Golub Capital BDC, Inc.
Q3 2013 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

Good afternoon, welcome to the Golub Capital BDC Incorporated June 30, 2013 Quarter 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 the statements of historical facts made during this call may constitute forward-looking statements and are non-guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in forward-looking statements as a result of a number of factors including those described from time to time in Golub Capital BDC’s Incorporated filings with the Securities and Exchange Commission. For a slide presentation that we intend to refer to on the earnings conference call please visit the events and presentation links on the homepage of our website, www.golubcapitalbdc.com and click on the Investor Presentation’s link to find the June 30, 2013 investor presentation. Golub Capital BDC’s earnings release is also available on the company’s website in the Investor release section. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead sir.

[David B. Golub:]

Thank you, operator, and good afternoon everyone. Thanks for joining us today. I’m joined today by Ross Teune, our Chief Financial Officer and by Gregory Robbins, one of our Managing Directors. Earlier today we issued our quarterly earnings press release for the quarter ended June 30 and we posted a supplemental earnings presentation on our website. We’re going to be referring to this presentation throughout today’s call. I’d like to start by finding an overview of the June 30 quarterly financial results. Ross is then going to take you through the results in more detail. And I’ll come back and provide an update on our agreement with United Insurance Company to co-manage a senior loan fund to invest in middle market loans as well as to give you an update on current market conditions. With that let me get started as highlighted on Slide 2 of the investor presentation I am pleased to report we had another solid quarter. For the three-months ended June 30 we generated net investment income of $12 million or $0.32 per share as compared to $10.4 million or $0.32 per share for the quarter ended March 31. Net increase and net assets resulting from operations, what I call net income was $12.7 million for the quarter or $0.34 per share as compared to $12.3 million or $0.38 per share for the quarter ended March 31, 2013. The $0.02 difference between net investment income and net income for the quarter was the result primarily of net realized and unrealized gain on investments of $0.7 million $700,000 so another quarter of negative credit losses. Overall credit quality of the portfolio remains strong and the net gain of $700,000 was attributable not to one but to a large number of small unrealized gains a couple of unrealized write-downs on no market debt and equity investments. Our net asset value per share for the quarter ended June 30 was $15.12 as compared to $14.80 for the quarter ended March 31. That $0.32 increase is attributable to two factors earnings in excess of our dividend and also the accretion from the current stock offering we completed in May. In regard to investment activity, new originations were very strong last quarter, we previously announced this, origination commitments $288.4 million for the three months ended June 30, approximately 20% of those new investment commitments were senior secured loans, 62% were one stop loans, 16% were second lien investments and 2% were equity securities. Overall net portfolio growth was also strong with total investments increasing by a $179.4 million during the three months up 22.7% from the prior quarter. Given the strong portfolio growth this quarter, we were able to very efficiently deploy the capital we’ve raised back in early May. I want to put today’s results in some context given the exciting macro environments of the last quarter. In May as probably everybody on this call knows, Chairman met the Federal Reserve. Ben Bernanke started talking about the possibility that maybe he would wake up one morning and want to begin to taper bond purchases and this discussion about the possibility of earlier tapering of the Fed bond buying caused the credit markets to swoon. Treasury is high yield, even liquid floating rate securities all fell in value as rates went up and spread widen. You can see this if you look at virtually every credit asset classes performance in the second quarter, couple of examples U.S. Treasuries, the 10 year treasury was down about 4.7% net for the quarter. The Barclays U.S. Ag was down about 2.3%. One of the broadest indices of investment grade corporate debt and high yield bond funds were down depending on the fund between 2% and 4% for the quarter. So it’s gratifying to us just to see that our strategy of focussing on very high quality resilient middle market, floating rate debt was successful at this quarter in giving us a very consistent performance despite the choppy market conditions. I want to touch on one other subject before turning the microphone back to Ross. As we previously disclosed in an 8-K filing, during the quarter, we entered into an agreement to co-invest with United Insurance Company of America in middle market senior secured loans and we’re dealing that through and unconsolidated Delaware LLC. I’m going to provide some additional details on this agreement after Ross discusses the financial results in more detail. Ross, over to you.

