Golub Capital BDC (NASDAQ:GBDC) Q3 2017 Earnings Conference Call August 8, 2017 10:00 AM ET
Greg Robbins - Managing Director
David Golub - CEO
Ross Teune - CFO
Jonathan Bock - Wells Fargo
Paul Johnson - KBW
Robert Dodd - Raymond James
Welcome to the Golub Capital BDC Inc. June 30, 2017 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 the company intends to refer to on today's earnings conference call, please visit the Investor Resources tab on the homepage of the company's Website www.golubcapitalbdc.com, and click on the Events Presentation link to find the June 31, 2017 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.
Thank you, Susan. Hello everybody, and thanks for joining us today. I am joined by Ross Teune, our CFO; and Greg Robbins, Managing Director.
Yesterday afternoon we issued our earnings press release for the quarter ended June 30, 2017 and we posted an earnings presentation on our website. We'll be referring to this presentation throughout the call today. I'm going to start by providing an overview of the June 30, 2017 quarterly financial results. Ross will then take you through the result in more detail and then I'll come back and provide some closing remarks and open the floor for questions.
In sum, the quarter ended June 30 was another solid quarter for GBDC despite a challenging market environment. For those of you who are new to GBDC, our investment strategy is and since inception has been to focus on providing first lien senior secured loans to healthy resilient middle market companies backed by strong partnership-oriented private equity sponsors.
Let me dive into the details for the quarter. Net increase in net assets resulting from operations, in other words, net income for the quarter ended June 30 was $20.1 million or $0.35 a share and this compared to $20.7 million or $0.38 a share for the quarter ended March 31.
Net investment income or as I prefer to call it income before credit losses was $17.8 million for the quarter ended June 30 or $0.31 a share as compared to $16.5 million or $0.30 a share for the quarter ended March 31. Excluding a $600,000 GAAP accrual for the capital gains incentive fee, net investment income was $18.4 million or $0.32 a share as compared to $17.4 million or $0.32 a share for the quarter ended March 31.
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.
Net realized and unrealized gain on investments in secure borrowings of $2.3 million or $0.04 a share for the quarter ended June 30 was the result of a $3.2 million net realized loss and a $5.5 million net unrealized depreciation. Net asset value per share rose in the quarter to $16.01 at June 30 from $15.88 at March 31 due both to earnings in excess of our quarterly distribution and accretion from completing a common stock offering on June 12 at a premium to NAV.
New middle market investment commitments totaled $241.9 million for the quarter ended June 30. This was a surprisingly strong origination quarter for GBDC and I'll talk about the drivers of this in my closing remarks.
As expected, our new originations activity shifted back toward one stops during the quarter as approximately 88% of our origination activity in the June 30 quarter was in one stops and the vast majority of the balance in traditional first lien senior secured loans.
Overall total investments and portfolio of companies at fair value increased by approximately 3.9% or $67.8 million to just over $1.8 billion during the quarter.
Turning to Slide 4, you can see in the table the $0.35 per share we earned from a net income perspective, the $0.32 per share we earned from an NII perspective before accrual for the capital gains incentive fee and you can see our NAV per share of $16.01 at June 30.
As shown on the bottom of the slide, the portfolio remains very well diversified with investments in 188 different portfolio companies at an average size of $9 million per investment.
With that, I'll turn it over to Ross who is going to provide you some additional portfolio highlights and discuss the financial results in more detail. After Ross concludes his presentation, I'll come back with some closing remarks in which I am going to talk about origination and then we'll open the floor for Q&A. Ross, over to you.
Great. Thanks David. Starting on Slide 5, the slide highlights our quarterly origination and net funds growth that David discussed.
Turning to Slide 6, this slide shows our overall portfolio mix by investment type which has remained very consistent quarter-over-quarter, with one stop loans continuing to represent our largest investment category at 79%.
