Golub Capital BDC, Inc.
Q1 2021 Earnings Call Transcript

Published: 10 Feb 2021

[Operator:]

Welcome to GBDC’s December 31, 2020 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 GBDC’s filings with the SEC.

[David Golub:]

Thank you. Hello everybody and thanks for joining us today. I’m joined by Ross Teune, our Chief Financial Officer; Gregory Robbins, Senior Managing Director; and Jon Simmons, Managing Director at Golub Capital. We and the rest of the Golub Capital team hope that your 2021 is off to a good start. Yesterday, we issued our earnings press release for the quarter ended December 31, and we posted an earnings presentation on our website. We will be referring to this presentation throughout the call today. For those of you who are new to GBDC, our investment strategy is and since inception it has been, to focus on providing first-lien senior secured loans to healthy, resilient middle-market companies that are backed by strong partnership-oriented private equity sponsors. Let me start by giving the headline for the quarter ended December 31 and that headline is that GBDC’s results were strong and they were in line with the preliminary estimates that we filed on January 20. GBDC’s performance for the quarter exhibited solid net investment income and continued strong credit performance. We will discuss both these topics in more detail as we go through today’s presentation. Gregory is going to start by providing a brief overview of GBDC’s performance for the 12/31 quarter and then he is going to hand it off to Jon and Ross for a more detailed review of the results. I will then provide some closing commentary reviewing our post-COVID performance and then we will open the line for questions. With that, let’s take a closer look at GBDC’s results for the quarter and the key drivers of those results. Gregory?

[Gregory Robbins:]

Thank you, David. I am going to begin on Slide 4. For the quarter ended December 31, GBDC’s adjusted NII per share was $0.29, adjusted EPS was $0.56 and ending NAV per share was $14.60, all within the ranges we published previously. What were the key drivers of those results? At the risk of repeating ourselves, the key drivers, besides good underwriting, were the same trends we have discussed for the last two quarters. These trends, which are summarized on Slide 6 are

[Jon Simmons:]

Thanks, Gregory. First, as a reminder, please note that in addition to the GAAP financial measures in the investor presentation, we have also provided certain non-GAAP measures. These non-GAAP or “adjusted” measures, as we refer to them, seek to strip out the impact of the GCIC merger purchase premium write-off and amortization. These adjusted measures are further described in the Appendix of our earnings presentation and we’ll refer to them throughout today’s call.

[Ross Teune:]

Great. Thanks, Jon. Turning to Slide 11, new investment commitments were a record for the quarter ended December 31, totaling $526.8 million. After factoring in total exits and sales of investments of $278.7 million as well as unrealized depreciation and other portfolio activity, total investments at fair value increased by 6.3% or $269 million during the quarter ended December 31. As of December 31, we had $43.5 million of undrawn revolver commitments and $126.2 million of undrawn commitments on delayed draw term loans. These unfunded commitments are relatively small in the context of our balance sheet and liquidity position. As shown in the bottom of the table, the weighted average rate of 7.1% on new investments and the weighted average spread over LIBOR on new floating rate investments of 6.1% both decreased from the prior quarter as market conditions continued to rebound since the onset of COVID. Just as a reminder, the weighted average interest rate on new investments is based on the contractual interest rate at the time of funding. For variable rate loans, the contractual rate would be calculated using current LIBOR, the spread over LIBOR, and the impact of any LIBOR floor.

[David Golub:]

Thanks, Ross. So to sum up, GBDC had a strong quarter. Adjusted net investment income rose to match our dividend, realized credit losses were very low and unrealized gains were substantial, continuing the reversal of unrealized losses that we incurred in the March quarter. I want to end our prepared remarks with a bit of what I am going to call “Post-COVID Hindsight.” I think now is a good time to start to reflect on COVID and what we’ve learned from COVID—but I recognize it’s still early as probably it’s not over yet. Having said this, I think enough has happened for us to look back at the post-COVID period and begin to assess how we performed. On Slide 24, we outlined three key goals that we established back in March 2020 for navigating COVID

[Operator:]

Thank you. And your first question comes from the line of Robert Dodd from Raymond James. Your line is open.

