Goldman Sachs BDC, Inc. (GSBD) Q2 2018 Earnings Report, Transcript and Summary

Good morning. This is Ian, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. Second Quarter 2018 Earnings Conference Call. Please note that all participants will be in listen-only mode till the end of the call, when we'll open up the line for questions. I will now turn the call over to Ms. Katherine Schneider, Head of Investor Relations at Goldman Sachs BDC. Katherine, you may begin your conference.

Thanks, Ian. Good morning, everyone. Before we begin today’s call, I would like to remind our listeners that today's remarks may include forward-looking statements. These statements represent the company's belief regarding future events that, by their nature, are uncertain and outside of the company's control. The company's actual results and financial condition may differ, possibly materially, from what is indicated in those forward-looking statements as a result of a number of factors, including those described from time to time in the company's SEC filings. This audio cast is copyright material of Goldman Sachs BDC, Inc. and may not be duplicated, reproduced or rebroadcast without our consent. Yesterday, after the market closed, the company issued an earnings press release and posted a supplemental earnings presentation both of which can be found on the home page of our website www.goldmansachsbdc.com under the Investor Resources section. The documents should be reviewed in conjunction with the company’s Form 10Q filed yesterday with the SEC. This conference call is being recorded today, August 3, 2018, for replay purposes. With that I'll turn the call over to Brendan McGovern, Chief Executive Officer of Goldman Sachs BDC.

Thank you, Katherine. Good morning, everyone, and thank you for joining us for our second quarter earnings conference call. We’re pleased to report another strong quarter for our shareholders. Net investment income per share was $0.50 in Q2, which equates to an 11.1% annualized return on book value. In addition, our board declared a $0.45 per share dividend payable to shareholders of record on September 28. I would like to highlight that including this most recent quarter, net investment income has now exceeded our dividend for each of the 12 quarters, reflecting the consistency of performance we strive for on behalf for our shareholders. In addition to delivering strong operating performance, we been working hard behind the scenes on matters that will lay the ground work for future performance. Specifically, during the quarter, we received shareholder approval to reduce the minimum asset coverage requirement to 150%, which is often referred in the industry as raising the maximum permitted debt to equity ratio to 2 to 1. Importantly, we received an overwhelmingly positive response for shareholders on this important proposal. Over 75% of our shareholders attended meeting in person or by proxy, and of those who voted, 95% voted in favor of the proposal. We’re gratified by strong endorsement, and we look forward to working on your behalf to deliver strong results under the changing regulatory framework. As a reminder, the management fee payable to GSAM was reduced from 1.5% to 1% of gross assets, beginning on the date we received shareholder approval. As we discussed in detail last quarter, we believe that the added balance sheet flexibility provided by the reduced asset coverage requirement, combined with lower management fee, will allowed to pursue a broader range of assets, while potentially increasing returns on shareholder equity. Any use of additional leverage will continue to be governed by prudent risk management practices, which we believe are our core competency of Goldman Sachs. These practices will help to ensure that our balance sheet leverage appropriately considers the underlying risk profile of our assets in a dynamic environment. We are also pleased that during the quarter, we received an investment-grade rating with the stable outlook from Fitch. Subsequent to quarter end, we issued $40 million in principal amount of 4.5% convertible notes due 2022 an add-on to our existing convertible notes. The add-on demonstrates our access to the institutional unsecured debt capital markets on attractive terms and further augments our mix of funding sources. Moreover, we are engaged in constructive dialogue with the bank lenders on amending the terms of our existing credit facility, and we have been approached by a number of other providers of financing often capital. We look forward to keep you posted as we carefully consider terms and structures for financing going forward. With that, let me turn it over to Jon Yoder.