Turning to Slide 7, the slide illustrates the fact that the portfolio continues to remain well diversified with an average investment size of $9 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 7.3% new investments this quarter was up from 6.4% last quarter, primarily due to the shift back to higher yielding one-stop loans. Due to a few large payouts on existing loans with high relative spreads, the weighted average rate on investments that paid off increased to 7.9%.
As a reminder, the weighted average rate on new investments is based on the contractual interest rate at the time of funding. For variable-rate loans, the contractual rate would be calculated using 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 the investments including interest and fee income, but excluding the amortization of discounts and upfront origination fees.
The income yield increased to 7.9% for the quarter ended June 30. This was primarily due to higher prepayment fees. The investment income yield or the dark blue line, which includes the amortization of fees and discounts, increased to 8.7% for the quarter due to an acceleration of OID amortization caused by an increase in payoffs and runoff in the portfolio.
The weighted average cost of debt or the green line, increased to 3.7% for the quarter due to corresponding increase in LIBOR.
Flipping to the next slide, credit quality remains strong with nonaccrual investment as a percentage of total investments at cost and fair value of 0.6% and 0.2% respectively as of June 30. These percentages increased slightly from the prior quarter as one additional portfolio company investment was placed on nonaccrual.
Turning to Slide 10, the percentages of investments, risk rated up five or at four, our two highest categories remain stable quarter-over-quarter and continue to represent over 85% of our portfolio. As a reminder, independent valuation firms value approximately 25% of our investments each quarter.
To reviewing the more detailed balance sheet and income statement on the following two slides, we ended the quarter with total investments at fair value of over $1.8 billion, total cash and restricted cash of $45.9 million and total assets are approaching $1.9 billion.
Total debt was $883.4 million. This includes $451 million of floating rate debt issued to our securitization vehicles, $288 million of fixed rate debentures and $144.4 million of debt outstanding in our revolving credit facility.
Total net asset value was $16.01. Our GAAP debt-to-equity ratio was 0.94 times, while our regulatory debt-to-equity ratio was 0.63 times. These are slightly below our targets due to the small follow-on equity offering that we completed in June.
Flipping to the statement of operations, total investment income for the quarter ended June 30 was $35.4 million. This was up $1.8 million from the prior quarter due to continued portfolio growth, higher fee amortization and an increase in prepayment fees.
On the expense side, total expenses of $17.6 million increased by $0.6 million during the quarter, primarily due to higher interest expense.
Turning to the 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 the capital gains incentive fee.
The annualized quarterly return based on net income was 8.8% this quarter and has averaged 8.7% for the past five quarters. The bottom of the page illustrates our long history of increasing NAV per share over time. For historical comparison purposes, we've presented NAV per share both including and excluding the $0.25 special distribution that we paid in December 2016.
Turning to Slide 14, this slide provides financial highlights for our investment in our senior loan fund, which had a disappointing quarter. The annualized total return for the quarter ended June 30 fell to 3.4%, primarily due to an unrealized loss on one portfolio company investment.
Total investments at fair value declined by just over 8% to $322.3 million, primarily due to an increase in prepayments.
Turning to the next slide, as of June 30, we had over $150 million of capital for new investments through restricted, non-restricted cash, availability on our revolving credit facility, an additional debentures available through our SBIC subsidiaries.
As summarized on the last bullet point at the bottom of the slide, on June 6, we entered into an agreement to sell 1.75 million shares of our common stock at a net price to us of $18.71 per share. Including the exercise of the underwriters option to purchase additional shares, we raised approximately $36.8 million in net proceeds. This price was 1.18 times. Our most recently reported NAV per share at the time of the share issuance.
Slide 16 summarizes the terms of our debt facility and lastly on Slide 17, our Board declared a distribution of $0.32 a share payable on September 29 to shareholders of record as of September 6.
I'll now turn it back to David, who will provide some closing remarks.
Thanks Ross. So GBDC had a solid third quarter 2017 that the key drivers were consistent investment income, strong credit quality and access to the Golub Capital origination platform. I want to close by talking a bit on the subject of origination.
