Golub Capital's CEO Discusses Q1 2011 Results - Earnings Call Transcript

| About: Golub Capital (GBDC)

Golub Capital BDC, Inc. (NASDAQ:GBDC)

Q1 2011 Earnings Call

May 6, 2011 11:00 AM ET

Executives

David Golub – CEO

Ross Teune – CFO

Analysts

Joel Houck – Wells Fargo

Dean Choksi – UBS

Troy Ward – Stifel Nicolaus

Jaunty Rogers [ph] – Janney Capital Markets

David Miyazaki – Confluence Investment Management

Operator

Good afternoon. Welcome to the Golub Capital BDC Inc. March 31, 2011 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 the 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 the 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 our homepage of our website, www.golubcapitalbdc.com and click on the Investor Presentation’s link to find the March 31, 2011 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 conference is being recorded Friday May 6, 2011. I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead.

David Golub

Thanks very much. Good morning, everybody and thanks for joining us today. I have with me Ross Teune our Chief Financial Officer. I hope you’ve been able to take a look at our earnings release in our investor presentation it’s posted on our website we’re going to look forward to some portions of that presentation over the course of the call today. I’m going to start by providing an overview of the March 31, 2011 quarterly financial results. I am also going briefly discuss what we’re seeing in the current market environment, Ross is going to take you through our quarterly financial results in more detail and then I’m going to come back and provide some reflections on our first year being a public company before opening the floor for questions.

So with that let me get started. For the quarter ended March 31, 2011 as expected financial results were we’re much study if you goes it’s compared to the quarter ended 12 31, 2010. New deal activities flowed repayments remained relatively high and this is a combination which limited our growth in total investments. This is very much in keeping with our expectations you’ll recall in our last call I talked about how deal activity in the early part of this calendar year it’s slow down after a very busy quarter ending December 31, 2010.

So, highlights for the quarter EPS was $0.33 per share down a penny from $0.34 per share last quarter net investment income was $0.29 per share again down a penny from last quarter. We had another quarter of what I like to call negative credit losses what I mean by that is that is that net realized and unrealized schemes on investments there are about $0.04 this year same as last quarter this is our third straight quarter of having positive net realized and unrealized gains on portfolio investments. Our net asset value accordingly when up a little bit when up to 1475 per share for the end of the quarter up from 1474 at the end of the prior quarter this is our fourth consecutive quarter in which we increased NAV per share.

Let me shift now and give you some color on the current market environment and what we’re seeing in terms of economic trends. Let me talk first about deal flow. We've seen a very significant increase in deal flow over the last two months March, April and we expect new originations and growth in total investments to be robust in the quarter ended June 30th. Why is that well to be the increase in deal flows the result a couple of things it’s a pickup in middle market M&A activity and it’s also a pickup in opportunistic re-financings and in dividend recaps. To give you a data point on this during the month of April we invested over $32 million in new middle market deals that’s the same pieces are robust December 31, 2010 quarter.

Moving on to a second element deal pricing in the structure. This been a lot written in the media and the press about how in liquid credit markets we’ve seen such strong inflows into high yield bunds in prime refunds that the liquidity it’s what high-yielding broadly-syndicated loan markets toward tighter spreads and higher leverage. I think I recently read that the high yield market average new issue is now between 6.5% and 7% in yield remarkable level. The middle markets been insulated from these trends but it’s not immune, new middle market transactions we’re seeing traditional senior debt pricing now in the 450 to 600 range that’s down about 50 basis points we’re seeing LIBOR flows in the 125 to 150 range and that’s down a little bit maybe 25 basis points. We’re seeing the main pricing in the 12 to 13% range again that’s down about 50 basis points in some cases in some cases up to a point.

