Golub's CEO Discusses F1Q13 Results - Earnings Call Transcript

| About: Golub Capital (GBDC)

Golub Capital BDC, Inc. (NASDAQ:GBDC)

F1Q13 Earnings Call

February 7, 2013, 1:00 p.m. ET


David B. Golub – Chief Executive Officer and Director

Ross A. Teune – Chief Financial Officer


Jim Young – West Family Investments

Jonathan Bock – Wells Fargo Securities, LLC

Ryan Lynch – Stifel Nicolaus


Good afternoon and welcome to Golub Capital BDC Inc's December 31st, 2012 quarterly earnings conference call. (Operator Instructions)

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 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 Golub Capital BDC Inc's filings with the Securities and Exchange Commission.

For slide presentation that we intend to refer to on the earnings conference call, please visit the events and presentations link in the homepage of our website, www.golubcapitalbdc.com. And click on the investor presentations link to find the December 31st, 2012 investor presentation.

Golub Capital BDC earnings release is also available on the company website in the investor relations section.

As a reminder, this call is being recorded for replay purposes.

I will now turn the call over to Mr. David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead.

David Golub

Thank you, Kim. Good afternoon, everyone, and thanks for joining us today. I'm joined today by Ross Teune, our Chief Financial Officer.

Earlier today, we issued our quarterly earnings press release for the three months ended December 31, 2012. And we posted a supplemental earnings presentation on our website. We'll be referring to this presentation throughout today's call.

I want to start today by providing an overview of the December 31, 2012 quarterly financial results. And then Ross is going to take you through the results in more detail. I'm going to then come back and provide an update on current market conditions. With that, let's go ahead and get started.

I want you to turn to slide two of the investor presentation. I'm pleased to report we had another strong quarter. For the three months ended December 31, 2012, we generated net investment income of $9.6 million or $0.34 per share. And that compares to $7.8 million or $0.30 per share for the September 30th quarter.

Net increase and net assets resulting from operations, otherwise known as net income, for the quarter ended December 31st was $9.3 million or $0.33 per share as compared to $8.7 million or $0.34 per share for the quarter ended September 30th.

Let me describe briefly the reason for the $0.01 per share difference or the $300,000 difference between net investment income and net income for the three months ended December 31, 2012. It was primarily due to two valuation adjustments during the quarter, one up, one down, both on non-earning accounts. There was a $1.3 million valuation increase on Pillar Processing. This increase was attributable to an improvement in the company's trailing 12 months EBITDA. In addition, since we restructured this debt in July, 2012, the company’s been current with all interest payments. And we've also received some significant principle repayments from liquidation of receivables.

The unrealized gain on Pillar was offset by an unrealized loss of $1.1 million on Extreme Fitness as this company's financial performance has continued to decline.

There weren't any other notable valuation adjustments for the quarter.

If you turn to slide four, you can see a rundown of investment activity during the quarter. New originations, as we expected, were quite robust totaling $262.2 million for the three months ended December 31st.

I'm sorry, my voice, I've got a touch of laryngitis, so I'm sorry if I sound a little hoarse.

Originations set a record as business owners expedited deals on the expectation that tax rates on dividends and capital gains would increase on January 1st. Repayments were also unusually high. So we had high originations and we had high repayments. In fact, at $145.8 million, the repayments were higher than we expected at the time we had our last quarterly earnings call. Overall, the net result was an increase in investments of $95.4 million.

If you look at that $95.4 million of new originations, I'm pleased to report that it had quite a good mix from the standpoint of our goal of increasing the percentage of one-stop investments in the portfolio. Of the new investments, 61% were in one-stop loans, 22% in senior secured loans, 15% in second lien loans, and 2% in equities.

During the quarter, we also made some important improvements to our liability structure. First, we received approval from the SBA for a second SBIC license. So we now have two SBIC licenses within the BDC. And between the two of them, we can issue up to $225 million of fixed-rate low-cost highly-flexible long-term debt.

