David Golub - CEO
Ross Teune - CFO
Greg Mason - Stifel Nicolaus
Jonathan Bock - Wells Fargo
Abu Ramin - UBS
Golub Capital BDC LLC (GBDC) F2Q12 Earnings Call May 3, 2012 2:00 PM ET
Good afternoon, welcome to the Golub Capital BDC Inc. March 31, 2012 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 at www.golubcapitalbdc.com and click on the Investor Presentation’s link to find the March 31, 2012 Investor Presentation. Golub Capital BDCs earning release is also available on the company’s website in the Investor Relations section.
I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.
Thank you, operator and good afternoon everyone, thanks for joining us today. I am joined by Ross Teune, our Chief Financial Officer. Yesterday in the afternoon we issued our second quarter earnings press release and we posted supplement earnings presentation on our website. We’ll be referring to that presentation through the call today.
I am going to start by providing an overview of the March 31, 2012 quarterly financial results. And then Ross is going to take you through the quarterly results in more detail. I’ll come back after Ross comments and provide some commentary on the termination of our total return swaps in April and also provide an update on current market conditions.
With that let me get started. As highlighted on page one of the investor presentation, we’re pleased to report we had a very strong quarter for the three months ended March 31. Golub Capital BDC generated net income of $11.4 million or $0.48 per share as compared to $6.2 million or $0.28 a share for the quarter ended 12/31/11. Net investment income for the quarter was $7.1 million or $0.29 of share as compared to $6.3 million or again $0.29 a share for the quarter ended 12/31.
Net investment income including the net spread payments of $1 million generated from the underlying assets in the total return swap was $0.33 per share for the quarter ended 3/31/2012 and that compares to $0.32 per share for the quarter ended 12/31/11. Let me give you some detail underlying the $0.19 per share, the $4.4 million of net realized and unrealized gains on investments and derivatives during the quarter.
First, let’s look at the total return swap. GAAP net realized and unrealized gains on the total return swap were $2.8 million and that was comprised of $1.8 million of unrealized gains driven primarily by a market rally in the prices of broadly syndicated loans during the quarter as well as an increase in the net interest accrued on the TRS. In addition to that we had a million dollars of realized gains from the quarterly cash settlements of the TRS. I will come back later in our commentary to describe the P&L impact of the termination of the swap that took place in the April as I will discuss. There was a further gain that will take into the income statement in the June 30th quarter.
Now let’s talk about investments in loans and equity securities. Net realized and unrealized gains on investments were $1.2 million. This was comprised of $2.8 million realized loss on the sale of a non-earning asset [AFPG], $3 million of unrealized depreciation because the carrying value of that asset was actually lower than the sale value and a $1 million of unrealized appreciation on the investment portfolio and this was broadly distributed across a variety of middle market debt and equity securities.
The final piece of $0.19 a share or $4.4 million of net realized and unrealized gain was our future’s hedge. You will recall that we put in place a $25 million hedge on treasuries to immunize us from movements in treasuries as those movements would affect the cost of our SBIC borrowings that had not yet been fixed. As of the end of the quarter we had a $400,000 net released non-realized gain on the futures contracts.
Turning to slide two of the investor presentation I want to highlight the increase in our NAV this quarter. It ended the quarter at 14.69 and this is right about our NAV at the time of the initial IPO of Golub Capital BDC in April 2010. Just want to highlight this is by design if we are doing our jobs well you will see limited quarter-to-quarter volatility in NAV and we will be earning our distribution maintaining a stable NAV overtime.
Turning to slide 3 of the investor presentation as we communicated in our press release back in early April, originations for the quarter were strong totaling $98.4 million. After factoring in repayments the net increase in investments was $57.1 million. That's a 10.2% increase from December 31 2011 and a 33.5% increase from September 30 2011. I am also pleased that with the asset mix on these new origins was consistent with our goals. 36% of the new investments we were one-stops, 21% subordinated debt and second lien investments, 39 % senior secured and 4% equity securities. After Ross discusses that financial results in more detail, I will come back and provide the additional commentary on the termination of the total returns swap and on current market and then we will take questions.
