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Golub Capital BDC Inc (NASDAQ:GBDC)

Q3 2014 Earnings Conference Call

August 7, 2014 12:30 PM ET


David Golub - CEO

Ross Teune - CFO

Gregory Robbins - Managing Director


Greg Mason - KBW

Jon Bock - Wells Fargo Securities

Doug Mewhirter - SunTrust


Good afternoon. Welcome to the Golub Capital BDC Inc.’s June 30, 2014 Quarterly Earnings Conference Call.

Before we begin, I’d 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, and click on the Investor Presentation’s link to find the March 31, 2014 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, Donny, good afternoon everybody and thanks for joining us today. I’m joined today by Ross Teune, our Chief Financial Officer; and by Gregory Robbins, Managing Director here at Golub Capital. Earlier today we issued our quarterly earnings press release for the quarter ended June 30th, 2014 and we also posted a supplemental earnings presentation on our website. I’m going to be and Ross will be referring to this presentation during the call.

I would like to start by providing an overview of the June 30th, 2014 quarterly financial results then Ross is going to take you through the quarterly results in more detail and then I’ll come back and provide an update on our outlook for conditions in the middle market lending environment over the next couple of quarters. So with that let’s get started and I’m going to start on page 2 of the investor presentation.

I’m pleased to report, we had another strong quarter for the three months ended June 30th, we generated net investment income of $0.32 per share $15.1 million as compared to $0.31 per share or $13.3 million for the quarter ended March 31st. Net increase in net assets resulting from operations what I call net income for the quarter ended June 30th was $0.35 a share or $16.3 million as compared to $0.32 a share or $14.1 million for the prior quarter. Net realized and unrealized gains on investments in secured borrowings were $1.2 million for the quarter ended June 30th, so we have another quarter of what I call negative credit losses.

The net gain related primarily to unrealized depreciation on a range of middle market debt and equity securities, overall credit quality remains very strong will go into that in more detail later in this call and our non-accrual rate rounds continues to round to zero about 95% of our investments have an internal risk rating of 4, 5 or 2 highest ratings.

Net asset value for the quarter ended at $15.44 up from $15.41 for the quarter ended March 31st, so we have $0.03 accretion that was primarily due to EPS in excess of our quarterly dividend I know this is the eighth consecutive quarter in which we’ve seen an increase in our net asset value per share that’s something we are proud of.

In regards to new investment activity, we had another strong quarter of new originations, commitments for the quarter totaled $158.7 million that includes 3 million reinvestments in senior loan fund, hop that amount approximately 18% were in senior secured loans, 79% were in one stops, 1% were in equities and 2% were investments in senior loan fund.

The overall mix of originations that we saw in the quarter is consistent with the strategy I discussed last quarter in particular our focus on one stop investments as we feel one stops offers the best risk award in the current investment climate. After taking into account portfolio run off and other activity investments at fair value improved $71.3 million during the quarter a 5.7% increase from March 31.

On June 05, we closed on a new securitization, we issued $246 million in debt, and this is our second balance sheet securitization provides us with another source of very stable and attractively priced debt financing. Ross, will walk you through the details of that debt issuance later on in this call. The highlights are, we have a four year reinvestment period that runs through April of 2018 of the notes mature in April of 2026 and we have a nice interest savings versus the Well Fargo financed bank facility that this replaces.

Due to the additional debt, we raised via the securitization partially offset by a reduction of debt outstanding on the Well Fargo revolving credit facility. We ended the quarter with a GAAP debt equity ratio of 1:1. When we think of debt equity we focus on what I call economic leverage and what I mean by that is we adjust debt outstanding by some tracking out cash. So if we adjust for cash our net debt-to-equity ratio was 0.83 times still below the target level we discussed in prior calls one-to-one. We ended the quarter with an unusually high level of cash and restricted cash about a $120 million in total. This was the result of the new securitization vehicle not being fully ramped with investments at the time of close. We anticipate that we will fully ramp that vehicle shortly. Calculated for regulatory definitions are leverage at the end of the quarter was 0.71 times, so we saw a substantial pushing against the one-to-one regulatory limit as of June 30th.

