Golub Capital's (GBDC) CEO David Golub on Q1 2017 Results - Earnings Call Transcript

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Golub Capital BDC (NASDAQ:GBDC) Q1 2017 Results Earnings Conference Call February 9, 2017 2:30 PM ET


David Golub - CEO

Ross Teune - CFO

Greg Robbins - Managing Director


Robert Dodd - Raymond James

Christopher Testa - National Securities


Welcome to Golub Capital BDC Inc. December 31, 2016 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 any number of risks and uncertainties.

Actual results may differ materially from those in the forward-looking statements as 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 the company intends to refer to on today's earnings conference call, please visit Investor Resources tab on the homepage of the company's website at www.golubcapitalbdc.com and click on the Events Presentation link to find the December 31, 2016 Investor Presentation. Golub Capital BDC’s earnings release is also available on the Company’s website in the Investor Resources section. As a reminder, this call is being recorded for replay purposes.

I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC. Please go ahead Sir.

David Golub

Thanks, operator. Hello everybody and thanks for joining us today. I am joined by Ross Teune, our CFO; and Jon Simmons, Director of Golub Capital.

Yesterday afternoon, we issued our earnings press release for the quarter ended December 31 and we posted an earnings presentation on our website. We are going to refer to this presentation throughout the call today.

I’ll start by providing our overview of the December 31 quarter. Ross is then going to take you through the results in more detail and then I’ll come back and provide some closing remarks and open the floor for questions.

The quarter ended December 31 was another solid quarter for GBDC. For those of you who are new to GBDC, our investments strategy is and since our investment has been, providing firstly lien senior secured loans to healthy resilient middle market companies backed by strong partnership-oriented private equity sponsors.

As we discussed last quarter, the competitive environment in middle market lending has grown more challenging and in particularly it grew more challenging over the course of calendar 2016 went from a relatively lender friendly environment to the beginning of calendar 2016 to a relatively borrower friendly environment towards the end of 2016.

We pursued and we continue to pursue a strategy of leveraging the competitive advantages of the Golub Capital platform to stay in strong performance. Advantage such as our leading market position, our long term relationships with private equity sponsors and our ability to deliver compelling buy-and-hold one-stop solutions in size.

Let me dive into the details of this quarter's results. Net increase and net assets resulting from operations, in other words net income for the quarter ended December 31was $19 million or $0.34 a share compared to $15.1 million or $0.03 a share for the quarter ended September 30.

Net investment income or as I call it income before credit losses was $16.9 million for the quarter ended December 31 or $0.31 a share as compared to $17.2 million or $0.32 a share for the quarter ended September 30.

Excluding $500,000 GAAP accrual for the capital gains incentive fees, net investment income for the quarter was $17.4 million or $0.32 per share roughly flat with the prior quarter. Consistent with previous quarters we provided net investment income per share excluding the GAAP capital gains incentive fee accrual, as we think this adjusted NII is a more meaningful measure of income before credit losses.

Net realized normalized gains on investments from secured borrowing for the quarter were $2 million or $0.03 a share and that was the result of $0.9 million of net realized gain and $1.1 million of net unrealized depreciation. So we had another quarter of what I'll call negative credit losses.

On December 29, 2016 we paid our usual quarterly distribution of $0.32 per share and we also paid a special distribution of $0.25 a share. As a result of the special distribution, our net asset value per share declined to $15.74 at December 31 from $15.96 at September 30. Excluding this special distribution, our net per share would have increased to $59.99 at December 31, as our earnings per share of $0.34 exceeded our regular quarterly distribution of $0.32 per share.

Newbuild market investment commitments totaled $113.6 million for the quarter ended December 31, consistent with recent quarter we continue to focus our originations efforts on our one-stop product and about 70% of our origination activity as of December 31 quarter was in one-stops with the vast majority of the balance and traditional first lien senior secured bonds.

Overall total investments in portfolio companies at fair value increased by 2.1% or $35.7 million during the quarter after payoffs of sales to our senior loan fund.

Turning to Slide 4 you can see in the table a $0.34 per share from a net income perspective to $0.32 per share we earned from a NII perspective before accrual for capital gains incentive fee, and our NAV per share of $15.74.

As shown on the bottom of the slide, the portfolio remains well diversified with investments in 182 different companies and average size of $8.7 million per investment.

With that, I’ll now turn it over to Ross, who is going to provide some additional portfolio highlights and discuss the financial results in more detail. As I mentioned I'll come back to provide some market perspective and open the floor for questions after that.

Ross Teune

Great. Thanks, David.