[Ross A. Teune:]

Thanks David. I’ll start on Slide 3 of the investor presentation. As you can kind of see on the table the $0.32 per share we earned from net investment income this quarter, as well as the $0.34 per share we earned from a net income perspective. The table also highlights the most bumped in our net asset value that David mentioned this quarter to $15.12 as of June 30, up from $14.80 as of March 31st. On the bottom of the slide, we saw a modest increase in our average size of our investment this quarter, but the portfolio still remains well diversified with an average investment size of $7.2 million. And lastly, on the bottom there the fair value of the total loan portfolio as a percentage of principle remained steady at 98.7%. Turning to Side 4, originations totaled $288.4 millions where exits and repayments and from sales totaled $92.7 million. Taking into account other variables such as net funding and revolvers net change on amortize fees and net change on unrealized gains and losses. Overall net quarterly funds growth was $179.4 million. Looking at the asset mix at the bottom of the slide, there was no meaningful change in our overall asset mix this quarter with senior secured loans steady at 33% of the total portfolio, one stops up marginally by 1%, 50% of the portfolio in junior debt and equity investments at 17%. Flipping to the next slide of the balance sheet, we ended the quarter with total investments of $967.8 million total cash and restricted cash of $34.6 million and total assets of just over $1 billion. Borrowings were $403.8 million this consisted of $203 million of floating rate debt issued through our securitization, $164 million of fixed rate debentures and $36.8 million of debt outstanding in our revolving credit facility. Total net assets at the end of the quarter were $601.5 million this was up just over $100 million from the prior quarter primarily due to the common stock offering that we completed back in May. From a GAAP perspective, our debt-to-equity ratio was 0.6, 0.7 times however calculated for our regulatory limit, our debt-to-equity ratio was 0.4 times. Flipping to the statement of operations on Slide 6, total investment income for the quarter ended June 30 was $22.3 million up $2.2 million from the prior quarter primarily due to growth in average investments, included in that total investment income included $1.6 million of fee amortization. This was down from $2 million from the quarter ended March 30. In addition to investment income, we have $0.4 million of fee income from prepayment penalties. This was also down from last quarter when prepayment penalties totaled $0.6 million. Of the declines in fee amortization and fee income from prepayment penalties was partially offset by an increase in our dividend income this quarter, which totaled $1.1 million which was up from $0.5 million earned in the quarter ended March 31. On the expense side total expenses of $10.3 million increased $0.6 million during the quarter primarily due to an increase in management fees and incentive fees. As David mentioned earlier we had a net realized and unrealized gain on an investment of $0.7 million and total net income was $12.7 million. Turning to Slide 7 these charts graphically summarize the break-down of our new originations and end of period investments. As shown on the bar chart on the left hand side we originated 20% of our new investments in senior secured loans 62% in one stop, and 16% in second lean loans. The chart on the right provides a product break-down based on total investments, which again shows that the overall product mix was relatively stable quarter-over-quarter. Turning to Slide 8, I’ll walk you through the changes in our yields and investments spreads for the quarter. Focus first on the grey line, this line represents the interest income or all income but earned an investments excluding fee amortization this line represents kind of the best single indicator of the portfolios current interest rates. Due to compressed pricing our new investments the interest income yield declined from 9.5% for the quarter ended March 31 to 9.2% for the quarter ended June 30. Although we have seen some stabilization of rates being quoted our new transactions we continue or expect to see continued pressure on the interest income line as we originate new loans at current market spreads. Including amortization of fees and discounts to total yields or the dark blue line at top for the quarter at ended June 30, was 9.9%. Despite an increase in prepayments during the quarter, the total yield was also negatively impacted by lower discount amortization, due to a lower average and unamortized fees or discounts on the loans that paid off. Partially offsetting the decline and then total yields on investments this quarter was a decline in our weighted average cost of debt. This is the green line towards the bottom of the slide. The weighted average cost of our debt declined from 3.5% at last quarter to 2.9% this quarter. The decrease was attributable to two factors, first, the current quarter and ended June 30 included the full quarterly impact of the re-pricing of our Class A Notes that were issued through our securitization vehicle, the pricing here a decline from LIBOR plus 2.40% to LIBOR plus 1.74%. And the second factor is the prior quarter included the acceleration of deferred financing fees associated with the $50 million downsize that we got on a revolving credit facility and those fees being accelerated caused a spike, in the quarter ended March 31. Turn to Slide 9, for new investments the weighted average rate, new middle market investments was 8%. The decline from the previous quarter reflects not only spread compression on new investments, but also a change in the asset mix from last quarter. If you look back at Slide 7, we originated a higher percentage of second lean investments last quarter as compared to this 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 is calculated as the LIBOR plus the LIBOR spread and the impact of any LIBOR floor. And for fixed rate loans, it’s the stated fixed-rate. As shown on the middle of the slide the investment portfolio remains predominantly invested and floating rate loans with floating rate loans representing over 90% of the portfolio. On the bottom of Slide 9 and on the Slide 10 overall fundamental credit quality continues to remain very strong with non-earning assets as a percentage of total investments on a cost basis at 0.7% and only 0.1% as a percentage of total investments on a fair value basis. Our non-earning ratios improved this quarter primarily due to the transfer of the senior term loan until our processing back to accrual status. Looking at Slide 11, although we did experience a modest increase in our category three investments looking at a risk rating chart here over 90% of our investments at fair value continue to be risk-rated at 4% or 5% are two highest product categories. The modest increase in the category three is not a surprise as we’ve indicated in the past that we do expect a downward migration to a degree in these statistics; just a reminder that independent valuation firms valued approximately 25% of our investments as of June 30, 2013. Quickly on Slide 12, the Board declared a distribution of $0.32 a share payable on September 27 to shareholders of record as of September 2013. Turning to Slide 13 with respect to liquidity and investment capacity, we ended the quarter with $12.0 million of unrestricted cash and $21.7 million of restricted cash, the restricted cash is primarily held in our securitization vehicle, our credit facility or within one of our SBIC entities as available for new investments that qualify for acquisition by these entities. As of June 30, subject to leverage and following base restriction we had $63.2 million available for additional borrowings and our $100 million revolving credit facility, and it regards to our SBIC subsidiaries as of June 30, we have $3.8 million in available an approved debenture and an additional $61 million of debenture available subject to customary regulatory requirements. I will now turn it back to David who will provide an update on the senior loan fund, we call managed with the United Insurance Company as well as provide an update on current market conditions.