Thanks David. I am going to begin on page four of the presentation. As David previously mentioned new investment commitments totaled $98.4 million for the quarter. Exits and repayments on existing investments was $43.6 million while our overall net funds growth was $57.1 million.
As we indicated in our call last quarter, looking at the asset mix year, although we would like to see further incremental decreases in the percentage of senior secured loans in the portfolio somewhere in the mid-30% range, you can see from the table here that we are getting close to where we want to be in terms of the asset mix of the portfolio.
Flipping to the balance sheet on the next page, we ended the quarter in a strong financial position with total assets of $719 million and total cash and restricted cash of about $72.6 million. Total debt on the balance sheet was $331.7 million. This includes $174 million in floating rate debt issued through our securitization vehicle, a $123.5 million of fixed rate SBA debentures which leaves $34.2 million outstanding on our revolving credit facility.
On the last page of the presentation we provided a summary of some of the key terms and provisions of our debt facilities which I want to highlight, kind of highlights, a very attractive low cost, highly flexible debt capital that we worked very hard to put in place.
On March 31, our net assets were $376 million and our net asset value was $14.69. The $60 million increase in net assets quarter-over-quarter reflects the secondary stock offering that we completed back in early April.
Flipping to the income statement on page 6, total investment income for the quarter was $14.4 million. This was up about 15% from the previous quarter. This increase reflects the robust asset growth that we've had in the past two quarters as well as the continued increase in the total investment yield in the portfolio which I will go through on successive slides. On the expense side, total expenses totaled $7.3 million, which is up $1.2 million from the previous quarter. This is primarily attributable to an increase in incentive fee expense as well as an increase in base management fees as average investments increased, as well as an increase in interest expense as the average debt outstanding increased as well. As David pointed out, we had a net gain on investments and derivatives of $4.4 million which he provided a breakdown in his opening remarks.
Turning to slide 7, these charts graphically summarize the breakdown of our new originations and then the period investments by asset class as shown on the chart on the left in terms of new originations. Again 36% in one stop, 39% in senior secured with the remaining 25% in junior debt and equity investments. The chart on the right provides a breakdown by end of period investments which you can see was fairly stable and consistent quarter-over-quarter.
Turn to slide eight. Looking at the yields and spreads in our investments, I will focus first on the red line. This line represents the interest income yield or all income earned on our investments excluding fee amortization, unlike some BDCs, we use the conservative GAAP treatment for the amortizing origination fees over the life of the loans.
As you can see by looking at the red line, we have 30 basis point increases this quarter to 9.6%, which again just reflects the progress we've made in shifting away from senior secured assets to higher yielding unitranche and junior debt investments, including fee amortization the dark blue line up on top. The total yields on the portfolio was 10.5% at the end of March.
Over to page nine for new investments. The weighted average rate on new investments was 8.9% for the quarter, the weighted average rate is based on the contractual rate at the time of funding for variable rate loans the contractual rate, the current LIBOR rate, the spread over LIBOR and the impact of any LIBOR floor and for fixed rate loan through obviously be the stated fixed rate.
The 8.9% compares favorably to the weighted average rate on investments that paid off of 7.4%. The weighted average rate on our new investments is down from the previous quarter as we did have a lower percentage of junior debt investment this quarter as compared to the previous quarter.
Turn to the middle of slide. The portfolio composition, again our portfolios predominately are variable rate loans at approximately 85% of the total portfolio.
As you can see by looking at the non-accrual data at the bottom of the slide, fundamental credit quality remains very strong. During the quarter we disposed one non-running assets which decreased the non-earning percentage based on fair value for 1% of total investments at the end of December, 2.5% at the end of March.
Further evidence of kind of strong fundamental credit quality is shown on page 11 on our portfolio. Risk rating is stable for the past two quarters. The percentage of loans in our highest category the four and five, you know, was over 90% of our total portfolio.
