Golub Capital BDC (NASDAQ:GBDC) Q4 2020 Earnings Call

0:00 Welcome to GBDC's September 30, 2020 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 GBDC's filings with the SEC. For materials 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 or Presentations link.

0:59 GBDC'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 at Golub Capital BDC. Please go ahead.

1:30 Thanks, Alicia. Hello, everybody, and thanks for joining us today. I'm joined by Russ Tooney, our CFO, Greg Robbins, and John Simmons, both managing directors at Golub Capital. We and the rest of the Golub Capital team hope that you and your family are safe and that, like us, you're all recovering from eating too much over Thanksgiving. Yesterday afternoon, we issued our earnings press release for the quarter and fiscal year ended September 30th, and we posted an earnings presentation on our website, We're going to refer to that presentation throughout the call today. 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 that are backed by strong partnership oriented private equity sponsors. Let me start today's meeting by sharing with you two headlines. The first headline is that GBDC's results for fiscal Q4 were strong and were in line with the preliminary estimates that we filed on October 19th.

2:34 The primary driver of the results was the continuation of trends that we described on last quarter's earnings call, and I'll discuss those trends in a minute. The second headline is that GBDC is very well positioned as we head into fiscal 2021 with Ample Dry Powder, Liquidity, and Flexibility to capitalize on what we expect will be an attractive investment environment in fiscal 2021. I'll discuss this in more detail in my closing remarks, and after that, we'll take your questions. Let's now take a closer look at GBDC's results for the quarter and for the fiscal year and the key drivers of those results. Please turn to slide four. For fiscal Q4, GBDC's adjusted net investment income per share was $0.28.

3:19 Adjusted EPS was $0.57 and ending NAV per share was $14.33. All of these were at the midpoint as we published previously. I said that the primary driver of these results was the continuation of trends that we talked about last quarter. What do I mean by that? Slide 6 outlines three key themes beyond just simple good underwriting that we believe drove GBDC's strong fiscal fourth quarter. First, in calendar Q3, the U.S. economy strongly rebounded from The story of this quarter was largely a continuation of the story of the prior quarter. and just like fiscal Q3, these themes are reflected in the positive credit quality trends listed on the right-hand side of the slide.

4:25 Let's take a closer look at each of the indicators on that slide, starting with performance ratings. Please turn to slide seven. In fiscal Q4, internal performance ratings continue to improve. Let me start with some context. You'll recall we highlighted in last quarter's earnings presentation The upward migration in internal performance ratings in fiscal Q3. There was an increase in loans in categories 4 and 5. Those are loans that are performing at or better than expectations at underwriting. And there was a decrease in category 3 loans. Those are loans that are performing or are expected to perform below expectations. The percentage of the portfolio performing materially below expectations, those that are in categories 1 and 2, also declined significantly between fiscal Q2 and fiscal Q3.

5:15 All of these positive trends continued in fiscal Q4. In fiscal Q4, loans in categories four and five continued to increase. They went from 76% of the portfolio as of 630 to 78.9% of the portfolio at 930. Category three loans continued to decrease. They went from 22.3% at 630 to 19.7% at 930. and Category 1 and 2 loans also declined quarter over quarter from 1.7% to 1.4%. The very small proportion of the portfolio that's in Categories 1 and 2, I think that's particularly important because it indicates that even in this COVID-stressed environment, significant credit impairment in the portfolio remains rare and idiosyncratic.

6:04 The proportion of the portfolio rated 3 is still higher than we typically saw pre-COVID But it's meaningfully improved from 331 and continues to go in the right direction. The second key indicator of improving credit quality is non-accruals. Non-accruals at fair value also declined. They went from 2% at June 30 to 1.7%. We'll come back to this point in our usual discussion of GBDC's financial results. Slide 8 shows two other key indicators of improving credit quality. Low Net Realized Losses and Solid Net Unrealized Gains. So this slide shows a bridge from GBDC's $14.05 NAV per share as of 6-30 to the 14-33 NAV per share as of 9-30.