[David B. Golub:]

Thanks Ross. So as I indicated in my opening remarks we entered into an agreement our last quarter to co-invest with United Insurance Company through what we call senior loan fund LLC, and senior loan fund LLC is going to be an unconsolidated data where limited liability company. It’s governed by an investment committee with equal representation from us and United Insurance all material portfolio company decisions and other decisions are going to be approved by that committee. As indicated by the name of the fund, senior loan fund is going to invest and senior secured loans in the middle market company as we expect that average investment sides, for transaction will initially range between $2 million to $4 million. It’s going to be capitalized with subordinated note with equity contributions from both United Insurance and us, as transactions are completed. United Insurance is going to be contributing 12.5% of the subordinated note and equity contribution and GBDC will be contributing 87.5%. To date United Insurance is committed $12.5 million to senior loan fund and we committed $85.7 million none of that amounted had been funded as of June 30, 2013, but we did fund our first loan in July. Senior loan fund is going to raise senior debt from a third-party that’s our plan. When it has a sufficiently large and diversify pool of investments, we think that the partnership with United Insurance will provide GBDC with an attractive vehicle for investing in lower risk senior secured loans and we’re excited about its potential overtime to be a meaningful contributor to GBDC’s earnings. We do want to note though that it’s going to take some time for senior loan funds to build a large leveraged diversify pool of assets. And so it’s going to take sometime before our investment in the fund provides a meaningful boost to earnings. Let me move on now and talk briefly about our current market conditions. As I mentioned in my opening remarks, beginning in late May the credit markets began to swoon after the Federal Reserve’s communication about tapering. In June and even more particular in July, we saw a substantial recovery and credit markets from the early May, June swoon, but we expect continued volatility over the coming period. One of the insights that we had in connection with the June swoon was very simple insight with rates since low as they are, relatively small moves in rates have very dramatic impact on bond prices, but sorry about the impact of this on the middle market, as I’ve said in the past, although the middle markets insulated from trends and liquid credit markets, we’re not immune. And as a result of the down draft in the liquid credit markets, we’ve seen some modest improvement in spreads and in leverage on new transactions more even than improvement I would say, we’ve seen stabilization. What I mean by that is that, the tendency, the trends toward lower spreads and towards some leverage creep as eased somewhat. Having said that, we’re seeing relatively slow deal flow as we go into the September 30 quarter. Our new originations in the quarter ended June 30 were very strong, exceeded our initial expectations. We anticipate that originations for the quarter ended September 30 will be slower than the June 30 quarter. Partly that’s a question of what we’re seeing in pipeline right now, partly also that’s the tendency for the summer quarter to be slower just as a seasonal factor. Third factor that I would highlight is we’re also particularly focused right now on being extremely selective and cautious. We’re focusing primarily on senior and one stop loans to very high quality Brazilian borrowers. That concludes our prepared remarks for today. As always I want to thank everyone on the line for your time and for your continued support. And operator, if you could please open the line for questions.

