Golub Capital BDC, Inc.
Q4 2020 Earnings Call Transcript

Published: 2 Dec 2020

[Operator:]

Welcome to GBDC's September 30th, 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. For materials the company intends to refer to on today's earnings conference call, please visit the Investor Resources tab on the homepage of the company's website, www.golubcapitalbdc.com and click on the Events/Presentations link. GBDC's earnings release is also available on the company's website in the Investor Resources section. As a reminder, this call is being recorded for replay purposes.

[David Golub:]

Thanks Alicia. Hello everybody and thanks for joining us today. I am joined by Ross Teune, our Chief Financial Officer; Greg Robbins and Jon Simmons, both Managing Directors at Golub Capital. We and the rest of the Golub Capital team hope that you and your family are safe and, like us, you’re all recovering from eating too much over Thanksgiving. Yesterday afternoon, we issued our earnings press release for the quarter and fiscal year ended September 30th and we posted an earnings presentation on our website. We're going to refer to that presentation throughout the call today. For those of you who are new to GBDC, our investment strategy is, and since inception has been, to focus on providing first lien senior secured loans to healthy, resilient middle market companies that are backed by strong, partnership oriented private equity sponsors. Let me start today's meeting by sharing with you two headlines

[Gregory Robbins:]

Thank you, David. Starting on slide 10, you can see that GBDC continues to execute on its three key goals for navigating the COVID-19 crisis. First, proactive management of our highly diversified first lien senior secured investment portfolio. Second, continued optimization of our balance sheet; and third, capitalizing on attractive new investment opportunities. Turning to slide 11, you'll recall that we described a three phase strategy for proactively managing our portfolio during COVID-19. That entailed gathering information, developing strategic plans, and executing those strategic plans. We're now in phase three of our strategy and we have been implementing game plans for each affected borrower, working collaboratively with sponsors, management teams and junior capital lenders. This strategy has produced meaningful results. Our team has executed more than 90 credit enhancing amendments. We define a credit enhancing amendment as one involving a spread increase, improved documentation terms, or an incremental equity infusion. We have talked at length about the strong sponsor support for our portfolio companies. Let me describe one flavor of this. Since COVID began, sponsors have put in over $700 million of new equity into GBDC portfolio companies. Slide 12 shows how GBDC has fortified its balance sheet at September 30th. GAAP leverage was 0.85 times, which is at the low end of our target range. Regulatory leverage was 0.76 times. GBDC had nearly $500 million of liquidity in the form of cash and borrowing capacity at quarter end. We've also continued to take steps to optimize GBDC's debt capital structure. During the quarter, GBDC completed its fourth flexible, low cost CLO. We remain one of a handful of BDCs with consistent access to this funding market on attractive terms, even during COVID. And on September 30th, GBDC received investment-grade ratings from S&P and Fitch, and priced its debut issuance of $400 million in unsecured bonds. The bonds have an interest rate of 3.375%, one of the lowest cost debut unsecured bond issuances in the BDC space.

[Jon Simmons:]

Thanks Gregory. So, just as a reminder, please note that in addition to the GAAP financial measures in the investor presentation, we're also providing certain non-GAAP measures. We refer to those non-GAAP measures as adjusted measures, and they seek to strip out the impact of the GCIC merger-related purchase premium write-off and amortization. We describe those adjusted measures further in the appendix of the earnings presentation. And we'll refer to them where appropriate as we think they're better indicators of our performance and are consistent with how we evaluate our own results. So, with that context, let's turn to slide 15 and I'm going to talk through the column on the right hand page -- the right hand side of the page to discuss the quarter in more detail. Adjusted net investment income per share, or as we call it, income before credit losses, for the September 30th quarter was $0.28. Adjusted net realized and unrealized gain per share was $0.29. This compares to adjusted net realized and unrealized gain per share of $0.66 for the June 30th quarter. The adjusted net realized and unrealized gain this quarter was primarily driven by the continued reversal of unrealized losses from the March quarter. Adjusted earnings per share for the quarter ended September 30th was $0.57. This compares to an adjusted earnings per share for the June 30th quarter of $0.94. Our net asset value per share at September 30th, 2020 increased to $14.33, up from $14.05 as of June 30th. On September 29th, we paid a quarterly distribution of $0.29 a share. And finally, on November 20th, 2020, our Board declared a quarterly distribution of $0.29 a share payable on December 30th, 2020 to shareholders of record as of December 11 2020. The distribution is consistent with our historical cash distributions, which approximate 8% of NAV annually.