On slide three of the investor presentation you can see in the table $0.32 per share we earned from net investment income and the $0.35 per share we earned from net income perspective. The table also highlights the bump in our net asset value to 15.44, as well as the increases we’ve experienced over the past several quarters. As shown on the bottom of page we had a slight increase in average size of investments but the portfolio remains very well diversified we have investments in a 146 different portfolio companies and the average size of our investments is $8.8 million.

Finally turning to slide four, the percentage of one stop in the portfolio continues to increase, it represented 65% of total investments as of June 30th. Junior debt remains a small portion of the portfolio comprising 7% of total investments and we continue to originate very little new junior debt reflecting our relatively negative yield market conditions for junior debt and as I’ll talk about at the end of this call our cautious microeconomic outlook.

With that I’m going to turn it over to Ross who will discuss the results in more detail and they I’ll come back with by outlook and then we’ll shift to Q&A.

Ross Teune

Great. Thanks, David. I’ll start on page five, balance sheet, we ended the quarter with total investments of just over $1.3 billion and we have total cash and restricted cash of $121.2 million and total assets of just under $1.5 billion.

As David noted restricted cash was unusually high this quarter primarily due to the closing of our second securitization which was not fully ramped with new investments. So if you look at the balance sheet we had a $109.8 million of restricted cash, this cash is generally available for new investments and as David mentioned we plan to fully ramp the COO.

Total debt was $703.3 million which includes $215 million of floating rate that issued through our first securitization $246 million of floating rate that issued through our second securitization, $208.8 million of fixed rate debentures and $33.5 million of debt outstanding in our revolving credit facilities.

Total net asset value at the end of the quarter were $726.8 million this is up about $5 million from the previous quarter primarily due to EPS exceeding dividends paid as well as proceeds from the partial exercise of the green shoe in early April relating the equity offering we completed back in March. Look into the statement of operations on page six. Total investment income for the quarter ended June 30th was $28 million up $2.8 million from the previous quarter or nearly 11%.

This increase was driven by strong asset growth as well as an increase in prepayment fees and dividend income. On the expense side, total expenses of $13 million increased by $1.1 million during the quarter primarily due to an increase in interest expense so [indiscernible]

There is an unusual non-recurring item in interest expense I just wanted to point out, the increase in interest expense was partially caused by the acceleration of deferred financing cost associated with revolving line of credit with Wells Fargo that we downsize simultaneously with closing our new securitization. As a result of the downsize from 250 million in commitments to $100 million commitment, a decrease of $100 million we accelerate approximately $450,000 of deferred financing costs.

Remaining increase in interest expense was primarily attributable to higher average debt outstanding increased non-utilization fees and increased interest rates of SBIC debentures that we pull at the end of March.

As David mentioned earlier, we had net realized and unrealized gain on investments of $1.2 million during the quarter, this was primarily due to unrealized depreciation on a range of middle market debt in equity investments and net income for the quarter totaled $16.3 million.

Turning to slide seven, this chart graphically summarize the breakdown of our new originations and the period investments shown in the bar chart on the left hand side, we continue to focus on originating one stop investments which have comprised over 70% of origination the past three quarters. For the current quarter, we originated 18% of our new investments in senior secured loans, a 79% in one stop, 1% equity securities and the remaining 2% in SLF.

The chart in the right provides breakdown based on total investments. This chart shows a 4% increase in one stop investments to 65% of the total portfolio with a decrease offset in second lien investments.

Turning to slide eight, I’ll walk you through the changes in our yield and investment spreads for the quarter. First focus on the gray line, this line represents the income yield for the actual amount earned on the investments including interest and fee income but excluding the amortization of discounts and upfront fees. Due to the increase in prepayment fees our new investments, the income yield increased from 8% last quarter to 8.3% for the quarter ended June 30th, excluding the impact of the increase in prepayment fees the income yield would have remained flat at round 8%.