As we previously mentioned, this ratings are probably too good and we do expect some downward migration in these ratings overtime. As the case every quarter, 25% of our loans are reviewed by an independent third party each quarter.
Turn to slide 12. The board declared a distribution of $0.32 payable on June 29 to shareholders on record on June 15.
Flipping again to slide 13, liquidity and investment capital remains adequate with unrestricted cash of $30 million at the end of March and restricted cash of $42.5 million. This restricted cash is either a SBIC or securitization entity and is available for new investments that qualify for one of those entities.
Under our senior secured revolving credit facility, we have approximately $41 million of availability under that line. Finally, in regards to our SBIC financing, we have $6.5 million in available, in approved debentures that we can draw upon. And lastly here, on February 2nd we received a green light from the SBA allowing us to proceed with an application for a second license and we recently submitted such an application.
Difficult to predict how long this would take, although we certainly anticipated it will take somewhere six, maybe as long as 12 months but if approved, will provide us another source of attractive long-term capital.
And I will turn it back to David who will provide some commentary on the termination of our TRS as well as some current updates on the market that we are seeing.
Thanks Ross. As I discussed in our last quarterly earnings conference call for purposes of compliance with the asset coverage ratio test, I am going to use quotation marks here. “We agreed with the staff, the SEC, the [inaudible] outstanding notional amount of the TRS less the amount of cash collateral deposit with the custodian under the TRS is a senior security with the like of the instrument” I also mentioned on that call that through this regulatory treatment that we viewed our investment in the TRS as significantly less attractive and we were likely going to look for an opportunity at the right time to terminate this swap. We found that opportunity and in April 11th, went ahead and terminated the swap. We are looking now too reinvest roughly $20 million of proceeds into new middle market debt and equity securities.
We included a summary on page 14 of the economics of the swap over the life of the swap as you can see it was very profitable transaction. We generated about $3.9 million in total income over 9 months on an average investment of about $20 million dollars. Of this $3.9 million, we recognize $3.1 million through the end of March and so we have $800,000 of profit from the GRS that we will recognize in our June 30th quarter. With the termination of the total return swap, we now don’t need to include that as debt in our pro forma asset coverage test, and so if you were to do a pro forma calculation of our asset coverage, it’s now a very comfortable 280%. So we’ve got a lot of room right now for incremental debt capacity.
Let me now shift and talk about current market conditions on our outlook for the remainder of calendar 2012. We've had two consecutive quarters now of strong originations and strong net funds growth and we do anticipate that the June 30th quarter is going to be a little slower.
Our deal flow began to slow down towards the end of March and this continued for most of April. We are seeing a limited supply of new deals in the marketplace. That’s also leading to some price compression with middle market transactions getting done with pricing in the range of 25 to 50 basis points tighter in the recent period than at the start of the year.
We think this is likely going to be temporary. We think that the increased deal flow is going to be visible starting quite soon based on our pipeline of transactions in process. We are starting to see a lot of discussion about the impact of perceived likelihood of increases in tax rates as of January 1, 2013, as probably everybody on this call knows, in the absence of congressional action, we’re going to see a massive increase in dividend tax rates and a quite large increase in capital gains and ordinary income tax rates at the end of the year. We anticipate that's going to drive sellers to want to complete sales before those higher tax rates go into effect.
We believe we are well positioned to benefit from increased deal flow in the second half of ’12. We've got a very strong market position right now. Our product offering is broadest in the industry and very well received by our private equity fund client base. Golub Capital BDC has got a very solid well diversified portfolio and we've got ample capital on both equity and debt capacity to grow.
So as always, I wanted to take this opportunity to thank all of you for dialing in today and giving us your time and for those of you who are shareholders giving us your support as well.
And with that operator, I would like to open up the lines for questions.
(Operator Instructions) And our first question comes from the line of Greg Mason from Stifel Nicolaus. Please proceed with your question sir.
