Golub Capital BDC's CEO Discusses F1Q2014 Results - Earnings Call Transcript

| About: Golub Capital (GBDC)

Golub Capital BDC (NASDAQ:GBDC)

F1Q 2014 Earnings Call

February 6, 2014 02:00 PM ET


David Golub - CEO

Ross Teune - CFO


Greg Nelson - Wells Fargo

Greg Mason - Keefe, Bruyette & Woods

Jim Young - West Family Investment


Good afternoon. Welcome to Golub Capital BDC Inc's December 31, 2013 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 Golub Capital BDC Inc's 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 Presentations link on the homepage of our website, www.golubcapitalbdc.com and click on the Investor Presentation’s link to find the December 31, 2013 investor presentation. Golub Capital BDC's earnings release is also available on the company’s 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 David Golub, Chief Executive Officer of Golub Capital BDC.

David Golub

Thank you very much. Good afternoon everybody and thanks for joining us today. I am joined here at Golub Capital by Ross Teune, our Chief Financial Officer and Greg Robbins, Managing Director. Earlier today, we issued our quarterly earnings press release for the quarter ended December 31 and we posted a supplemental earnings presentation on the website. We'll be referring to that presentation throughout the call today.

I’d like to start by providing you with an overview of the December 31, 2013 quarterly financial results. Ross is then going to take you through the quarterly financials in more detail. And then I'm going to come back and provide an update on our outlook for conditions in the middle market lending generally over the next couple of quarters.

So with that, let’s get started. I'm pleased to report we had another solid quarter and our results were very consistent with the goals that we talked about last quarter. We anticipated that the December 31st quarter would be a heavy originations quarter and it was.

We planned on increasing our utilization of leverage and we did. And we also indicated that the portfolio was unusually clean from a credit perspective and as we'll talk about today, it got even more so over the course of the December 30 -- the fourth calendar quarter of 2013. So with that, with those headlines let's run through the numbers started on page 2 of the investor presentation.

For the three months ended December 31, 2013, we generated net investment income of $13.3 million or $0.31 a share, that compares to $12.4 million or $0.31 a share for the quarter ended September 30. Net increase in net assets resulting from operations what I call net income or EPS ended the quarter at $14.8 million, $0.34 a share as compared to $12.3 million or $0.31 a share for the quarter ended September 30.

The difference between the two -- the $0.34 and the $0.31 is of course net realized and unrealized gains on investments and that totaled $1.6 million for the quarter ended December 31st. It related primarily to net unrealized appreciation on several middle market debt and equity securities, as we’ll talk about we also sold one underperforming investment and we wrote-off two nonaccrual investments all at values that were very close to their September 30th carrying values. As Ross will discuss the impact of that, was that not only can you see credit value remaining strong, but non-accruals now stand at essentially zero.

Net asset value per share for the quarter ended December 31st was $15.23 and that compared to $15.21 for the quarter ended September 30th. The $0.02 of accretion was attributable to our EPS being in excess of our quarterly dividend and we’re proud to say this is the sixth consecutive quarterly increase in our NAV.

In regards to new investment activity, as I mentioned we had strong new originations for the quarter, totaled $286.7 million. That includes $25.6 million we invested in Senior Loan Fund, approximately 12% of the new investment commitments were senior secured loans, 71% were one stops, 7% were second lien loans, 1% were equity securities and 9% were investments in the senior loan fund.

As you’ll see on the subsequent slide, the portfolio mix continue to shift towards one stops. So let’s look at this bit more carefully right now as we take a look at Slide 4 of the presentation, you can see one stops are now up to 59% of the total portfolio. This is consistent with our strategies, we feel one stops right now are generally offering the best risk reward in current market conditions.

After you take into account portfolio runoff during the quarter and other activities, investments at fair value grew by $155.3 million during the quarter, a 15.1% increase from September 30th. We financed the growth in investments with debt and in doing so we made quite a lot of progress on our goal of increasing our targeted economic leverage about 1:1.