[Ross Teune:]

Great thanks, Jon. Turning to slide 16, this slide highlights our total originations of $141.2 million and total exits and sales of investments of $172.4 million for the quarter ended June 30th -- I'm sorry, September 30th. As we noted on last quarter’s earnings call, we started to see a pickup in deal activity and that trend has continued into the current quarter. Factoring in unrealized appreciation and other portfolio activity, total investments at fair value decreased slightly by 0.3% or 12.2 million. As of September 30th, we have $41.6 million of undrawn revolver commitments and $100.2 million of undrawn commitments on delayed draw term loans. These unfunded commitments are relatively small in the context of GBDC's balance sheet and liquidity position. As shown in the table on the bottom, the weighted average rate of 7.6% on new investments and the weighted average spread over LIBOR on new floating rate investments of 6.5% both increased from the prior quarter. 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. The top of slide 17 shows that GBDC’s portfolio remained highly diversified by obligor, with an average investment size of less than 40 basis points. The bottom of the slide shows that our overall portfolio mix by investment type has remained consistent quarter over quarter, with one stop loans continuing to represent our largest investment category at 82% of the portfolio. Turn to slide 18, 97% of our investment portfolio remained in first lien secured floating rate loans and defensively positioned in what we believe to be resilient industries. It is worth noting that we updated our industry classification this quarter using the S&P 2018 industry codes. We think this change provides investors with more detail and transparency about the industry exposure of our underlying portfolio relative to industry classifications that we were using previously. Turn to slide 19, this graph summarizes portfolio yields and net investment spreads for the quarter. Focusing first on the light blue line, this line represents the income yield, or the actual amount earned on the investments, including interest and fee income, but excluding the amortization of upfront origination fees and purchase price premium.

[David Golub:]

Thanks Ross. So, to sum up, GBDC had a strong fiscal Q4. Adjusted net investment income remained consistent, realized credit losses were very low, and unrealized losses were substantial, reflecting the continued reversal of unrealized losses that were incurred in the March quarter. I mentioned in my opening comments that we think GBDC is well-positioned. I want to elaborate now on why we think that's the case. First, credit. We think the company's portfolio is nicely diversified, it's defensively positioned, and we're poised to see more reversals of unrealized losses in coming quarters. Second, dry powder and balance sheet flexibility. The company's GAAP leverage is low at 0.85 times debt-to-equity, that's below our target. Liquidity is abundant and our capital base is strong and flexible. Third, the deal environment. M&A now is muted because of COVID-related uncertainty, but we think that in 2021 conditions are going to improve and private equity firms are going to accelerate their investment activity. Consider that private equity has its largest reserves of dry powder ever; it's over $1.5 trillion according to data from Preqin. To put that in context, the whole of the current syndicated loan market is $1 trillion. So, the continuing growth of private equity is, in our judgment, a near certainty and represents a large tailwind for sponsor finance firms like ourselves. Fourth, competitive advantages. In important ways, this COVID impacted period has been playing to our strengths. It's hard to form new relationships; it's hard to form deep bonds over Zoom. So, there's a natural tendency for sponsors to want to work with lending partners they already know. For us, that's been very helpful because we already have a lot of great relationships. Now, as I've told this group before, more than 80% of our originations each year, going back nearly a decade, have been with a core group of about 200 sponsors that we've done multiple deals with. Incumbencies are a similar story. Pre-COVID, the existing lender tended to be in the pole position when a company needed more capital or the company was getting sold from one sponsor to another sponsor. Post-COVID, we think it's proving even more true for the reasons that I just noted. Again, it's -- the difficulty of switching versus of doing due diligence and creating new relationships over zoom. All these things accentuate the competitive advantages of larger established lenders like Golub Capital. Our other competitive advantages are also important, including our large buy and hold capabilities, our reputation for reliability, our market leadership in one stops, our deep industry expertise, our ability to partner with sponsors on a wide range of different kinds of transactions

[Operator:]

Thank you. Our first question is coming from the line of Robert Dodd with Raymond James. Please go ahead.

[Robert Dodd:]

Hi guys and congratulations on the quarter on multiple fronts. A first housekeeping one if I can

[David Golub:]

Ross, I'm going to let you handle that.

[Ross Teune:]

Yeah, no, nothing material, Robert.

