Q3 2022 Golub Capital Bdc Inc Earnings Call
Hello, everyone and welcome to the G. Bdcs June 30th 2022 quarterly earnings 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 <unk> SEC filings.
For materials, we intend to refer to on today's call. Please visit the investor resources tab on the homepage of our website, which is www dot Golub capital BDC Dot com and click on the events presentation link.
Our earnings release is also available on our website in the Investor resources section.
As a reminder, this call is being recorded.
I'm pleased to turn the call over to David Golub CEO of G. B D C. David.
Thanks, John Hello, everybody and thanks for joining us today I'm joined by Chris Harrison, Our Chief Financial Officer, Gregory Robbins, Senior managing director and Jon Simmons managing director at Golub capital.
Yesterday, we issued our earnings press release for the quarter ended June 30, and we posted an earnings presentation on our website will be referring to this presentation through the call today.
For those of you who are needed to <unk>, our investment strategy is and then.
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 with the headlines for this quarter. The headline is the GBP six results were fundamentally solid.
Quite a major downdraft in credit and equity markets and despite a volatile and uncertain economic environment.
Do you really see as borrowers continue to perform well realize losses remained low and net investment income stayed strong.
Unrealized losses, primarily due to spread widening did impact results. We believe these unrealized losses are in general not due to fundamental credit issues and the likely to reverse over time.
We remain focused as usual on minimizing realized credit losses.
For the quarter ended June 30th adjusted NII was 34 cents adjusted net realized and unrealized loss per share was <unk> 25, and adjusted EPS was nine cents during the quarter Jimmy D. C made a quarterly distribution of <unk> 30 per share and ending NAV was $15 14 per share a decline of <unk>.
One 4% quarter over quarter.
For comparison, the leveraged loan index declined four 5% in Q2, the high yield index declined nine 8% in the S&P 500 declined 16, 1%.
We believe the relatively modest decline in G. Bdcs NAV reflects the resilience of our investment strategy and importantly, we expect a decline in that to reverse in future quarters.
Now I'll hand, the Florida, Gregory John and Chris to elaborate on <unk> performance for the quarter ended June 30th and after that I'll provide some commentary on the investment environment and what we see coming from here then I'll open the line for questions.
Gregory over to you.
Thank you David.
I'm going to begin on slide six which highlights several key themes that played out in the quarter ended June 30th and how they specifically relate to GBT sake.
The first theme is strong portfolio performance.
Despite the down draft in equity and credit markets and the slowdown in the U S economy, generally golub capital portfolio companies continue to perform well.
This is reflected in our strong credit results of our borrowers including stable internal performance ratings.
Low non accruals and low net realized losses.
We'll take a closer look at the data later in this presentation.
The second theme is rising base rates.
Short term interest rates increased meaningfully during the quarter as the U S. Federal reserve look to address high inflation.
G. B D C will be able to take advantage of the higher interest rate environment and got some benefit in the quarter.
Nearly all of GBT sees investments are floating rate, while only about 25% of its funding sources are floating rate.
Bear in mind that base rates for different loans reset with a lag. So we haven't yet seen the full benefit of a higher base rates across the portfolio.
We believe GBT see will continue to benefit as higher base rates are fully realized in future quarters.
The third theme is unrealized losses.
Market uncertainty and higher interest rates caused credit spreads to widen across nearly all classes of credit.
This resulted in net unrealized losses for G. B D C and I wanted to emphasize the word unrealized.
Hey, David mentioned earlier, we believe fundamental credit issues remain rare and that these unrealized losses will likely reverse over time.
Lastly, golub capital's origination was solid and consistent with our activity in the second calendar quarter of 2021.
We continue to benefit from our strong sponsor relationships incumbencies roughly.
Roughly 90% of our originations in Q2 was with repeat sponsors.
Over 50% was with repeat borrowers.
Moving on to slide seven this slide provides a bridge from Jbt's seeds, $15 35, snapper share as a $3 31, which decreased $15 14 NAV per share as of 630 <unk>.
Walk through the bridge.
Adjusted NII per share was 34 cents dip.
