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Edited Transcript of GSBD earnings conference call or presentation 8-Nov-19 2:00pm GMT

Q3 2019 Goldman Sachs BDC Inc Earnings Call

New York Nov 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Goldman Sachs BDC Inc earnings conference call or presentation Friday, November 8, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brendan M. McGovern

Goldman Sachs BDC, Inc. - President & CEO

* Jon Yoder

Goldman Sachs BDC, Inc. - COO

* Jonathan Lamm

Goldman Sachs BDC, Inc. - Treasurer & CFO

* Katherine Schneider

Goldman Sachs BDC, Inc. - VP IR

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Conference Call Participants

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* Derek Russell Hewett

BofA Merrill Lynch, Research Division - VP

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning. This is Ian, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

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

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Katherine Schneider, Goldman Sachs BDC, Inc. - VP IR [2]

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Thanks, Ian. 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 indicated in those forward-looking statements as a result of a number of factors, including those described from time to time in the company's SEC filings. This audiocast is copyright material of Goldman Sachs BDC, Inc., and may not be duplicated, reproduced or rebroadcast without our consent.

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 8, 2019, for replay purposes.

With that, I'll turn the call over to Brendan McGovern, CEO of Goldman Sachs BDC.

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [3]

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Thank you, Katherine. Good morning, everyone, and thank you for joining us for our third quarter earnings conference call.

As usual, in terms of the agenda for the call, I'll start by providing an overview of our third quarter results. From there, Jon Yoder will discuss our investment activity and portfolio metrics before handing it over to Jonathan Lamm to discuss our financial results in greater detail. And finally, I'll conclude with some closing remarks before we open the line for Q&A.

So with that, Q3 net investment income per share of $0.47 resulted in dividend coverage of 104% and equated to an 11.1% annualized NII return on common equity. As we announced after the market closed yesterday, our Board declared a $0.45 per share dividend payable to shareholders of record as of December 31, 2019. This equates to a dividend yield of 10.6% based on net asset value per share at the end of Q3.

Moving on to investment activity. This quarter was characterized by a significant portfolio activity, reflecting a continued robust private capital markets backdrop as well as solid execution by the team. During the quarter, we made $173 million of investment commitments to 10 new portfolio companies and 7 existing portfolio companies. Repayments totaled $241 million, driven by the full repayment of loans by 9 different portfolio companies. The repayment of nearly 1/5 of the Q2 ending portfolio balance, coupled with diversified origination, enabled us to continue to shape the portfolio composition consistent with previously stated goals. First, we improved the asset mix towards more senior loans. New originations were comprised almost exclusively of first lien investments, while over 1/3 of repayments were in junior capital investments. As a result, the percentage of first lien investments in the portfolio increased to 72% during the quarter, continuing the execution of our strategy to reposition the portfolio into more senior investments and away from junior capital investments.

We are pleased with the pace at which we've been able to execute this strategy. For context, first lien investments were 33% of the total portfolio just 6 quarters ago. Second, we continue to reduce single name concentrations. This quarter, we received the full repayment of 4 older vintage investments. All these investments were made prior to our receipt of co-investment exemptive relief, which now allows us to cross-allocate loans across our platform. As a result, these older loans were significantly larger on average than the size of new loans added to the portfolio since obtaining co-investment relief. At the end of Q3, our top 10 investments represented 24% of the total portfolio, down significantly from 40% at the end of 2016. Finally, we believe that activity this quarter improved overall credit quality. Our largest repayment was in NTS Communications, a portfolio company that we have discussed at length in prior quarters and which was placed on nonaccrual in Q4 of 2018. The loan was repaid this quarter consistent with the mark we signaled in prior discussions. Notwithstanding the fact that we chose to turn off the NTS interest accrual a few quarters ago per our nonaccrual policy, GSBD ultimately earned a 7% IRR and a greater than 1.3x money multiple on this transaction. At quarter end, nonaccruals were just 1% and 1.4% of the total investment portfolio at fair value and cost, respectively.

Aggregate portfolio company metrics were stable to improve quarter-over-quarter as measured by the portfolio's net debt-to-EBITDA and interest coverage ratios. Portfolio yields did come down this quarter, consistent with our planned asset mix shift towards senior assets, exacerbated by concentrated repayments of higher-yielding earlier vintage investments and the downward trajectory of LIBOR. We do see opportunities over time to counter this dynamic by rotating lower-yielding assets that we received upon the unwind of our senior credit fund into directly originated loans having higher spreads. In addition, our success in shifting the portfolio into more first lien investments with less single name concentration provides the opportunity to move our debt-to-equity ratio somewhat higher, which should contribute positively to income generation.

