Golub Capital BDC, Inc. (NASDAQ:GBDC) Q2 2014 Results Earnings Conference Call May 8, 2014 12:00 PM ET
David Golub - Chief Executive Officer
Ross Teune - Chief Financial Officer
Greg Mason - KBW
Jon Bock - Wells Fargo Securities
Good afternoon. Welcome to the Golub Capital BDC Incorporated March 31, 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 Incorporated’s filings with the Securities and Exchange Commission.
For a slide presentation that we intend to refer to on the earnings conference call, please visit the Events and Presentations link on the homepage of our website, www.golubcapitalbdc.com and click on the Investor Presentation’s link to find the 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 would now like to turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.
Thanks, operator. And good afternoon to everybody, thanks for joining us today. I’m joined today by Ross Teune, our Chief Financial Officer; and Gregory Robbins, Managing Director here at Golub Capital. Earlier today we issued our quarterly earnings press release for the quarter ended March 31st and we posted a supplemental earnings presentation on our website. We are going to be referring to the presentation through the call today. I want to start by providing an overview of the results for the March 31, 2014 quarter, Ross is then going to take you through the results in more detail and I’ll come back and provide an update on our outlook at the end and take some questions.
With that let’s get started. I’m pleased to report we had another strong quarter of great steady financial results. In addition to the steadiness and consistency of the earnings for the quarter the financial themes in this quarter’s results are very much consistent with the themes that we have talked to you about over the last couple of quarters. And I want to highlight three of those themes particularly at the outset.
First we continue to see some spread compression in the first calendar quarter of 2014, but we have seen some signs recently of stabilizing rates. Second we continue to view the market for junior debt as very competitive and very challenging and given this and given our cautious macroeconomic outlook, we continue to focus on originating high quality senior secured and one stop investments and not to be particularly focused on junior debt.
And third, overall the credit quality of GBDC’s portfolio remains very strong and we will give you some statistics backing that up. So with that context let’s run through the numbers and we’ll start on page two of the investor presentation.
For the three months ended March 31st, GBDC generated net investment income of $13.3 million or $0.31 per share. Net investment income was essentially flat to the quarter ended December 31, 2013 as growth in investment income from our larger investment portfolio was substantially offset by a decrease in prepayment fees and lower average spreads.
That increase in net assets what I usually call net income for the quarter was $14.1 million or $0.32 per share compared to $14.8 million or $0.34 per share for the quarter ended 12/31/13.
Net realized and unrealized gains on investments and secured borrowings were $0.7 million for the quarter. This is another quarter of what I call negative credit closes. So the net gain primarily related to net unrealized depreciation on a range of investments, it wasn’t one or two. And as I mentioned above, credit quality remains very strong with non-accrual rate that rounds to zero and 95% of our investments within internal risk rating of four or five, those were our two highest ratings.
Net asset value per share for the quarter was $15.41 that’s up from $15.23 at the end of December. The $0.18 of accretion was primarily attributable to the stock offering we completed in March at a premium to net asset value. But I would point out this is the 7th consecutive quarterly increase in our net asset value per share.
Let me talk briefly about new investment activity. The first calendar quarter tends to be seasonally slow for originations but this year less so, we had new origination commitments for the quarter of $182.5 million, this includes $9 million that we invested in senior loan fund. Approximately 14% of the new investment commitments were senior secured loans and 80% were one stop loans. So very small proportion was in junior debt and equity; 5% was in the senior loan fund.
The overall mix of these origination was very consistent with the strategy I mentioned that has been our strategy for a number of quarters now, focusing on senior debt and one stops as we continue to feel that those offer the best risk reward in the current market environment.
After taking into account portfolio runoff and other activity investments at fair value grew $73.7 million during the quarter, a 6.2% increase from 12/31/13. With that strong net funds growth, we decided to and completed a small equity offering toward the end of March; we've raise just over $60 million in net proceeds. This caused a modest drop in our economic leverage expressive at the end of March from 0.9 times at December 31 to 0.82 times at the end of March.
Given our current asset mix and our current strategy of focusing on senior debt and one stops, we continue to believe that the right economic leverage is about 1-to-1 and so we plan to get closure to that 1-to-1 level as we deploy the capital that we recently raised in new offering. Regulatory leverage was 0.54 times at March 31st, so we have plenty of cushion against the 1-to-1 regulatory limit.