Dividends per share paid during the quarter with 30 <unk>.
And adjusted net realized and unrealized losses per share were <unk> 25 shops.
We have spoken about this in the past, but we are firm believers that golub capital should be strongly aligned with key BDC stockholders.
We have created this alignment in multiple ways.
First store fee structure, which is both the highest incentive fee hurdle rate in the industry.
Since inception cumulative look back on our incentive fee.
We're only one of a limited number of Bdcs to have this type of a lifetime look back.
Second we have also sought to maintain strong insider ownership of <unk> stock.
On this last point I want to mention that during the three months ended June 30th at Golub Capital employee Grant program Rabbi Trust purchased approximately $11 $5 million.
Over 800000 shares of our common stock for the purpose of awarding incentive compensation to employees about capital.
Through the first two calendar quarters of 2022.
<unk> purchased $23 $2 million or over one 6 million shares of our common stock.
For that let me hand, the call over to John Simmons to walk you through the results in more detail John .
Thanks Gregory.
Slide nine summarizes our results for the June 30 quarter, which are shown in the column on the far right as well as over the last several quarters.
Moving to slide 10, new investment commitments totaled $449 $6 million for the quarter.
After factoring in total exits and sales of investments of $171 $2 million as well as net changes in fair value and other portfolio activity total investments at fair value increased by three 5% or $187.4 million during the quarter.
Also as of June 30, we had $42 $9 million of Undrawn revolver commitments.
And $225 $7 million of Undrawn commitments on delayed draw term loans.
Each of these unfunded commitments are relatively small in the context of G bdc's balance sheet and liquidity position.
The table at the bottom of the slide shows that the weighted average rate on new investments increased meaningfully quarter over quarter due to rising base rates, while the spread over the applicable base rates on new investments remain consistent.
Slide 11 shows that GBT CS overall portfolio mix by investment type remained consistent quarter over quarter with one stop loans continuing to represent over 80% of the portfolio at fair value.
Slide 12 shows that G. Bdc's portfolio remained highly diversified by obligor.
With an average investment size of approximately 30 basis points.
As of June 30th 94% of our investment portfolio was comprised of first lien senior secured floating rate loans and defensively positioned in what we believe to be resilient industries.
Turning to slide 13, this graph summarizes trends in our portfolio yields and net investment spreads.
Focusing first on the light Blue line.
This line represents the income yield or the actual amount earned on our investments, including interest and fee income, but excluding the amortization of upfront origination fees and purchase price premium.
The income yield increased by 20 basis points to seven 1% for the quarter ended June 30th.
The investment income yield or the dark Blue line, which includes the amortization of fees and discounts.
Also increased by 20 basis points to seven 5% during the quarter.
During the quarter ended June 30th repayments increased from an unusually low level in the prior quarter, which resulted in an increase in fee income and amortization of origination fees.
Our weighted average cost of debt, which is the Aqua Blue line increased by 20 basis points to 3%.
And our net investment spread the Green line, which is the difference between the investment income yield and the weighted average cost of debt.
Mean flat at four 5%.
The majority of our investment portfolio have base rate contracts that reset during the last month of the quarter.
So as a result of that we expect the continued rise in base rates will be a positive for G bdc's portfolio yield.
Starting next quarter.
With that I'll hand, the call over to Chris to continue the discussion of our quarterly results Chris.
Thanks, John .
Flipping to the next two slides nonaccrual investments as a percentage of total debt investments at cost and fair value stayed consistent at one 5% and one 1% respectively as of June 30th.
There were eight nonaccrual investments at quarter end, one of which was repaid with a full recovery of prior subsequent to quarter end.
Overall fundamental credit quality remains strong and stable with over 90% of the investments in our portfolio, having an internal performance rating of four or higher as of June 30th.
As a reminder, independent valuation firms value at least 25% of our investments each quarter.
Slide 16, and 17 provide further details on our balance sheet and income statement as of and for the three months ended June 30th.
Turning to slide 18, the graph on the top summarizes our quarterly returns on 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.
Turning to slide 19, this graph illustrates our long history of strong shareholder returns since our IPO.
