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Edited Transcript of GSBD earnings conference call or presentation 21-Feb-20 2:00pm GMT

Q4 2019 Goldman Sachs BDC Inc Earnings Call

New York Mar 5, 2020 (Thomson StreetEvents) -- Edited Transcript of Goldman Sachs BDC Inc earnings conference call or presentation Friday, February 21, 2020 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. - IR

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Conference Call Participants

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* 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 Dennis, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. Fourth 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. - IR [2]

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Thanks, Dennis. 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 belief regarding future events that, by nature -- 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 home page 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-K filed yesterday with the SEC. This conference call is being recorded today, February 21, 2020, 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 fourth quarter and year-end 2019 earnings conference call. I'm joined on the call today by Jon Yoder, our Chief Operating Officer; and Jonathan Lamm, our Chief Financial Officer.

I'll begin the call by providing an overview of our fourth quarter and full year results, including an update on the proposed merger of GSBD with Goldman Sachs Middle Market Lending Corp, which we refer to as MMLC.

Jon Yoder will then discuss our investment activity and portfolio, before turning it over to Jonathan Lamm to walk through our financial results in more detail. Finally, I'll conclude with some closing remarks before we open the line for Q&A.

So with that, let's start with our fourth quarter results. Q4 net investment income per share was $0.48, bringing NII per share for the full year to $1.98 or an 11.5% return on common equity for 2019.

Our net investment income covered our dividend by 107% during the quarter and 110% for the full year 2019. As we announced after the market closed yesterday, our Board declared a $0.45 per share dividend payable to shareholders of record as of March 31, 2020. This equates to a dividend yield of 10.7% based on net asset value per share at the end of Q4. We believe that these are strong quarterly and full year financial results for our shareholders. Looking back on the fourth quarter and the full year 2019, we saw a continuation of the steady execution of several facets of our strategy.

On the asset side, we leveraged our origination platform to significantly shift our investment mix toward more senior loans over the past year, and we also increased overall portfolio diversification. These improvements in portfolio attributes have in turn facilitated improvements in our liability mix.

Earlier this month, we executed our inaugural institutional bond offering. The $360 million offering came with a coupon of 3.75%, and the proceeds were used to repay borrowings under our secured credit facility. The offering diversified our funding mix toward more unsecured debt, which improved our financial flexibility without increasing our overall cost of borrowing. And finally, on December 9, we announced the proposed merger of GSBD with our affiliated vehicle MMLC.

To those of you who may not be familiar with the transaction, MMLC is a private affiliated BDC that commenced operations in 2017. Since its formation, MMLC has participated in a common investment program alongside GSBD, with the result that over 90% of the investment portfolio of MMLC overlaps with GSBD's portfolio. I would like to reiterate the key -- the 5 key reasons why we believe the merger of GSBD and MMLC is such a compelling transaction.

First, we expect the merger to be highly accretive to GSBD's net asset value per share. As disclosed in the joint proxy statement filed with the SEC on January 8, 2020, the transaction is expected to result in over 5% accretion to GSBD's net asset value per share.

Second, we expect the combination with MMLC to be accretive to net investment income per share, both in the short and long term. In the short term, we expect accretion to NII to be delivered primarily by the variable cap on GSAM's incentive fees that GSAM agreed to as part of the transaction.

In the long term, we expect the increased net asset value per share will allow us to grow the investment portfolio and add additional income-producing assets to drive NII growth.

Third, we believe that the transaction results in an overall improvement in portfolio metrics, including an increase in the yield on the portfolio at amortized cost and a reduction in the percentage of investments on nonaccrual status.

Fourth, the increased size and scale of the combined company should facilitate greater access to institutional debt markets. And fifth, the transaction offers all these benefits without the typical due diligence risks that accompany M&A since over 90% of MMLC's portfolio overlaps with GSBD's portfolio.

Following the announcement of the transaction in December, GSBD filed a preliminary joint proxy statement with the SEC in early January. This filing starts a review and comment process with the SEC that typically takes several months to complete, though the exact timing is difficult to predict.

However, based on our current expectations, we expect to hold a stockholder meeting for each of GSBD and MMLC in Q2 of 2020 to vote on the proposed merger. If we obtain approval from both shareholder bases, we would anticipate closing the transaction shortly thereafter. We look forward to providing future updates on the status of this merger as they progress.