For the quarter ended December 31st our economic leverage was 0.9 and that’s up from 0.64 as of September 30th. Obviously regulatory leverage was much lower than that because of our SBIC borrowings, regulatory leverage was 0.6 at December 31st, so we saw plenty of cushion against the 1:1 regulatory limit.

Let’s look at Slide 3 of the presentation. On Slide 3 you can see in the table $0.31 per share of NII and $0.34 of EPS. The table also highlights the bump in our net asset value per share this quarter to 15.23. What I want to point on this page is, we continue to have a very granular, very well diversified portfolio with 139 different portfolio investments and an average investment size of only about $8.5 million.

I'm going to now turn it over to Ross, who’s going to discuss the results in more detail.

Ross Teune

Great, thanks David. I’ll start on Page 4, the balance sheet. We ended the quarter with total investments of nearly $1.2 billion, total cash and restricted cash of $71.7 million and total assets of just under $1.3 billion.

Our total debt was $577.2 million at the end of the quarter, which includes $215 million in floating rate debt issued through our securitization vehicle, $196.3 million of fixed rate, SBIC debentures and $165.9 million in debt outstanding in our revolving credit facility with Wells Fargo. Asset growth this quarter was principally financed by increased borrowings on a revolving line with Wells, which increased by just over $136 million quarter-over-quarter.

Total net assets were $666 million up slightly from the previous quarter as net income exceeded our dividends paid. From a GAAP perspective as David mentioned, our debt to equity ratio was 0.9 times, and we moved closer to our target of 1:1 from a GAAP perspective and calculated for a regulatory limit, our debt to equity ratio was 0.6 times.

Flipping to the income statement on the subsequent slide, total investment income for the quarter ended December 31 was $25.6 million, this was up $2.8 million from the previous quarter or just over 12%. This increase was driven by strong asset growth as well as an increase in prepayment fees and discount free amortization that was driven by higher run off.

On the expense side, total expenses of 12.3 million, increased $1.9 million during the quarter due to an increase in interest expense as average debt outstanding increased, an increase in management fees driven by an increase in average total investments as well as an increase in incentive fees which was driven by an increase in net investment income.

As David mentioned we had net realized and unrealized gains of $1.6 million during the quarter, this is primarily due to net unrealized depreciation on several middle market debt and equity investments. And last on the page here, net income for the quarter was $14.8 million.

Turning to Slide 7, these charts graphically summarize the breakdown of our new originations end of period investments. As shown on the bar chart on the left hand side, we originated 12% of our new investments in senior secured loans, 71% in one stop, 7% second lien, 1% in equity securities and the remaining 9% in the senior loan fund.

The chart on the right provides a breakdown of our total investments by investment category. This shows the 5% increase in one stop investments this quarter, with corresponding decrease in both the senior secured investment category and the junior debt. The subordinated debt, the green bar if you can see it, as you will see has nearly disappeared from this chart and now represents only 1% of total investments as we continue to avoid most new subordinated debt opportunities and the good subordinated debt that’s on our books continues to get refinanced.

Turning to Slide 8, I’ll walk you through the changes in our yields in investment spreads for the quarter, first looking at the grey line. This line represents the interest income or kind of all income earned on the investments but excluding fee amortization. This line represents the best single indicator of the portfolio’s current interest rates. Due to continued compressed pricing and new investment fee interest income yield declined from 8.9% for the quarter ended September 30th to 8.6% for the quarter ended December 31. We expect to see continued pressure on this line as we originate new loans at current market spreads, some of our older higher yielding loans continue to pay off.

Including amortization the fees and discounts, the total yield on investments, the dark blue line at the top, the yield was 9.3% for the quarter ended December 31. The decrease in this total yield was consistent with the decrease and the interest income yield as income from fee amortization was relatively stable quarter-over-quarter.