[Robert Dodd:]

Okay, got it. Thank you. Then just one of your comments at the end there, David, that you think you're poised to see additional unrealized appreciation in the portfolio? I mean, if I looked at it you've still got, round numbers, $1 per share of depreciation in there, given the fair value of the portfolio versus cost right now, what gives you the confidence that you're going to get back more? Is that -- that you've recovered some so far, is that directly tied to the 700 -- sponsor $700 million additional equity that sponsors have put in? Is the appreciation -- expected future appreciation kind of contingent on private equity being willing to put in more money or what drives the confidence that you're going to get more of that back?

[David Golub:]

Sure. So, let's go back and let's put it in context. So, at 3/31, we had write-downs that were the result of multiple factors. One was a degree of spread widening, market-wide spread widening that resulted from COVID-related uncertainty. And the second was an expectation that lockdowns and COVID impacts were going to negatively affect credit, quite apart from spreads. So, we think about these -- it's hard to disentangle the two of them one from the other. But there were two key elements to it. One was spread-related and one was credit-related. And here we sit, and it's what, nine months later and we've got a lot more information than the market had at that time about what the impact of COVID is going to be and how companies were going to perform. And two things have happened. One is that spreads have narrowed as the markets generally have recovered significantly from the March timeframe. And the second is that, in specific respect of our portfolio, we've seen better than expected performance. And we talked about how we saw meaningfully better than expected performance when we were talking about the June 30th quarter. And you've heard me again talk about it in the September 30th quarter. Why have we seen that better than expected performance? Well, there are a variety of reasons. One element is good underwriting. A second element is management teams have been very adept at pivoting, cutting costs, finding new revenue sources, managing their companies to be meaningfully profitable and cash generative, despite challenges. A third element, and you alluded to this, is that sponsors have stepped up and we've seen very significant support from sponsors, sometimes in the form of advice and counsel, sometimes in the form of operating executives who've been parachuted in, and sometimes in the form of equity infusions. I think it's challenging to try to dissect which degree of improvement in valuations and unrealized gains stems from which of these different threads that I just described. The good news, Robert, is that all of them are continuing with significant momentum. What do I mean by that? Well, we're continuing to see the economy perform better than I expected; we're continuing to see management teams deliver in a way that's better than expected. We're continuing to see sponsors be very supportive. So, it's not one factor that gives me optimism. It's a variety of factors. Now, I don't want to make it sound like it's a guarantee. It's not a guarantee. There are many sources of uncertainty that we're all, as investors and as people, dealing with today. COVID's not cured. We don't have a vaccine that's been widely administered. We've got a variety of different potential sources of risk. But as we sit here today, in November, I would -- actually December 1, excuse me, I would tell you that I am cautiously optimistic about our ability to continue to manage the portfolio to keep realized losses low and to sustain some continuing unrealized gains.

[Robert Dodd:]

I appreciate that. Thank you. And if I can, one more quick question, when -- your comments -- you sounded like you're a lot more optimistic about 2021 than you are -- we are now in December, there's one month of the year left to go. I mean, what's the activity level, clearly, I think started to ramp up into this fourth calendar quarter. I mean, what are you just seeing in terms of activity or is -- when you talk about the M&A market being muted in terms of -- is that closings? Is that activity? Are people just not in a hurry now and less worried about taxes changing next year or things like that. I mean is there anything going on this year versus things just spilling over to next year?

[David Golub:]

So, again, just putting in context. So, in calendar Q2, very low activity, everybody was responding to the surprise of COVID. And there was very little new deal activity anywhere, even in sectors that were less COVID impacted. In calendar Q3, we started to see some comeback particularly in less COVID impacted sectors, including software, including some elements of healthcare. And you can see in the reported results that we discussed today, a meaningfully higher level of new originations in the quarter ended September 30th than the quarter ended June 30th. I anticipate that that the quarter ended December 31st will continue that trend. We'll see more improvement; we'll see a higher level of originations in calendar Q4 than we saw in calendar Q3. And we're seeing that more broadly. In other words, it's not just software and a few niches within healthcare, it's broader than that. But if you compared activity in calendar Q4 2020 and calendar Q4 2019, calendar Q4 2020 is muted relative to calendar Q4 2019. And I think it's going to be into 2021 until we start seeing year-over-year increases in M&A activity and new origination activity. The key factor is going to be very simple. It's going to be reduced uncertainty related to COVID.

[Robert Dodd:]

Understood. Thank you.