With that, let me turn it over to Jon Yoder.

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Jon Yoder, Goldman Sachs BDC, Inc. - COO [4]

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All right. Great. Thanks, Brendan.

So the third quarter presented an interesting market backdrop to our activities. In particular, treasury yields fell precipitously in August and briefly inverted, as trade tensions and evidence of slowing global growth provoked expectations of further rate cuts and a flight to safety. Broadly syndicated loan markets showed stress in certain industries, which weighed on average bid prices. Investor sentiment regarding leveraged loan markets turn more cautious, and loan funds experienced outflows, while CLO formation was muted. In general, we think that these developments are healthy and over the long run can lead to increased discipline. We've been cautious for quite some time, and as Brendan mentioned in his remarks, we made the strategic decision early last year to shift the portfolio away from junior debt. We were very pleased this quarter to get repaid from 2 of our larger remaining junior debt investments.

This quarter also continued our multiyear effort to enhance the durability of the portfolio by reducing single name concentrations as some of our largest single name positions were repaid. At the end of the quarter, the average single name position size in our portfolio is just 1% of total assets, down from 2.5% prior to implementing our co-investment order in January of 2017. In addition, we believe that the sum of the origination and repayment activity this quarter further focuses our portfolio on durable businesses with strong cash flow profiles, which we expect will be resilient if the fears that drove market sentiment this quarter, in fact, do come to pass.

So let's turn to some specific activities for the quarter. New investment commitments and fundings were $172.5 million and $145.5 million, respectively, which include net fundings of $6.5 million of previously committed unfunded commitments. 98.7% of new investment commitments were in first lien floating rate debt investments. These new investment commitments were across 10 new portfolio companies and 7 existing portfolio companies. Sales and repayment activity was elevated, as Brendan mentioned, and was $240.7 million, which was driven by the full repayment of investments in 9 different portfolio companies.

Regarding portfolio composition. At the end of the quarter, total investments in our portfolio were $1.4302 billion at fair value, comprised of 92.5% senior secured loans, which includes 72.4% in first lien, 2.5% in first lien/last-out unitranche and 17.6% in second lien debt as well as 0.5% in unsecured debt and 7% in preferred and common stock.

We also had $93.4 million of unfunded commitments as of September 30, bringing total investments and commitments to $1.5236 billion. As of quarter end, the company had 199 investments across 102 portfolio companies. The weighted average yield of our investment portfolio at cost at the end of the third quarter was 8.3%, down from 8.7% at the end of the second quarter. The weighted average yield of our total debt and income-producing investments at cost was 9.1% at the end of the third quarter as compared to 9.8% at the end of the second quarter. This quarter-over-quarter decline was driven in equal parts by the decline in LIBOR and the exit from some older vintage, higher-yielding investments during the quarter.

Turning to credit quality. Performance of our portfolio companies overall was stable to slightly improved quarter-over-quarter. In fact, the weighted average net debt-to-EBITDA of the companies in our investment portfolio was 5.4x at quarter end, which is down from 5.5x at the end of the second quarter. The weighted average interest coverage of the companies in our investment portfolio was 2.4x, which was modestly up from the prior quarter at 2.3x.

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

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Jonathan Lamm, Goldman Sachs BDC, Inc. - Treasurer & CFO [5]

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Thanks, Jon.

We ended the third quarter of 2019 with total portfolio investments at fair value of $1.430 billion, outstanding debt of $732 million and net assets of $685 million. Our net investment income per share was $0.47, which was unchanged from the prior quarter. Earnings per share were $0.22 as compared to $0.40 in the prior quarter. During the quarter, our average debt-to-equity ratio was 1.22x versus 1.11 in the prior quarter. We ended the third quarter with a debt-to-equity ratio of 1.07 versus 1.22 at the end of Q2.

Much of our repayment activity occurred toward the end of Q3, providing the company with ample available liquidity for reinvestment.

Turning to the income statement. Our total investment income for the third quarter was $36.9 million, which was down from $38.4 million last quarter. While our average balance of the income-producing assets were up quarter-over-quarter, the decline in interest income quarter-over-quarter was largely attributed to lower prepayment-related income. As Brendan mentioned, although we had elevated repayments this quarter relative to prior quarters, the majority of this quarter's repayments were in older vintage loans where prepayment-related income protection had already expired. Additionally, older vintage loans have a lower amount of remaining unamortized discount to be accelerated upon a prepayment.