In addition, these SBIC licenses could become even more valuable if some legislation currently before Congress moves forward. That legislation raises the SBIC family of funds leverage limit from $225 million to $350 million. We're not counting on this legislation passing, but we've very hopeful that it will pass.

Second on the liability structure front, we amended our revolving credit facility with Wells Fargo. The amendment, among other things, increased the size of the revolving credit facility from $75 million to $150 million and it extended the stated maturity date to October 20th, 2017.

I'm going to now turn it over to Ross to discuss the financial results in more detail. And I'll be back at the end to give you an assessment of current market conditions and also to address questions. Ross, over to you.

Ross A. Teune

Thanks, David. I'm going to start on slide four of the presentation.

As David mentioned, we originated $262.2 million of originations this quarter, which was a quarterly record. Exits from repayments and sales were also high totally $145.8 million. As I'll discuss in a few slides, this heightened level of repayments during the quarter contributed to an increase in fee amortization as well as an increase in fees from pre-payment penalties.

Taking into account other variables, such as net fundings on revolvers, change on unamortized fees, change in unrealized gains or losses, overall, net quarterly funds growth was $95.4 million, up about 14% from September 30th.

If you look at the asset mix at the bottom of the slide there, due to the high percentage of one stop transactions that we originated this quarter, the overall percentage of investments in one stop loans increased to 47% of total investments with senior secured investments declining to 33%. The percentage of junior debt investments and equity investments remained stable at about 20%.

Flipping to the balance sheet on the next slide, we ended this quarter with total investments of approximately $768 million, total restricted cash of about $60 million, and total assets of $839 million. Borrowings were $400.5 million, up $48 million from the previous quarter due to an increase in debentures of $11.5 million and an increase in our revolving credit facility of $36.7 million. So a total breakdown of the $400.5 million of debt, $174 million in our CLO securitization, $135 million of SBIC debentures, and $91.5 million in our revolving credit facility.

Total net assets at the end of the quarter was $419.6 million. This was up about $44 million for the quarter due to the common stock offering that we completed back in October. Given the growth of our investments of $95.4 million, our growth was financed about equally between debt and equity.

From a GAAP perspective, our debt to equity ratio remained stable at .95 times. Calculated per our regulatory calculation, our debts equity ratio was also stable at .63 times.

Flipping to the statement of operations on slide six, total investment income for the quarter was $18.6 million. This was up $2.4 million from the prior quarter. Total investment income included $2.4 million of fee amortization, up from $1.6 million for the quarter ended September 30th.

In addition to investment income, or I'm sorry, in addition to investment income and fee amortization for the quarter, we also had $0.9 million of income from prepayment penalties and other fees.

On the expense side, total expenses of $9 million increased by $0.6 million during the quarter primarily due to an increase in management and incentive fees driven by an increase in total assets and increased investment income.

Looking at the net gain and loss in investments, we had a small net gain of approximately $100,000. And total sales of $14 million, which is primarily more liquid senior secured loans. And we had a net unrealized loss of $0.4 million on investments, which David provided some commentary in his opening remarks.

Turning to slide seven, these charts graphically summarize the breakdown of our new originations and end of period investments. As shown in the gray bar on the left hand side, we originated 61% of our new investments in one stop loans increasing the overall percentage of one stop loans to 47% of the total investment portfolio at December 30th as shown on the right hand side.

We're quite pleased with the acid mix at the end of December with senior secured loans at 33%, one stop loans at 47%, and junior and equity investments at around 20%.

Turning to slide eight, I'll walk you through the changes in our yields and investment spreads for the quarter. Focusing first on the gray line, this line represents the interest income or all income earned on the investments, excluding the amortization of discounts and origination fees. Primarily due to an increase in prepayment fees during the quarter, this interest income yield increased from 9.5% from the quarter ended September 30th to 9.7% for the quarter ended December 31. Excluding prepayment fees for both quarters, the interest income yield would have been flat quarter-over-quarter.