As I mentioned at the beginning of this call, we believe the investment environment today is quite challenging. Credit markets are relatively borrower-friendly and we think the combination of relatively slow middle-market M&A activity and robust capital raising in the industry means that these conditions are likely to remain challenging for some time.
So, despite these market conditions, GBDC had relatively high originations in the quarter ended June 30. I attribute this to three factors. One a lot of hard work by the Golub Capital origination underwriting team. Two, success in leveraging the firm's competitive advantages and three, a bit of good luck. Let me say a bit more about each of these.
The first factor I mentioned was hard work. The hard work was finding attractive opportunities in a challenging environment. There's no substitute for shoe leather and our team showed a lot of grid in generating these attractive opportunities. This is the kind of market where we believe being able be selective is critically important than through our origination channels, the Golub Capital team generated almost 1300 investment opportunities in the first half of calendar 2017 of which we closed about 2%.
Generally, if you look at the new financings we completed, they leverage our competitive advantages and this brings me to the second factor I wanted to talk about. One key competitive advantage we focused on is our capacity to deliver large scalable one-stop solutions.
We believe Golub Capital's one-stop are gold facilities can be a win-win solution for both sponsors and investors. For sponsors, the gold facility gives them a straightforward capital structure, it's simpler, it's easier on day one and it can be scaled up over time easily as the sponsor looks to bring in tuck-in acquisitions.
For investors, the scalable gold offers us the opportunity to deploy increasing amounts of capital in companies we know and we believe are performing well and are likely to continue to perform well. As an example, in the last quarter, GBDC invested in $675 million Golub Capital led one-stop financing for pet debt.
We think the Golub Capital solution here be the number of competing first lien, second lien syndicated alternatives because we offered up a faster, simpler, better structure. We were the incumbent lender, so we knew the company and the management team and we had seen them executed well on their accretive growth strategy and also help that the firm has a strong relationship with the sponsor and expertise in the pet care sector.
But I think the key piece that made our solution compelling, was our ability to deliver reliable, easy-to-access dry powder for future acquisition. So, what about the first factor, good luck. When we find a deal that we believe plays to our strength and we partner with a great sponsor in a competitive sales process, our sponsor doesn't always win. In the quarter ended June 30, our partners won at an unusually high rate.
So, to sum up, we believe our hard work, competitive advantages and good luck, all contributed to the strong origination results we had in the third fiscal quarter of 2017. One thing wasn't a contributing factor and that one thing is a lowering of credit standards.
Our credit standards remain very high across the Golub Capital platform, our approval rate for new investments for the first half of 2017 was at the low end of our historical averages. Now we believe this borrower-friendly market is going to last forever. As I've said before, our plan is to sustain our high credit standards through this period and to prepare for a range of potential future scenarios.
We think our origination results this quarter reflect the power of the Golub Capital platform to generate attractive investment opportunities, even in a challenging environment. We're looking forward to a point in the future where there's a correction where there's a less challenging environment and in that -- in that more attractive set of market conditions, we think our senior debt portfolio should continue to perform reasonably well and it will be very well-positioned to play offense.
Thanks for your time today. Thanks for listening today and for your partnership. Operator, if you could please open the line for questions?
Thank you. [Operator instructions] And the first question is from the line of Jonathan Bock with Wells Fargo Securities. Please go ahead Sir.
Good morning and thank you for taking my questions. David, Ross, maybe let's go with a quick postmortem on Ignite or Joe's Crab Shack and just a bit more detail because I know you both limit losses, but also, I learned from them. And then also, a discussion on the opportunity for growth in SLF in light of the unrealized loss and perhaps the amplified effect of leverage and how that impacted return this quarter. So, thoughts on those two investments, Joe's as well as the SLF please.
Sure. Let's start with Joe's. So, this is a company under the formal name Ignite. If you're looking in our financial statements, you'll find it under its corporate name, which is Ignite. For those of you who aren't familiar with the story here, Ignite's principal asset is a chain of restaurants called Joe's Crab Shack that has not performed well in recent years.