Turning to Slide 5, as David mentioned, we had total investment in middle-market companies of $113.6 million and total investment of $122.7 million including a $9.1 million investment in SLF. Total assets and sales of investments were $93.9 million and net funds growth was $35.7 million.

Turning to Slide 6, this slide shows our quarterly portfolio mix by investment type which has remained very consistent quarter-to-quarter with one-stop loans continuing to represent our largest investment category at 79% of the portfolio.

Turning to Slide 7, this slide illustrates the fact that our portfolio continues to remain well diversified with an average investment size of $8.7 million, our debt investment portfolio remains predominantly invested in floating rate loans and there have been no significant changes in the industry classifications over the past year.

Turning to Slide 8, the weighted average rate of 6.9% our new investment this quarter was down from 7.6% the previous quarter. As we noted on our last call, the increase in the weighted average rate on new investments last quarter was largely the result of the few higher spread loans originated and not a general market move.

As a reminder, the weighted average interest rate on new investments is based on the contractual interest rate at the time of funding. For variable rate loans, the contractual rate would be calculated using current LIBOR, the spread over LIBOR and the impact of any LIBOR floor.

Shifting to the graph on the right-hand side, this graph summarizes investment portfolio spreads focusing first on the light blue line. This line represents the income yield or the actual amount earned on investments, including interest and fee income, but excluding the amortization of discounts and upfront origination fees. The income yield decreased by 10 basis points to 7.7% for the quarter. This was primarily due to a $300,000 decrease in prepayment fees.

The investment income yield or the dark blue line, which includes the amortization of fees and discounts decreased by 40 basis points to 8.1% at December 31 as OID amortization declined by nearly $1 million due to a decrease in payoffs. The weighted average cost of debt or the green line remained stable at 3.4% for the quarter.

Looking to the next slide, credit quality remains strong with nonaccrual investments as a percentage of total investments at a cost and fair value of 0.3% and 0.1% respectively as of December 31. These percentages were unchanged from the prior quarter and there were no new loans added to nonaccrual status during the quarter.

Turning to Slide 10 the percentage of investments risk rated a 5 or 4 our two highest categories remained stable quarter over quarter and continue to represent over 85% of the portfolio. As a reminder, independent valuation firms value approximately 25% of our investments each quarter.

In review of the more detailed balance sheet and income statement on the following two slides, we ended the quarter with total investments at fair value of nearly $1.7 billion. Total cash and restricted cash of $71.7 million and total assets of almost $1.8 billion.

Total debt was $889.5 million which includes $451 million in floating rate debt securitization vehicles, $283 million of fixed-rate debentures and $155.5 million of debt outstanding on our revolving credit facility.

Total net asset value on a per share basis was $15.74. Our GAAP to net equity ratio was 1.03 times at December 31, while our regulatory debt to equity ratio was at 8.7 times. These are both up from last quarter and very close to our targets.

Flipping to the statement of operations, total investment income for the quarter ended December 31 was $33.8 million. This is down $0.7 million from the prior quarter, primarily due to lower OID amortization and lower fee income.

On the expense side, total expenses were $16.9 million, decreased by $0.4 million from the prior quarter, primarily due to a decline in incentive fee expense, which was partially offset by higher interest expense resulting from higher average debt outstanding. As David highlighted earlier, we had net realized and unrealized gains of $2 million and net income for the quarter ended December 31 was $19 million.

Turning to following slide, the tables on the top provide a summary of our quarterly distributions and return on equity over the past five quarters. Our regular quarterly distributions have remained stable at $0.32 per share which is consistent with our net investment income per share when excluding the GAAP accrual for capital gains incentive fee.

As David mentioned earlier, we paid a special distribution of $0.25 per share for the quarter ended December 31, as our GAAP and taxable income have exceeded net investment income over the past few years.

The annualized quarterly return based on net income was 8.6% this quarter and has averaged 8.4% for the past five quarters. The bottom of the page illustrates our long history of increasing NAV over time. For historical comparison purposes, we have presented NAV per-share both including and excluding the $0.25 special distribution.

Turning to Slide 14, this slide provides some financial highlights for our investment in senior loan fund. The senior loans have experienced an increase in it's return as compared to the prior quarter but is still below our long-term target of the low teens return. The annualized total return for the quarter at December 31 was 7.1%. This was negatively impacted by a decline in evaluation of one investment that is a non-accrual status. Total investments at the senior loan fund at fair value was $333.3 million at the end of the quarter.