On slide 3 of the investor presentation, you can see in the table the $0.31 per share we earned from net investment income and the $0.32 per share we earned from net income perspective. The table also highlights the bump in our net asset value to $15.41. As you can see on the bottom of the slide, the portfolio remains very well diversified; investments in a 139 different portfolio companies and an average size up $9 million per investment.
Finally if you turn to slide 4, you can see the percentage of one stop investments in the portfolio continues to increase representing 61% of total investments at March 31, 2014 and consistent with the fee I’ve been talking about of emphasizing senior debt and one stops and de-emphasizing junior debt, you can see junior debt remains a small percentage of the portfolio, about 10% of total investments reflecting our negative yield market conditions.
So with that I'm going to turn it over to Ross and he will discuss the results in more detail.
Great, thanks David. Flipping to slide 5 the balance sheet, we ended the quarter with total investments of $1.25 billion, the total cash and restricted cash of $54.1 million and total assets of just over $1.3 billion. Our total debt was $572 million; this consists of $215 million of floating rate debt issued through our securitization vehicle. We had approximately of $202 million of fixed rate debentures issued through our SBIC entities and $155 million of debt outstanding in our revolving credit facilities.
Total net assets at the end of the quarter were $721.9 million and this is up about $62 million from the previous quarter primarily due to the equity offering that we completed back in March. As David mentioned, from a GAAP perspective, our debt to equity ratio was 0.82 times and calculated for our regulatory limit our debt to equity ratio was 0.54 times.
Flipping to the next slide, the statement of operations, total investment income for the quarter ended March 31 was $25.3 million. This was a decrease of about $300,000 from the prior quarter. The decline in investment income was due to $1.1 million decrease in prepayment fees and this was partially offset by an increase in interest and dividend income of about $800,000.
On the expense side, total expenses of $11.9 million decreased by about $400,000 during the quarter as we had $1.4 million decrease in incentive fee expense which was partially offset by higher interest expense and higher base management fees.
As David mentioned earlier, we had net realized gain on investments of $0.7 million during the quarter primarily due to unrealized appreciation on a range of middle market debt and equity investments. And finally net income for the quarter ended March 31 totaled $14.1 million.
Turning to slide 7 these charts graphically summarize the break-down of our new originations and end of period investments. As shown on the bar chart on the left hand side we originated 14% of our new investments in senior secured loans, 80% one stop, 1% in equity securities and 5% in the senior loan fund. The chart in the right provides a breakdown on total investments. And as you can see there we had a small increase in one stops with a corresponding decrease in the senior security investment category.
Turning to slide 8, walk you through the changes in our yields and investments spreads for the quarter. I’ll first talk about the grey line. This line represents the income yield or the actual amount earned on the investments and this includes interest and fee income, but excludes the amortization of discounts and other upfront origination fees.
Due to the drop in prepayment fees, as well as kind of continued spread compression, our new investments the income yield declined from 8.6% for the quarter ended December 31st to 8% for the quarter ended March 31.
The $1.1 million decline in prepayment fees caused the income to drop approximately 40 basis points, while the spread compression on new investments caused the remaining 20 basis point decrease this quarter. Including amortization of fees and discounts the investment income yield on the investments or the dark blue line up on top that was 8.6%. Again this decrease was primarily attributable to the decline in prepayment fees as well as spread compression on new investments. Looking at the green line the weighted average cost of our debt has remained relatively stable over the past several quarters ranging from 3% to about 3.1%.
Turn to slide 9, for new investments the weighted average rate at new middle market investments was 7.5% this was up from 7.2% from the previous quarter. As David mentioned we think this reflects some stabilization in spreads being quoted on new transactions. However as you noticed, this rate is still lower than the rate on investments that are paying off and so we continue to expect some continued pressure on yields kind of going forward.
As a reminder the weighted average interest rates and new investments is based on the contractual interest rate at the time of funding, for available rate loans the contractual rate would be calculated using current LIBOR, the spread over 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 at the end of the quarter. Overall, credit quality continues to remain very strong with non-earnings assets as a percentage of total investments on a cost basis at 0.02% and essentially zero based on a fair value basis.