[Robert Dodd:]

Hi, guys. First, on to your point, David, kind of a post-COVID hindsight, the market certainly seems to have moved on from the COVID point. Can you give us any color on, I mean spreads like now you held – and your new deployment spreads were wider than they were a year ago. So, there still seems to be some widening at least in the fourth calendar quarter on spreads versus pre-COVID. I mean, is that still true as we go into January? And can you give us any color on, I mean the market spread seems to have compressed? Are terms holding up? And any color you can give us on that front would be appreciated.

[David Golub:]

Sure. Hello, Robert. Good to hear your voice. So, let me put it in context. Calendar Q4 was a record quarter for Golub Capital, an unusual quarter in the sense that there was a surge in M&A activity market-wide. So, it wasn’t just a good origination quarter for Golub Capital, it was a strong origination quarter for most of the large private debt managers who are open for business. I would say if you looked at calendar Q4, quite as you said, Robert, spreads were a bit better than pre-COVID. Documentation terms were a bit better. Leverage was a bit better. And importantly, we were able to focus on companies that had proven post-COVID performance. The bulk of the activity that we saw in calendar Q4 was with sponsors we have worked with multiple times. Over 90% of our Q4 originations were with repeat sponsors. I believe over 40% of our originations in calendar Q4 were actually add-ons. So, we were able to focus on credits that we know very well with sponsors that we know very well. I think that makes for attractive investment opportunities, because we are able to make decisions with lots of information. As we crossed 12/31, moved into calendar year 2021, first quarters tend to be slower in general than Q4 quarters. There is a bit of seasonality that’s typical in the sponsor-financed business. And I think we are seeing that in the first quarter this year. We are also seeing that there is a burst of competitiveness and spread compression in the broadly syndicated market. And I think you were alluding to that, Robert. We have seen that in the form of lot of flexes, a lot of spread tightening on loans that are being syndicated during the syndication process. So, my expectation is that the middle-market is impacted by what happens in the high-yield market and in the broadly syndicated market. Usually, there is a lag and it’s not a one-for-one relationship. But my expectation is that we are going to see pressure on spreads in the private markets over the course of the coming months, unless there is a change in dynamics and what’s happening in the broadly syndicated market. For now, it continues to be attractive. We are – I would characterize Q1 as a good solid quarter right now from an origination pipeline standpoint, but I think it’s reasonable to anticipate that we are going to see the same kinds of patterns in the private market that we are seeing right now in the broadly syndicated market.

[Robert Dodd:]

I appreciate that a lot. If I can next question, not related to market, well, I mean the overall credit quality book looks to be improving. I mean, it looks pretty good. The only thing that kind of sticks out to me is PIK income. Obviously, I mean, it’s triple where it was a year ago. You generally run very low PIK income, so you are still below the industry average even there. The only thing that stands out a little bit is up fairly meaningfully from the last – from the third calendar quarter to the fourth calendar quarter. Nothing leaps out in the portfolio that I have seen. I mean there is no single big PIK asset or anything like that. But was there a trend in amendments or something else that grew that PIK a little bit in the fourth quarter. Again, it’s not a horribly high number. It’s not overly concerning, but it did tick up a bit.

[David Golub:]

I think you are right. To put it in context, PIK income is relatively small at Golub Capital by industry standards. It has increased some. And I think the two areas that we have seen where it’s grown, one relates to our activities in late-stage lending. So, this is with companies that are in the software-as-a-service business, where they, in some cases, prefer to have PIK as a portion of the way in which they compensate us. And our portfolio of LSL loans has grown over the last number of years. The second is a point that you alluded to, which is in negotiations on amendments to existing credit facilities through COVID. We have in some circumstances used incremental interest in the form of PIK as part of the mix of different components of amendments. And so there is some increase in PIK income associated with that. I don’t think this is going to be a continuing trend. I think you are going to see PIK income stabilize and perhaps even go down in coming quarters. And I don’t think that you are going to see what I suspect you are afraid of which is a repetition of a pattern that we have seen with other BDCs where PIK income has never been received. I am not terribly concerned about credit risk associated with our PIK accruals at this point.

[Robert Dodd:]

Yes, I am pretty transparent about what I was really asking about, but I appreciate the answer. Thanks a lot and congrats on the quarter. Thanks.

[Operator:]

And your next question comes from the line of Finian O’Shea from Wells Fargo Securities. Your line is open.