[Operator:]

Thank you. (Operator Instructions) And our first question comes from the line of Troy Ward with KBW. Please proceed with your question.

[Troy Ward:]

Great, thank you and good afternoon guys. David, you were talking about you’ve been very selective in the current market. Can you provide a little color around that, what is I mean and obviously we know that, it’s a competitive market, but is there any one thing that you’re seeing in the market that causes you some worry as it leverages its structures it is just not getting paid for the risk level? What are you seeing in the market?

[David B. Golub:]

Well, we are seeing an increased level of competition and that competition is taking the forum of both price competition and structure competition. We are prepared to be very competitive when it comes to price competition and if we find a deal particularly attractive we are going to battle it out on the price front, on the structure front if the structure doesn’t do an adequate job of protecting our interests, we are going to past. We are seeing an increasing proportion of transactions that either due to too high leverage or two week structures from a covenant standpoint or from a structural protection standpoint don’t meet our criteria.

[Troy Ward:]

No, when you…

[David B. Golub:]

By the way, I would say what’s really striking to us, and I mentioned this last quarter when we talked Troy, but I’d say it probably even more emphatically now. Those transactions that we are trending down they’re getting done. They are just not getting done by us.

[Troy Ward:]

Right. And then when you say an increased level of competition is it the same players just getting more aggressive or is there new buckets of money coming in.

[Ross A. Teune:]

A bit of both, we are seeing some increase in new entrance activity we were not seeing a meaningful increase in bank activity other than in low let per transactions and asset-based transactions. So I wouldn’t say we’re seeing a meaningful increase in bank led activity. So it’s the usual players plus little bit of activity from some new players or some smaller players who gained access to new pockets of capital.

[Troy Ward:]

Okay. And then if you look at the Slide back, on Slide 4…

[Ross A. Teune:]

Let me tell one other thing, sorry, sorry, one other aspect in answer to your question. I think one other thing we’re seeing is our relatively lighter level of activity than we and the market generally had anticipated.

[Troy Ward:]

Right.

[Ross A. Teune:]

And I think one of the things that has driven the comparative activity this year more so than new entrant activity, more so than new activity from existing players who have gotten access to new pools of capital has been just a flat out slow M&A market.

[Troy Ward:]

Right. Same people fighting over fewer products?

[Ross A. Teune:]

Right.

[Troy Ward:]

On the Slide 4, into your asset mix on the bottom of the Slide 4, now I know it’s not a big piece of your portfolio. If you look over the last four quarters there – five quarters, you’re showing from Q3 2012 to Q3 2013, your second lean and subordinate basically flip-flop, right. You’re doing much more or less subordinate that and a little more second lean. Is that a function of what’s available in the market, or is it that function of you don’t like what you are seeing in subordinated debt these days or just a level of activity?

[David B. Golub:]

I’m not sure how to make a distinction between the two choices you gave me, which what’s available on the market and what we like. I think it’s a combination of the two. We don’t really making a big distinction between subordinated debts and secondly, we do them as from a risk standpoint substantially similar that the big distinction is one floating rate, second lien is floating rate, sub debt is fixed, in theory you have a lien, and second lien. But you can count me as a skeptic that those security interest are ever particularly helpful in restructurings and my experience they’re very rarely, meaningfully helpful in restructurings. So, I wouldn’t want to make too big distinction between second lien and sub debt, other than the floating rate versus fixed rate distinction and I tell you we just as a generalization for floating rate.

[Troy Ward:]

That’s great. Your answer got to us. I was trying to get you and I really want to see how you view that second lien and the value of that second lien, and then couple of real quick ones, what is the average EBITDA in your portfolio?

[Ross A. Teune:]

It’s a good question. I don’t know the answer. I have to come back to you on that assuming that we’ve got something that we’ve got some data that I can share.

[Troy Ward:]

Okay. And then one final one; is the fund the senior loan fund, it is accounted as a non-qualified asset?

[Ross A. Teune:]

The GBDC’s investment in senior loan fund will count toward our 30% bucket.

[Troy Ward:]

Great, all right. Thanks guys.

[Operator:]

(Operator Instructions) Our next question comes from Jonathan Bock with Wells Fargo. Please proceed with your question.

[Jonathan Bock:]

Good afternoon and thank you for taking my questions. David I’m curious as to the actual yield amounts that you are receiving on your senior, your one stop, second lien and sub, just blocking down the capital structure if you could, in terms of what you’re getting and bidding for in this market broad brushstrokes.