And leverage is up leverage I’d say in general is up about half turn from the levels that we saw 3 to 6 months ago. Pricing on unitranch deals are what we call gold loans obviously falls between those benchmarks that I decided the senior debt pricing on the one hand in the Mojave pricing on the other. As we continue our work of searching for the places where we see the most attractive was returned in the market we’re increasingly focused on gold loans on unitranch loans. We’re getting spreads that are still well above historical leverages the lower than they work with still well about historical leverages and we’re continuing to be able to get loans that have in addition to attract that the economics very reasonable leverage levels in the strong covenants. I want to overstate this we are currently in the mids of underwriting some junior debt deals that we also think are very attractive but we expect the asset mix that we were putting on we shifting more heavily toward the unitranch product over the next couple of quarters.

Let me talk last about credit quality. Our credit quality remained strong and we continue to have only one non-accrual in the portfolio that loan represents less than 1% of the total portfolio for a value Ross is going to talk in a few minutes about our portfolio ratings table in the investor presentation and you’ll see we did see an increase in the level of accounts that are weighted number three as I previously communicated this is expected we anticipate downward migration in our ratings our ratings in a sense have been too good in prior quarters reflecting unusual combination of a starting portfolio was very strong from a credit standpoint and a robust credit environment when the falls are going to start increasing I don’t know but I would tell you our expectation is that well the going to remain low in the market through the remainder of 2011. We think there’re going to start to tick up as we done in the past we’re going to focus very closely on originating a large variety of transactions in using our credit discipline in our underwritings skills to pick loans that have a particularly low likelihood creating credit losses.

I’ll taking more about that when I come back after Ross’s comments but the point I want to really emphasize here is that I think the market we’re innovate now is exactly the kind of market that place to development capital strengths. So Ross I’m going to handed over to you.

Ross Teune

Thanks David. Let kind of flow through the investor presentation David already touched on some of the EPS information and net asset value information on page 2 so I’m lets started page 3 kind of portfolio highlights as we noted in our originations press release back early April, we closed a new investment commitments totaling 54.6 million for the quarter ended March 31 access from repayments in the sales total 46 million for the quarter well overall net funds growth was 6.6 million.

Looking towards middle of the page as shown on the asset mix table, we increase the overall percentage of unitranch deals by about 3 percentage points this quarter with the offsetting decrease in the traditional senior secure product category as you’ll notice the junior debt and equity product categories in percentage terms remained unchanged.

Turning over to the next slide the balance sheet as of March 31, total assets were 495.5 million which included total investments of 389 million of fair value and total cash and restricted cash of just under 60 million. Liabilities were 197.5 million which includes 174 million an affording rate debt that we issued towards securitization and we’re also includes 20 million of fixed rate SBA debentures.

At the end of March net assets were 262 million and our net asset value per share as David mentioned was $14.75. Flipping over to slide five with respect to our operations for the quarter total investment income was $9.1 million as you will see with essentially flat quarter-over-quarter other interest income excluding fee amortization increased by nearly 700,000 during the quarter due to higher average investments as well as an increase in the average interest income yield this increase was offset by decline in fee amortization caused by decrease in middle market loans at paid after in the quarter.

On the expense side again expenses kind of relatively flat quarter-over-quarter and looking at the individual components interest expense declined due to decline in the average LIBOR rate that we barrowed at on the securitization of approximately 30 basis points the remaining expense core categories experience modest increases quarter-over-quarter as turned expenses such as base management fees and administrator service fees are based on average quarterly assets which did increase during the quarter.

The net realized gains of $1 million during the quarter which was result of the sales approximately 16.5 million and lower-yielding broadly-syndicated loans. There was a small net unrealized loss of 350,000 for the quarter, which is primarily due to the sales of broadly syndicated loans the sale causes an unrealized loss for the quarter as the previous unrealized gain is reversed and flips to a realized gain. This offset kind of a continued broader improvement in middle market loan evaluations.

Turning over to slide six, the couple of charts the one in the last provide the breakdown of our new originations by product category for the quarter ended March 31 approximately 67% of our new originations were in the traditional senior secured category were 32% or unitranch with remaining 1% in equity investments. The chart on the right provides a breakdown of the portfolio by asset type which I talked about briefly before again you can kind of see the shift a little bit with an increase in unitranch in a decrease a new traditional senior secured category.