With that, let me turn it over to Jon Yoder, who'll discuss our portfolio investment activities for the quarter in greater detail.

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

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Great. Thanks, Brendan. We continue to operate in an environment that is broadly supportive of our investment strategy of directly originating loans to middle-market-sized companies operating in the United States. The U.S. economy continues to produce steady gains in GDP and unemployment remains historically low. This backdrop has created a very active deal-making environment, which, in turn, has presented us with a lot of investment opportunities to choose from.

During the course of 2019, our team originated approximately $2.4 billion of new investments across our platform, including $605 million for GSBD. These new investment commitments were across 30 new portfolio companies and 22 existing portfolio companies.

As a result of this activity, and inclusive of the consolidation of the senior credit fund onto our balance sheet, we increased the total number of companies in GSBD's portfolio from 72 to 106. That's nearly a 50% year-over-year increase in single name diversity. The percentage of GSBD's portfolio invested in first lien loans also materially increased from 53% to 74% year-over-year. I would emphasize that while the operating environment for our strategy continues to be strong, we've maintained our focus on investments in durable businesses that we believe are less impacted by cyclical pressures.

So let's turn to specific investment activity for the quarter. New investment commitments and fundings were approximately $159.8 million and $160.8 million, respectively, which included net fundings of $11.5 million of previously unfunded commitments. 100% of new investment commitments were in first lien floating rate debt instruments.

These new investment commitments were across 7 new portfolio companies and 10 existing portfolio companies. Sales and repayment activity totaled $126.1 million, driven by the full repayment of investments in 6 portfolio companies.

Several of our exits this quarter were from older vintage investments that were fully repaid. In addition to these, we were repaid out of our investment in a company called Continuum. This was an investment that we originated back in 2017. We made a first lien loan to the company, together with a small equity investment, because we believe that the company had multiple avenues of growth as well as margin optimization and acquisition opportunities.

While our equity investment was small, the sale of the company resulted in a 3.4x multiple on our equity investment. We think that this investment is a good example of how we selectively make small equity investments in connection with certain lending opportunities to drive attractive overall returns.

Regarding portfolio composition. As of the end of the year, total investments in our portfolio were $1,454,300,000 at fair value, comprised of 92.8% senior secured loans, including 74.3% in first lien, 2.4% in first lien/last-out unitranche, and 16.1% in second lien debt, as well as 0.5% in unsecured debt and 6.7% in preferred and common stock. We also had $87.2 million of unfunded commitments as of December 31, bringing total investments and commitments to $1,541,500,000.

As of quarter end, the company had 206 investments across 106 portfolio companies. As Brendan mentioned earlier, we've been very pleased with our ability to diversify the company's single name portfolio exposure in recent years. The weighted average yield of our investment portfolio at cost at the end of the fourth quarter was 8.2% as compared to 8.3% at the end of the third quarter.

The weighted average yield of our total debt in income-producing investments at cost was 9% at the end of the fourth quarter as compared to 9.1% at the end of the third quarter. This slight decrease is primarily attributable to the decline in LIBOR that transpired during the fourth quarter.

Now turning to credit quality. The underlying performance of our portfolio companies overall was stable quarter-over-quarter. The weighted average net debt-to-EBITDA of the companies in our investment portfolio was 5.7x at quarter end versus 5.4x at the end of the third quarter. The weighted average interest coverage of the companies in the investment portfolio at quarter end was 2.4x, which was flat from the prior quarter.

I'll now turn the call 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 fourth quarter of 2019 with total portfolio investments at fair value of $1.45 billion, outstanding debt of $773 million and net assets of $676 million. Our net investment income per share was $0.48, which was up $0.01 from the prior quarter. Earnings per share were $0.22, equal to the prior quarter. During the quarter, our average debt-to-equity ratio was 1.11x versus 1.22x in the prior quarter. We ended the fourth quarter with a debt-to-equity ratio of 1.14x versus 1.07x at the end of Q3.