Greg Mason - Stifel Nicolaus
I’ve done my math correctly, if you fully borrower your $75 million revolving credit facility that would put at regulatory leverage of about 0.6 debt-to-equity excluding the SBIC debt. So I wanted to see if you could give us some color on why you would like to take your regulatory leverage up to and do you have any plans on expanding some of your debt capacity to get there?
Sure. So let me go back a step and just talking about debt and how we look at that, because I think the way we look at debt is a bit different from some other BDCs. We spend a lot of time managing the right hand side of our balance sheet and we spend a lot of time looking at ways for the benefit of our shareholders to have a very low cost long-term locked-in financing.
So right now we’ve got three forms of that financing; we’ve got a debt securitization with an effective yield is 3.3%. We’ve got a revolving credit with an effective yield of about 3% and we’ve got SBIC financing that’s fixed rate and the effective yield of about 3.5%.
So I just want to repeat those number 3.3%, 3% and 3.5% because they compare really favorably to what you are seeing amongst our competitive brethren in our industry who are busy issuing what they call baby-bonds or unsecured notes that yields that are in the 6.5% to 7.5% range.
And I’ll be very honest with you Greg, I don’t understand why that’s happening; I don’t think it’s good for shareholders, I don’t think its attractive debt financing; you will not see Golub Capital pursuing that kind of debt.
So as we look at expanding our debt capacity, we have the ability to expand all three of these sources of debt capital. We have the ability to expand our securitization. We have the ability to negotiate an increase in the size of our revolving credit facility and we have the ability to draw additional SBIC debentures.
So one that is the most limited as of now is the SBIC debentures; we have $123.5 million of SBIC debentures outstanding. We have the ability to draw another $6.5 million in debentures, so total of $130 million. One of the reasons we are applying for a second SBIC is we want overtime to increase our ability to address SBIC debentures to $225 million which is the legislative cap for now.
And I say legislative cap for now, because there are active efforts in Congress underway to increase that cap. But assuming that cap doesn’t increase, our long-term expectation would be that we’ll increase our SBIC debentures to $225 million and that will balance on whichever is more favorable, based on what we’ve got going on. We will balance between our debt securitization financing and our revolving credit facility; the remaining debt that we are going to carry.
We look at the right level of debt not so much from a regulatory capital perspective, because the SBIC debt doesn’t count for regulatory purposes. We look at it more from a perspective of what’s the right leverage level for our shareholders benefit; what’s the right leverage level for us to be running. We think that running at approximately one-to-one overall, given our current mix is a reasonable level which is somewhat higher than where we are at right now.
I think if we were looking at a high leverage than that we would, absent changes in our mix, we would think that would be too high. But we think we’ve got a meaningful amount of room between where we are now and where we could go, where we would be comfortable. And that’s more than you asked for, I think I got what you asked for in there.
And one last question and I’ll hop back in the queue, of the $2.3 million TRS that came in on April 1st was any of that already in the value of the TRS at March 31st in book value already; or is that all additive to what we value more?
We try to footnote that, about $1.5 million was already on our books as of March 31st as the fair value, the unrealized depreciation on the TRS. So there is about $800,000 net that will come through for the quarter end at June 30th.
(Operator Instructions) Our next question comes from the line of [Joe Hansen]. Please proceed with your question.
Hi David, I had a question just on that same theme of capital structure. I saw that Golub Capital Partners did a CLO the other day; and securities, if you guys have you know obviously that’s part of your capital strategy. But I am curious, how much you think you would be able to do in sort of a CLO for the BDC as well as also to some of your brethren have been converts along the way too and I am curious to see what’s your views on those?
Sure. Let me answer you in reverse order. My view on the converts is a bit like my view on the unsecured notes. I don't think they are an attractive form of capital for shareholders. I think they are great for managers who want to increase their assets under management and get the opportunity, they charge more management fees. But the risk of harping on the theme that I tend to harp on I feel like almost every conference call. We really are focused at GBDC on creating shareholder value and doing what's best for our shareholders not doing what's best for maximizing income to the manager.