Including amortization of fees and discounts, the income yield on investments are the dark blue line at the top of the chart that was 8.9% for the quarter. The increase here again is due to the increase in prepayment fees as amortization from fees and discounts was stable quarter-over-quarter. The weighted average cost of debt increased to 3.3% for the current quarter as compared to 3% to previous quarter due to an increase in non-utilization fees increased interest rates on SBIC debentures that were pooled at the end of March and higher differed fee amortization.

Turning to slide 9 for new investments, the weighted average rate and new middle market investments was 7.1%, this is down from 7.5% the previous quarter primarily reflecting some mix differences quarter-over-quarter. Our overall sense is that pricing has been relatively flat quarter-over-quarter. As the weighted average rate our new investments continues to remain below the weighted average rate on investments that are being paid off, we continue to expect some pressure on the income yield over the next few quarters.

This is reminder that weighted average 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 the current LIBOR, the spread up in LIBOR and the impact of any LIBOR floor. And shown on the middle of the slide the investment portfolio remains predominantly invested in floating rate loans with variable rate loans comprising over 96% of the portfolio as of June 30th. Overall, credit quality continues to remain very strong with non-earnings assets as a percentage of total investments on a cost basis at 0.3% and essentially 0% of total investments on a fair value basis.

Looking to slide 11, two slides over to slide 11, the percentage of investments risk rate of 5 or 4 our two high risk categories remains stable quarter-over-quarter and continues to represent nearly 95% of our portfolio. The number of investments with the risk rating of 3 also remain stable at just below at 5% and the percentage of investments risk rated a 2 or 1 remains fairly in consequential at less than 0.5% of the portfolio at fair value.

As shown on slide 12, the portfolio is well diversified by industry concentration, our highest concentrations are in three industry verticals in which we have meaningful domain expertise, these are in healthcare, retail and restaurants and software. The portfolio has a lower exposure to commodity dependent and highly cyclical companies.

As a reminder in regards to valuations independent valuation firms continue to value approximately 25% of our investments each quarter. Turning to slide 13, this slide provides some financial highlights for investment in senior loan fund or what we call our SLF. As shown in the table, total investments at SLF continue to grow and now exceed the $100 million at the end of the quarter.

In addition, SLF continues to expand the use of third party leverage with senior leverage increasing from 0.55 times at the end of March to 1.69 times at the end of June. Due to the increased use of third party leverage, the annualized quarterly return improved from 6.2% the previous quarter to 9.6% for the quarter ended June 30th. We anticipate a faster rate of growth in investments at SLF as well as increased use of third party leverage in coming quarters.

Turning to slide 14, our board declared a distribution of $0.32 per share payable on September 26, to shareholders as a record as of September 16. Turning to slide 15, as of June 30th, we had approximately $190 million of capital available for new investments, this capital consist of restricted and unrestricted cash SBIC debentures as well as availability on our revolving credit facilities.

As of June 30th, subject to leverage and borrowing base restrictions we had $52.8 million of availability under our revolving line of credit with Wells Fargo and private bank in regards to our SBIC subsidiaries, we had $16.2 million of additional debentures available subject to customary regulatory requirements.

As David noted in his opening remarks, we completed a $246 million of securitization as these notes consisted of $191 million of AAA Class A-1 notes that their interest and LIBOR of 1.75, we issued $20 million of AAA Class A-2 notes that their interest rate at LIBOR plus 1.45 and $35 million of AA Class B notes that their interest rate at LIBOR plus 250. As David mentioned the notes have a four year reinvestment period that expires in April 2018 with the maturity date in April 2026.

I’ll now turn it back to David, who will provide an update on current market conditions as well as some closing remarks.

David Golub

Thanks Ross. So we are now halfway through our last fiscal quarter, the quarter ended September 30th and we anticipate that we’re going to have another solid quarter of origination activity. This is somewhat unusual off in the summer it is a slow period but not this summer our deal close partially being driven by a pickup in middle market M&A activity but we think more of it has to do with our ability in this environment win the deals we want to win with sponsor clients that we want to work with and I’ll give you some statistics on that.