Turning to slide 7, I’ll walk through the changes in our yield and investments spreads for the quarter. For the total yield investment standpoint this is interest income plus fee amortization or top dark blue line on the chart the yield increased from 10.6% from the quarter ended December 31 to 9.9% for the quarter ended March 31 this decline is attributable to lower fee amortization again due to a decline in runoff on middle market loans for the quarter.

Excluding kind of the impact the fee amortization the interest income yield the red line increased about 20 basis points due to the mixed impact we’ve been seeing over the last two quarters we will now have a higher proportion unitranch and junior debt products in the portfolio. Kind of lastly on the slide the yield when our debt the green line again declined by about 30 basis points for reasons as previously mentioned.

Turning to slide eight, for new investments the weighted average weight on our new investments was 7.2% this includes the impact of LIBOR force this compares favorably to the weighted average rate of 6% for investment that were sold or paid off during the quarter. So, we picked up approximately 120 basis points the replacing lower-yielding loans with higher-yielding new originations.

As shown in the middle of the slide, the investment portfolio remains predominantly investing in floating rate loans; and last as shown on the bottom at the table as David mentioned we currently have one non-accrual investment, which represents less than 1% of the portfolio at fair value.

Turning over to slide nine, with respect to portfolio company ratings, our credit quality remains strong, with nearly 99% of the portfolio rated in the 4 and 5 category; as David mentioned we did experienced increase in the three rated category loans which we anticipated would occur. We had no change in our category two loans we continue to have two such loans again one of which is on non-accrual. And again for the quarter, independent valuation firms have valued approximately 25% of our portfolio.

Turning to page ten, just highlighted the very bottom of the slide there our Board declared a distribution of $0.32 a share table on June 29 to shareholders on record as of June 17. An addition one other thing I’d like to highlight here as we noted in our press released that went out yesterday, our Board of Directors approved an amendment to a dividend reinvestment plan. But in the event in market price per share of our common stock on the data distribution exceeds the most recently computed net asset value per share of our common stock we will assure [ph] shares of common stock to participants in the trip a degrade of the most recently computed net asset value per share of our common stock or 95% of the current market price. This amendment is expected to be effective for the distribution that will be payable on June 29th.

Turning to last slide that I’ll cover here kind of liquidity and investment capacity as we communicated in our recent press releases we raised approximately 58.6 million in net proceeds from our recent follow on stock offering with the proceeds from this stock offering as well as the additional borrowings that we have available through our SBIC we’re feel well positioned to take advantage of opportunities to grow our portfolio and increase our net investment income.

As David previously mentioned, our deal flow was strong and during the month we invested over $33 million in new middle market portfolio companies.

And I’ll turn to back to David who provides some reflections on our first year’s being a public company.

David Golub

Thanks, Ross. As Ross just said, we’ve recently passed our one year anniversary is a public company and I wanted to just take a few minutes to offer some reflections. The first thing I want to do is to say thank you it’s a privilege for us Golub Capital to be managing GBDC and through GBDC your money this is a really important point we with you this not as a job it’s not an entitlement for sure it’s a privilege and it’s a responsibility we think about every day. So, I want to take this opportunity to thank all of you for the confidence and the support that you’ve given us.

Let me summarize what I’d view is our key accomplishments in challenges in the first year. First cover originations over the period since the beginning of April 2010 we’ve originated over $270 million of new investments. As we expected it’s been somewhat I’m even quarter-to-quarter the nature of our business I’m also as expected we kind of high level of pay offs we have to more to do on originations especially given the relatively low level of originations we saw this last quarter. But we’re encouraged by the pickup we’ve seen in deal flow in the last two months and we anticipate the coming period of substantial growth in total investments it’s one of the reasons we proceeded with our secondary.

Secondary, I want to talk about is credit quality we started strong and we’ve remained strong we’ve got only one non-accrual loans we mentioned an earlier and we had $3.4 million of net realize and unrealized gains on the portfolio what I like to call a negative credit losses. I think we deserve high marks on the credit quality front. Third area is mix we’ve made some progress on increasing the proportion of unitranch and junior debt in the portfolio clearly we’d more work to do here I think we’ll see some more progress on this in the quarter ended June 30.