Including amortization of fees and discounts, the total yield on the investments, the dark blue line at the top of the chart, the yield was 11.2%. Again, this increased this quarter due to the unusually high level of prepayments that we experienced.

Turning to slide nine for new investments, the weighted average rate, a new middle-market investment, was 8.3%. This was up modestly from the previous quarter due to a lower percentage of senior secured assets originated this quarter. And it's slightly above the average rate on investments that paid off during the quarter.

Again, the weighted average rate on the new investments is based on the contractual interest rate at the time of funding. For variable rate loans, then contractual rate would be calculated using the LIBOR rate, the spread over LIBOR, and the impact of any LIBOR floored. For fixed rate loans, it would be the stated fixed rate.

As shown in the middle of the slide, the investment portfolio remains predominately invested in floating rate loans with floating rate loans comprising nearly 90% of the total portfolio at the end of December.

Turning to slide 10 and 11, the overall fundamental quality continues to remain very strong with non-earning assets as a percentage of total investments on a cost basis at 1.1% and 0.3% as a percentage of total investments on a fair value basis.

Looking at our risk ratings on slide 11, portfolio risk ratings remained stable with over 90% of the investments in our portfolio rated in the top two categories, a four or a five. During the quarter, there were no new non-earning accounts added.

As a reminder, independent valuation firms valued approximately 25% of our portfolio as of December 31st.

Turning to slide 12, our board declared a distribution of $0.32 payable on March 28th, 2013 to shareholders of record as of March 14th.

Flipping to slide 13, we ended the quarter with $21.4 million of unrestricted cash and $39 million of unrestricted cash. Restricted cash is held in our securitization vehicle, a revolving credit facility or SBIC. And this cash is available for new investments that qualify for acquisition by these entities.

In addition, subject to leverage and borrowing base restrictions, we had approximately $58.5 million available for additional borrowings on our $150 million revolving credit facility.

In regards to our SBICs, we had $15 million in available and approved debentures as of December 31st. That was available in our first or existing SBIC entity. As David previously mentioned, we received approval for our second SBIC license in December. And in early January, we received approval, a commitment approval for $37.5 million. This commitment may be drawn upon subject to customary regulatory capital requirements and including examination by the SBA.

I'll turn it back to David who'll provide some commentary on current market conditions.

David B. Golub

Thanks, Ross.

So as we previously communicated, we completed a common stock offering in mid-October. We did it in anticipation of strong originations in the fourth calendar quarter of 2012. We raised about $44 million in new capital through the offering. And we quickly deployed it. In fact, due to the quick deployment, we've talked about the deployment earlier in this call, we decided to raise additional funds in mid-January through a second common stock offering. We raised approximately $69 million in that offering. And these proceeds are going to be used to invest n new portfolio companies and to capitalize our new SBIC entity.

In the two recent stock offerings, Golub Capital entities purchased a total of $4 million worth of the shares primarily for the purpose of awarding stock compensation to members of our team. This increases the total value of shares purchased for employee compensation to over $10 million during the last 12 months. One of the things we're very proud of is the ownership of GBDC by Golub Capital employees. And we think it is very important to fostering alignment between our investment team and our shareholders. And it's a key part of our long-term success.

Let me hit briefly on current market conditions and our outlook for calendar 2013. As expected, our deal pipeline in the first calendar quarter of 2013 is much slower than it was last quarter. It's not anemic. We're still getting some deals done. But there's no question that we and others in the market are feeling the full-forward effect of last quarter.

We remain cautiously optimistic that new deal flow in calendar year 2013 is going to improve in the coming months. The reason for that is fundamentals. We think the fundamentals remain strong for an increase in M&A activity. And that includes a slow, but improving economy, historically low interest rates, a strong appetite among businesses for growth through acquisitions, and private equity firms looking to deploy plentiful capital commitments.