Turning to the income statement. Our total investment income for the fourth quarter was $35.5 million, which was down from $36.9 million last quarter driven by the lower average debt-to-equity ratio in the quarter as well as from the decrease in LIBOR. Net expenses were $15.6 million for the fourth quarter as compared to $17.4 million in the prior quarter. Expenses were down quarter-over-quarter, primarily driven by a decrease in interest and other debt expenses as a result of lower average borrowings and the decrease in LIBOR.

We ended Q4 with net asset value per share at $16.75 as compared to $16.98 from the prior quarter, driven by unrealized depreciation on select investments partially offset by the realized gain in Continuum that Jon mentioned in his remarks.

The company had $46.7 million in taxable accumulated undistributed net investment income at quarter end resulting from net investment income that has exceeded our dividend. This equates to $1.16 per share on current shares outstanding. Consistent with prior years, we spilled over all of the undistributed NII into 2020 as we believe the cost of this spillover in the form of the excise tax is a small price to pay relative to the much higher cost of issuing new equity. Subsequent to quarter end, we have been active on the right side of the company's balance sheet.

As Brendan mentioned earlier, the company conducted its inaugural institutional debt offering in February. Our notes offered -- offering closed on February 10, 2020, and we were very pleased with the execution. The notes priced at a fixed rate of 3.75%. The spread at issuance was 230 basis points to 5-year U.S. treasuries. At this pricing level, we were able to price our unsecured debt at nearly the same level as our secured revolving credit facility.

In addition to increasing the company's exposure to attractively price debt, we were also able to further diversify the company's funding mix and enhance our overall financial flexibility.

We are pleased to report that the company received a second investment-grade rating of Baa3 from Moody's in January 2020. In addition, the company's investment-grade BBB- rating from Fitch was reaffirmed. As the company now has 2 IG ratings, we recently launched an amendment with our lenders in our revolving credit facility to reduce the spread on our facility from LIBOR plus 200 basis points to LIBOR plus 187.5 basis points, and extend the maturity date to 2025.

These amendments to the credit facility, among other items, are expected to close by the end of February, and are subject to certain closing conditions. As a result of these financing actions, we believe the company's balance sheet and funding profile will be materially strengthened.

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, we are pleased with our execution on behalf of our shareholders in Q4 and for the full year 2019.

As we look forward to the coming year, we believe GSBD continues to be well positioned to take advantage of the attractive opportunities in the middle market lending 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 course of 2020.

With that, Dennis, let's open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from the line of Finian O'Shea with 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 first on your market strategy. Looking at the deal being mostly in the core middle market, mix of sponsored/non-sponsored is how I'd have viewed you historically. Understanding the Continuum to ConnectWise commitment, did you see a few other of these large sponsor-backed private transactions, your Parts Town, your Acquia? So it has me thinking, is this just sort of one-off? Or is there a shift in what your -- the deals you're looking at and what you're interested in investing in now?

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

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Fin, Brendan, thanks for joining. I'll take a crack. I'm sure Jon has comments as well.

There's no change at all, Fin. Our strategy, I think, when you look at the underlying portfolio metrics, we've been quite consistent in the portfolio construction here. The average size of a company in our portfolio is under $40 million of EBITDA. We do find ourselves from time to time in circumstances where we've made a loan to a company that grows and matures, you mentioned one of them in this -- in your question here, which is Continuum. That's a loan that we've had in the portfolio going back to 2017. It was acquired by another company called Continuum. Jon mentioned, we had a very nice -- sorry, by ConnectWise. So we did roll a small amount into that new loan on a heads up basis with the lead lender there.

So I would describe that as a situation where we had a very strong, very profitable investment in one company. We have the benefit of many years of watching it perform. And just decided to participate in the continuing exposures of the company in the context of it being merged by a competitor in a great industry, in a great space, with a great sponsor. So no change at all in the overall approach to what we're doing here.

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

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Yes. The other thing I would add to that, Fin, is that a lot of these -- well, some of the key sponsors that we've worked with for years on the -- obviously, on the sponsor side, are increasingly raising larger and larger funds, and thus going for larger and larger companies. And so I think probably some of the deal flow that we get as a result of that can be from larger companies. So it's not -- as Brendan said, we're not changing our strategy. We're not now targeting the upper middle market, but occasionally, a sponsor that we know, trust and have worked with for a very long time, given the size of their funds is growing, the size of deals that they're doing is growing, that results in selective opportunities we might participate in. But I agree with Brendan, that's not where we're targeting our originations.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [5]

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Okay. And I guess, just a couple portfolio questions. I'll start with a good one. Hunter looks like it's been on a little bit of a run. Can you -- this is -- I don't know how this works, it's a preferred stock, but obviously has some common stock element to it.