So if you look at recent issuances on the convert front, prospect did a 5.375% convert in April. So we have a cost of capital on our debt that's non convertible, that's 200 basis points cheaper than that and we have not given up the option value of the convert. So I scratched my head and don't really understand why BDC management teams think that these converts or these recent unsecured bond transactions at rates of 6.5% to 7.5%, why they make sense for shareholders. To us it seems like very, very expensive capital and non capital that's creating shareholder value.
Now let me go back and answer your first question. You are quite correct through another fund, a private fund of Golub Capital, we issued -- actually we haven't issued it yet, we priced a CLO last week. It is analogous in structure to the securitization that we put in place in the BDC in July of 2010. I think there's no obstacle to Golub Capital BDC using securitizations to grow going forward.
In fact on the Golub Capital platform we've now completed 12 different securitizations. We are a very prolific issuer of middle market loan securitizations. I think we maybe the most experienced at doing so and it’s a great form of financing.
Our next question comes from the line of Jonathan Bock with Wells Fargo.
Jonathan Bock - Wells Fargo
David just kind of a higher level question here first but if we think about economic concerns, whether it's here in Europe. I know we've heard you mention this before, would you say that perhaps maybe it is your intention to keep a little powder dry on the hopes that the markets crack and you would be able to invest at wider spreads in the future?
I think it’s a great question Jon. I mean there's always a balancing act between having the optimal capital structure for producing EPS for shareholders on the one hand and keeping some dry powder available to be able to burst into the market with a high origination quarter when market conditions are favorable.
I think that with our strategy of relying significantly on SBIC Financing which doesn’t count for asset coverage test purposes, we can to a substantial degree achieve both of those goals and I think you will see as over time never want to run our liquidity out entirely and always want to be in a position where we have incremental debt and equity capital available to spend.
One of the reasons that we terminated the total return swap was with the additional regulatory leverage that we, no secret, we didn’t agree with the SEC's view on this, but with the additional leverage that under the SEC's interpretation we had to add to our asset coverage test. We didn’t feel like we had enough room. So that’s one of the reasons why from our perspective, terminating the swap made sense.
Jonathan Bock - Wells Fargo
And so with spreads tight I guess one other question on low yielding maybe asset churn, do you think right now you have maybe an opportunity to continue to sell some of the senior loans. I mean you’ve blown through a lot of them but perhaps on the 6% or perhaps 5% all in yield level sell those and to strengthen and redeploy the proceeds and then maybe average coupons of 8.5% maybe 9% to 10%.
I think there is some continuing opportunity for us to shift our assets in our assets and our asset mix into higher yielding assets. Part of it is quite as you say getting rid of some of our lower yielding senior secured assets. Some of it is just shifting our mix a little bit more toward unit tranche where we continue to see probably the most value in our product suite right now from the shareholder perspective. I think both of those are avenues for us to push up our yield a bit. I do think you know right now that it's more challenging than it's been in the last six to nine months to originate attractively priced, well-structured assets. And so, again one has to balance the right time to sell.
And we don’t have that much that's really saleable at this point. It’s really more a question of redeploying repayments. But one has to balance the desirability of selling the handful of things that we can sell and my current attitude is not to be in a rush to do that. Most of what we have got, we have already sold. That which remains, we are very comfortable with from a credit perspective. And if we need to capital to redeploy, we will. But I don’t see that in the short term. I think we have got ample incremental equity in that capital that we will be able to deploy into the opportunities that we are seeing.
Jonathan Bock - Wells Fargo
And just one last question, you know you mentioned perhaps difficulties in finding attractive risk-adjusted returns or maybe a little bit harder than six months ago. May be your views on mezzanine asset class itself in light of where yields are, do you see credit risk in today’s market being priced correctly or perhaps do you feel that we have overheated a bit.