Total expenses were $17.4 million for the third quarter as compared to $18.9 million in the prior quarter. Expenses were down quarter-over-quarter, primarily driven by a decrease in incentive fees, which was partially offset by higher interest expenses due to higher average borrowings during the quarter. We ended Q3 with net asset value per share at $16.98 as compared to $17.21 from the prior quarter.

The company had $48 million in accumulated undistributed net investment income at quarter end resulting from net investment income that has exceeded our dividend. This equates to $1.18 per share on current shares outstanding.

With that, I will turn it back to Brendan.

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [6]

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Thanks, Jonathan.

In closing, Q3 was a solid quarter for our investors as we continue to produce strong net investment income while simultaneously strengthening portfolio attributes in single name diversification and lien type. We believe the company continues to be well positioned for the long term to take advantage of opportunities in the growing middle market landscape.

As always, we thank you for the privilege of managing your capital, and we look forward to continuing to work hard on your behalf over the remainder of the year. With that, Ian, let's open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Finian O'Shea from Wells Fargo Securities.

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

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Just a first question towards the end of your remarks on the LIBOR front. The impact on the top line seems a little more than a lot of your peers. And I know there's a couple of moving parts there. You talked about the season prepays. But looking at more -- you have a pretty recent vintage profile, so I would have thought that floors would be better as they've been slowly but surely trending up. Can you talk about sort of where you are on the floor side and what you think the next 25 bps has for a top line impact for you?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [3]

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Yes. Fin, I think the last part of the question, I want to make sure we understand the totality of it. So as Jonathan mentioned, if you look at the yield impact this quarter, about half of it was the move in LIBOR. I would say, as a general matter and probably reasonably consistently, the LIBOR floors on the asset side of our portfolio is around 1. So given where we are with LIBOR today, I think that next 25 basis point move, continue to be exposed there, I think that would be consistent across much of the industry. From time to time, you might be able to get -- I think we had one transaction this quarter where we did get one better floor. That was a transaction to our private wealth network that we originated. But in general, I think our profile is going to be consistent with most market participants.

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

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And on -- I think you talked a bit about the market opening up, and we're certainly hearing that's the case especially on the larger end, and therefore, I'm sure it helps private credit as a whole in terms of deal flow. But if you take that backdrop, assuming that sustains for some time alongside your platform growth, is there a shift in portfolio company issuer size that is currently underway or perhaps expected? What sort of frame do you view your sweet spot now and down the road for EBITDA, let's say?

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Jon Yoder, Goldman Sachs BDC, Inc. - COO [5]

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Yes. Fin, obviously, really good question, and you're well in touch with the markets here. What we are seeing a little bit, as you're pointing out, is some of the private credit -- some opportunities coming for deals that are the types that otherwise would have normally been syndicated. So I think it's been reported that particularly for lower -- companies that would garner lower ratings and they're typically obviously having higher leverage profiles and the like, the public capital markets are less accommodating of those types of things, and so some of those -- at the moment, at least. And so a number of those companies are otherwise seeking capital into private and private participants. I think -- we're monitoring it. I don't expect that -- we're not sort of leading the charge there or expecting to be particularly active. I think what we'd want to see is -- what's important to us is, when you're doing private credit, the value proposition that ultimately we're offering to our investors here is that this is a higher return, lower, better credit protection kind of strategies than what you can get in broadly syndicated markets.

And so if all the private credit participants are doing is replicating what otherwise would have been available in the public credit markets, meaning the same sort of covenant-light and fairly low spread terms, that doesn't seem like a real value to be adding to our investors. So I'm not saying that, that is what's going on. I'm just saying that until there's strong evidence that you can get really good terms and attractive spreads that are better than what are available in public markets, it doesn't feel like something that we would want to stretch into.

So for the time being, we're pretty focused, continue to be pretty focused on what we think is the core of the middle market, kind of a $15 million to $50 million EBITDA business. You look at the weighted average EBITDA of our portfolio companies, it's right around $35 million, $37 million. So kind of right in the middle of that range. Pretty consistent. We're not -- quarter-over-quarter, that's kind of where we've been living. And so I don't -- we don't anticipate any change, again, unless it suddenly became obvious that there was a lot of just really attractive, better than sort of traditional capital markets execution terms that you can get in larger transactions. But at the moment, I don't know that that's true.