Looking at the green line, the weighted average cost of debt increased slightly from 3% last quarter to 3.1% for the quarter ended December 31. Turning to Slide 9, for new investments the weighted average rate on new middle market investments was 7.2%. This is down from 8.1% the previous quarter. The primary reason for the decline was due to a change in asset mix as we originated a much lower percentage of second lien investments this quarter. However, a modest decline in rates on new investments also contributed to the decrease.

The weighted average rate at 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.

As shown in the middle of this slide, the investment portfolio remains predominantly invested in floating rate loans and this has gone up continuously throughout the year and represents over 95% of the total portfolio as of December 31st.

Overall credit quality continues to remain strong with non earning assets as a percentage of total investments at a cost basis, at 0.2% and essentially 0% based on a fair value basis. Flipping over to slide 11, looking at our risk ratings. Over 90% of our investments at fair value continue to be risk rated in our four or five category, our two highest categories. And we also experienced declines quarter-over-quarter in both of our lower risk rated categories, the 2 and 3 accounts. As a reminder independent valuation firms valuated approximately 25% of our investments as of December 31st.

Turning to Slide 12, our board declared a distribution of $0.32 a share payable on March 28 to shareholders of record as of March 17th. Now flipping to the last slide looking at liquidity and investment capacity, we had approximately 200 million of capital available for investments as of December 31st. This consisted of restricted and non-restricted cash, SBIC debentures and availability on our revolving credit facilities. We have 31.8 million of unrestricted cash and 39.8 million of restricted cash. Restricted cash is primarily held in our securitization vehicle as well as a revolving credit facility with Wells and our SBICs is generally available for new investments that qualify for acquisition by these entities.

As of December 31st subject to leverage and borrowing base restrictions we had $84.1 million of available borrowings, our $250 million revolving credit facility with Wells Fargo, and we had the full $15 million available on a revolving credit facility with Private Bank. Regards to our SBIC subsidiaries as of December 31st, we had $28.7 million of additional debentures available subject to the customary regulatory requirements. In regards to the senior loan fund, subsequent to quarter end we entered into a $50 million revolving credit facility with Wells Fargo, this facility has a reinvestment period through January 17, 2015, and a final stated maturity date of January 17, 2019.

The facility bears an interest rate ranging from LIBOR + 1.75 to LIBOR + 2.25 with no LIBOR floor and depends on a composition of the portfolio. After the reinvestment period the interest rate increases to LIBOR + 2.75. With the addition of the third party credit facility, we expect to fund a larger portion of new investments with this third party debt thereby improving our returns on our investment in this fund. I’ll now turn it back to David who’ll provide an update on market conditions and provide some closing remarks.

David Golub

Thanks, Ross. As expected our deal pipeline in the first calendar quarter of 2014 is slower than it was in the last quarter. Not to say it’s slow, we’re still getting some deals done, but the first calendar quarter is typically slow relative to the rest of the year and I think in 2014 the first quarter will be no exception to that rule. Our macroeconomic outlook remains very similar to what I’ve talked about for the last several quarters. We expect calendar 2014 to be a year of continued bubbling growth, not as good as the economic statistics that came out on calendar Q4 of 2013 and not as bad as some market pundits have been predicting since the stock markets started to decline.

We think our credit results this year are likely to stay strong, certainly the portfolio isn’t very strong credit shaped right now. We’ve heard that M&A activity is showing signs of increasing and we’re hopeful that it will, but we’re not counting on it and we haven’t yet seen it materialize in transaction volume.

Our approach in this environment -- I’ve said this for a couple of quarters in a row, it remains very consistent. Our approach is to remain highly selective and to focus on senior debt and one stops in resilient recession resistant borrowers that have low risk capital structures and that are owned by relationship oriented private equity sponsors.

That concludes Ross and my prepared remarks for today, and as always I want to thank everyone on the phone for taking the time to be with us today and also thank you if you’re a shareholder for your continued support.

Operator, can we please open the line for Q&A.

Question-and-Answer Session


[Operator Instructions] One moment please for the first question. Our first question comes from Greg Nelson with Wells Fargo, please go ahead. Mr. Nelson your line is open.