[Finian O’Shea:]

Hi, good afternoon everyone. David, first question, appreciate the commentary at the end on the underperforming or COVID impacted names, can you provide any additional color on how well the EBITDA or profitability levels of this category are improving as the economy generally, although slowly perhaps, recovers and opens up and so forth?

[David Golub:]

So we have been very candid over the course of the last several quarters about how pleased we have been with the performance of companies in the industry categories that we mentioned in the March 31 quarter as being the industry categories we are most concerned about. So, if you recall, going back to the April timeframe, we talked about dental care, restaurants, retail, eye care and fitness franchises. And while we don’t disclose EBITDA performance, a proxy for EBITDA performance is fair value marks. And if you look at the fair value marks in those industry sectors, I mean, a typical one of those industry sectors has gone from fair value marks averaging in the high 80s to fair value marks averaging in the now high 90s. The one sector that I would say we continue to monitor really carefully, that I continue to have some concerns about is fitness franchises. At the risk of stating the obvious, with the way in which the COVID vaccination campaign has been going slowly, I think there is a general view that the recovery in fitness franchises is going to be also slow. Good news for us here is it’s a small portion of the portfolio. It’s diversified amongst a half dozen different companies. We’re focused on the low-cost, high-value segment, which I think will recover well and recover fast when people feel comfortable going back into gyms. I don’t mean to sound alarmist. I’m cautiously optimistic about our fitness franchise exposure. But of those COVID industries – COVID-impacted industries that we identified early – the others have really recovered quite well.

[Finian O’Shea:]

That’s helpful. Thank you. And then just a follow on, on origination style, obviously, for at least a long time, you’ve been focused mainly on unitranche, and there’s some activity in first lien this quarter, for example. But with the shift on the right side of the balance sheet, we now have unsecured. And it sounds like that number will grow. Do you anticipate any style drift into any element of added risk, whether it be second lien, other financings and so forth?

[David Golub:]

Short answer, no. We are not anticipating any meaningful change in strategy. Our focus is to continue to achieve our mission, which is to be best in sponsor finance with a strong focus on enabling sponsors to finance their businesses a number of different ways, depending on what’s right for the deal. And I anticipate that the mix within GBDC is unlikely to shift much. If you go back and look at the charts that we present every quarter about the proportion of the portfolio that’s in one-stops currently is about 81%, it really hasn’t moved much in many, many quarters. And if you look at the statistics about degree of diversification and granularity in the portfolio, again, it really hasn’t moved in many, many quarters. So, those core elements of our strategy are, I’d say, unlikely to change.

[Finian O’Shea:]

Very well. That’s helpful. And thank you. That’s all for me.

[Operator:]

Your next question comes from the line of Ryan Lynch from KBW. Your line is open.

[Ryan Lynch:]

Good afternoon and thanks for taking my questions. David, you provided some commentary around your reflections on kind of how your portfolio has performed during this COVID period as you kind of reflect back. One of the questions I had was a broader question. It feels like term structures and yields are quickly returning, if not already returned to kind of pre-COVID levels. But my question is a little bit larger than that. Do you see any lasting changes or lasting effects on the direct lending industry post-COVID, whether it’s players, whether it’s how players are funding themselves or where companies – or where direct lenders invest? I’d love to hear your commentary on any potential lasting changes you think could come out of the direct lending industry kind of post-COVID?

[David Golub:]

I think it’s a great question, Ryan, and one I’ve been thinking about a lot recently. We’ll see if I’m right, but one of my hypotheses right now is that coming out of COVID, we’re going to see a continuation of a trend that we saw during COVID, which is the big got bigger. And we saw that trend, to be honest, before COVID began. The largest of the private debt players have been growing at a pace faster than the industry has been growing. So why do I think COVID may have contributed to an acceleration of this trend? It goes back to some comments that I made last quarter. If you think about the challenges of establishing new relationships over Zoom, the challenges of managing multiple relationships without in-person meetings, it stands to reason that leading private equity firms are going to be inclined to reduce the number of relationships that they have and to focus more on strategically important credit partners. What I think we will see further exacerbate that trend, that we’re seeing a degree of the same phenomenon in the private equity industry. The larger private equity complexes are growing more quickly than private equity is growing. And they are developing multiple product lines, multiple industries, multiple sized companies that they are working on. So if you think about the future direction of the private equity industry, where you are going to have a smaller number of larger companies comprising the biggest customer pool, they’re going to want to work with a smaller number of large-scale private debt managers who, in turn, can offer a variety of different solutions. So, I think that’s where we are headed. I think that’s good for Golub Capital. I think it’s probably also good for the industry, because it will lead to a more stable, smarter industry with fewer outlier players who are in and out and, to your point earlier, messing up terms or offering solutions that don’t make any sense.