[Ross A. Teune:]

Sure. Let’s start at the top of the capital structure with new senior secured debt. New senior secured debt that we’re doing in middle market traditional loans would range from about LIBOR plus 450 at the low end to LIBOR plus 525 at the high end. Typically with a LIBOR floor of 1% to 1.25% and a couple of points upfront. As we look to one stop, I would add 150 to 250 basis points off premium for that. The second lean positions, that market is a little bit challenging to make generalizations about, but I would say typical second lean deals right now are in the range of LIBOR plus eight, again with the LIBOR floor, 100 to 125 basis points and again with some fees upfront. Subordinated debt today as low as 2011 as high as may be 2013, but those are pretty [hairy].

[Jonathan Bock:]

Okay. I appreciate that. And then one common theme that investors have been focused on vehemently is the potential for spread compression to limit or for limit NIO growth best case. And that worst-case costs NOI to decline. And so to the extent and then just looking at simple math, if one were more focused on an [L+450 an L+100] 100 basis points floor in light of both cost of debt at 2.9 and 2.5% on average is the percentage of assets to run the business fees in G&A, maybe give us a sense as to what you’ve think about in terms of trying to either grow NOI in this environment or the later trying to just protect the stream to make sure one is not taking excessive risks in new investments they’re making?

[David B. Golub:]

Well, I think it’s a great question. I have said for several quarters, now that I think BDC is more focused on higher yielding assets are going to face a very devilish dilemma of either moving up the capital structure and cutting their dividends or taking risks that we’re not comfortable with. I think in our case, we’re operating at a return on equity level that’s sustainable in today’s market environment. I think we even have some ability to expand our ROE particularly by increasing modestly our use of leverage. At the end of the quarter, we were operating with a debt-to-equity ratio of just checking my number. Ross, 0.67%, is that correct?

[Ross A. Teune:]

0.67% right.

[David B. Golub:]

So that’s actually we under the target that we’ve spoken previously about, so I think we have some opportunities in the stabilized environment increase ROE even when I think of our competitive breadth in the opposite maybe the case. If we get into an environment in which spreads continue to compress from current levels, raises a number of questions. One question would be, “Are these new investments still attractive from a risk award standpoint?” If the answer is no, our answer is going to be to shrink. If the answer is yes, then it’s going to raise questions like, “Well, can we reduce our cost of financing these assets?” In other words, can our cost of debt contract along with our spreads on our assets, are there other steps that we can take in order to improve our ROE by shifting our mix again in the context of having in attractive risk return there maybe an opportunity to shift our mix more toward one stops as an example. So, I think it’s a hard question John, to answer in a hypothetical, but I hope the guidance that I’ve given you illustrates the way in which we would think about that kind of environment.

[Jonathan Bock:]

No and we absolutely appreciate investors that are very focused on limiting risk, because that’s where people end up or getting snagged. One question as it relates to the SLS a few technical one, what’s the fee upfront fee sharing arrangement between United and GBDC upfront fees or origination fee I should say.

[David B. Golub:]

The senior loan fund will participate in any upfront fees that are earned. We don’t have the same accounting policy that I think you’re thinking of that areas has where we treat those upfront fees as earned and has income in the period in which the new loan is made. We view that as being income that’s appropriately amortized over the life of the loan. So we would anticipate that senior loan fund would use that to increment.

[Jonathan Bock:]

Fair David, and I guess the question is, is if you do alone and you have an upfront fee of $10 do you split that $10 to 50/50 or do you split it according to the proportion of capital that’s in the fund?

[Ross A. Teune:]

The later.

[Jonathan Bock:]

And then finally one question on the average investment size of about $2 million to $4 million, my guess is the senior loan fund more targeted toward direct origination across the broader platform. Do you also believe that there might be a portion of this fund that would invest in more liquid and syndicated type of transactions given your experience with the asset class?

[David B. Golub:]

Definitely think that we will look at club, and what we call club which basically means transactions where we’re not necessary the lead. We will look for opportunities with our partners that united in the broadly syndicated market and to that agree we think they were interesting opportunities there. We may pursue it, that’s not part of our current plan.

[Jonathan Bock:]

Okay. Okay, thank you very much.

[Operator:]

And there are no further questions at the time. I will now turn the call back to you sir.

[David B. Golub:]

Thank you. Again, just want to express my appreciation to every one on the call. We very much appreciate your partnership and should you have questions that occur to you post this call, please fell free to reach out either me or to Ross. Take care of everyone. Bye-bye.

[Operator:]

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and you please disconnect your line. Have a great day.