[Operator:]

Our next question is coming from the line of Ryan Lynch with KBW. Please go ahead.

[Ryan Lynch:]

Hey, good morning. Thanks for taking my questions. First one that I just wanted to touch on, you mentioned you had one default in the quarter and restructuring, was that Rubio Restaurants or what portfolio company was that related to?

[David Golub:]

Rubio's is a default -- it is currently in bankruptcy, we are working with the company and the sponsor on a restructuring of the company, so that it can emerge from bankruptcy and do well again. And I think it's -- as a company in good shape to be able to do that. The other company that I think you're alluding to, which is a calendar Q3 event, is a dental practice company called Elite Dental, where we also did a consensual restructuring, as part of which we reduced the amount of debt on the company, and we took an equity stake.

[Ryan Lynch:]

Okay, perfect. And then you kind of touched on this earlier and you mentioned in your presentation, but you executed 90 plus credit enhancing amendments since COVID with a focus on some of these most -- impacted COVID-19 impacted sub sectors. Just from a higher level, when you are looking to make a credit amendment to a company, and I know every situation is general, but maybe could you just walk through kind of the priorities that you look at? Are you guys looking to get higher spreads, more fees, tighter guardrails around your covenants, and what are you most wanting in return from the private equity sponsors in support of those amendments?

[David Golub:]

It is hard to generalize, I think your introduction, your question is right. It's hard to give you a single answer to that question. Our key priority, and I think I've been very clear about this, our key priority is to minimize realized credit losses. So, if you were to rank order the things that are important to us, the first and most important of all things to us is help us avoid losing money. Beyond that, it's very much situation-specific and we look at all the facts and circumstances in a particular borrower and assess what's most important to us and what's most important to the sponsor and the company, and seek to create a win-win solution.

[Ryan Lynch:]

Sure. Okay. And I just had one last one regarding the unsecured notes issuance. First off, congratulations on the investment-grade rating and that note issuance, that was a very attractive rate. Just as you sit here today, your balance sheet looks to be in very good shape, very low leverage. Some pretty good diversity, at this point, but just looking forward looks like you have about 20% of your liability structure in unsecured notes today. Is that kind of a level that you guys want to run going forward? Or would you guys like to increase that? Or is it more -- just going to be kind of an opportunistic approach to when new -- when a market opens up and has very attractive rates, you guys will look to tap the unsecured market for more?

[David Golub:]

I'd say somewhere between two and three. So, yes, we would like over time to have a higher proportion of our debt in the form of unsecured notes and yes, we're going to be opportunistic and thoughtful about when we go to market because we think that our liabilities are a critical competitive advantage, we think it's one of the most important things we can manage.

[Ryan Lynch:]

Okay, that's all for me. I appreciate the time today.

[Operator:]

Our next question is from the line of John Kemmerer with Zeke Capital. Please go ahead.

[John Kemmerer:]

Yeah. Hi, this is John. My question is in response to the Fed talking about the LIBOR phase-out yesterday. Just curious when we might see your first loan with a non-LIBOR benchmark? And then sort of related question, maybe you could just summarize for me the overall impact on your operations of this change?

[David Golub:]

Sure. So, as I think everybody on this call probably knows, there's an industry-wide effort underway to shift from LIBOR to a new standard for floating rate loans known as SOFR. We serve on the LSTA, that's the industry trade association for the Loan Syndication Trading Association, the LSTA's special committee on LIBOR transition, and our expectation is that the LIBOR transition to SOFR is not going to be particularly eventful. Internally, we have a number of working groups making sure that we have the appropriate systems and operational procedures to make the transition. I think that's well in hand. So, I think this is a bit like Y2K, it requires a lot of work in preparation and then when it happens, it's -- there's -- you almost forget such a deal, because all of the preparation and work and anticipation of it made it not a big deal. So, that's -- we're in the work in preparation phase right now.

[John Kemmerer:]

Got it. So, is there a timeline when you might originate the first loan with the new benchmark?

[David Golub:]

Well, I think the loans are going to have a LIBOR language with what's called fallback language, which means a specified language that shows what happens when LIBOR is removed. And we're starting to see that -- all that within credit agreements now.

[John Kemmerer:]

Okay. Thank you.

[Operator:]

There are no further questions at this time.

[David Golub:]

Great. Well, I want to thank everyone once again for tuning in for this quarter's call. Look forward to speaking to you all next quarter. And as always, if you have any questions before then please feel free to talk to any of us.

[Operator:]

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