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

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And just one more, if I may, a small question on animal supply that's common stock, but part of your fall this quarter. One, is that broad-based -- sorry, market valuation-based or company decline? And then second, that would obviously be accretive or -- to rotate into earnings, so any update on your pathway to move from that name that you're allowed -- able to provide?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [7]

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Yes. So we talked a bunch about this one in the past, a recent restructuring, so we currently hold really non-income-producing paper. So would agree, in general, with the focus on doing our best to rotate that but doing so in a way that can optimize outcomes. So we did knock the portfolio -- that position down a bit this quarter. I would say there's a little bit of a mixed bag. On the one hand, there are some industry headwinds with respect to certain of the products that the company is distributing, which lowered some volumes there. But on the other hand, I would say we're becoming increasingly excited about potential synergistic opportunities in terms of the industry consolidation that's taking place here. I think you've heard us describe that in the past. So overall, continue to remain optimistic in terms of the trajectory, the path here.

And when we look at these types of situations, there's the balance, as you're describing, between perhaps quickly rotating the position into something that can be more income-producing versus optimizing. And I think we're quite aware of that and think about that all the time. And in here, I think specifically with this investment, we're hopeful that just given some of the industry trends around consolidation, there could be an opportunity. But nothing to report yet. And of course, if and when there is, we'll be forthright and quite descriptive about that.

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Operator [8]

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And your next question comes from the line of Robert Dodd from Raymond James. Robert?

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [9]

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Looking at, obviously, the rotation you've gone through in the portfolio, right, I mean first lien is up a lot. You've reduced particularly the second lien exposure versus a year ago or more. Yet when I look at where the big marks were, that seemed to be this quarter, they seem to be, not surprisingly, primarily in the junior side of the portfolio. So can you give us any color on how much, if any, there's adverse selection, obviously, in the second lien side? The ones that are doing relatively well are the easiest ones to encourage to refinance, et cetera, et cetera, and the ones that stick with you longer can be more problematic. So could you give us some color on the relative quality of what's left on the junior side of the book, particularly in light of the marks this quarter?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [10]

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Yes. No. Rob, appreciate the question. I think fair observation as well. When you look at this quarter, marks aren't terribly large, but the biggest one was MPI, which you're accurately describing was an earlier vintage, 2014 vintage second lien investment that we made there. And I think that's a company that is -- think of a business that does precision auto parts. It's our own auto type of exposure. So I think when we look at that business, what's impacting the mark in this go around is pretty significant valuation changes taking place in that specific industry. So I wouldn't read anything sort of that would impact other parts of the investment. It's very much a function of the specific industry that, that company sits within.

And the other position which is second lien which just launched this quarter is Zep. That one is actually a bigger company. We look at that business, there's been, I'd say, some management missteps. The fundamental value proposition for the business, it's basically branded cleaning supplies, pretty stable market trends and a little bit of some management missteps around a sales force reorganization. Nothing, I think, that's going to permanently impact the earnings profile of that business, and we're looking at things stabilizing there. It's also a little bit unusually large in terms of the size of the business perspective. The company is on the bigger end of the scale. We actually knew that company through our senior credit fund, going back aways and assets moving to the second lien a bit more opportunistically. And I would say that's one where we look at that position. It's marked where it is. But longer term, saw optimism with respect to the final outcome for that investment.

So I don't think, Robert, there's much more across the portfolio that we would point you to. In fact, and Jon mentioned this in his prepared remarks, much of our repayment activity this quarter was in some of those older vintage second lien investments. Vexos, for example, would be one that comes to mind. So we're actually quite pleased when you look at the sort of the quarter-over-quarter portfolio quality. So on the one hand, as we talked about in the discussion, improving lean type significantly, also improving the overall portfolio concentration, and also, at the same time, many of those older vintage investments were actually repaid to a pretty significant degree this quarter. So in other words, the vintage, the cleanliness, if you will, of the existing portfolio, still feel quite good about.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [11]

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Okay. Got it. I appreciate the color there. And then if I can, on kind of just a near-term question. A question about your pipeline, because if I look at -- obviously, a lot of the repayments occurred late in the quarter. So you're starting off the fourth quarter with a -- at a lower earnings run rate. Add on to that LIBOR, add on to that, hypothetically if NAV is stable this quarter, incentive fees are higher. And it looks like you may be in a position where NII earnings perhaps wouldn't cover the dividend in the fourth quarter based on the portfolio size at the end of the third quarter. So can you give us any color on the pipeline and the ramp rate to get the portfolio size back up, to your point, lower yields, more leverage, et cetera? I mean I don't think there's any long-term, in my view, questions about your ability to earn it. But when is it going to happen?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [12]

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We're certainly not going to make projections, Robert, about next quarter. We'll be happy to answer that with the team on model questions offline. All that being said, getting the portfolio optimized from a calculation perspective is not something we've got a lot of concern with. The pipeline continues to be quite good. Again, we gave that commentary this quarter in terms of the portfolio activity, highly, highly diversified, 10 new portfolio companies into the book this quarter. As I think you hear from a lot of other management teams, most of what they're doing is follow-ons to existing portfolio companies. We get some of that benefit. But we've been a bit more skewed towards new deals, which augurs well for the continued growth of the business and I think speaks well of just our position within the market.