Thanks, Brendan. During the second quarter, we continued to see strong demand for credit in the middle market, driven primarily by continued activity from private equity sponsors. While the market to provide capital remains competitive, we are focused on maintaining appropriate underwriting discipline and focusing on what we believe are higher-quality companies. There continue to be many attractive elements of lending to middle-market-size companies in the U.S. Mainly, the accelerating growth in gross domestic product in very low unemployment rates are providing very good operating backdrop to our portfolio companies. The increase in LIBOR that we’ve experienced in recent quarters is offsetting pressures on credit spreads. Strong equity markets are supporting higher enterprise values for the companies that we lend and which served as the primary source of our collateral, resulting in loan-to-value ratios trending lower. But notwithstanding the positive environment that we are currently experiencing, we do not lose sight of the fact that economies will cycle rates will cycle, rates will move and markets will fluctuate. Furthermore, the duration of our loans is likely to be longer than the current positive environment. As a result, we continue to maintain a cautious approach to asset selection and continue to focus on companies that we believe are in more durable sectors that are less prone to cyclicality. One new investment to highlight this quarter is a loan in equity investment that we made to a company called Accuity Delivery Systems. This is a company that we resource through our PWM network in which we track for several years before making the investment. Accuity is a revenue cycle management business that serves hospital systems and focuses on improving clinical documentation processes. The company is a strong value proposition in its ability to capture foregone revenue for hospitals at meaningful and measurable ROIs. We’ve structured a first-lien loan at L + 700 basis points that we believe has attractive characteristics, including the comparatively modest leverage ratio in the low loan-to-value. Furthermore, our loan is supported by the company's contracted revenue business model and in a blue-chip customer base. Alongside this loan, we also need a small equity investment which restructured with downside protection, including the liquidation preference and a minimum return. We believe that this investment in a good example of the importance of a strong origination network to find attractive deals even during the competitive environment and middle market learners are currently experiencing. During the quarter, we were also able to harvest some older investments at attractive levels. As an example, we exited our second-lien position in Global Tel*Link. Some of our longstanding investors may recall that we mark this position as low as 60% of par in December of 2015, after a regulatory change was announced that many investors feared could have a meaningful impact to the company. While we marked the position lower to reflect this risk, we believe that the company was positioned to navigate through the change in regulations. Our view was ultimately proven correct as the company made the necessary adjustments to its business strategy, and we were able to sell our remaining position at par. Turning to some specifics for the quarter. New investment commitments and findings were $92.6 million and $58.9 million, respectively. Regarding placement in the capital structure, our new originations this quarter will comprise of 94% senior secured loans, including 85% in first-lien loans, 9% in second-lien loans and 6% in preferred and common equity. These new investment commitments were cross-selling new portfolio companies and four existing portfolio companies. Sales and repayment activity totaled $79.6 million, driven primarily by the full repayment of investments in three portfolio companies and the sale of investment of investment in one portfolio company. During the quarter, the yield on our investment portfolio was relatively steady. The weighted average yield of our investment portfolio at cost at the end of the second quarter was 10.9% as compared to 11.1% at the end of the first quarter. Regarding portfolio composition. At the end of the second quarter, the total investments in our portfolio were $1,237,000,000 at fair value and they were comprised of almost 89% senior secured loans, including 36.2% in first lien, 16.6% in first lien/last-out Unitranche and 36.1% in second-lien debt, as well as 0.5% in unsecured debt, 3.1% in preferred and common stock and 7.5% in the senior credit fund. We also had $58.6 million of unfunded commitments as of June 30, bringing total investments and commitments to $1,295.9 million. We are pleased to increase the company's single-lien portfolio company diversity by 5% quarter-over-quarter and 31% year-over-year. As of quarter end, the company has 99 investments across 59 portfolio companies operating across 31 different sectors. Turning to credit quality. The weighted average net debt to EBITDA of the companies in our investment portfolio at quarter end was 5.2 times, reflecting stable performance in our portfolio companies quarter-over-quarter. The weighted average interest coverage of the companies in our portfolio was 2.2 times versus 2.3 times as of the end of the first quarter. The senior credit fund continues to be the company's largest investment at 7.5% of the company's total investment portfolio, and we've been very pleased with the performance of the investment since its inception. Over the trailing 12 months, the senior credit fund has produced 11% return on our invested capital at fair value. During the quarter, the senior credit funding had new originations of $60.8 million across five new companies. Sales and repayments were relatively muted at only $11.9 million, resulting in net funded portfolio growth of $43 million during the quarter. The total size of the portfolio as of quarter end was $490.5 million. And of into the second quarter, the weighted average yield at cost on investments in the senior credit fund was 7.6%, which was unchanged from the prior quarter. First lien loans comprise 97% of the total investment portfolio within the senior credit fund, and all of our investments are floating rate. The senior credit fund also remains well diversified with investments in 36 portfolio companies operating across 20 different industries. I will now turn the call over to Jonathan to walk through our financial results.