The -- I think holding's almost doubled. Can you give us any update there? And I guess, first, can you remind us, does that pay income? And is there a potential exits on the horizon?

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

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Yes. I'll give a little bit of context there and recognize that there's limitations on what we can and can't say. But you're right, the business has been improving its performance cadence for some time now. This was an investment that we made in earlier vintage investments that was restructured. So we've taken back a significant amount of preferred stock here and have had ongoing exposure to the company's positive performance since that deal was done, which has allowed us to recoup a very significant amount of that initial investment.

So the investment we have today is not an income-producing asset. But I think, suffice to say, as we look forward and working collectively with Charlesbank, who's a sponsor here in this name as well, we do see potential opportunities for an exit. Nothing imminent to speak to here, but I think a good opportunity for us to take what is, say, an income -- a non income-producing assets and reinvest that into income-producing proceeds. Again, hopefully, at a total value that's going to be at or near the amount of initial capital that we put into this transaction. So quite a good story here.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [7]

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Sure. And then a comment you provide on IHS, was a -- I know it's second lien, so it'll be more sensitive to things. But any context on the fairly steep drop quarter-to-quarter?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [8]

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Yes. I'll speak to this one. So IHS is a small $10 million at cost position that we have -- we made back in 2015. The business is focused on what I'll call workplace health care programs. They do things like on-site screening for employees. They collect data for the employers. Ultimately, the goal is to help reduce the overall cost of health care for the employee base.

So there's been some competitive pressures in the business. And you're right, as a second lien, as that has unfolded with a few customer losses more recently, it's become a bit more of a challenging situation. So we did put this on to nonaccrual this quarter and did mark it down. But again, a relatively small position overall in the context of the $1.5 billion portfolio here.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [9]

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Okay. And then just a small follow-up. Did you say it was based on customer loss? How -- to the extent you may say, how severe was that? Is there just a couple of customers on this one? Is it something that...

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

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I would say, overall, there's been competitive pressures and the company has been lagging some of its peers in the offerings, which have led to a couple of these customer losses. There's a little bit of a cadence to the business where there's a renewal period. So some of that has come through quicker than one might otherwise have expected. And so that's been the dynamic with respect to the speed. We marked it down significantly last quarter, and that continued through the course here. And so something that we continue to monitor quite closely, again, here. But context is, this is quite a small investment overall in terms of our exposure here in the context of the portfolio.

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Operator [11]

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Your next question is from the line of Robert Dodd with Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [12]

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On the debt-to-EBITDA for the portfolio, obviously, it ticked up a little this quarter. The portfolio did grow a touch. But can you give us any -- I mean, was that entirely related to just the mix of repayments versus originations? Or was there anything in there where there was an EBITDA deterioration at one of the -- at any particular business or area?

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [13]

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Yes. No -- yes, thanks, Robert. The tick up this quarter was really a function of that portfolio turnover that you typically see. And so, as you know, when you make an investment, typically, you'll end up seeing the company deleveraging over time, and that might result in a repayment. Those proceeds are then reinvested into new loans. So there's nothing driving that number higher. That's company specific, where EBITDA has ticked up, or portfolio specific. I would say, looking across a broader portfolio, performance continues to be quite steady and consistent. We had no major changes in our risk ratings for the quarter in terms of the percentages of the company's moving down in the overall risk ratings. We mentioned IHS as a small one-off that had already been a rating 3 for us. That moved to a rating 4. But broadly speaking, across the portfolio, we continue to see healthy trends. And the dynamic in the number this quarter is really just some movements of companies coming in and out.