Greg Nelson - Wells Fargo

Thanks so much for taking my questions. So David on the leverage for the SLF, you know you guys had the credit facility and that’s great. Is there a particular kind of advance rate that you guys are getting there? How should we think about leveraging the facility going forward as you guys utilize that credit facility?

David Golub

You know SLF is going to be a work in progress for the foreseeable future, so we’ve said previously and I’d say again our goal is to build a diversified portfolio in SLF and upon having that diversified portfolio we’ll be very comfortable leveraging it at about a 3:1 ratio, three parts debt to one part equity. We’re not going to get there overnight, it's going to take us some time to build that portfolio to the level of diversification that will enable us to feel comfortable with that level of leverage. The Wells facility is a great start on that and what it will enable us to do is to earn a good, not great but a good ROE from here as we continue to build up that portfolio and look toward achieving our larger goal.

Greg Nelson - Wells Fargo

Perfect. Is there a kind of a minimum origination level in there that you guys have to reach before you can start pulling down on it?

David Golub

No, we already have sufficient assets in SLF to be able to draw on that facility.

Greg Nelson - Wells Fargo

Okay great. And then we heard one of your competitors say recently that pricing on -- given tranche [ph] one stop has come in. Are you guys seeing that in the deals that you compete in?

David Golub

Well I think you can see in our calendar Q4 2013 results, as well as in the comments I made earlier about the relative slowness of calendar Q1 of 2014, some of the same themes that you’re referencing. We’re definitely seeing that there’s a tremendous interest in the middle market loan asset class right now, I think it’s for a good reason because I think it offers value in a floating rate form at a time when traditional fixed income is hard to get comfortable with because of interest rate risk. But when you combine that interest with relatively slow M&A, the natural consequence is going to be a high level of competitive activity and we saw that in Q4 of 2013 and we’re seeing it again in Q1 of 2014.

Greg Nelson - Wells Fargo

Sure. And then lastly, you guys mentioned that obviously the yields came down as you guys were originating less in the second lien. Is there you know a fundamental reason for that, are you guys avoiding it on a risk adjusted return basis or is it just less deal flow from your sponsor relationships?

David Golub

We have -- some people view second lien debt as being very different from subordinated debt, we don’t. We think second lien debt is really best part of is being floating rate mezzanine, so our views on second lien and on subordinated debt we’ve been pretty vocal about for a number of quarters now. We think that with pricing where it is on second lien and on junior debt and leverage where it is, we think it’s quite difficult to find attractive piece of paper in that category on a risk adjusted basis, so if you look at our originations over extended period of time, proportion of our originations that are in senior secured loans and one stop loans as a percentage of all of our originations, that proportion has continued to grow. So we did -- you know, we do find some attractive second lien and mez loans, we did make a couple this quarter and I suspect we will make more of them in calendar 2014, but not at the pace that we would if the environment for those loans is more attractive.

Greg Nelson – Wells Fargo

Great, guys thanks for answering my questions.


Our next question comes from Greg Mason, he’s with Keefe, Bruyette & Woods. Please go ahead.

Greg Mason - Keefe, Bruyette & Woods

Great. Good afternoon gentlemen. First on slide 9 when you have your weighted yield on new investments, the 7.2 -- David does that include your new investments in the SLF which right now obviously have a pretty modest yield, how is that impacting that 7.2?

David Golub

No, that does not include the weighted average rates on the new investment in SLF. So these are just, it's the weighted average rate on assets that are coming on balance sheet.

Greg Mason – Keefe, Bruyette & Woods

What about the $25 million investment you made in SLF, that I think yielding 4% right now if I’m thinking of that right. Is that $25 million a percent in that number or is this just the debt investments this quarter?

