to increase GBDC's quarterly dividend to $0.33 per share after the closing of the merger, provided that GBDC's board reserves the right to revisit this intention if market conditions or GBDC's prospects meaningfully change.

A final note, in addition to the expected direct benefits to GBDC's shareholders associated with the proposed merger, there is also the continuation of a benefit that I don't think we highlight enough and that's access to the competitive advantages of the Golub Capital platform. I'm telling that advantages that include scale and not just talking size, a big balance sheet today is not enough. I'm talking about a platform with 25 years of operating history in the U.S. middle-market, over 450 employees, over 130 investment professionals and over $30 billion of capital under management.

Talking about relationships, Golub Capital has done repeat business with over 180 different private equity sponsors and in recent periods, repeat sponsors have accounted for 80% or more of the firm's origination volume.

I'm talking about incumbencies. Golub Capital today lends to about 250 middle-market obligors and more than 50% of the firm's origination volume has typically come from these repeat borrowers.

Talking about distinctiveness of our product suite, we believe Golub Capital is the market leader in one stops and our ability to offer buy-and-hold solutions up to $600 million and provide underwrites of up to $1 billion is quite distinctive.

And finally, I'm talking about the industry expertise. We believe Golub Capital is seen by the market as expert in our key verticals, including software, health care and consumer businesses.

So post-merger, we believe GBDC will be better positioned than ever to benefit from the advantages of the Golub Capital platform and to continue its long-standing track record of delivering consistent premium returns for shareholders.

With that, let me thank you for your time today and your partnership, and let's open the floor for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question is from the line of Fin O'Shea with Wells Fargo Securities.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

--------------------------------------------------------------------------------

So first question on the large versus core middle-market, you've been highlighting the view of a more favorable risk-adjusted return in the core middle-market recently and seeing some of the larger unitranche positions. Are you shifting here in terms of what's more available, what's better and available or is the recent volatility sort of opening up the larger side?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [3]

--------------------------------------------------------------------------------

So great question. I don't actually think about it in terms of 2 segments in the market. I tend to think about it in terms of 3. So let's just talk about the 3. So the first would be traditional middle-market companies, which would range in size from $10 million to $25 million of EBITDA. That market, we've historically been very active in, we continue to be active in. I would describe it as the most competitive segment of our market right now. It's the portion of the market where new entrant activity has been most significant, and that's driven down what historically were better spreads and better documentation terms.

The second segment would be traditional middle-market, which would range from $25 million in EBITDA up to $50 million in EBITDA, and that is the segment that we're most active in, I would say, that's the segment that we've typically been most active in. And market conditions there are pretty consistent with how they have been for the last 3 or 4 years. In that market, we are continuing our strategy, which is to really focus on transactions where we have competitive advantages that we can bring to bear.

The last segment would be upper middle-market. So $50 million to $80 million EBITDA companies, where we as direct lenders compete with the syndication market because those borrowers have the ability to choose, whether they prefer to go with a -- by a whole lender or with a syndicated solution. As you point out, Fin, in that last category, we tend to see benefits from market volatility, when the syndication market is choppy, borrowers tend to be more receptive to buy and hold solutions. And when the syndication market is hot, it tends to be harder to compete with the syndication market.

Right now, I'd say we're neither in the hot nor cold phase. I'd say it's -- the syndication market is active, but the syndication market is selective. We've seen a period where CLO investors have been picky about which kinds of credits they like and which they don't like. So as a consequence of all that, our activity has tended to be focused in the recent period in that $25 million to $50 million EBITDA size range company and my expectation would be that, that's going to continue.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [4]

--------------------------------------------------------------------------------

Got it. And just a follow-on. Upon origination of a new loan, does the adviser at Golub retain any of the upfront economics prior to allocation?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [5]

--------------------------------------------------------------------------------

So in a typical transaction, there is a number of different upfront fees, there is a -- somewhat OID or original issue discount. There is also a structuring fee involved and as we disclosed in all of our documentation, we treat the BDC in a manner very similar to how we treat our private funds and that means that the adviser does in some cases retain a portion of the structuring fee.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [6]

--------------------------------------------------------------------------------

Sure, I appreciate the color and just generally on the parameters of the fee, is it generally 1/3, 1/2, on the upfront amount of, say, 2 points? Just some general figures?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [7]

--------------------------------------------------------------------------------

Rather than speculate, I'd rather get back to you with specifics. So let us do some work and come back to you.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Our next question is from the line of Ray Cheesman with Anfield Capital.