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Jon Yoder, Goldman Sachs BDC, Inc. - COO [14]

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Yes. And just to add to that, Robert, I guess, on the -- I mentioned in the prepared remarks, we had a couple of sort of older vintage deals that got paid off in full, and they happen to be quite, at this point in their life cycle, quite low levered companies. So we had one company called Artisan, which we've had for a very long time. It'd -- frankly, the only reason we hadn't been refinanced a lot earlier is because of that very, very strong call protection in the form of a make-whole, and we effectively -- the company took advantage of refinancing as soon as that make-whole obligation expired. But by the time we got to the end of that, it was quite conservatively levered.

And the other one -- another older vintage one was a company called, I think, it's -- I'll refer to it as legacy buyer, but the brand name of the company is Legacy ER. And again, that was a situation where we had been in it since, I think, 2015, roughly, time frame. And the company just delevered a lot. And so when you -- those are a couple of examples. But when you lose kind of older vintage deals that are, frankly, very low levered at this point in their life cycle, as Brendan was mentioning, it can have an impact in terms of the weighted average on your overall portfolio.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [15]

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Yes. Yes. Understood. And then moving on to the transaction. I know there's limited amount you can say about that, but there's a high level of overlap between the GSBD and MMLC portfolios. But some of the assets at GSBD, obviously, were on there -- were put on the balance sheet of the BDC before the other portfolio existed. So there's a segment of the legacy portfolio that has a -- could you characterize -- obviously, that will become a meaningfully smaller portion when you combine the two. Can you give us any color on what you would -- how you would -- with the individual company risk ratings, but what kind of benefits do you think you're going to get from that piece of the business shrinking materially? Because I -- if I remember right, those are some of the, relatively speaking, riskier assets.

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Brendan M. McGovern, Goldman Sachs BDC, Inc. - President & CEO [16]

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Yes. I wouldn't necessarily, Robert, point to that dynamic as the overall -- kind of what improves the overall portfolio construction. We're talking about, I think the number is 7% of the assets that are in GSBD are not in MMLC. So it's a pretty small number overall. But you are right that there's a little bit of that legacy issue, which when you combine the two companies together -- so for example, MMLC today has no investments on nonaccrual and say there's 1% at fair value of investments in GSBD on nonaccrual. So just given the nature of the transaction, that number will be halved pro forma for the deal. So that's a positive. We do have a handful of non income-producing assets. I've mentioned Hunter in Fin's question as one of them. That's only in GSBD and not in MMLC. And so again, when you combine the 2 companies, there'll be a greater proportion of income-producing assets overall.

None of those numbers are really dramatic, one way or another. And so there is, I would say, certainly, a pro-forma benefit that the combined company will get, but nothing, I think, is something that I would focus on too exclusively.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [17]

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Got it. Got it. Appreciate it. And then one more, if I can. On the undistributed income, the $1.15, obviously, at GSBD. Is there going to be any requirement or expectation that any of that will get distributed right at or right prior to the close of the merger, because if -- I don't think MMLC has the same kind of spillover characteristics, if that's right?

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Jonathan Lamm, Goldman Sachs BDC, Inc. - Treasurer & CFO [18]

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Right. So there's no requirement for GSBD -- for the merger to distribute any of it's spillover income. There's no -- there are no RIC issues that we're coming up on with respect to the merger that would cause us to have to distribute out of GSBD. MMLC will have to make whatever spillover distributions, it has -- spillover income it has in order to meet the RIC requirements prior to the merger because that's effectively the end of its existence.

But as you mentioned, it's not a significant amount. We -- given where our spillover income is now, we would project, given the fact that we're -- we've been over-earning the dividend, that in 2020, at some point, we would have to pay out a special dividend out of GSBD in order to meet the RIC tax requirements absent the merger. So if the merger were not to close, then we would, at some point in September, October time frame when we file our tax return, we'd be required to pay out some of that spillover, just given the fact that we're sort of bumping up against that limit later in the year. Effective or pro forma for the merger closing prior to that date, though, that issue goes away, and we would not be required to pay out any of that spillover.

So a lot of detail there, Robert, but I just want to make sure you had the entire picture.

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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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Okay. Thanks, Dennis. And thank you, of course, everybody, for joining us for the conference call today. As always, if you do have any additional questions or follow-ups, please don't hesitate to reach out to the team. In the meantime, 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. Fourth Quarter 2019 Earnings Conference Call. Thank you for your participation. You may now disconnect.