Financing another area I think we deserve high marks and we successfully completed a securitization last OY which give us $174 million of very attracted the price long term flexible plus 2.4% debt we also received our SBIC license in August and overtime we’re anticipating that will give us access to of $150 million in long term flexible very cost effective fixed rate financing. So, we’re very pleased with the combination of financing we have in place.

We also recently raised just $160 million in the secondary offering at 1575 per share that’s 8.6% premium over the price we have been careful and we will continue to be careful about within too much earning solution from large or frequent equity offerings we’re focused on creating shareholder value.

Last subject I want to hit on this is NAV, EPS and dividends NAV is increased we mentioned that from 1467 at June 30th to 1475 at the end of March 31 quarter quarterly EPS has been – has been trending up we’ve got some more work to do on that we’ve increased our quarterly dividend to $0.32 a share we also think we got some more work to do on that we’re having in the right direction but we’re head on driving both our ROE and/or EPS higher.

So to some up we’re proud of our accomplishments over the past year but that’s not we’re in anyway resting on our loss we know we’ve got more work to do in a number of areas with the proceeds from the recent follow on offering and with additional borrowings through SBIC we think we’re well position to take advantage of the pickup we’re seeing now and new deal activity this will help us grow our portfolio we don’t help us advanced toward our targeted asset mix and help us grow our net investment income.

Our markets definitely becoming more competitive right now this is effective life on the ground we’re seeing spread compression we’re seeing some leverage but I’ll also tell you that the new investments that we’re making right now are still in my judgment very attractive from a risk toward standpoint. And this is the kind of market that place to our strength to develop capital strengths of the franchise. We’re really good at sourcing, we’re really good at originating, we’re really good at underwriting and these are the key success factors right now. We’re going to continue to drive the origination engines to produce a very large cool of investment opportunities and then use our we’ve seen in underwriting to selected out the investments that we think particularly high quality in an effort to grow the portfolio and produce long term value for our shareholders.

At this point Ross and I would like to open up the line for questions. Operator, could you help us with some questions?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Joel Houck with Wells Fargo, please proceed with the question.

Joel Houck – Wells Fargo

Thank you and good morning David and Ross. I wonder if you can maybe update us on the close as you can the size of the lower-yielding broadly-syndicated loans that are targeted for moving out of the portfolio over the next several quarters or how long it takes.

David Golub

So we’ve been to your point –we’ve been working down a set of broadly-syndicated loans that were in the portfolio at the time of the IPO and replacing those loans overtime with new loans. We’ve got about $20 million of such loans right now that we’re looking to replace and that I anticipate replacing over the next several quarters.

Joel Houck – Wells Fargo

Okay and kind of unrelated question, the asset mix I noticed obviously your increased force near tracks and junior debt and no one likes to be pinned down the exact number. Maybe give us some thoughts on how you see that playing out over the next several quarters and what we might see out of Golub?

David Golub

Well, to your point I think predicting these things has always challenging, we’re going to make the investments that we think are the best investments not within eye toward hitting in any particular month or any particular quarter, a targeted asset mix. But I’ll tell you, right now we’re at a unitranch percentage of 29% and we’re at a junior debt and equity percentage of about 15%. I’d like to see us push both of those up by about 10 percentage points over the relatively near term.

Joel Houck – Wells Fargo

Okay, now that’s helpful. And then last question, I was just you mentioned the increase in grade three can you give us a little color with their how many, what type of companies and what were you seeing that that caused you to lower the rating on those names?