Not surprisingly given that new deal activity is slowed so far this quarter, we're also seeing some continuing spread compression and leverage creep in the new deals that are getting done. It's not as dramatic as the trends that we're seeing in the liquid credit markets. But as I've said before, the middle market is not immune from broad market trends.

I'm going to stop there and open the floor for questions. Before I do so, I want to just do something I think I always do on these calls. But I want to draw special attention to it this quarter. I want to thank everybody for giving us the confidence of being shepherds of their capital. We take that very seriously and I want to thank you for your time and support today.


Question-and-Answer Session


Thank you. (Operator instructions) Our first question is from the line of Jim Young, with West Family Investment. Please go ahead.

Jim Young – West Family Investment

Yes, hi David. The spread compression in leverage creep that you had mentioned in the middle market segment, can you please quantify that for us?

David B. Golub

I’m sorry Jim, we’re having a little bit of static on the line. Can you repeat the question please?

Jim Young – West Family Investment

Yes, sure. You mentioned spread compression and leverage creep in the middle market area, could you please quantify that issue for us?

David B. Golub

You were asking about leverage creep and spread compression. Yes, it’s hard to say, because it’s so earlier in the year so far, but you know, we’re seeing, you know, I’d say in the range of 25 basis points of spread compression. And again, about I’d say a quarter turn of leverage creep in that range.

Where we are right now, it’s not entirely clear where we’re going to end up because we’re in a period right now of relatively light transaction volume. I think the bigger question, and I don’t think anyone really knows the answer to this is, you know, what’s going to happen going forward.

We’re planning on an environment where we may see continuing spread compression and leverage creep, and you know, we’re setting ourselves up to use our origination engine to find very attractive transactions if that happens.


(Operator Instructions) Our next question is from the line of Jonathan Bock with Wells Fargo Securities, LLC. Please go ahead.

Jonathan Bock – Wells Fargo Securities, LLC

Good afternoon, and thank you for taking my questions. David, while we have seen some compression on the asset side of the balance sheet or in general in the middle market, could you perhaps maybe talk about some of the opportunities on the liability side, as it relates to strong CLO issue, and particularly on balance sheet securitizations. And how perhaps, you know, that might fit in to near term liability strategy over the next 12 to 24 months?

David B. Golub

Sure. You know I think, Jon you are making a really important point, which is you know, one of the attributes of our business is that we have to manage both the left hand side and the right hand side of our balance sheet at the same time.

One of the things we’ve been historically very focused on [inaudible] capitalist, making sure that we have low cost, highly flexible safe financing against our middle market loans. So, one of the ways in which in which we’ve historically done that is through the securitization market. And we have an existing securitization that’s priced at LIBOR plus 2.4%. That pricing was very attractive at the time that we entered into the transaction.

Now, I think if we’re to look at that pricing in recently completed transactions, you’d see that there have been some recently completed transactions that are at levels that are …


I do apologize ladies and gentlemen, we’ve seen to have lost connection with the main line. We ask that you please remain online while we do reestablish the connection. One moment please. Ladies and gentlemen, please standby, your conference will resume momentarily. Please go ahead Mr. Golub.

David B. Golub

Thank you Kim. Kim, do you know when I was cutoff?


Unfortunately, I do not. I do know you were answering Mr. Bock’s question.

Jonathan Bock – Wells Fargo Securities, LLC

David, you had just started by saying that you had utilized the securitization market, and then cutoff right after you were about to give us what the new spreads were on securitization/liabilities. So it’s like L-plus 242, and now it’s perhaps something a bit tighter.

David B. Golub

Yes, thank you Jon. I apologize for the technical difficulties everyone.

So, yes as I was saying, I think one of the important things that’s part of our job, is to manage the right hand side of the balance sheet, as well as the left. And that means making sure that we’re minimizing our cost of funds while at the same time, you know, using debt that’s safe and flexible and long duration.