Turning to the next slide, as of December 31, we had nearly $100 million of capital for new investments through restricted and unrestricted cash, availability on our revolving credit facility and additional debentures available through our SBIC subsidiaries. Subsequent to quarter end, we received approval for our third SBIC license, which will allow us to issue an additional $50 million of debentures. Through our three SBIC licensees we are now able to issue up to $350 million of fixed-rate debentures, which is a regulatory cap of licenses under common control.

In regard to our investment in our Senior Loan Fund or SLF in late December based on approval from both co-managers, SLF recapitalized its balance sheet by redeeming and terminating the subordinated loan commitments and replacing this capital with equity commitments in contribution in a like amount. There is no economic impact to GBDC as a result of this simplified capital structure, but it does change a geography of income from our investment in SLF which will now be recorded as dividend income on the income statement as opposed to a combination of interest and dividend income.

Slide 16, summarizes the terms of our debt facilities. And lastly on Slide 17, we have summarized our distributions including the two distributions, both regular and special declared by our Board that David highlighted in his opening remarks.

I'll now turn the call back to David who will provide some closing remarks.

David Golub

Thanks Ross.

So to summarize, GBDC had a solid first quarter of fiscal 2017, the key drivers were consistent investment incomes from credit and access to the Golub Capital origination platform. Last quarter I talked about the market environment about how middle market M&A has been slow and how we've seen signs of what I call credit market inflation and this story continues. We are seeing some continued spread compression leverage creep and pressure on documentation and terms. I'd like to talk more about that, I thought this quarter I focused on a different issue.

The issue for this quarter, where is the economy headed? The interesting question. So this market is optimistic, credit and equity markets have delivered very strong returns in the last couple of months especially post election. For the three months ended January 31, the total returns for Broadly Syndicated Loans in the BSL market been an annualized basis about 80%. High-yield market annualized basis of about 11.2%, and the S&P 500 of an annualized basis of about 31%.

But if we take that closer look at the data, indicators are actually pointing in different directions. Let's talk first about some positive signs. The economy added 227,000 new jobs in January, it's a little bit over trend and the unemployment rate remains low at 4.8%. We saw some improvements in the participation rate.

Initial jobless claims have been near post recession most four week average for the end of January was $248,000 - that 248,000. Consumer confidence is high as 15 year high for the consumer confidence index, the NFID publishes small business optimism in index, which is also showing very high numbers, its highest levels since 2004. So that's on a positive side. But on the other hand there is some broader trends that they don’t look so good.

Our corporate profit margin seem to be facing headwinds and the headwinds have identifiable sources rising wages, rising funding prices, rising debt service cost as interest rates have ticked up a bit.

We publish as many of you probably know - we publish a quarter of the call the Golub Capital middle market report. And it looks at the median EBITDA and revenue growth of companies in our middle-market portfolio. And for the fourth quarter of 2016 it told us that the corporate profit margins are under pressure in the middle market. Labor productivity growth remains low. Productivity increased just 0.2% year-over-year in 2016. And labor costs increased by 2.6% that's a bad combination.

And in many sectors we're seeing an increasing dispersion between winners and losers. The most obvious example of this is retail where Amazon and Costco continue to do very well, but much of the rest of the sector are not so much, hundreds of store closings announced already in 2017. So what does all this mean and we got a situation where Mr. Market is optimistic, but the data, I think the data are used for caution.

Maybe this means that we are in a period post-election where increases in consumer spending and increases in business investment are coming, but they are not yet visible or maybe it means that Mr. Market right now is little exuberant in his optimism. I am not sure which it is, but here is the good news. The good news is that like our capital we're well compared to both scenarios. What do I mean by that?

By investing in loans to healthy resilient middle-market companies that are at the top of the capital structure, we think we benefit if economic growth accelerates as Mr. Market is right. In that scenario we should see acceleration in deal flow, we should see better credit results.

If on the other hand, Mr. Market is too exuberant and we go back to a muddling environment, we think we'll see a marked increase in junior debt default rates and we'll be very happy with our strategy focusing on senior debt in resilient companies and I am hopeful that our portfolio will continue to perform reasonably well.

So no matter what scenario developed here, we're going to continue to do what we do with just the aim to sustain our long-term track record of consistent premium returns. Very interesting period we're in right now though very high degree of uncertainty. So thanks for your time this afternoon for your partnership.

And with that operator, let's open the line for questions.

Question-and-Answer Session


[Operator Instructions] And we'll get to our first question over the line from the line of Jonathan Bock with Wells Fargo. Go right ahead.