6:52 Let's just quickly walk through the bridge. Adjusted NII per share of $0.28 was in line with our dividend of $0.29 and consistent with prior quarter. Net realized losses were very low at $0.02 per share and net unrealized gains were $0.36 per share. These unrealized gains reflect a reversal of another portion of the unrealized losses that were created in the March quarter. You've heard me say before that our top priority since COVID has been and continues to be to minimize GBDC's permanent or realized credit losses. In the long run, unrealized gains and losses wash out all that matters for Lenders like us who tend to hold their loans to maturity is whether or not those loans get repaid.

7:37 So we're pleased to report that in fiscal Q4, GBDC kept realized credit losses low and enjoyed another meaningful reversal of unrealized losses. With that, let me hand the call over to Greg Robbins. He's gonna offer an update on our strategic response to COVID-19. Thank you, David.

7:58 Starting on slide 10, You can see that GBDC continues to execute on its three key goals for navigating the COVID-19 crisis. First, proactive management of our highly diversified first lien senior secured investment portfolio. Second, continued optimization of our balance sheet. And third, capitalizing on attractive new investment opportunities. Turning to slide 11, you'll recall that we described a three-phase strategy for proactively managing our portfolio during COVID-19. That entailed gathering information, developing strategic plans, and executing those strategic plans. We're now in phase three of our strategy, and we have been implementing game plans for each affected borrower, working collaboratively with sponsors, management teams, and junior capital lenders.

8:52 This strategy has produced meaningful results. Our team has executed more than 90 credit enhancing amendments. We define a credit enhancing amendment as one involving a spread increase, improved documentation terms, or an incremental equity infusion. We have talked at length about the strong sponsor support for our portfolio companies. Let me describe one flavor of this. Since COVID began, sponsors have put in over $700 million of new equity

9:21 into GBDC portfolio companies.

9:25 Slide 12 shows how GBDC has fortified its balance sheet. At September 30th, GAAP leverage was 0.85 times, which is at the low end of our target range. Regulatory leverage was 0.76 times. GBDC had nearly $500 million of liquidity in the form of cash and borrowing capacity at quarter end. We've also continued to take steps to optimize GBDC's debt capital structure. During the quarter, GBDC completed its fourth flexible, low-cost CLO. We remain one of a handful of BDCs with consistent access to this funding market on attractive terms, even during COVID. And on September 30th, GBDC received investment grade ratings from S&P and Fitch and priced its debut issuance of $400 million on secured bonds.

10:16 The bonds have an interest rate of 3.375%. one of the lowest cost debut unsecured bond issuances in the BDC space. GBDC used the proceeds primarily to pay down secured debt under its revolving credit facilities, which has significantly expanded GBDC's unencumbered asset base without materially changing GBDC's overall leverage. As a result of these initiatives, GBDC has more flexibility and firepower. That flexibility and firepower put GBDC in a great position to capitalize on attractive opportunities. And as we've discussed in prior quarters and illustrated on slide 13, we believe GBDC has powerful competitive advantages, which will help us deliver premium shareholder returns going forward.

11:04 With that, let me hand it over to John Simmons to go through our financial results for the quarter ended September 30th and more to tell.

11:10 John? Thanks, Gregory. So just as a reminder, Just note that in addition to the GAAP financial measures in the investor presentation, we're also providing certain non-GAAP measures. We refer to those non-GAAP measures as adjusted measures, and they seek to strip out the impact of the GCIC merger-related purchase premium write-off and amortization. We describe those adjusted measures further in the appendix of the earnings presentation, and we'll refer to them where appropriate as we think they're better indicators of our performance and are consistent with how we evaluate our own results. So with that context, let's turn to slide 15 and I'm gonna talk through the column on the right hand side of the page to discuss the quarter in more detail.