We think that our strong relationships with private equity sponsors are reflected in the fact that this year and last year over 80% of our deals have been with sponsors we’ve done multiple deals with previously. We think that we’re succeeding in part because of our reputation as a market leader and we think increasingly we’re succeeding because we’re leveraging our size and scale and our ability to buy whole part one stop facilities.

Let me shift and talk briefly about our micro view. I’m often asked various settings based on the position that we have in seeing lot of financials, what would we see, how healthy is the economy based on what we’re seeing in our underlying portfolio companies. And our sense is the things are okay, not great, not bad okay. Calendar Q2 balanced from a relatively weak calendar Q1 but our sense is that folks were too pessimistic after Q1, the Q1 results were heavily impacted by weather related issues and there are also too exuberant about Q2 because we think that the weather related issues in Q1 push some activity into Q2.

So our expectation is that the macro numbers for the rest of the year going to show a reversion to small middling growth and that perspective is informing our credit and underwriting decisions.

So consequently we’re cautious in the current environment we think that this is environment where competition is challenging, growth is likely to be slow and it’s a time for us to be very selective to focus on the transactions that we really feel conviction about, well structured transactions with resilient power version with relationship oriented fee sponsors. In most cases, fee sponsors we work with before.

That concludes our prepared remarks for today. And as always I want to thank everybody on the call for taking the time to listen to today’s call and for your continued support. And Donny I’d ask your help in opening the line for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line Greg Mason from KBW. Your line is open. Please proceed.

Greg Mason - KBW

Great, good afternoon gentlemen. First David could you just talk about the backup that we’ve seen in the high yield bond market and liquid market so far in the third quarter, has that begun to impact your market at all, and if it hasn’t, how long do you think it has to stay like this before it does start filtering into your pricing on new deals?

David Golub

We have not seen it begun to filter in yet, these things do quite as your question implies, these things do tend to involve the lag, so you’ll see impact of changes in funds flows in high yield market before you’ll see it in the broadly syndicated loan market and you’ll see it in the broadly syndicated loan market before you’ll see it in the middle market. So right now we definitely seen it in high yields, there is bit of choppiness in the broadly syndicated market, particularly in the heavily liquid name. So if you looked for example of what they call flow names in that market which are the most easily traded names. There has been about a 1% decline in the price of flow names, less so outside of the flow names I think it’s too early to expect to be seeing this in middle market land. But if we see continued weakness in the high yield market in the broadly syndicated market it bodes well for somewhat less pressure on leverage in pricing in Q4, calendar Q4.

I just want to caution that, we we’re not seeing a big change in pricing and leverage today. Ross talked about the fact that in the quarter ended June 30th we saw a lot of relative stability in pricing and in leverage, if you ask me to guess right now I would be more in the account of stability than guess that we’re going to see a widening of spreads.

Greg Mason - KBW

Its great color, thanks. Then one additional question on the senior loan fund, there is a fellow BDC participant that has a structure that looks a lot like yours I think it’s even the same partner, they are putting about $150 million to work in their senior loan fund, you guys have been averaging about 35 million of quarters since you started yours in much slower pace. So, just wanted to see if you could give us some color on what that pace and then maybe some color on Ross’s comment that you think that pace is going to increase?

David Golub

So, we’ve been focused to beat on a strategy of growing our senior loan fund with new issue as oppose with sales from the balance sheet 2 SLF Fifth Street like presume it’s part that you are talking about Fifth Street has chosen a different strategy of moving assets from balance sheet into SLF, I think there is a road both strategies we’ve been exploring potentially using to a degree the strategy of selling assets from balance sheet in our SLF and we actually anticipate that we’re probably going to do some of that and that’s one of the reasons why we contemplate that our SLF asset growth is going to accelerate in coming quarters.


Our next question comes from the line of Jon Bock from Wells Fargo Securities. Your line is open, please proceed.

Jon Bock - Wells Fargo Securities

Good afternoon, thank you for taking my questions. Tail end of the results to the SLF, David, that there are many pockets within Golub that hold it at the same loan and just curious as you look at the opportunities to go into the SLF in addition to your partner, would it be fair to say that a majority of lower yielding one stops or just pure senior secured loans that you have done that perhaps maybe aren’t necessarily strike senior investments. We would end up in that fund maybe and allowing us to bifurcate that more as to what’s going to be more appropriate for that fund to the extent you chose to sell some balance sheet assets in to it?