Thanks, Jon. We ended the second quarter of 2018 with total portfolio investments at fair value of $1,237,000,000, outstanding debt of $508 million and net assets of $726 million. Our net investment income per share was $0.50 as compared to $0.47 in the prior quarter. Earnings per share were $0.43 as compared to $0.46 in the prior quarter. During the quarter, our average debt-to-equity ratio was 0.72 times, which was unchanged from the previous quarter. We ended the second quarter with a debt-to-equity ratio of 0.7 times versus 0.73 times at the end of Q1. Turning to the income statement. Our total investment income for the second quarter was $37.2 million, which was up from $35.5 million last quarter. The increase quarter-over-quarter was primarily driven by higher interest income as a result of higher effective LIBOR resets on our investment portfolio in Q2 as well as higher prepayment-related income. Total expenses before taxes were $16.8 million for the second quarter as compared to $16.5 million in the prior quarter. Expenses were up quarter over quarter, primarily driven by an increase in interest expenses, also as a result of higher effective LIBOR resets on our borrowings and from other operating expenses, which is partially offset by a decrease in investment advisory fees. NAV stable quarter-over-quarter as we ended Q2 with net asset value per share at $18.08 versus $18.10 from the prior quarter. Our supplemental earnings presentation provides a NAV bridge to walk you through these changes. The company had $34.8 million in accumulated undistributed net investment income at quarter end, resulting from net investment income that has exceeded our dividend in prior quarters. This equates to $0.87 per share on current shares outstanding. As Brendan mentioned earlier, subsequent to quarter end, we closed on an issuance of $40 million in principal amount of 4.5% convertible notes due April 2022. These notes have identical terms that are part of the company's outstanding $115 million notional convertible notes. Net proceeds of the offerings were used to pay down a portion of the debt under our revolving credit facility. We were very pleased with this reopening as it allowed us to opportunistically increase our unsecured funding. With that, I will turn it back to Brendan.

Thanks, Jonathan. Overall, as I mentioned, we are pleased to have produced a strong quarter and first half of 2018 for our shareholders. We believe our execution this quarter in the face of dynamic regulatory and market conditions will position the company with increased flexibility, thereby enhancing opportunities to continue to deliver attractive returns for our shareholders. As always, we thank you for the privilege of managing your capital, and we were look forward to continue to work hard in your behalf over the remainder of the year. With that, Ian, let’s open it up for questions.

[Operator Instructions] And our first question comes from the line of Leslie Vandergrift from Raymond James.

Just a question on the senior credit loan, pretty good growth this quarter there. Some of the peers have already announced that they are shrinking their senior loan fund. What kind of outlook do you have there? And what is the credit environment look like for those loans right now? Are there seem to be moving away?

Leslie, Jon Yoder here. I guess what I would say is, on the senior credit fund, as we’ve talked about in prior quarters, we have slowed down sort of the growth. In fact we had some portfolio decline if you go back over the last two, three quarters prior to this quarter, and a large part of that was we’re looking at what the best options are across the market. And our view was for much of the past few quarters that sort of the upper middle market, which is really where the senior credit fund is focused was a little bit less attractive. There's a little bit more competition from CLOs and other types of vehicles that are focused more on the upper middle market. And so we didn’t want to force capital out, didn’t want to reduce the yields that we were getting on the assets that were already in the vehicle, and so we've – we kind of go to step back a little bit. This quarter, I would say -- I would say this quarter we saw a little bit of improvement in terms of the environment for deploying capital into that part of the market, especially in June, when we saw spreads widen a little bit for those types of loans. So we were able to grow the portfolio fully a little bit. But I would say, overall we’re are not -- there is no big strategic shift that we’re making. We still are pleased with the senior credit fund. It's been a great performer for us. It is our largest investment as we’ve talked about. And if we can find good opportunities, we will continue to deploy there. If we can’t, we’re fine letting the vehicle kind of produce returns as producing based on existing portfolio. So I wouldn't expect any major strategic shift in that portfolio.