11:59 Adjusted net investment income per share, or as we call it, income before credit losses for the September 30th quarter was 28 cents. Adjusted net realized and unrealized gain per share was 29 cents. This compares to adjusted net realized and unrealized gain per share of 66 cents for the June 30th quarter. The adjusted net realized and unrealized gain this quarter was primarily driven by the continued reversal of unrealized losses from the March quarter. Adjusted earnings per share for the quarter ended September 30th was 57 cents. This compares to an adjusted earnings per share for the June 30th quarter of 94 cents.

12:44 Our net asset value per share at September 30, 2020 increased to $14.33, up from $14.05 as of June 30. On September 29, we paid a quarterly distribution of $0.29 a share. And finally, on November 20, 2020, our board declared a quarterly distribution of $0.29 a share, payable on December 30, 2020, to shareholders of record as of December 11, 2020. The distribution is consistent with our historical cash distributions, which approximate 8% of NAV annually. With that, I'll hand the call over to Ross to go through the quarterly results in more detail. Ross?

13:32 Great.

13:33 Thanks, John. Turn to slide 16. This slide highlights our total originations of $141.2 million. Total exits and sales of investments of $172.4 million for the quarter ended September 30th. As we noted on last quarter's earnings call, we started to see a pickup in deal activity, and that trend has continued into the current quarter, factoring in unrealized appreciation and other portfolio activity. Total investments at fair value decreased slightly by 0.3% or $12.2 million. As of September 30th, we have $41.6 million of undrawn revolver commitments and $100.2 million of undrawn commitments on delayed draw term loans.

14:18 These unfunded commitments are relatively small in the context of GBDC's balance sheet and liquidity position. As shown on the table on the bottom, the weighted average rate of 7.6% on new investments and the weighted average spread over LIBOR on new floating rate investments of 6.5%. both increased from the prior quarter. 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. The top of slide 17 shows that GBDC's portfolio remained highly diversified by obligor with an average investment size of less than 40 basis points.

15:06 The bottom of the slide shows that our overall portfolio mix by investment type has remained consistent quarter over quarter with one-stop loans continuing to represent our largest investment category at 82% of the portfolio. Turn to slide 18, 97% of our investment portfolio remained in first lien senior secured floating rate loans and defensively positioned in what we believe to be resilient industries. It is worth noting that we updated our industry classifications this quarter using the S&P 2018 industry codes. We think this change provides our investors with more detail and transparency about the industry exposure of our underlying portfolio relative to the industry classifications that we were using previously.

15:54 Turning to slide 19, this graph summarizes portfolio yields and net investment spreads for the quarter. Focusing first on the light blue line, this line represents the income yields or the actual amount earned on the investments, including interest and fee income, but excluding the amortization of upfront origination fees and purchase price premium. The income yield decreased by 30 basis points to 7.4% for the quarter, primarily due to the continued decline in LIBOR. The investment income yield of the dark blue line, which includes the amortization of fees and discounts, also decreased by 30 basis points to 7.8% during the quarter, primarily due to the decline in LIBOR. Since our variable rate debt facilities are not subject to a LIBOR floor, our weighted average cost of debt for the aqua blue line decreased by 50 basis points to 2.7%.

16:47 As a result, our net investment spread, or the green line, which is the difference between the investment income yield and the weighted average cost of debt increased by 20 basis points to 5.1%. Flipping to the next two slides, non-accrual investments as a percentage of total debt investments at cost and fair value remain low and decreased to 2.4% and 1.7% respectively as of September 30th. During the quarter, the number of non-accrual investments decreased to nine investments as one portfolio company investment was restructured and returned to accrual status. As David discussed in his opening commentary, as a result of stronger portfolio company performance, the percentage of investments rated three on our internal performance rating scale decreased to 19.7% of the portfolio at fair value as of September 30th.