[Ryan Lynch:]

Got it. Yes, that makes sense. And certainly, if those trends would persist, that it certainly would be a big beneficiary to Golub and your broader platform given your scale and reach on relationships. This might be an easy one. But if I look at the liquidity on your balance sheet today, right now, you guys have about $27 million of unrestricted cash, $45 million in Morgan Stanley facility, but that’s just been downsized by $75 million, so nothing really available on that, and then $25 million on your Wells facility, but that reinvestment period ends in March. And so, as I look at your liability structure and your available capacity as well as the cash on the balance sheet, I wanted to get your thoughts on, you guys had $270 million of growth this quarter, where would the next $270 million of growth be funded?

[David Golub:]

Sure. So, two good questions. Two comments on this. First, if you look at year end, the picture is somewhat distorted because we have a very large amount of restricted cash in the CLOs as a consequence of year-end or almost year-end payoffs. So, imagine in the period post year-end, a significant number of assets were moved from bank facilities into securitizations using up that restricted cash and creating more availability in the bank lines, so we have very ample liquidity right now. Having said that, your question is an important one, which is where do we want to go with the balance sheet from here? And our intention is to do two things going forward. The first is we plan to pursue a corporate revolver. And one of the things that we are trying to manage in dealing with the bilateral bank facilities is to have the right mix between a new corporate revolver and existing bank facilities. So, I expect we will have more information to share with you in the coming period as those discussions continue. The second piece is we do want to grow the unsecured component of the balance sheet. When we did our first unsecured issuance, we were very clear in saying we anticipate being a serial issuer. We don’t anticipate this being our last issuance by any stretch. And I can’t remember, Ryan, whether it was you or – but I think it was you who asked what’s the ideal percentage of unsecured as a mix within our liability structure. And my answer at the time was something north of 35%. Again, we’re not in a rush to do that. We want to make sure that we are accessing that market at a time that is opportune from an execution standpoint. But I anticipate that we’re going to want to add to the unsecured component of our liability structure over the course of this year.

[Ryan Lynch:]

Okay. That’s helpful. And then you gave some really good commentary on how your portfolio has really performed through COVID, and it’s performed really well. But one of the statistics that you mentioned was 75% of your unrealized losses from the March 2020 quarter have reversed. So that means 25% have not reversed are still out there. So, I think there’s a couple of different ways to think about that, but how would you encourage investors to think about that remaining 25% of unrealized losses that have not reversed from that March 2020 quarter?

[David Golub:]

Well, I think it’s opportunity, right? We have seen a significant increase in net income over the course of calendar Q2, Q3 and Q4 of 2020 in connection with reversals of unrealized losses. If you would ask me after the March quarter, over how many quarters will we see reversals, I would have probably told you to expect it to occur over 2 years. In fact, 75% of it occurred in three quarters. So, it’s been faster than I would have anticipated. I don’t think one should have anticipated that all of it would – all of that which is going to reverse, would it reverse by 12/31. It’s reasonable to assume that we’ve got some loans that are marked at a discount to par, not necessarily a big discount to par, that will pay off. And when those loans pay off, we will see a reversal – we may see a reversal sooner than that if our fair value marks go up back to par. So, I don’t think there’s a negative conclusion to draw from the fact that we’ve got 25% that has not yet reversed. I think the fact that we’ve only got a very small proportion of the portfolio in Performance Ratings 1 and 2 is a good indicator that we don’t have a lot in the portfolio that’s really seriously impaired right now. Look, things can change. We can get surprised. We were surprised last March by COVID. I certainly wasn’t expecting a global pandemic. So I’m not arguing there isn’t risk here. We are in a business of managing risk, but I feel pretty good about where the portfolio is right now.