As illustrated investors in <unk> 2010, IPO have achieved a nine 9% IRR on NAV since inception.
Slide 20 summarizes our liquidity and investment capacity as of June 30th which remained strong with over $700 million of capital available through cash restricted cash and availability in our various credit facilities.
Slide 21 summarizes the terms of our debt facilities as of June 30th.
Slide 22 summarizes our recent distributions to stockholders.
<unk>, our board declared a quarterly distribution of <unk> 30 per share payable on September 29, 2022 to stockholders of record as of September 2nd 2022.
And with that I will turn it over to David for some closing remarks David.
Thanks, Chris to wrap up we believe <unk> demonstrated its resiliency this quarter our portfolio companies continue to perform well realized losses were low and while we saw some unrealized losses. They were generally the result of market wide spread widening and not from fundamental credit deterioration.
Let's talk briefly about our outlook before I open the line for questions.
Headline is wearing confusing times and this is exactly the kind of environment, where <unk> is poised to outperform.
Let me start with why I think we're confusing times theyre, an unusual number of powerful vectors right now affecting the economy. Many of them don't have precedent and there are occurring at the same time and pushing in different directions, let's start by looking at what I'll call. The bad vectors, we're experiencing high inflation rising interest rates quantitate.
Tightening and declining fiscal stimulus.
At the same time there are also some powerful positive forces very low unemployment.
Healthy consumer balance sheets momentum from a sustained period of high revenue and profit growth and in most sectors low durable goods inventories. Thank you supply chain problems.
So where are we going from here some people sell confident but I think the intellectually honest answer is we don't know.
The truth is there's no historical period that we can cite as a good parallel for what we're experiencing right now.
And the collection of characteristics that were that I just went through they don't book reminiscent of a traditional economic downturn, where the precursors of a traditional economic downturn.
So in this context, we think the prudent approach is to prepare for a variety of potential scenarios and to seek investment strategies that can be resilient across a wide range of them I wanted to elaborate on some of the key factors that we think make <unk> strategy resilient.
If inflation remains elevated.
The impact of inflation on G. Bdc's portfolio is going to be muted, we focus on lending to market leaders in resilient industries that have strong competitive advantages limited substitutes in other words the companies that we lend you typically have pricing power that enables them to paas higher costs through to their customers.
If interest rates continue to rise <unk> stands to benefit given its asset sensitive balance sheet nearly all of <unk> investments are floating rate, while roughly three quarters of its funding sources are our equity your low cost fixed rate debt.
As interest rates for our borrowers reset it at prevailing base rates, we think <unk> will capture more and more benefits of higher short term rates at the same time key bdc's portfolio companies can generally bear higher interest expense without much impact on default rates.
If theres, a sustained economic slowdown or even a recession G. Bdc's portfolio is positioned conservatively the portfolios predominantly first lien first out floating rate senior secured loans to companies in resilient industries with minimal exposure to cyclical industries like energy or real estate.
In fact, the monthly economies fine for our strategy, our borrowers don't need rapid growth to be able to pay us back.
We focus so far in GBT cease resilience to the risks and uncertainties in today's environment, but there is a important positive sides of the story the same risks and uncertainties create opportunities I want to highlight three of those opportunities.
First as investors look for safety amidst the uncertain environment. The odds are that the BSL and high yield markets are going to remain volatile. This makes the reliability and the simplicity of golub capitals financing solutions, particularly valuable to sponsors.
Second the environment has improved market conditions for direct lenders are world has gotten more lender friendly we've been pleased in recent weeks to see spreads terms and leverage getting more favorable across our sponsor finance business from the small into the larger it.
Finally, our incumbencies are particularly valuable in this environment.
Our experienced market volatility tends to drive M&A activity from new deals from new logos to adults, we love doing add ons for borrowers that we know well and.
That we're in the pole position to win incremental business for us.
In short we are cautiously optimistic about <unk> prospects in this uncertain environment, we see a lot of opportunity going forward and <unk> conservative portfolio and rock solid balance sheet should enable the company to play offense during this coming period.
With that operator, please open the line for questions.
To ask a question. Please press star one on your telephone keypad.