17:42 As a reminder, independent valuation firms value at least 25% of our investments each quarter. Slides 22 and 23 provide further details on our balance sheet and income statement as of and for the three months ended September 30th. Slide 24, the graph on the top summarizes our quarterly returns and equity over the past five years, and the graph on the bottom summarizes our regular quarterly distributions as well as our special distributions over the same timeframe. Turn to slide 25. This graph illustrates our long history of strong shareholder returns since our IPO. Slide 26 summarizes our liquidity and investment capacity as of September 30th and highlights the recent initiatives to further enhance the right side of our balance sheet.

18:35 As Gregory mentioned, during the quarter, we issued 189 million in notes through a term debt securitization on August 26. Proceeds were used to redeem all outstanding notes issued in the 2014 debt securitization and outstanding debentures issued by one of our SBIC subsidiaries, GCSBIC IV. We also issued 400 million in unsecured notes on October 2, the proceeds of which were used to pay down existing debt including a full repayment of the revolving credit facility with Deutsche Bank. Slide 27 summarizes the terms of our debt facilities as of September 30th prior to the closing of the bond deal on October 2nd. And lastly, slide 28 summarizes our long history of consistent distributions.

19:22 Most recently, our board declared a distribution of 29 cents per share payable on December 30th to stockholders of record as of December 11th. With that, I'll turn it back to David for some closing remarks.

19:37 Thanks, Ross. So to sum up, GBDC had a strong fiscal Q4. Adjusted net investment income remained consistent, realized credit losses were very low, and unrealized losses were substantial, reflecting the continued reversal of unrealized losses that were incurred in the March quarter. I mentioned in my opening comments that we think GBDC is well-positioned. I want to elaborate now on why we think that's the case. First, credit. We think the company's portfolio is nicely diversified, it's defensively positioned, and we're poised to see more reversals of unrealized losses in coming quarters. Second, dry powder and balance sheet flexibility.

20:22 The company's gap leverage is low at 0.85 times debt-to-equity, That's below our target. Liquidity is abundant, and our capital base is strong and flexible. Third, the deal environment. Now, M&A now is muted because of COVID-related uncertainty, but we think that in 2021, conditions are going to improve, and private equity firms are going to accelerate their investment activities. Consider that private equity has its largest reserve of dry powder ever. It's over $1.5 trillion, according to data from Prequin. To put that in context, the whole of the current syndicated loan market is $1 trillion. So the continuing growth of private equity is, in our judgment, a near certainty and represents a large tailwind for sponsored finance firms like ourselves.

21:14 Fourth, competitive advantages. In important ways, this COVID-impacted period has been playing to our strengths. It's hard to form new relationships. It's hard to form deep bonds over Zoom. So there's a natural tendency for sponsors to want to work with lending partners they already know. For us, that's been very helpful because we already have a lot of great relationships. As I told this group before, more than 80% of our originations each year going back nearly a decade have been with a core group of about 200 sponsors that we've done multiple deals with. Incumbencies are a similar story. Pre-COVID, the existing lender tended to be in the pole position when a company needed more capital or the company was getting sold from one sponsor to another sponsor.

22:03 Post-COVID, we think it's proving even more true for the reasons that I just noted. Again, it's the difficulty of and others. Our other competitive advantages are also important, including our large buy and hold capabilities, our reputation for reliability, our market leadership in one stops, our deep industry expertise, Our ability to partner with sponsors on a wide range of different kinds of transactions, large or small, traditional senior or one-stop, buy and hold or syndicated.

22:51 That's why our game plan for fiscal 21 is going to sound very familiar. It's stay humble and cautious and lean on these competitive advantages that have served us well. Thank you. Operator, please open the line for questions. Thank you. If you would like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. Once again, to register for a question, please press the 1 followed by the 4. One moment please. Once again, please press 1-4 if you would like to ask a question.

23:37 Our first question is coming from the line of Robert Dowd with Raymond James. Please go ahead.