One of the sources of debt we like, that has those attributes, is securitization debt. We in place a securitization facility at LIBOR plus 240 in 2011. I think there is an opportunity today to look at expanding our use of securitization and financing at lower spreads. Spreads have come in a bit, particularly over the last three or four months, and I think there are, you know, opportunities for us in the sub-LIBOR 200 range to develop new sources of financing.

That market is, you know, losing quickly these days, and so I don’t want to give a specific number other than to say there was a recent triple A rated middle market CLO that was priced at approximately LIBOR 170.

Jonathan Bock – Wells Fargo Securities, LLC

Okay, great that’s excellent collar. And just as we try to get a sense of risk, kind of broadly speaking, obviously the opportunity in senior debt on a risk adjusted basis is strong. Could you perhaps give us some views as to how you approach subordinated or second lane debt. So this would be outside of your typical one stop or Gold facilities. And maybe walkthrough items that you check on the risk mitigation list, in light of the fact that it is a bit more competitive. And so to the extent you’re competing at higher leverage levels or perhaps being a bit more on the game is needed now more than ever?

David B. Golub

Let me just amplify the point that you’re making Jon. I think if you asked us to assess the market opportunity today, we would very emphatically say that it’s much more attractive than middle market senior secured loans in our one stop positions than it is in subordinated debt.

The characteristics that have created the opportunity, the masses reduction, the number of providers on the senior side, simply isn’t the case on the junior debt side. There are a lot of mezz funds, there are a lot of insurance company affiliates, there are a lot of high yield funds with crossover capabilities. And with the high yield market at 6%, the middle market mezz opportunity in the low double-digits looks very attractive on a relative basis, even if on a risk adjusted basis it doesn’t look so attractive to us.

So, we have deemphasized mezz, we have deemphasized mezz for the last couple of years, but we are continuing to do so. We think the environment for mezz is more negative today, than it was a year ago. And, you know, that doesn’t mean that we won’t ever do a second lean or a subordinated debt investment, we will. But we’re being very selective in doing so and focusing on companies that are particularly resilient companies with particularly robust equity cushions, and companies with particularly robust opportunities for us to develop second ways out, or ways of managing the credit if things go wrong.

So, you’ll see us focus on companies of particularly high quality when we’re looking at mezzanine transactions today.

Jonathan Bock – Wells Fargo Securities, LLC

Thank you. And then just one question on the competitive dynamic in the senior space; there are at lease, as we’ve kind of looked around, you know, two extremely large entities both with low cost of capital, whether ones part of a large industrial, or another part of a large insurance company conglomerate. Could you perhaps maybe give us a sense, are bids in the senior space while they’re tighter, are they still rational? And is that competitive dynamic tilting perhaps a little bit away, where risk base pricing is starting to get maybe beyond the appetite. Not this quarter could be an aberration, by maybe looking out let’s say new deal flow is a bit modest. Are your competitors acting rationally?

David B. Golub

I don’t see irrational acting. You know, I think we have a great deal of respect for G Capital and Madison Capital, who are two primary competitors in the middle market senior space. And, you know, I don’t see signs of irrationality at all.

Jonathan Bock – Wells Fargo Securities, LLC

Excellent. All right then, I’ll hop back in the queue. Thank you very much.


Our next question is from the line of Ryan Lynch with Stifel Nicolaus. Please go ahead.

Ryan Lynch – Stifel Nicolaus

Good afternoon gentlemen. You guys had a pretty dramatic shift in – from you senior secure loans to you one stop loans this quarter. Is that more of a function of kind of the market, you know, providing more track of opportunities in the one stop loans, or is that just kind of part of your continued strategy to rotate into more one stop loans?

David B. Golub

Can I choose C? Both A&B? I think it’s both factors. You know, one of the things we like about our business model is having a very broad product suite, is an ability to shift our originations to where we see the best opportunities from a risk/reward standpoint.

Now I think in calendar Q 4, we saw the best opportunities from a risk/reward standpoint in our one stop product.