The company went into a bankruptcy proceeding this last quarter. It has a stalking horse bid from another large restaurant chain and the courthouse auction to resolve the bankruptcy is expected to take place later this month. We've taken our lumps on it. Our valuation reflects the approximate expected proceeds at the stalking horse bid level. So, we have some potential for upside if the auction results in a higher price.
We don't have absent some unusual circumstances. We don't have a meaningful level of downside from here. We were wrong on this credit. We pride ourselves on being wrong infrequently, but we are wrong a significant part of the time.
And in this case, we underestimated the pace of shift in the restaurant sector. This company saw a very dramatic shift in it same store sales, which has persisted for an extended period of time. The restaurant faces a challenging space. We approach it cautiously.
This one was an unusual one for us in that it was a participation in a loan facility that we did not lead and I think one of the learnings to go back to your questions on one of the learning from our standpoint is that in challenging sectors particularly, we're going to be increasingly stringent about the investment decision to participate in deals led by others.
So that's the story on Ignite. I wish it was a happier story. We'll see what's the final act looks like when we get together next quarter.
Second question that you had was about SLF at the prospects for SLF. I'd repeat what I've said in prior quarters, which is it's our intention over time to grow SLF but we're going to do it if, as and when we identify attractive traditional senior secured loans to go into it and in this challenging environment, our expectation is that that's going to be a relatively slow process.
I appreciate that David and just as a follow-up more of an environment question, you talked about the attractiveness of the one-stop product. Oftentimes if you look at the compared contrast that a sponsor will face between a one-stop and a syndicate option, which while once-stop-shop for surety have close the tightness of the credit markets and just general liquidity sometimes give a surety of close and a lower price to the syndicate type lender in today's environment on tariff being won.
And so, understanding there is always an idiosyncratic set of deals that will go one-stop, right, I am learning to talk about those, but for the current option for a sponsor down the fairway transaction, are you finding that the syndicate market is offering better terms and prices and forcing the one-stop product to compete on both price and term today?
And if you're seeing that or not is it also your intention if your sponsors are looking to do syndicate-type transactions where you will step in and be that loan syndicate provider given the depth of the team that you have.
So, couple different component to your question. So, first part if I understood it right was is the market today competitive in a way that forces us as a leading one-stop provider to be attentive to making sure that we have a compelling value proposition and that means being competitive on price, being competitive on terms.
The answer is yes, I would say that's always true. It is particularly challenging today because the syndicated market is so strong and pricing and terms have both become meaningfully more borrower-friendly over the course of the last approximately 1.5 years.
On your second question, which if one of our sponsors prefers for any variety of different reasons, prefers a syndicated solution as opposed to a one-stop solution, have we put ourselves in a position to be able to offer that solution to our sponsors; the answer to that again is yes.
We have a well-developed capital markets group and our goal is to be a solution provider to our sponsors. We think that we will over the long-term do better as a lender if we can provide a variety of different potential solutions to our sponsors inclusive of both syndicated and one-stop by an whole type solutions.
Thank you so much.
The next question is from Paul Johnson with KBW.
Good morning, guys. Congratulations on the a good quarter. Thanks for taking my question. My question today, a couple of questions, the first one was on the SLF, I just want to get a sense of what's going on? I think previously at least in the past, you usually paid a dividend after the BDC that's kind of tracked NII.
I think quarter, NII was around $3.4 million or so in the SLF, but obviously the dividend was lower a lot closer to that net income level of that $1.1 million or so. So, going forward should we expect distribution to track contract more in line with the net income level or be back maybe closer to that net investment income level?
So, over time it's our goal to have a distribution policy that's reasonably predictable and steady over time, but we also want the distributions to approximate net income over time. Otherwise we're effectively de-capitalizing SLF. So, in this quarter, which was as Ross indicated, a week quarter for SLF due to a meaningful credit loss within the SLF portfolio.