--------------------------------------------------------------------------------

Raymond Cheesman, Anfield Group, LLC, Asset Management Arm - Analyst [9]

--------------------------------------------------------------------------------

I'm wondering if you could give us what you're seeing out in the marketplace on LIBOR floors? I see your charts in your presentation with LIBOR declining, I'm also seeing the floor that protected us in the past, is not being included in as many deals as it used to be. What are you seeing?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [10]

--------------------------------------------------------------------------------

I think that's accurate. We're pushing for LIBOR floors where we can. I think as LIBOR goes down, we'll probably see the reemergence of a reasonably standard 1% LIBOR floor. But in the period when LIBOR rose to meaningfully higher than the 1% formally standard level, that started to fade as the standard. So I think your observation is right on, that if you looked at the universe today, you'd see a smaller portion of the universe having LIBOR floors, but I think, if we have a sustained period of decreasing LIBOR, we'll very likely see the reemergence of the standard 1% LIBOR floor.

--------------------------------------------------------------------------------

Raymond Cheesman, Anfield Group, LLC, Asset Management Arm - Analyst [11]

--------------------------------------------------------------------------------

On a kind of parallel topic, with the happy days of the last 122 months of recovery and all of our indentures faded away to nothingness and we all did covenant-lite loans, do you think that the stress that's returned to some of the markets will lead people to, for lack of a technical term, wise up and request a little bit of protection looking forward into what could be rougher waters in the next set of deals?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [12]

--------------------------------------------------------------------------------

Yes and no. So if you look at the situation in documentation land, I would characterize it as falling into 2 buckets. There's one bucket that we could call financial covenants and there's one -- a second bucket that we could call leakage-related provisions. We're seeing -- let me describe what I mean by each of those. So financial covenants as the name implies would be tests that if a borrower fails, would enable a lender to come to the table with the borrower and have a discussion. And these tests would be debt-to-EBITDA or absolute level of EBITDA or fixed charge coverage.

The second category, leakage provisions, have to do with restrictions on the company's ability to take assets out of the box that lenders are lending to. So that might be, for example, restrictions on dividend, so-called restricted payments. Or it might be restrictions on the company's ability to repurchase debt, or restrictions on the ability to -- of the company to put in place debt that is actually or structurally senior to the existing debt. I think we're seeing a lot of signs that the market is getting smarter about leakage provisions. And I'm pleased to see that because I think the documentation terms in the broadly syndicated market, in particular, around leakage provisions were under very significant pressure earlier this year and were moving in a direction that was bad for the industry. So I'm pleased to see that in the last 60 to 90 days, we're seeing more and more pressure on arrangers to make sure that documentation terms related to leakage are improved.

I don't see the same phenomenon on the financial covenants front and I don't anticipate that we're going to see it for larger-sized transactions. In the broadly syndicated market, covenant-lite has become a norm. In the middle-market, less so and we have retained the predominant number of our transactions, including one or several financial covenants. The good news is, I don't see as much pressure on documentation terms related to financial covenants in the middle-market transactions, but the flip side is, I don't anticipate that we are going to see a return to 2011-style documentation terms anytime soon.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question is from the line of Bill Weisbrod with Debtwire.

--------------------------------------------------------------------------------

Bill Weisbrod, [14]

--------------------------------------------------------------------------------

I wanted to -- I saw the -- a change to the mark and addition of a pick component to Oliver Street Dermatology. So wanted to ask what's going on there?

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [15]

--------------------------------------------------------------------------------

Thanks for your question, Bill, but I'm going to defer discussing a specific situation like Oliver Street. I don't think it's an appropriate topic for this call.

--------------------------------------------------------------------------------

Operator [16]

--------------------------------------------------------------------------------

(Operator Instructions) There are no further questions at this time, sir.

--------------------------------------------------------------------------------

David B. Golub, Golub Capital BDC, Inc. - CEO & Director [17]

--------------------------------------------------------------------------------

Okay, great. Well, thanks, everyone, again, for your time today. And should you have any questions that come up after today's discussion, please feel free to reach out to any of -- myself, or Ross or Gregory, or Jon, and we look forward to talking to you again next quarter.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

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