First question is from Finian O'shea of Wells Fargo Securities. Please go ahead. Your line is open.
Hi, everyone. Good morning.
First question on.
Looking at origination it was strong this quarter it sounds like the outlook is good.
But of course.
The the credit look back ticks down.
What would be your incentive fee.
Sort of a modeling question here really are are you effectively approaching or above your high hurdle.
What to model, there and and if so.
What would we do.
Expect for.
Perhaps supplemental dividends retained earnings or whatnot.
Sort of a two part question so I'll stop there.
Sure so.
As we look thin at the future.
There are a number of elements that.
Point to higher earnings.
We talked about several of these in our prepared remarks.
One is higher base rates and I think Jonathan Gregory both made this point in their remarks.
Important enough to reiterate.
The calendar Q2 results that we just discussed don't really reflect the full benefit or even most of the benefit of higher base rates because our borrowers generally did not see resets in their loans until either late in.
Quarter, or perhaps not even at the time of the end of the quarter. So we think we're going to see meaningful improvement in net investment income in the coming quarters as a consequence of the lag effect of increases in base rates that have already taken place and then they are.
Further increases that are that are embedded in the forward curve.
Second element.
Which is important relates to.
Let's.
Slipped.
Page 13 of the presentation.
If you think about what's going to happen to the.
Teal line with the the triangles, which is our weighted average cost of debt, it's going to move up meaningfully more slowly.
Then the income yield bond because 46% of our debt is fixed rate.
And has an average cost of about two 8%.
I think thats, either the lowest or among the lowest in the BDC industry.
So we have one benefit our assets are going to be generating more interest income we have a second benefit our liability structure is.
Asset is asset sensitive it has a very significant fixed rate component to it.
Third.
Tailwind is that spreads are improving.
Now this doesn't impact results right away it doesn't impacted in one quarter or even two quarters because.
You need time for the portfolio to turnover.
But we are seeing a more lender friendly environment right now and as a consequence, we're seeing higher spreads on many of the new loans that we're making I'd also add a bit of a caution on this.
In that while I anticipate new originations going to be okay in the coming period.
We are seeing a more generalized slowdown in deal activity in Q3, and my expectation is that's going to continue into Q4 as a result of the decline in equity markets and the more challenging.
That environment for new deals.
So so I think there are a number of sources of improvement.
In earnings power than that.
All play a role here I'm not prepared to give you guidance right now on where I think this is going to shake out.
But I think the direction is clearly improving.
Yes, that's helpful.
Did I Miss the interest rate part in there so that's helpful.
Helpful as well.
I guess, a second question I'll admit to.
David I have this is a bit the question for me is tiring a little bit I've asked for a few quarters on the technology topic.
In the Gulf of Bolton Index, you put out.
It is showing slower.
Revenue and earnings revenue is still very good earnings still positive but.
Seeing a slower trend there.
A high level you can give on on the tech side.
The portfolio or if theyre facing headwinds or if this was.
This was anticipated and underwriting.
So sure by way of context again for those who may not be so familiar with it golub capital publishes on a quarterly basis in <unk>.
An index called the Golub capital Altman index that.
Details the median company in our portfolio's growth in revenues and in EBITDA and it also provides a breakout by sector and what fin is referencing is if you look at the the Golub capital Middle market index over recent quarters. The most recent quarter showed sustained good salt.
Should growth across the portfolio and revenues, but slower growth in EBITDA, reflecting some margin compression that I think is largely attributable to inflation.
And if you look specifically at the technology sector.
You see.
Our rate of revenue growth, while still double digit while still attractive it's lower than it's been in prior quarters and and we are starting to see the same margin compression the same slower EBITDA growth in technology that we've seen in other sectors.
I think this is broadly reflective of market conditions generally.
Our technology portfolio remains very strong from a credit perspective, and we remain very confident and comfortable with our technology exposures I do think there is a market change Finn.
In spaces within technology that we're not players so spaces in technology like streaming services and consumer oriented web.
Web platforms.
<unk> seen very significant slowdowns in demand.
And.
In the public markets very sharp decreases in equity prices.