David Golub

Sure, first let me tell you. I think we’re very tough graders. So when we do a downgrade to three, I mean, a couple of these or companies that would fall into the category, I’m not at all worried about them from a credit perspective but we’re seeing by way of example in the restaurant space, we’re seeing that some restaurant credits are having a more challenging time passing through food price increases than others. So one of the credits that’s in here is a restaurant credit that again I’m not worried about, I think it’ll be doing fine. But we’ve seen some weaker than expected results that relate principally to margin. One of the themes that I think we are going to seeing more and more over the course of the coming period is the dispersion of results the economic recovery has led to most companies seeing vastly better results over the course of last couple of years as we move into the first quarter of this year. And I anticipate this is a trend that will continue through 2011. We are going to see a greater degree of dispersion of results where some companies are going to continue to have momentum and other companies are going to struggle year-over-year with showing improvements.

Joel Houck – Wells Fargo

Okay, thank you very much.

Operator

Our next question comes from the line of Dean Choksi, UBS. Please proceed with your question.

Dean Choksi – UBS

Good morning gentlemen. Can you talk a little bit more about the average EBITDA level of the companies in the pipeline or in the new commitments?

David Golub

Sure, I mean as a generalization, our marketing efforts aims to source middle market opportunities with companies that range in range in EBITDA from about $10 million at the low end to about $40 million at the high end with most of what we do being solid, be in the middle of that range in the $15 million to $30 million range. And that has not been different recently Dean, I’d say our recent experience has been very consistent with our historical experience. We see opportunities in that full range. We want to see opportunities in that full range, that means from a competitive standpoint that we find ourselves competing with different groups of other firms of the small end of our target range versus the high end. But we’re not changing our stripes in terms of, in term of the kind of the deals that we are going after.

Dean Choksi – UBS

Okay, and then you’ve also mentioned to give some color on the market terms and pricing that you are seeing. Can you talk about what’s driving the changes in pricing as the fundamentals are improving in the underlying companies or is it new entrants coming and pressuring pricing? What’s really driving those changes that you are seeing?

David Golub

I think we are – as we in the middle market are lagers of what happens in the probably syndicated loans market I think I said before we are insulted but not immune. So when new probably syndicated deals are getting at market lower spreads then there were 6 months ago or 9 months ago, and evidently that causes there to be pressuring in our market. Right now you’ve got a large group of borrowers very sophisticated private equity firm led borrowers, who did transactions in 2008, 2009, 2010 times when credit was challenging to get them and terms where owners from borrower standpoint. And they are looking at world and saying why should I be paying this much. And for us as lenders, we need to be responsive to market forces or we lose the assets. So I think one of the things that we’ve seen and that is going to be a theme for the BDC sector over the course of remainder of this year. You are going to see a very, very high level of refinancing, recapitalizations and relatively short lived high priced 2009, 2010 deals.

Ross Teune

This will affect us less than it will affect some other BDC’s because we don’t have within Golub capital BDC we don’t have a portfolio that has a very large proportion of those 2009, 2010 vintage deals. But if you are looking at by way of example being if you are looking at 15% mezzanine deal that was originated in 2009 or 2010 and the company has done well, that company has a lot of refinancing sources right now. And about the last thing they’re going to want to do is keep that mezzanine loan outstanding. So my own view is that as we look at a year from now, year and half from now there are going to two kinds of 2009, 2010 loans. There are going to be those that have been refinanced and those that the lenders which they never made.

Dean Choksi – UBS

That definitely be interesting dynamic just to watch to play out. Can you just with the kind of the shift and the target asset mix how does that change your view on leverage at the portfolio level kind of looking out on normalized basis.

David Golub

I am sorry, I not sure, I understand your question.

Dean Choksi – UBS

Well, if you guys are moving from subject more to unitranch does that change your kind perspective how much leverage you’d use.

David Golub

How much leverage we’d use at the BDC?

Dean Choksi – UBS

Yes.

David Golub

Yeah, I mean definitely look at those two in combination. I mean we are not as a generalization –we are not comfortable thinking about leveraging our junior debt portfolio. We think that leverage junior debt is a bad concept and that the last cycle proved that in space. These of the senior debt and unitranch loans we have a long history of successfully managing leverage portfolios of those and we anticipate continuing to do what we are doing now which is to use prudent levels of low cost flexible long duration match funded leverage against those portfolios.