David Golub

This is just the balance sheet debt investment, it does not include the investment in SLF. I think where you’re going Greg is that we currently have a bit of a drag as a consequence of a relatively low return on our investment in SLF, because it’s not leveraged, and you’re right. And that’s why we were eager to start to ramp it up to put in place the Wells Fargo facility and to going forward from here start to use debt financing as opposed to incremental equity financing to grow that portfolio.

I think one of the potential sources of earnings growth that we have going forward is a higher level of returns from SLF. But I want to emphasize something you also heard me say couple of times which is -- we're very optimistic about SLF in the long term, we think it’s a great strategic took for us. But we think it's going to take some time before we get it to the size and scale and leveraged levels that we want to get it to.

Greg Mason – Keefe, Bruyette & Woods

Great and then another question on just to funding your liabilities, as you approach your target economic leverage of 1:1, based on our calculations you should have over $200 million borrowed on our credit facility, kind of a similar size that you did your last securitization at 215 million. What are your thoughts about doing another securitization, do you want to continue to have capital out on the credit facility -- just thoughts on balance sheet construction?

David Golub

Yes, we’re actively thinking about the issues that you just described. I think that the right liability structure for GBDC involves a combination of securitization debt, SBIC debt and bank debt and we’re getting towards the higher end of the percentage I’d want to see in bank debt and that will incline us in coming quarters to look at securitization options, as a means of shifting more into that category and essentially recreating, letting room for growth through a less utilized bank facility.

Greg Mason - Keefe, Bruyette & Woods

Great, and then one last question. You talked about selling one underperforming asset and writing off two non-accruals, as I look through the portfolio would those be Extreme Fit, KHKI and Promise [ph]?

David Golub

Yes, we sold KHKI what we call Hawkeye and we wrote off Extreme and Promise [ph], which we had valued previously at either 0 or very close to 0.

Greg Mason – Keefe, Bruyette & Woods

Great, thank you guys.


[Operator instructions] Our next question comes from Jim Young with West Family Investment, please go ahead.

Jim Young - West Family Investment

Hi, you had mentioned -- the portfolio is shifting towards the one stop loans because of their best risk reward characteristics. Could you kind of quantify those, the risk rewards that you see in one stop and then there’s a follow up?

David Golub

Would you like me to give you what kinds of rates we’re seeing in our portfolio and in the market for senior secured loans and for one stops today? I just want to make sure I answer the question you want me to answer.

Jim Young - West Family Investment

Yes, that’s exactly what I’m looking for.

David Golub

So the market for -- middle market, traditional middle market senior loans today ranges from LIBOR + 400 with 1% floor at the low end, LIBOR + 5.25%, again with a 1% floor at the higher end, this is for a good solid credit, middle of the fairway deal with relatively limited leverage and we're able to earn 100 to 150 basis point premium over that when we are doing our goal to one stop product. We go a little bit deeper into the capital structure, so we’re taking a bit more risk, but as I’ve explained in prior quarters what we’ve found is that we've been able to select credits to do our one stop loans to that have very good credit characteristics. So our default experience with respect to our one stop loans is actually slightly better than our default experience on our traditional senior secured loans, which is counter intuitive but that’s what the data is. Does that answer your question, Jim?

Jim Young - West Family Investment

Yes, that component of it and then the follow up is basically how deep into the capital structure are you going at this stage on an average with your new commitments and how does that compare to your prior quarters?

David Golub

Leverage on new deals I don’t think has moved very much for us over the course of the last couple of quarters. Traditional senior debt, we’re seeing in the 3.5 to 4 times EBITDA level in typical transactions and on GOLDs we’re typically seeing those go to about five times. As I’ve said in prior calls, everyone has their own approach to underwriting and to thinking about risk, we tend here to be prepared to be very competitive on price, but not stretch when it comes to working with iffy credits or working with iffy structures. So there are some somewhat more aggressive structures out there that we’ve seen, those are not the transactions we choose to do.

Jim Young - West Family Investment

Great, thank you very much.


There are no further questions at this time.

David Golub

Great, well thank you everyone again for joining us this afternoon and we look forward to catching up with you next quarter.


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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!