23:44 Hi, guys, and congratulations on the quarter. First, a housekeeping one, if I can. With the termination of the Deutsche Bank facility after you did the unsecured notes, will there be any acceleration or accelerated expenses tied to that in the next quarter?

24:04 Ross, I'm going to let you handle that. Yeah, no, nothing material, Robert. Okay, got it. Thank you.

24:11 Then just one of your comments at the end there, David, that you think you're poised to see additional unrealized appreciation in the portfolio. I mean, if I look at it, you've still got round numbers, a dollar per share of depreciation in there, given the fair value of the portfolio versus cost right now. What gives you the confidence that you're going to get back more? Is there of that that you've recovered so far, is that directly tied to the 700 million additional equity that sponsors have put in? Is the expected future appreciation contingent on private equity being willing to put in more money, or what drives the confidence that you're going to get more of that back?

25:09 Sure. So let's go back and let's put it in context. So at 331, we had write-downs that were the result of multiple factors. One was a degree of spread widening, market-wide spread widening. that resulted from COVID-related uncertainty. And the second was an expectation that lockdowns and COVID impacts were going to negatively affect credit quite apart from spread. So we think about these, it's hard to disentangle the two of them, one from the other, but there were two key elements to it. One was spread-related and one was credit-related. And here we sit and it's We've got a lot more information than the market had at that time about what the impact of COVID is going to be and how companies were going to perform.

26:07 And two things have happened. One is that spreads have narrowed as markets generally have recovered significantly from the March timeframe. and the second is that in specific respect of our portfolio, we've seen better than expected performance. And we talked about how we saw meaningfully better than expected performance when we were talking about the June 30th quarter and you've heard me again talk about in the September 30th. Why have we seen that better than expected performance? are a variety of reasons.

26:53 One element is good underwriting. A second element is management teams have been very adept at pivoting, cutting costs, finding new revenue sources, managing their companies to be meaningfully profitable and cash generative despite challenges. A third element, and you alluded to this, is that sponsors have stepped up, and we've seen very significant support from sponsors, sometimes in the form of advice and counsel, sometimes in the form of operating executives who've been parachuted in, and sometimes in the form of equity infusions. I think it's challenging to try to dissect which degree of equity Improvement in valuations, unrealized gains stems from which of these different threads that I just described. The good news, Robert, is that all of them are continuing with significant momentum. What do I mean by that?

28:02 Well, we're continuing to see the economy perform better than I expected. We're continuing to see management teams and many more. We've got a variety of different potential sources of risk. to keep realized losses low and to sustain some continuing unrealized gains.

29:15 I appreciate that. Thank you. In fact, one more quick question. Your comments sound like you're a lot more optimistic about 2021 than you are. We are now in December. There's one month of the year left to go. I mean, what's the The activity level clearly, I think, started to ramp up into this fourth calendar quarter. I mean, what are you just seeing in terms of activity or is, when you talk about the M&A market being muted in terms of, is that closings? Is that activity? Are people just not in a hurry now and, you know, less worried about closings? Thanks for joining us.

30:23 anywhere, even in sectors that were less COVID impacted. In calendar Q3, we started to see some comeback, particularly in less COVID impacted sectors, including software, including some elements of health care. And you can see in the reported results that we discussed today, a meaningfully higher level of new originations in the quarter ended September 30th and the quarter ended June 30th. I anticipate that the quarter ended December 31st. We'll continue that trend. We'll see more improvement. We'll see a higher level of originations in calendar Q4 than we saw in calendar Q3. And we're seeing that more broadly. In other words, it's not just software and a few niches within healthcare. It's broader than that.

31:18 But if you compared activity in calendar Q420 to calendar Q419, calendar Q420 is muted relative to calendar Q419. And I think it's going to be into 2021 until we start seeing year-over-year increases in M&A activity and new origination activity. The key factor is going to be very simple. It's going to be reduced uncertainty related to COVID.