Dean Choksi – UBS

All right, thank you.

Operator

Our next question comes from the line of Troy Ward with Stifel Nicolaus. Please proceed with your question.

Troy Ward – Stifel Nicolaus

Thank you and good morning.

David Golub

Hi, Troy.

Troy Ward – Stifel Nicolaus

Real quick on your April originations can you give us indication where you are seeing the yields on the April origination comes in?

David Golub

I think that I can tell you that the yields on our new investments are consistent with my comments where we are seeing yields in the market on tradition seniors and on mez with one stop being in between, I am sorry, I can’t give you more specifics. We didn’t disclose the more specifics in our queue. So I can’t give more specifics on the $33 million of new origination that we did.

Troy Ward – Stifel Nicolaus

Okay, fair enough. And can you just provide a little bit more color on the prepayment activity obviously we agreed that’s going to be big driver this year with regarding to net portfolio. So when you think about, when you see a repayments in the prior couple of quarters is that more driven or is it entirely driven by folks coming to you unsolicited repayments, are you still moving some as the portfolio. And is that just your syndicated stuff or are you moving other out as well?

David Golub

So in the last quarter a portion of our exits were sales as opposed to refinancings or repayments. The approximate number for that would about 16 million of the exists related to – sales bias, we are going to continue to have that kind of activity as we move out the remaining portion of our probably syndicated portfolio other than small probably syndicated portfolio that we are going to using on an ongoing basis and alternative to holding cash because holding cash 22 basis points so painful so I think we’ll see a little bit more of that from our story, I think the big drivers of exit for us and for others over the rest of this year is going to be combination of private equity firms putting companies up for sale we are seeing more and more that activity that activity as P firms who are happy with the performance of their portfolio companies and happy with the multiple that are available in the market for seller looking to pose some wins on the board. But even bigger category in mind is going to be refinancing where in an environment in which you have a deployed and spreads there is a very large incentive on borrowers to reduce their borrowing cost by refinancing I don’t even think for it to beginning of beginning of bad I think this is something that – is going to become that the central theme of our market over the course of the next year 18 months.

Troy Ward – Stifel Nicolaus

Okay, and you think about refinance and M&A picking up as the private equity gets more intrigue with the current pricing how are you viewing the primary versus the secondary market from an attractive standpoint today.

David Golub

We are not players at the present time in secondary purchase we think as a generalization that liquid credit markets have gotten so tight that there is its very challenging to find value there so we think that our origination base model is key success factor in current market conditions because it enables us to create as opposed to buying existing to create new loans at – much more attractive terms, much more attractive spreads if we were and we are not if we were one of the BDC that cost us over between the high yield market and the origination market will be running from the high yield market right now.

Troy Ward – Stifel Nicolaus

Fair enough, and then one final question high percentage your portfolios floating rates can you remind us whether kind of the average floor is on those models?

David Golub

You know it’s shifted a little bit I say most of the floors are one and half percent.

Troy Ward – Stifel Nicolaus

Great thanks.

Operator

Our next question comes from the line of Jaunty Rogers [ph] with Janney Capital Markets, please proceed the question.

Jaunty Rogers – Janney Capital Markets

Good morning thanks for taking my question. In the current environment how does unitranch stock ups versus the traditional so senior mess structure in terms of attractiveness in the total cost of the borrower.

David Golub

It’s a great question – it’s a great question the answer is at one level credit specific let me tell you how we talk about to our private equity from clients about the trade off, from their perspective from the borrowers perspective the advantage of unitranch steel are couple, first is it’s a lot simpler, you have one lender you don’t have to negotiate, and or credit or agreements, you don’t have two parallel negotiations going on if you have subsequent changes that you want to make to covenant or level of capital spending or you want to do an acquisition or have a divestiture you have only one party that you need to get and approval from mix like much easier. second element of the advantages financial, one of the strange ironies of the traditional senior mess structure is that as the borrower generates cash flow to pay down debt the first debt that gets paid down is the least expensive debt is senior debt so for our successful borrower with a traditional senior mess structure there average cost of capital increases with their success this is a strange counter fugitive type of situation but it’s the nature of having free cash flow sweets and amortization on senior debt.