[Ryan Lynch:]

Certainly. Great. Those are all my questions that I have this afternoon. I really appreciate the time.

[Operator:]

And your next question comes from the line of David Miyazaki from Confluence Investment. Your line is open.

[David Miyazaki:]

Hi. Hello, thank you for taking my questions. Just a little bit of – and you have to forgive me for not knowing this or not remembering this properly, but a question regarding the amortization of GCIC. Is that premium allocated specifically to individual credits, and that’s the principal driver of the recognition or, is part of it straight lined in some manner or just kind of trying to get my arms around how quickly this dissipates over time?

[David Golub:]

So, it is attached to specific credits and so it will dissipate as the credits that GBDC acquired from GCIC, as those credits are repaid. And I would strongly encourage you to speak to our resident experts, Jon Simmons and Ross Teune, about this because it gets complicated in a hurry.

[David Miyazaki:]

Okay, okay. I will take you up on that. In kind of a distantly related manner, can you talk a little bit about other GCIC-like concepts that might be happening at the external manager? What are some of the activities that are taking place? Are you raising other funds? Is there other longer-term strategic plans for more GCIC-like combination?

[David Golub:]

So publicly available information on this, we have a private BDC that’s very creatively called Golub Capital BDC 3, which we are in the process of ramping up. And when it is ramped, we will look at a variety of different options for GBDC 3, as we did for GCIC. One of those options will be a potential merger with GBDC if we can figure out a way that’s good for everybody to affect that and all of the respective Boards and appropriate shareholder votes go the right way. That might be one of the paths that we look at. But no decision has been made at this point, David, that’s the path that we are going to go down. As you know, we also, at Golub Capital, have a large family of private funds, very creatively called the Golub Capital Partners Funds, and we are in the process of fundraising for Golub Capital Partners 14 at the moment.

[David Miyazaki:]

Okay. Is there – have you disclosed the size of what Golub Capital BDC 3 is or what your targeted fundraising size is?

[David Golub:]

It’s a public filer. You can see both the size of its fair value of assets and its commitments in the SEC filings.

[David Miyazaki:]

Okay, okay. Thank you. And then just to shift gears a little bit. One of the things that we’ve heard from a lot of the successful BDCs in the industry was a credit focus prior to COVID on companies that were acyclical or had a measure of recession resistance because of their size or their margin protections or just where they are situated in specific industries. And what I’m beginning to hear is that origination is now focused on COVID-resistant industries and companies. And it seems to me that there is probably a pretty sizable overlap between the two. I mean given how – while your portfolio has managed through the pandemic and against the backdrop of the ones that have had problems, when you said you thought it would be a couple of years before you had this much recovery in unrealized losses. What is sort of the difference between COVID-resistant and recession-resistant? And I don’t think COVID is going to go away anytime soon, but as we look forward, is COVID-resistant underwriting the best way to go?

[David Golub:]

Well, I think there are two timeframes here. In the near-term, because of the degree of uncertainty about how long vaccination process is going to take, whether we’re going to get a mutant strain that’s resisting to vaccines, I think it’s prudent as a lender to be focused on COVID-resistant companies, COVID-resistant borrowers right now. There are some hedge fund players in distressed debt who disagree with me and are loading up on movie theaters and amusement parks and cruise ships and a whole variety of similar credits, but that’s not what we are doing. In the longer term, assuming that the vaccines are effective, and we get back to something that we can call normal, I think there’s an element of underwriting that’s going to be forever changed. I don’t think I’m ever going to forget what this global pandemic has looked like. And the idea of people congregating in close proximity being a risk factor that we need to think about in an underwriting context, I think that’s going to be around for a long time. Does that mean that all such companies are going to be ruled out? Probably not, but does it mean that we are going to need to factor in potential new pandemics as a downside case? I think that would be prudent. So, it’s going to be interesting to see how that dynamic plays out, David. I think we’re likely to see different players approach your question in different ways.

[David Miyazaki:]

Okay, great. Well, I appreciate your insight and congratulations on a nice quarter.

[David Golub:]

Thank you, David. Well, thanks, everyone, for joining us today. As always, if you have any further questions, please feel free to reach out to a member of the Golub Capital team. And I look forward to having the opportunity to talk again next quarter.

[Operator:]

This concludes today’s conference call. You may now disconnect.