In addition, it was a quarter in which sponsors saw particular value in one stop’s as well. You know, bear in mind if you’re a sponsor and you know you’ve got a looming 12/31 debt line that you absolutely positively need to meet in order to achieve your tax objectives, you know, certainty and reliability become particularly important to you. And one of the great advantages of our one stop product versus a more complicated multilayer capital structure is that we’re able to provide that high degree of reliability.

Ryan Lynch – Stifel Nicolaus

Okay, thanks. Right now you guys have about 47% of the one stop, is that kind of your ideal, you know, about half your portfolio in one stop’s, is that where you guys are kind of ideally like to be running your portfolio at?

David B. Golub

You know, I can answer that question for today. You know, this is something we’re going to reevaluate all the time. As Ross said earlier today, I think as we look at the market, and market conditions today, we feel very good about this portfolio construction. We reserve the right to change our views.

Ryan Lynch – Stifel Nicolaus

Okay, thanks. And then one last question; just kind of broadly speaking about your portfolio. Are you guys seeing any kind of EBITDA revenue trending the underlying business? Are they still performing strong? Have you guys seen any trends as kind of macro level?

David B. Golub

You know, I said this last quarter I would repeat what I said last quarter. We’ve seen signs in the portfolio of slowing growth. The easy comparisons have largely gone away. But we’re not seeing any signs of a, you know, dip into recession. We’re seeing isolated signs of weakness of the sort that you’d expect for where we are in the credit cycle. Overall I’m very pleased with the performance of the portfolio from a credit perspective it’s in very good shape.

Ryan Lynch – Stifel Nicolaus

All right, thanks you guys.


(Operator Instructions). We have a follow-up question from the line of Jonathan Bock with Wells Fargo Securities. Please go ahead.

Jonathan Bock – Wells Fargo Securities, LLC

Thank you. One last item, more of an industry question. It deal with backend leverage as tighter spreads have come in or as spreads have tightened people have found the ability to bring on a partner, back-end lever loan and maybe back into a higher yield spread. Could you, perhaps talk about the appropriateness of such a – I imagine you’ve done it many times, but the appropriateness of that in the BDC structure and whether or not that’s something you would be considering in an environment where spreads are conceivably tighter?

David Golub

Sure. So just for the sake of everyone on the line who may not be so familiar with this form of financing, what we and a number of our competitors have done from time to time, some more frequently than others is to make a loan and put the loan on our books and then to arrange with a third party, usually a bank, to buy a first-out position in the loans. So to just give a concrete example, we would make a $30 million loan and we would then sell $20 million of that position to a bank, you know, CoAmercia, just pick one, they happen not to be in this business, where pursuant to a waterfall, the bank would have the first rights to principle repayments and to the collateral in the event of a downside scenario. So because of the improved credit position that the bank would have in this scenario, the bank would look to get paid a lower interest rate than we would be charging on the loan.

The way we look at this, Jon, is it’s just – it’s a form of financing. There’s really no difference between bifurcating a loan into a first-out and a last-out and using leverage. The only difference is, you know, whether the leverage involves a degree of cross collateralization.

Jonathan Bock – Wells Fargo Securities, LLC


David Golub

What we have found generally is that the cost of first-out leverage is higher than the cost of securitization leverage. Let me put that in, again, concrete terms. So if a typical securitization leverage all-in cost today would be LIBOR plus 200, you know, you would typically have to pay a bank, you know, LIBOR plus 300 with some kind of LIBOR floor for a typical first-out position. So we would need to be convinced that the benefits of the bifurcated structure offset, you know, something like 150 basis points increments in cost. And I would say in our experience we typically haven’t seen ample justification for that.

Jonathan Bock – Wells Fargo Securities, LLC

Great commentary. Thank you.


And there are no questions at this time.

David Golub

So thanks, everyone, for participating. My apologies, again, for the technical difficulties and I look forward to reporting to you again in the future.

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