The BD of the one stop solution is that that doesn’t happen you have pay down of your one stop dead end and your cost of capital stays the same overtime. So, when private equity sponsors are looking at the choice of senior and mess on the one hand versus one stops these are some of the consideration that come into play I think in our experience now that the one stop answer proves very attractive for companies with EBITDA of $30 million or lower as you move above $30 million it becomes more attractive not necessary compelling but it becomes more attractive for sponsors to look at the two layer cake solutions because of the number of mezzanine buyers who are out there, interested in large size mezzanine transaction and because of the trusty nature of the senior debt in that situation whether the senior is on the verge of his probably syndicated loans.

Jaunty Rogers – Janney Capital Markets

Great that’s helps and just question on the SBIC I guess you have $135 million of debentures outstanding at revolving funds what do you see those debentures ruling off and when does those roll of, do you see that increased availability of being allocated to the BDC or with those other funds – issues need benches.

David Golub

So right now across Golub Capital we’ve manage three different SBIC one of those is subsidiary area of Golub Capital BDC our intension and we had prior communications investors about this we have prior communication to the SBA on this, our intension is to grow the BDC SBIC and to wind down the other two and we are not actively making new investments through our two non BDC SBIC moment we are just doing some follow one’s through vehicles but no new investments and it’s our intension to continue that if I am right that are we going to entering in an environment with a lot of repayment activity and refinancing activity then – we should see fairly grafted repayments within the legacy SBICs which would open up significant capacity for our BDC SBIC as of now it’s not a constraining factor we are not constrained right now in our SBIC within the BDC by our outside SBICs and we plan and growing additional SBIC debentures within the BDC this quarter, next quarter and the quarter after and growing our SBIC within the BDC.

Operator

Our next question comes from line of (inaudible), please proceed with the question.

Unidentified Analyst

Good morning gentleman, congratulation on your one year. David a quick question when does that incentive catch-up hurdle or run out?

David Golub

So, the way that our structure works is there is a affectively on an annualize basis there is an 8% preferred return for investors following which we go into the catch-up component of our water fall and that the catch-up component would end when the manager gets 20% of the net investment income so effectively that 10% pre incentive fee ROE.

Unidentified Analyst

Okay, and that will take us out to what, well that take us out to the end of the 2011 or in 2012 from what you are running at currently?

David Golub

Well that’s a great question and my honest answer is I don’t know, as we shift the mix of our investments and as we put more investments into the BDC, both of those things will increase our net investment income and pulls us through the catch-up and up to higher lease for shareholders. Our goal is to, our goal is frankly to do that as quickly as we responsibly can and I certainly hope to be through that before the end of this year. But, there are lot of factors that, that are going to go into that and my honest answer is I don’t know.

Unidentified Analyst

And just, if I understand that right basically it’s going to be harder for the earning to improve until that incentive fee catch-up hurdle is passed.

David Golub

It’s going to be harder for us to raise our net investment income until we are through that catch and that’s exactly what.

Unidentified Analyst

Okay and just one follow up question for something you said earlier. In dollars how big is your total exposure to hospitality including restaurant, hotels and motels and so forth?

David Golub

I don’t know the answer that up off the top of my head, we can come back to you because it is a public ally disclosed item. We can come back to you with an exact number in the queue if you want to look before we can get back to you in the queue you can look at the industry breakout in the schedule of investments, you will find that we have a very diversified portfolio both by industry and within industry by Obligor.

Unidentified Analyst

Okay, I didn’t have a chance to fully look it all up, I will take a look at it. Thanks again.

David Golub

You’re welcome.

Operator

(Operator Instruction) Our next question comes from the line of David Miyazaki with Confluence Investment Management, please proceed with your question.