We determine that it was an appropriate time to reduce the distribution from SLF to GBDC parent and we want to over time have this be more predictable, but if we have performance as we did this quarter that we've got to reflect that.
NII is not net income. I keep saying this over and over and over again in the context of GBDC. NII is income before credit losses. So, credit losses are part of the business. We got to reflect credit losses in our distributions from SLF.
Sure. That's makes sense. Well, my next question was one of the investments in the SLF pay less, obviously one [non-stop] quarter but it took a write down. Is it faced to assume that the loan there is on nonaccrual because of the bankruptcy process and that we can expect maybe it come back on accrual at some point?
So, two things, yes, it's safe to assume it's on nonaccrual and yes, it safe to assume that the mark on the loan within SLF is reflective of the trading value of the loan that is a traded loan.
Okay. My last question is just on your view, your general thoughts of the market today and its competition. I am wondering how you think about competition? Are you guys comfortable on the face of the high refi activity you had, the lower M&A activity. Are get comfortable with holding or even slowing fundings to avoid making any kind of defect on investments or are you looking at this a time where I guess you're more willing to go forward I guess at what you might consider normal rate despite those conditions?
So great question. We think this environments are really challenging ones and it's particularly challenging in respect of the firms that we're seeing accepted in the syndicated market terms around definition of EBITDA, in terms around covenant levels and we think that the prudent way to respond to this environment is to increase our degree of selectivity and slow down if that's what's necessary from a new origination standpoint.
We did exactly that in Q1 if you review our calendar Q1 results, you'll see that are origination levels were meaningfully down year-over-year. I expected our calendar Q2 originations to be down as well for the three reasons I talked about in today's commentary.
We actually saw solid originations in calendar Q2, but I don't think all three of those reasons are reasons that we're going to be able to sustain. Good luck is wonderful to have, but you can't count on it.
Sure. That's great commentary. Those are all my question, thanks.
[Operator instructions] The next question is from the line of Robert Dodd with Raymond James. Please go ahead.
Hi guys. Just a follow-up to Jonathan's question on the SLF opportunities. Obviously if we -- the on-balance sheet portfolio grew, the SLF portfolio shrank. One obviously net originations, one lead payments, both of them have access to the platform, both of them access to the people who as you say are working hard.
One of your other points was that the one-stops have more flexibility and people are leaning towards some of that in some cases where they clearly, they are things something other than pure price that determine a decision about who to uses as a financing provider.
Obviously the one the SLF and the on-balance sheet have slightly different type one's one-stop, one traditional senior as you said. Is there any idea in may be SLF to move to something slightly less traditional, still mainly traditional first lean, but slightly less, a little bit more flexibility that might give it a leg up in the market where as you point out, right traditional first lean is incredibly competitive right now? So, has it been full on the product or late, giving that a tweak to give it a little bit more of the competitive edge?
It's a great question. It's something that we think about a lot and talk about a lot. We want to be careful -- we want to accomplish two goals right. One goal is we'd like to grow SLF and have it generate attractive return for GBDC and GBDC investors.
On the other hand, we don't want to take too much risk in an entity that has a higher level of leverage than GBDC parent and so managing those two goals simultaneously requires finding a kind of optimal middle ground. Just because first lien traditional senior secured loans are competitive right now doesn't in my mind mean we automatically ought to take more risk in the SLF portfolio by pushing it more in the direction of one-stop.
That's the reach for yield that kills lenders. On the other hand, if we find ourselves in a sustained environment in which traditional first lien loans are challenging to find attractive ones, then we need to respond to that environment in some way.
That may mean reducing leverage and changing the portfolio mix. That may mean other steps.
Okay. Got it. Thank you.
And there are currently no other questions at this time, sir.
Great. Well, I want to thank everyone again for joining us today and appreciate your time and patience and as always if you have additional questions, either today or as we move into calendar Q3, please feel free to reach out to me or to Ross or to Gregory. Look forward to talking again next quarter.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.