Looking to slide 11, two slides forward. Although we have consistently indicated in the past that we expect some downward migration in our internal risks ratings. Last quarter we saw the opposite and portfolio risk ratings improved again this quarter with investments [misgraded] four or five or two highest categories increasing to nearly 95% of our portfolio.
The number of investments with the risk rating of three or low remains unusually. As a reminder independent valuation firms valued approximately 25% of our investments this quarter.
Turning to slide 12, this is a new slide that we are providing this quarter this slide provides some financial highlights for our investment in the senior loan fund or what we commonly refer to as SLF. Over the past quarter, total SLF investments grew from $36.6 million at December 31 to $74.1 million at March 31. In addition due to the closing of a $50 million credit facility with Wells Fargo back in January the fund started to utilize third party leverage and had total senior debt outstanding of $26.1 million at the end of March.
Senior leverage at 0.55 times at the end of the quarter remains below our longer term target of employing between two to three times leverage within this fund, but we expect the fund to make continued progress towards this goal over the upcoming quarters.
Due to the growth in SLF assets this quarter the fund recently increased the size of SLF credit facility to $100 million. We also extended the reinvestment period to April 2015 and extended the final maturity date to April 2019. Pricing remained unchanged which ranges from LIBOR plus 1.75 to LIBOR plus 2.25 depending on the competition of the portfolio.
And last on this slide the table at the bottom summarizes the profitability and total return. For the fund for the past two quarters our overall profitability is not yet as significant contributor to GBDC and the total return remains below our longer term target of a low to mid teens return but we expect overall profitability and our total return to improve as the fund continues to grow its assets and utilize more third party leverage.
Turning to slide 13. Our Board declared a distribution of $0.32 a share payable on June 27th to shareholder of record of June 16th.
[Moving] to slide 14, looking at liquidity and investment capacity. We had approximately $150 million of capital available for new investments. This consists of restricted cash, unrestricted cash SBIC debentures and availability on our revolving credit facilities.
As of March 31st, subject to leverage and borrowing based restrictions we had approximately $74.5 million of availability under our revolving credit lines with Wells Fargo and Private Bank and in regards to our SBIC subsidiaries we had about $22.7 million of additional debentures available.
I'll now turn it back to David, who will provide an update on current market conditions and some closing remarks. David?
Thanks Ross. So since our last quarterly call not much has changed in terms of our macroeconomic outlook. We continue to see in our portfolio company's results generally slight improvements in profits. Although we are seeing some exceptions in calendar Q1 due to a weather and consumer reluctant [dispend].
I would say overall we don't see signs of an imminent downturn, but likewise we remained quite cautious about the medium term outlook. Because we see many potential negative catalysts and not many, in fact very few potential positive ones. So our approach in this environment has been and remains consistent. We are going to continue to be highly selective and we're going to continue to focus on senior secured and one-stop investments in resilient, recession resistance borrowers and partnership with responsible relationship oriented private equity sponsors. We hope to continue to see the fruits of this strategy and the kinds of strong credit results and steady earnings that we talked about today.
So that's concludes our prepared remarks. And as always I want to thank everyone on the phone for your time and your continued support. And operator we'll open the floor for questions.
Thank you. (Operator Instructions). Our first question comes from the line of Greg Mason with KBW. Please proceed with your question.
Greg Mason - KBW
Great, thanks guys. I appreciate you taking my question. David, as I look on slide 8, the overall portfolio yields and slide 9, the new yields you are putting on, I guess my question is why raise capital and grow in an environment that's clearly at least competitive from an asset yield standpoint? Just can you give us a view on is it better to just hold the line steady here versus continuing to grow?
I think it's a great question. The question of when is it in investors’ interest for GBDC to grow, it's one we think a lot about. In the March quarter, we determined that it made sense to do an equity offering and to take some additional capital in, in substantial part, because we saw an opportunity to raise that capital at a price level that was accretive for shareholders. And I think if we had not seen the opportunity to raise additional capital at a value that was accretive for shareholders, your question would have been difficult to get DSI.
So, we're very focused right now on using our existing capital base in order to produce an attractive ROE for our investors, we're very focused on improving our NAV over time and we’re very focused on not taking too much risk. And all of those things argue I think in this environment for definitely for slow growth and potentially for a period without growth.