Those are not sectors that we play and we are very focused on <unk>.
Backing companies in the sector that are.
Mission critical business to business software providers.
And what we're seeing is is.
Continued resilient demand for the products and services of these companies.
One reason I think is that as all companies are looking to become more efficient to keep costs under control in an inflationary environment.
Labor, reducing software products are actually.
<unk> compelling part of that solution.
So.
Im.
We remain quite optimistic about our our software portfolio, we're not seeing additions to the watch list in two.
<unk>.
Our non accrual assets from from that sector and I don't expect to.
Thank you again.
Just one small bonus question looking at my notes here, Chris mentioned I think.
A post quarter repay was that in the was that part of our non accrual or.
Our underperforming or can you remind us of that Chris the context in which you mentioned that the first quarter repay.
Sure.
Flip to.
<unk>.
The page that details our non accruals, which is on page 14.
We had at quarter end $62 million at fair value of non accrual investments that included.
$3 9 million position in a company called paradigm, which paid off in full shortly after quarter end. This is actually a great Golub capital story.
We made this low number of years ago. It underperformed, we ultimately reached an agreement with the sponsor to.
Take control over the company.
And worked with.
New management New board.
To.
Improve the company's operations and recently.
Company went through a sale process and was purchased by a strategic competitor.
I think it's very reflective of our.
Skills and talents and managing.
<unk> credits that we were able to get a very good outcome here.
Very good thank you so much.
Your next question is from Paul Johnson of K B W. <unk>. Please go ahead your line is open.
Good morning.
Thanks for taking my questions.
One of my questions actually answered from what it thins questions but.
I'm just wondering as you mentioned that your pipeline is just kind of slow here in recent quarters, but here more recently in the last six months or so we've seen.
A significant turn in sentiment on the equity markets and perhaps.
Getting the worst of the recession or or.
Correctly discounting a mild recession, but how quickly.
Does that type of turn in sentiment usually define kind of take to see back into I guess the.
Market sponsors and the sentiment that you find in on.
The sponsors as you work with.
Yes, it's a great question. If you look at Q2 overall deal volume in the industry was down in Q2, our origination at Golub capital was actually up year over year in the second quarter of 'twenty, one was a record quarter for us. So it was quite a strong.
Quarter, the second calendar quarter of 'twenty two.
As I look forward into the current quarter and the rest of the year.
I do think we're currently being impacted by the.
The market downdraft that we saw in both both equity and credit markets in the late part of calendar Q2.
And.
I think even with the sentiment shift that you're quite correctly pointing out that we've seen over the last couple of weeks.
I think we're still seeing relatively slow new deal.
New deal volume.
We will be fine at Golub capital. During this period, we have an enormous proportion of our new originations in any quarter coming from add ons, it's been running 50% to 60%.
For for the last almost 10 years, so we're well positioned for an environment like this I think firms that are more focused and more dependent on new are going to be more impacted by this.
When will that new deal environment start to strengthen I think that's a great question and it's really hard to say.
Clearly the recent improvement in sentiment is that help.
But it's August right now that tends to be a seasonal low.
Credit markets are are are still.
Choppy, particularly the broadly syndicated and high yield markets.
So I think its reasonably likely that we're going to see.
<unk>.
Lower than normal deal activity into the fall.
Okay.
Thanks for that David I appreciate that's a great answer.
And I guess in addition to that I mean have you.
<unk> seen.
Particularly in this last quarter here in the second quarter have you experienced any sort of benefit from I guess broken.
Yes, potentially broken bank deals or any sort of syndicated deal that.
I just didn't quite work out at some point during the market volatility in the.
In the second quarter that you were able to potentially capitalize on.
So.
Great question, we're often asked what's the relationship between the middle market.
The broadly syndicated loan market.
The answer is that while on the one hand, there are different markets. They are distinct markets on the other hand.
It was influenced by the other and so if you look at what happened in calendar Q2 late in the quarter, we saw significant downward movement in broadly syndicated loan secondary prices and we saw a rangers in the broadly syndicated market.
Have more difficulty placing deals unless they increased spreads or increased OID.