So in terms of all the variables that sort of go into the net investment income at the end of the day, getting the portfolio ramped relative to ending portfolio balances is not one we have particular worries about.

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Operator [13]

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And your next question comes from the line of Derek Hewett from Bank of America Merrill Lynch.

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Derek Russell Hewett, BofA Merrill Lynch, Research Division - VP [14]

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Circling back to MPI Products, and given that it's a -- it seems to be a sector-specific issue, will this be rolling off the book shortly given the near-term maturity? Or will the investment need to be restructured over the next 2 to 3 months?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [15]

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Yes. So as we mentioned, Derek, it's a fluid situation right now. The company is in a sale process. As I mentioned, when you look at the mark today, I think what we're looking at is industry valuations there, in particular, coming down quite dramatically. So in terms of the range of outcomes, it could be a full repayment, it could be a partial repayment, it could be a variety of different outcomes. But I think specific to the sector commentary, in any event, we're talking about a quite, quite small exposure. We had one other company that was related to the auto industry that was repaid this quarter. Even if this one continues to be part of the exposure, it would be literally the only exposure in the sector and would be quite, quite small.

And I think as a general matter, when you do look at where we do have most of the capital, it certainly is a way from more cyclical, more capital-intensive, more industrial types of businesses and much more focused on areas like health care and health care IT, business services, technology, which is exactly where we want to be based on where we are within the overall economic cycle. And as you heard, it really has been a focus for us in terms of active repositioning to get to where we are.

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Derek Russell Hewett, BofA Merrill Lynch, Research Division - VP [16]

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Okay. And then could you provide a little bit more color on the yield? I realize roughly 50-50 percent of the 70 basis point decline was due to lower benchmark rates in older vintage loans. But at this point, will the yield trend a little more closely to benchmark rates? Or could we see additional pressure due to further portfolio rotation from older vintage investments?

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Jon Yoder, Goldman Sachs BDC, Inc. - COO [17]

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Derek, so I don't think that -- so if you look at the totality of kind of where our portfolio looks like today, remember, one of the big driving factors on the top line is that we brought on balance sheet all of the lower-yielding loans that used to be in our joint venture, our senior credit fund. And if you remember the strategy in that joint venture was upper middle market. It was not our directly originated deals. It was like mostly narrowly syndicated type deals that generally came with lower spreads. And so if you look at the average yield at cost from that legacy -- that portfolio that we took on, it's just under 8%. You compare that to what we are originating today, and we've been pretty consistent in recent quarters at being just right around 9% in terms of the yields on the direct originations that we do on the balance sheet. I think one of the opportunities that we have in -- and you've seen us execute on is to rotate some of those senior -- the old senior credit fund assets into higher-yielding directly originated deals. So we think that's a pretty powerful sort of toggle that we have here to fight any further decreases in rates should they come to pass.

Obviously, the rate environment has been fluid at the moment. It feels a bit more stable. But obviously, things can change as they have been throughout the course of the year. So I don't think that, broadly speaking, we feel like -- well, I should say, broadly speaking, we do feel like there are opportunities to maintain an attractive top line here, even in the face of potentially further decline in rates.

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [18]

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And the only thing I'd add, Derek, to one specific part of your question with respect to the potential for future repayments of some of those earlier vintage investments. I think when you look at our SOI and when you look at this quarter, I think you'll see that there's not a ton of exposure remaining. And so we wouldn't expect there to be that continued trend of getting repaid out of some of those earlier, much higher-yielding deals. I think we've borne the brunt of that at this point. And I think an examination of our SOI would show that quite clearly.

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Operator [19]

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(Operator Instructions) And at this time, there are no further questions. Please continue with any closing remarks.

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [20]

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Well, thanks, Ian, and thank you, of course, everyone, for joining us for this conference call. As always, if you have any additional questions, please don't hesitate to reach out directly to the management team here. Enjoy your weekend. Thank you.

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Operator [21]

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Ladies and gentlemen, this does conclude the Goldman Sachs BDC, Inc. Third Quarter 2019 Earnings Conference Call. Thank you for your participation. You may now disconnect.