Greg Mason - KBW
I appreciate those comments. And as we evaluate what is potentially accretive for shareholders at --when you raised an 18 that was at 1.18 of book value and a 7% dividend yield with the stock today still above book value but only at 107 today and 7.9% yield. Where the stock is at now, does that change your calculation for if it would be accretive today, just thinking about going forward for future issue?
I think the statistics you just highlighted are central to a discussion that we would have with our Board about what the right answer is. I can’t tell you with specificity we would raise at such and such a price and we wouldn’t raise at a penny less; that’s not I think a useful exercise because we’re really not looking at raising additional capital right now. It’ll be a potential conversation at some point in the future. So, I think the more useful thing I can say is exactly the considerations you’re describing, what’s going to happen to book value post an offering, what’s going to happen to EPS per share post an offering, what’s going to happen to the quality of the portfolio post an offering, those are critical questions that we’re very focused on.
Greg Mason - KBW
Great. Thanks David.
(Operator Instructions). Our next question will come from the line of [Robert Don] with Raymond James. Please proceed with your question.
Hi guys. Just so on the yield and the market, your commentary at the beginning indicates that you’re seeing some recent stability in the yields. Can you give us a bit more color on that? I mean obviously we’ve heard that from some other sources this quarter relatively recently and whether that ties to yields only -- coupons only, or fees or leverage levels that you are seeing in deals at this point? Any more color there would be appreciated.
Sure. I’ve said many times before that in middle market lending, we are insulated from but not immune to trends in broader credit markets. So, let me start by talking about broader credit markets because these are influential in what we are seeing in our market. And in particular the broader credit market I want to talk about is that the broadly syndicated loan market. This is the loan market dominated by JP Morgan and Bank of America and other large banks.
What we are seeing that market is a very clear change in retail inflows. And retail inflows have been very strong and have been driving that market toward a very borrower friendly terms for many, many months in a row. So in the first quarter of this quarter, we have seen a change in that and then several of the months actually reversal, some outflows. And we have seen general trend in the broadly syndicated loan market toward stabilizing or even a higher spreads on new transactions that are coming out.
Generally speaking, what I anticipate is that as a pattern is that when we see this kind of movement in the probably syndicated market, we can expect to see similar a phenomenon in the middle market often with a little bit of lag. And that’s what I think we are seeing right now. So we are seeing stabilization in spreads, we are seeing a stabilization in leverage levels, and I think that trend is likely to continue. I think we have a number of sources of tailwind on that trend. One of the major sources of tailwind on that trend is what we are hearing and perceiving to be an increasing level of discussion between regulators and banks about the regulators’ desire to see banks abiding by the regulatory guidance with respect to leverage loans.
So I am cautiously optimistic that we’re either at or close to the end of the cycle of spread compression. But as Ross indicate, there is still a trend in our portfolio which is our new investment yields or a bit lower than the existing investments that are being sold or paid off, mostly paid off. And so we -- while I anticipate an easing of spread compression, I don’t want to make it sound like it’s over from the standpoint of our portfolio on our financial results. I think we’ve got and others do too, we’ve got a few more quarters to go of seeing some incremental decrease in weighted average yields in the portfolio.
Okay. That is helpful, very helpful color. Can you give us a bit of discussions on why the decision this quarter for example to do so much of these new lower yield unit tranche deals on balance sheet rather than through the SLS where you can frankly get higher returns for the capital on the equity, the shareholders’ equity you are putting in?
It’s actually not a decision per se. the senior loan fund has its stated strategy investing in traditional middle market senior loans and not in one stops. So SLS this quarter did not participate in our one stop loans, but that's not a new decision, that's part of our strategy with respect to SLS. SLS kind of focus on traditional middle market senior debt.
Okay. Thank you.
Our next question will come from the line of Jon Bock with Wells Fargo Securities. Please proceed with your question.
Jon Bock - Wells Fargo Securities
Hi. Good afternoon and thank you for taking my question. David, as we see lower yields going to balance sheet, we understand that you're protecting the portfolio particularly in the event of credit issues et cetera. But there is a slight offers, just to make sure you could give us some clarity around. Can you walk us through the impact of putting these lower rates on the balance sheet, but then falling below the hurdle rate and what that does to or what that should likely do to NOI in the near future from a downside perspective?