Unidentified Analyst

Good afternoon. [Joe] filling in for Jonathan Bock here. David, first, could you please remind us again of kind of the thought process behind the special dividend last quarter? Clearly shareholders in the market appreciated the addition of distribution, but I think it will be helpful if you can briefly outline your thoughts in consideration of retained capital versus the special just to remind folks?

David Golub

Sure. So for those of you who are not on last quarter's call, we found ourselves at the end of 2016 and the position where our taxable income on a cumulative basis exceeded the distributions that GBDC had made. And so we had a choice, we could pay a special distribution so that we could bring those two into balance or GBDC will need to pay an excise tax on the difference between its cumulative taxable income and its cumulative distribution.

So, I'm simplifying slightly but that's the broad picture. If we choose not to do the special distribution that excise tax would not be a one-time event, it would be an annual event. So every time we would come to the end of the year and we hadn’t paid out enough in distributions as a matter of taxable income, we would have to pay an excise tax.

And so we came to the conclusion that from a shareholder perspective that starting from behind the 20 yard line, this was not a good idea that we want to earn an ROE that our investors are satisfied with, starting with a negative number and having to earn more than that 8.5%, 9% referring that our shareholders are expecting to us to make that this was not good for shareholders.

So many managers are reluctant to first to pay out special distribution because they earn fees on capital that they keep within the vehicle. Our approach is a little different. Our approach is to think about this from the perspective of what's good for shareholders and that led us to the inclusion that the right answer was to pay a special distribution.

Unidentified Analyst

Thank you for that, that’s very helpful. And just a quick housekeeping, was the portion of the special dividend paid under DRIP or was there special 100% cash?

Ross Teune

This is Ross, Joe if investments participate in DRIP plan they would - those shares - that cash would be used to issue additional shares.

Unidentified Analyst

Okay, I got you that make sense. And now kind of a broader question with broadly syndicated markets has it become more difficult for Golub and other larger middle market lenders to compete in the upper middle market. Are there more opportunities that you're seeing at Golub within smaller segments of the market with companies who might not be large enough to access the broadly syndicated solution?

Ross Teune

Well I’m not sure if there is any way as the market is broadly. I would characterize it as competitive and I’d say we’re seeing a competitive market in small deals, as well as in larger deals. The main complaint if I can use that word - the main complaint I use right now about where the market is that there are too few high quality companies pursuing M&A transactions and in need of financing.

So we’re in an environment right now where M&A is slow and quality adjusted M&A is particularly slow. I don’t think that’s a function of upper middle market companies versus smaller companies. I think it’s through across the Board and I don't think we're seeing more competitive pressure in upper middle market transactions than we are in lower middle market transactions. We’re seeing competitive pressure across the board.

And our response to that is really simply. Our response is to lean on our competitive advantages. So we're focused on transactions where we’re not only like the credit but where we can provide a compelling value proposition to our private equity sponsors clients that compelling proposition may be because we’re the incumbent lender and maybe because it’s a sector where we have domain expertise.

It may be because we can provide a one-stop in size on our highly confidential basis that serve some need that they have. There are variety of different ways in which our competitive advantages can be brought to bear, but -it is difficult now where, if we were a lender without our competitive advantages I just try today’s environment is very difficult with our competitive advantages I described it as challenging.

Unidentified Analyst

That's very helpful, and certainly appreciate the value of the one-stop over syndicated solution. And just one more question from me this is kind of a follow-up but with Massage Envy right, I think we saw the tenure was extended two years and pricing was reduced by 50 basis points. So we see massive repricing in the broader markets I was wondering if you've kind of felt pressure from issuers to reduce pricing on existing loans and maybe the refinancing to more issuer friendly pricing similar to this Massage Envy transaction?

Ross Teune

So in the Broadly Syndicated Loan market its reasonably common whether to be repricing transactions what that basically means is that the borrower works with his agent bank and amendment goes out to holders of the Broadly Syndicated Loan that gives those holders the choice between excepting a lower spread and getting repaid at par.

In the middle market that’s much less common. It does happen from time-to-time but it’s much less common. So we’re seeing most pressure of what I’ll call credit market inflation on new transactions and less on the portfolio. And this is one of the reasons why the middle market lags the broadly syndicated market it's not as responsive to changes upward or downward in spread in short periods of time.

Unidentified Analyst

Okay. Thank you for that. And that's it for me. Thank you for taking my questions.


We'll going into our next question on the line and it’s from the line of Robert Dodd with Raymond James. Go right ahead.

Robert Dodd

Hi guys. Two questions one hopefully easy, the other one a little bit harder and more speculative, but first on the SLF, can you give us any color on the motivation for peers I wanted to convert the sub notes to equity. Was there any -- because obviously there were unfunded commitments on the subnotes and it's debatable whether that applies to the equity in the same way.