David Golub

Yes, I think if I understood your question Jon, you were asking, is it our philosophy that it’s appropriate to use somewhat higher leverage with more senior assets and so could we anticipate that to the degree we’re choosing assets potentially to move from the balance sheet with our partners approval in consent into SLF, would we be more likely to do that with senior assets I think the answer is yes, we would be. And I think that’s entirely consistent with what that before in prior discussions that we’ve had in respective HR1800 I mean respective just philosophy I’m leveraged generally, we’re more comfortable using higher levels of leverage with senior assets than with other kinds of assets.

Jon Bock - Wells Fargo Securities

Makes sense so just maybe the bifurcation being if you were thinking of one stop assets of if there was some form limitation in the indenture that perhaps relegated you to pure first or what we’ll call very low leverage senior secured loans that would go into the fund or if you had a little bit more flexibility to put in some of the higher yielding strep seniors that you might have on your balance sheet?

David Golub

In the debt facility at SLF today there are no restrictions this is all series of judgment calls but it involves discussions that we have had and we’ll continue to have with our SLF partner.

Jon Bock - Wells Fargo Securities

Got it and then in terms of risk award, I know we talk about the backup and the more liquid markets. If you give us any sense of structure at the moment, we were believe we have such question two quarters ago, was your intention to compete on pricing of structure which obviously we’ve seen in high quality deals we’ve done in the portfolio. Are you seeing further competition in today’s environment that perhaps structures that are getting done or less advantages or is it still as long as you’re willing to offer the best price, you will still get the deal on the terms which you require to make is a decent risk adjusted opportunity?

David Golub

Well, I think that in the competitive environment, you have competitors who are competing on both price and structure. So, there are transactions that have structures that we are not comfortable with and so we’ve -- . where we tend to draw a credit line it tends to be on the structure level as oppose to on a pricing level now there is exceptions, there are deals where we pass because prices too low. So all of these factors are important and ultimately we’ve got reach agreements with our sponsor clients and obligors that terms that we’re offering both price and structure are compelling value. I think what I meant when I discuss this previously is that from a philosophical standpoint we don’t compromise on credit. If we aren’t very confident that we’re going to be able to sustain our track record of very low credit losses we’d much prefer to not make loans then to make loans, the risk in which we don’t feel comfortable with.


(Operator Instruction) Our next question comes from the line of Doug Mewhirter from SunTrust. Your line is open. Please proceed.

Doug Mewhirter - SunTrust

Hi, good afternoon. I just had the two very quick numbers questions and one bigger picture question. First the numbers questions, what was your average total debt EBITDA in your portfolio companies if you have that handy?

Ross Teune

I don’t think that the number that we previously released so we’re not going to be able to give it to you on this call because of FT related issues. But let us look into that and if we can release that we will get back to you.

Doug Mewhirter - SunTrust

Can you say whether it’s been rising, falling or holding steady over the past two or three quarters?

Ross Teune

I would say that over the last two or three years it’s been increasing.

Doug Mewhirter - SunTrust


Ross Teune

Along with markets general.

Doug Mewhirter - SunTrust


Ross Teune

In the last two or three quarters it has not moved meaningfully.

Doug Mewhirter - SunTrust

And my second numbers question is, could you remind me what kind of goals you have with the SLF in terms of capacity on a invested capital basis or invested equity basis or on a total capacity to absorb fund the loans basis, so would you put it, you go to have 50 million invested and I think a 200 million of loans in the facility or something like that I don’t know if you’ve mentioned that before.

Ross Teune

Well, it’s a developing strategy, there is no one goal that we anticipate hitting and then stopping I think the bookends are probably the best way to look at this. So one bookend is we’ve got to be mindful of our 30% basket which investments in SLF would fall into. We currently are very, very far away from our 30% basket. So this is not a big concern. Another is we want to look at a running SLF overtime with sufficient scale to be able to achieve real efficiency in our debt financing cost. So that means that the practical level unless market condition is change that we’re going to run into the size where we can have one or two securitizations underlying the company. A typical securitization minimum efficient scale is about $300 million of absence.