31:52 Understood. Thank you. Our next question is coming from the line of Ryan Lynch with KBW. Please go ahead.

32:03 Hey, good morning. Thanks for taking my questions. First one I just want to touch on. You mentioned you had one default in the quarter and restructuring. Was that Rubio Restaurants or what portfolio company was that related to?

32:20 So Rubio's is a default. It is currently in bankruptcy. We are working with the company and the sponsor on restructuring of the company so that it can emerge from bankruptcy and do well again. And I think it's, as a company, in good shape to be able to do that. The other company that I think you're alluding to, which is a calendar Q3 event, is a dental practice company called Elite Dental, where we also did a consensual restructuring with the sponsor, as part of which we reduced the amount of debt on the company, and we took an equity stake.

33:09 Okay, perfect. And then, you know...

33:13 You kind of touched on this earlier and you mentioned in your presentation, but you executed 90 plus credit enhancing amendments since COVID with a focus on some of these most impacted COVID-19 impacted subsectors. Just from a higher level, You know, when you are looking to make a credit amendment to a company, and I know every situation is general, but maybe could you just walk through kind of the priorities that you look at? Are you guys looking at to get higher spreads, more fees, tighter guardrails around your covenants? And what are you most wanting in return from the private equity sponsors?

34:05 It is hard to generalize.

34:10 I think your introduction to your question is right. It's hard to give you a single answer to that question. Our key priority, and I think I've been very clear about this, our key priority is to minimize realized credit losses. So if you were to rank order the things that are important to us, the first and most important thing of all things to us is help us avoid losing money. Beyond that, it's very much situation specific. And we look at all the facts and circumstances in a particular borrower and assess what's most important to us and what's most important to the sponsor and the company and seek to create a win-win solution.

35:05 Sure. Okay. And then I just had one last one regarding the unsecured notes issuance. First off, congratulations on the investment grade rating and that note issuance. That was a very attractive rate. Just as you sit here today, your balance sheet looks to be in very good shape, very low leverage, some pretty good diversity at this point. But just looking forward, it looks like you have about 20% of your liability structure in unsecured notes today. Is that kind of a level that you guys want to run going forward, or would you guys like to increase that, or is it more just going to be kind of an opportunistic approach to when the market opens up and has very attractive rates, you guys will like to tap the unsecured market for more?

36:05 I'd say somewhere between two and three. So yes, we would like over time to have a higher proportion of our debt in the form of unsecured notes. And yes, we're going to be opportunistic and thoughtful about when we go to market because we think that cost of liabilities is a critical competitive advantage. And we think it's one of the most important things we can manage.

36:34 Okay, that's all from me. I appreciate the time today. Our next question is from the line of John Kemmerer with Ziki Capital. Please go ahead.

36:47 Hi, this is John. My question is a response to the Fed talking about the LIBOR phase-out yesterday. Just curious when we might see your first loan with a non-LIBOR benchmark and then So a related question, maybe you could just summarize for me the overall impact on your operations of this change.

37:11 Sure. So as I think everybody on this call probably knows, there's an industry-wide effort underway to shift from live work to a new standard for floating rate loans known as SOFR. We serve on the LSTA, that's the Industry Trade Association, the Loan Syndication Trading Association, the LSTA's special committee on LIBOR transition, and our expectation is that the LIBOR transition to SOFR is not going to be particularly eventful. Internally, we have a number of working groups making sure that we have the appropriate Thank you very much.

38:23 We're in the work and preparation phase right now. Got it. So is there a timeline when you might originate the first loan with the new benchmark? I think the loans are going to have a LIBOR language with what's called fallback language, which means a specified language that shows what happens when LIBOR is removed. And we're starting to see that fallback language in credit agreements now. Okay. Thank you. There are no further questions at this time.

39:12 Great. Well, I want to thank everyone once again for tuning in for this quarter's call. I look forward to speaking to you all next quarter. And as always, if you have any questions before then, please feel free to up to any of us. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.