Now what happened is what typically happens and what I mean by that is.
In the immediate term the direct lending market didn't move nearly as much.
And there was a lag before you started to see spread widening and more favorable terms start to start to appear in direct lending deals.
But they did they did start to appear and they have continued to move in what I would characterize as a lender friendly direction.
As we push the calendar into calendar Q3.
No.
All of us in the direct lending industry have been beneficiaries of the.
The moves in the market in the in the broadly syndicated space.
And I think.
The relationship between the two will probably continue to be one where the.
Direct lending spaces is insulated, but not immune.
From what's happening in the BSL market and what's happening in the BSL market tends to occur in the direct lending market with a lag.
Got it I appreciate it I appreciate those answers and thanks for taking my questions and congrats on a great quarter.
Thank you.
Your next question is from Robert Dodd of Raymond James. Please go ahead. Your line is open.
Hi, David Hi, guys.
Just really.
Following on to that question I mean GOP David.
David in the prepared remarks, you talked about your spread widening which is ongoing in the private private credit markets.
But now obviously and it tends to lag the BSL market in the BSL market.
Titan trading spreads and origination still as you say choppy and salt.
But trading spreads seem to be tightened.
Tightening back up with with half of the second quarter whitening White cap, so far I think in this quarter.
To your point with the direct space lending space.
Yes kind of.
It moves in the same direction as the BSL market with a lag.
With your comment about spread widening and the benefit of that.
Do you think thats going to stick do you think direct lenders.
The light a little bit or is it more just just purely a lag.
If the BSL market does tightened back up and get more active again.
Is the current spread widening environment, just kind of went back to that.
Got it.
Again, great Great question, Robert and one when I'm not sure I can give you an answer to that that I have a lot of confidence and I think it depends on a lot of factors, including new inflation numbers that come out including.
New new indicators of how the economy is doing.
Including funds flows in the broadly syndicated market. So there are enormous number of factors that I think are going to influence the answer to your question.
What I can tell you right now is there does it.
The market today feels meaningfully more lender friendly than three months ago, and I don't see pressure right now that's pushing Chris.
Pushing the pendulum back toward a more borrower friendly environment.
Sure.
Factors that would cause that to happen would include.
Continued improvement in economic data coming out and in sentiment.
Alright.
Alright.
She just thoughts I realize it.
Sure.
Tough question, let's just call it tough question.
Follow up if I can go.
Going back to the Ultimate Index <unk>.
Technology still growing consumer still growing in.
Maybe surprisingly still growing earnings.
In the second quarter, but healthcare did see a decline.
And EBITDA.
Revenues.
Is that.
That's the second largest sector within within your portfolio that healthcare I think that's the other.
Software and I think that's the biggest piece of software.
Is there any anything any color you can give us on I mean is that is that labor costs.
Or any color you can give us about what's what's.
Going on in the health care market and why that's underperforming the other the consumer industrials and technology segments and development index by a fellow materials on that.
Okay.
A couple of points I'd make one I think youre right that.
Pressure on labor cost has been part of the reason for healthcare company margin compression.
I think a second element is that.
In many cases health care companies need a bit more time to adjust their pricing and have their new pricing, reflecting inflationary pressures than companies in other sectors. So.
So imagine for example that you're reliant on contracts with insurance companies those insurance company contracts don't get reset on a month to month basis.
Or imagine that we're looking at the services that are.
Reimbursed under Medicare again, those are not rates that are reset on a monthly basis.
So I think they are there.
There are a large number of factors I think in many cases healthcare companies saw maybe unusually high margins in the immediate bounce back post Covid period, and now we're seeing some normalization.
But I think the probably most important factors relate to labor costs and lags in in revenues adjusting to inflationary pressures.
Thank you I appreciate that.
There are no further questions at this time I will now turn the call over to David Collins for closing remarks.
So thanks again for joining us today very much appreciate the opportunity to give you an update on the Golub capital story.
As always should you have any questions before we get together next quarter. Please feel please feel free to reach out to me or to where to Chris.
We'd be happy to answer more questions.
This concludes today's conference call. Thank you for your participation you may now disconnect.
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