David Miyazaki – Confluence Investment Management

Hello, good morning. First I wanted to say I appreciate your comments of not viewing this business as an entitlement and managing your capital raises. I think that becoming bigger as clearly been a prodigy for many of the companies industry and not necessarily getting better, so, we do appreciate that management style. I wanted to see if you could provide a little bit of perspective from beside of the private equity investor with regard to how they view refinancing. You said that you thought that many of the 09, 2010 (inaudible) are more likely to prepay, yeah, I am just curious does the make hole not working to the economics to help prevent that or slow it down some one?

David Golub

So, our clients are incredibly smart, on the private equity side and the way they think about things is that breakeven analysis. So, they will think David, how long do you I think I am going to own this company for before I put it up for sale. That defines the time period that is relevant that they want to measure against and then they look at whether the all in cost of doing a refinancing including a prepayment fee if there is one including legal cost or other fees or expenses that maybe associated with refinancing and they measure that against the interest rate savings that they can generate over the period between now and when they are going to sell. And generally speaking if that analysis yield something marginal they have got better stuff to do but if that analysis shows that they can save a meaningful amount of money they are all over.

David Miyazaki – Confluence Investment Management

And so, in the way that you look at the opportunities of refinance particularly as they already de-leverage right now that it’s a pretty easy call for many of them to go and just eat the pre-payment fee?

David Golub

Well, again that fact set here is, I can’t think about this policy but I mean if the company has done really well they may want to sell the company and put the win on the board, which will help them in fund raising for their next fund or just be able to declare victory and go home, in that scenario you got repaid but second scenario is they decide they want to hold on to the company for a substantial period of time and to your point they will leverage significantly and the market got stronger from a landing standpoint, so, which generally lower all that spills an opportunity to refinance at the significantly lower cost of capital. If they are going to hold the company for an extended period of time again it’s going to make sense for them to refinance even if there is a meaningful prepayment penalty and we are going to be repaid but the third scenario is they aren’t ready to sell yet but they also aren’t planning to hold for a long time and in that third scenario it may make sense for them to just not do anything and in that scenario we as lender get to enjoy relatively high spread for a period of time given the credit risk. So, those are the dynamics and I think in an environment where we are seeing a lot of M&A activity, I think categories one and two are pretty big and category three is pretty small.

David Miyazaki – Confluence Investment Management

Okay, that’s helpful, thank you. I also want to touch on you, you comment that you are expecting higher defaults going forward and long alongside your comment that if you did traffic and the look what high outside of the market that you would be running away from that side of things right now, when you think about the default rising, is that sort of related to, you talked a little bit about lack of pricing pattern for your restaurant credit but is it something beyond that, is it economic issue, you are seeing backlog that your company is declining or is it too much leverage or poor structure. Could you kind of give a little bit of colors to how you come up with the expectation for higher default, that you see and not certainly for you guys?

David Golub

So, at one level David the answer is, it’s simply where are at that stage of the cycle right, when you come out of the downturn you see a typically see a dramatic reduction in default activity for a period of time and then things start to creep up again. So, part of it is just purely cyclical second part of it is in our judgment we are seeing a very slow ladling recovery. The number has just came out this morning on employment that it’s a little better than expected but if you look at overall employment level now verses pre-recession we are still in the midst of an extraordinarily slow period of job growth given that we just have the recession. We are still seeing very significant weakness in new home construction and commercial construction, we are seeing despite the decline of last two days very high commodity prices and gas prices at the pump, all of this is leading us to believe that coming period is going to be challenging for companies to be generating growth and from an underwriting perspective this is a theme I have been sounding for a couple of quarters but I emphasized it again, again today, we are not counting on a robust recovery in the context of our underwriting. I think there are lots of elements of the credit market that are counting on a much more robust recovery then we are and if the way to that recovery isn’t happening then that’s going to translate into higher defaults.

David Miyazaki – Confluence Investment Management

Okay, thank you very much, David, appreciate your thoughts.

Operator

There are no further questions at this time.

David Golub

I would like to thank you everyone for joining us this morning and as always we are available to answer questions at any time from our investors. So, please feel free to reach out to either me or Ross should you have other questions today or going forward.

Operator

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

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