We are seeing some signs of overheating in mez, there is no question about it. We have seen leverage creep and we have seen some pricing compression and we did a fair amount of new mez origination in our quarter ended 12/31 coming out of the credit crunch in Europe. And in August we saw a bunch of transactions that we thought were attractive. Right now, our focus is on one stops. That's where we think the best risk award is in the market place. I am not saying you won’t see us do any mezz, but it’s clear to us that there are some folks out there who are being too aggressive on the mezz fund right now and you know with our long term hats on, we think now is not the time to be real brave on mezz.
Thank you (Operator Instructions) Our next question comes from the line of Dean Choksi with UBS. Proceed with your question sir.
Abu Ramin - UBS
Hi guys, it’s actually Abu Ramin filling in for Dean currently, thanks for taking my questions. I just wanted to ask about your lower rated category loans there. One, two, three category loans, it looks like it increased quarter-over-quarter and it is on -- this includes an exit in the one your non-accrual (inaudible) as was increased valuations that remain non-accruals (inaudible) coverage experience lies in non-accrual. Can you guys offer any commentary on the state of the market credit relative to where it’s been in the past two quarters and what do you think it is going in the next two quarters?
Sure. First to just make sure we’re all working from the same fact base. If you go back to slide 11, you will see that our one and two rated assets actually fell significantly and level three were up from $39.8 million, to $54 million, so we added a couple of loans. I think it’s a grand total of three that fell from category four to category three.
The category three is not [tedious] in the same way that category one and two are; category three for us are, these are loans we’re watching carefully. These are not loans that we at least at this time anticipate losing money on. And you would expect some increase just based on the increasing portfolio size that we have. So if you look at it in percentage terms its about 1.7% increase in that category three bucket.
Ross mentioned, we actually think our overall risk rating categories look right now too good from a profit maximization perspective. We've got about 90% of the portfolio in four’s and five’s and it’s in that 90% range now for the last several quarters. I think to optimize profitability we would actually want to run a bit lower than that 90% in category four and five.
All that having being said, I don't think I am answering your question which was what are we seeing in terms of trends? We continue to see an environment where problem credits are not common. Companies are generally doing pretty well. Some are seeing slowdowns in their revenue growth, but even those that are seeing split outs in revenue growth are in general continuing to be able to produce year-over-year improvements in their profitability.
We are not seeing signs of meaningful economic downturn in our company’s financials. We are not seeing signs of a robust recovery. We are seeing signs of continuing muddling economy where growth is difficult to come by, but where strong management teams are able to eek out year-over-year EBITDA growth.
I do think you know we've been, if you look at the broader credit markets, we've been in a period of abnormally low credit defaults; if you look at the broadly syndicated loan market by a way of example, it’s been running at levels that are well below historical averages.
So my expectation would be, if you look at the middle market or the broadly syndicated loan market that we’re going to see a revision to more typical levels over the course of the current period which will mean that an uptick from the levels of the last 1.5 to 2 years.
Abu Ramin - UBS
Thank you very much and I do agree that in a good timing eventually for a credit investment. Could you give us a little bit can, or could you follow-up on the comment and I think it was on Greg’s question, AND it was highlighted fairly in the prepared commentary. I heard $0.8 million being booked in quarter for gains on the TRS, just wanted how much of that is going to be (inaudible) versus realized?
We’ll have a $1 million roughly that will be part of the spread income in all; $2.2 million is going to come -- $2.3 million will come to as a realized gain and that will be offset by a reversal of an unrealized gain, but a $1 million are attributable to spread and the difference attributable to capital gains on the disposition of the loans.
Abu Ramin - UBS
And so that was in the June quarter?
(Operator Instructions) And we seem to have no question at this time sir.
Well, thanks everyone again for joining us today and as always should you have any questions after today’s call, please feel free to call either Ross or me. Have a great afternoon.
Ladies and gentlemen that does conclude our conference call for today. We thank you for your participation and ask that you please disconnect your lines.