So was there any push on to from either your lenders, the SEC anything like that about obviously economically to you doesn't matter which way you structure it, but was there any outside factor that triggered the decision to restructure that?

David Golub

Two reasons why it was useful to do. One is just simplicity, simple is always better than more complex and the second is that there is some tax advantages to investors who are taxable to eliminating the subordinated debt that reduces this is highly technical, but it reduces something called QII and basically puts distributions from GBDC into a position of generating less tax for shareholders.

Robert Dodd

Okay. Got it, thank you. The second one when we look at the market obviously, you have value to sub but that might be driven by economic over exuberance perhaps some of it may be by obviously the expectations the tax rates may change lower tax rates high profits maybe right, because we're talking about moving it may be -- moving interest deductibility as well but allowing people to expense capital expenditures upfront.

So when I look at industries, obviously one of there that was last quarter or two quarters ago, we were talking about a software company low capital intensity, high leverage, good loan, but hypothetically if the tax rate comes down but they lose the interest deductibility, but don't have a lot of capital expense, what does that do without necessarily focusing on that investment?

What does that do to interest coverage for some of these businesses if tax gets really shaken up and deductibility of interest versus capital expenditures really moves around? Any kind of feel of that would be very speculative I understand that?

David Golub

So I’m tempted to say, I don’t know and leave it at that, but I think you’re not going to let me. So clearly this is speculative. I don’t think anyone really knows where the discussions about tax reform are going to head right now. My understanding of the discussions about changes to interest deductibility are that they would be prospective not retrospective and so that existing debt securities or debt, or loans, would not be subject to the new rules.

So if I'm right on that, then the question really become, how much are companies worth in a new tax regime and how will sponsors in this new regime finance those new companies? I think there is a potential for some change on both of those fronts. So, if a company is going to end up being negatively impacted by the two vectors that move in different directions, the first being elimination of deductibility of interest and the other being lower tax rates and those do work in opposite directions and I think in some cases, companies will actually benefit, leverage companies will benefit from the combination of those.

But let’s assume that a company is going to see its after-tax cash flow reduced by the combination and I think its value will go down. So, we'll see some diminution in the NAV value of companies that fall in that category. Then the question becomes if a sponsor buy such a company, will the lack of interest deductibility change the way that they choose to finance the company?

We’ve spent a lot of time thinking about this and our conclusion is that the sponsor is likely to see more things stay the same and want to change things because from a sponsor’s perspective, they're seeking to achieve some targeted rate of return, if that becomes more expensive because it isn’t deductible that might argue for replacing that debt with more equity or if you replace it with more equity you actually return even more because the equity is higher cost than even the higher cost debt.

So I think sponsors are going to look at a post-tax reform world and make decisions that are obviously calculated, carefully based on the new map of that post tax reform world. I think in the likely scenarios in leverage lending plan we're probably not going to see much change.

Robert Dodd

Okay. Thanks a lot.


[Operator Instructions] And we do have a question in queue from the line of Christopher Testa with National Securities. Go ahead.

Christopher Testa

Good afternoon, guys. Thanks for taking my questions. I was just wondering if you can provide some color on how much the leverage multiples have gone up on one-stops for now compared to last year this time. Just how many more deals are effectively falling out the funnel from sponsors being aggressive in the market at this point?

David Golub

So it's hard question to answer because as you know the leverage levels on new transactions are very transaction specific, but I would say if you look at broadly at market trends that we've seen leverage creep in the quarter that have churn range over the course of the last 12 months.

Christopher Testa

Okay, great. And just wondering also if you could just talk about how you know the potential repeal of the deal all the fiduciary rule that seems to be put on hold at least. Have you foresee that impacting private fundraising David, because it seems like that was big issue from one of the private fundraising for BDC over the past year?

David Golub

So, I think I'm really the wrong person to ask that question. I think you probably be better off asking that question of Franklin Square or one of the other firms that are very active in the brokerage channel. The fiduciary rule absent to the fiduciary rule will have no impact on Golub Capital.


Thank you very much. Mr. Golub we seem to have no other questions queued at the time. I'll turn it back to you.

David Golub

Well, I'll just reiterate what I said before. Thank you everyone for tuning in for today's call and thank you for your partnership. If you have any questions over the course of the quarter, please feel free to reach out to me or to Ross and we look forward to talking to you again next quarter.


Thank you very much. Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation and ask that you disconnect your lines. Have a good day everyone.

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