Yes, I mean you can -- this is a great question. Jon's pointing out phenomenon and I'll describe it slightly differently and let’s look to the income statement together, so we can actually see this in operation. It's a page 6, if you look at the March 31, 2014 column versus the December 31, 2013, column and look at the row called incentive fee and you'll see that it's fell from 3 million in the December quarter to 1.65 million in the March quarter. So why is that happening? It's happening because net investment income falls right now in the catch-up zone. And so the manager is absorbing the reduction in profitability in order to sustain appropriate income level at our preferred return level for shareholders. And that's the deal that we as manager have with our shareholders, I think it's a fair and appropriate deal. One of the ramifications of this is that the decision to go quality here is substantially coming out of the manager’s pocket. And another ramification of this is that, if especially to compress a little bit more, it would continue to come out of the manager's pocket without a comment in decrease in net investment income per share or earnings per share.
So, in a way we're very much putting our money where our mouth is here and putting forward a quality first strategy. And I think it's important for everybody to understand that it's very much a thoughtful decision on our part. But it's a consequential one from the standpoint of manager compensation.
Jon Bock - Wells Fargo Securities
Appreciate the color. And then turning to the SLF, I understand that it's focused for traditional middle market senior loans. When I do look in the portfolio though, it seems that there was a little bit of activity in names, maybe that I wouldn't classify necessarily as middle market, let's say DAL, et cetera, systems, BMC and a few others. Could we take that to mean that there is a certain amount of liquid senior loan collateral you would be willing to contribute to the SLF, still earn good returns and maybe benefit from other areas of your platform that are adapted at managing those types of senior loan collateral and maybe we should look for a bit more sustained growth in that entity going forward?
Again, thanks Jon for raising that. I appreciate it, because your point is dead right. So we have struggled with the question with respect to senior loan fund of how to increase the piece of growth of senior fund in order to be able to get the level of leverage on the portfolio that we want in order in turn to get the level of equity return that we’re seeking. And one of the strategies that we’ve decided to undertake in partnership with our partner on SLF is to put some select larger loans into the portfolio.
We’re going to continually evaluate whether we want to increase or decrease the portion of that portfolio that is in larger loans. But right now it is our judgment that with the cost of borrowing that we’ve got and availability of attractive secondary market larger loans that we can sell later if we decide we want to, but it makes sense to purchase some of those loans into SLF and accelerate the ramp.
And one of the discussions that we are undertaking right now is whether to do more of that or whether to just continue to be patient with the slower ramp of traditional middle-market senior loans in SLF.
Jon Bock - Wells Fargo Securities
Got it. And then we all seem to be again very focused on yields where we see compression from one stops that went from 8.7, 8.2. Maybe getting to more of the risk adjusted yield, could you give us a sense of the leverage levels into our kind of we’ll call it risk quality assessments of those types of one stops and how they’ve compared to a few of the transactions that you’ve done maybe in years past to get a sense of the risk adjusted return today as it stands in those new loans that you’re putting on the books?
I mentioned earlier in this call we did see, have seen a pattern of some reduction in spreads. I don’t think and we can go back and check some numbers and come back to you. But I don’t think there is data supporting the hypothesis that we’ve seen, we’ve seen meaningful leverage creep in recent quarters. I think we and others are holding the line with respect to the levels of leverage that we are prepared to accept in one stop loans. So I think from a quality standpoint these are very strong, very solid companies and from a structural standpoint, I think these are not -- what we are not stretching.
Jon Bock - Wells Fargo Securities
And then maybe just a blockbuster to your say earliest attachment point is what today and that goes all the way for your last attachment point of what just speaking more broadly about these types of transactions, you are looking at?
It’s a hard question to answer because credits are idiosyncratic, so there is no one answer to your question. But I would say in general we are looking at one stop loans for our starting attachment line to zero with the first dollar of debt and our ending attachment point would typically be in the fives.
Jon Bock - Wells Fargo Securities
Okay. All right, thank you very much.
And at the present time, there are no further questions from the phone lines.
Great. Well again, I just want to thank everybody for their time today. And as always offer the opportunity to anyone on the phone to call Ross or myself if you have further questions. Thanks everybody.
Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. I say you please disconnect your lines. Have a great day everyone.
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