So I guess where I’m headed is I think about this is stages, stage one is to get this to $300 million $400 million of assets at a roughly 3 to 1 leverage ratio with the goal of then reducing our financing cost through a securitization and at that point we would revisit and think about whether it make sense to grow it further.

And again the risk of stating the obvious, when I talk about SLF I don’t mean to be implying that we’re the only ones making decision with respect to it, we’re not. All decisions at SLF level are all meaningful decisions are joint decisions.

Doug Mewhirter - SunTrust

Thanks. That’s a very comprehensive answer. My last question regarding one stop, you obviously you’re a major participant leader in that one stop market so you have a lot of visibility into what’s going on I mean why the banks have pulled way back from middle market lending. There have always been lots of banks they are sort of floating around the one stop market popping up here and there, have their activity just in the past calendar year-to-date or over the past 12 months, are that stabilized or they still sort of leaking out of the market or some of them can back in?

David Golub

I don’t think there has been a meaningful change, you see a little bit of change in terms of the cast of characters but in terms of overall level of involvement and relevant side I don’t think there has been a meaningful change I think we’ve seen a fairly dramatic pull out over the course of years and I don’t sense a change in that.

Doug Mewhirter - SunTrust

Okay, great, thanks. That’s all my questions.


And we have a follow up question from the line of Jon Bock from Wells Fargo Securities. Your line is open. Please proceed.

Jon Bock - Wells Fargo Securities

Thanks again. One more question and this is an item that is affected a number of BDC managers. If you look at the recent equity issuance at the curtain space it is in some cases shareholder describe it as problematic, right? And that’s in some cases for BDC it’s a push on learning spaces at worst it’s a complete degradation of shareholder value given that the managers are not going to be able to reinvest that spread that appropriate to cover their require rate of return on the equity issuance. David, looking at where we are at today with what you are putting on the books, to the extent that you were able to raise equity, where would you fall in that spectrum? Would it be safe to assume that one could earn shareholders more by issuing equity today or not and if the answer is it’s a push, what is that look like in terms of how would you consider raising new equities, new shareholders wouldn’t get a chance to benefit?

David Golub

Well, I’m going to answer the last question first because I think it’s easy for us I often said this in the context of our new equity issuances that they have to be good for new investors, old investors and the manger we shouldn’t doing and that’s our philosophy it’s been our philosophy since day one. In the current environment, we have adapted a number of strategies in an effort to improve our ROE in the context of challenging environment, one of those strategies has been to increase our focus on one stops where we see a particularly attractive risk award. One of our strategies has been to use some incremental leverage and to focus on reducing our cost of leverage. Our third strategy has been to develop and to ramp up our senior loan fund not among our strategy it’s been the issuance of large amounts of equity, we’ve been very varying in our equity issuances we’ve done small equity issuances that have been non-diluted and even in the quarters in which we’ve done them and I think what you should anticipate as investors going forward is that we’re going to continue to use the same philosophy and the same approach, the same way of thinking going forward. I will add one other point Jon, which is something that I said before, it puzzles me, why investors can simultaneously be focused and I think appropriately focused as you just worrying your question on asking management teams about assertiveness of share issuances and at the same time routinely approve BDC proposals to issue shares below book, BDC can’t issue shares below book unless their shareholders approve it. We have consistently said and we will continue to consistently say that we’re not going to ask, we don’t think it’s the right thing to do but we are consistently puzzled by the fact that these proposals routinely passed by wide margins.

Jon Bock - Wells Fargo Securities

We will remain as perplexed you are although I would say more of the people will understand the harm that comes through poor issuance of equity that better off the entirety of the spaces might not be good some managers but good for us all. So, thank you for taking the questions.


And we have no further questions at this time.

David Golub

Well, once again thanks everybody for joining us today and as always if you have any questions that you’d like to discuss. Please feel free to reach out to me or to Ross at any time.


Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and I say you please disconnect your lines.

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