Leslie, if you look back historically over how we've deployed capital here, it’s been thoughtful, it's been opportunistic. We’ve taken the balance sheet up and down as we have seen opportunities. That really a result of what we’re seeing on a micro basis. We talked about it often, but this is not simply a beta expression of the significantly leverage loan market, a relatively small pool capital where we’ve been able to find predominantly first-lien assets at pretty attractive yields within sort of the upper part of the middle market. So it's a relatively small and disciplined sandbox, if you will, where we’ve been looking for opportunities, and you can rest assure what continue to be thoughtful in this point as we do continue to deploy capital here. And I think when we look at the growth this quarter, it was really a reduction and repayments that primarily drove the increased balance, which I think is a reflection of a little bit of the market opportunity that, the market's offers that Jon described. So just like Jon said, no dramatic philosophical changes, and we will continue to be thoughtful and opportunistic with new opportunities there.

On balance sheet now, you have access – shareholders, like you said, overwhelmingly approved. You guy have begun using the increased term of leverage. Now what does that pipeline look like then so between co-investing with the other funds and your own investment? Now, over the next 12 months, are you looking at the same size of average EBITDA companies? Are you looking at same size -- hold sizes [indiscernible] there? What…

Again, we talked about a lot last quarter. That’s obviously a big change from regulatory perspective. I think the first order analysis that we as a team do is strategically in light of changing regulation what's the right to do. And we certainly think that the added flexibility by the reduced asset coverage ratio is a tremendous asset that we think as management team we should avail ourselves. So we took the step to get shareholder approval rather than board approval and just waiting a year to be able to implement the strategy. If it’s something good, we rather get that sooner rather than later. But recognize and sitting here today, there is still some work to do to be able to implement the leverage. We just got shareholder approval a couple of weeks ago. We continue to work with our financing providers to amend our credit facility to be able to incur the incremental debt, and we are hopeful. The discussions are constructive. We think there's a certainly financing available for us, given the strategy that we are pursuing. And so we will continue to leverage our capital base across the three different vehicles and co-invest in a similar fashion across the different vehicles based on those market opportunities. So no dramatic change that happens philosophically this vehicle versus the others. Again, I think when you look at this quarter, most of what we did, as Jon mentioned, was in more senior assets. I think 78% of what we did was first lien loans. We did a little bit of the last year unit tranche as well. That's a reflection of what we saw from bottoms-up perspective in the market. And that’s how we will always look at capital deployment opportunities. We may be sitting here a year from now and there is a lot of capital chasing with senior deals and there’s better opportunities away. So the most important thing to remember is the flexibility that we get by virtue of having the ability to shift our balance sheet. We have taken steps to do that, and now we are positioned really to be able to deploy in the right part of market, given market conditions.

And just the last modelling question. The spillover income at the end of the quarter, do you have that number?

We recorded that number as $0.87. It’s the $34.3 million I believe was the number I had in my prepared remarks.

And your next question is from the line of Fin O'Shea from Wells Fargo Securities.

My start out question for Mr. Lamm. Forgive me if this is in the public domain already, but can you provide an update on discussions with the credit facility providers? And to the extent that assuming we haven't heard anything thus far to the extent that more owner’s terms would be -- more tighter terms generally would be applied beyond one to one, are we seeing you move more into the unsecured market for financing?

We’re having very constructive dialogue with our lenders and certainly with respect to terms where we’re recently going back and forth if this is a change to go from 1-to-1 to 2-to-1 [ph] and there will be certain amendments to those terms. But as we look at a variety of at least early discussion items, we think that there is a very, very workable solution here to be achieved between us and our lenders. And frankly, the way that we think about risk management in levering our portfolio conforms very nicely with the way that the lenders do. So we don't anticipate having an issue there. But with respect to accessing the unsecured markets, we’re certainly going to continue to avail ourselves of opportunities to do that. When available, we’re very pleased with the Fitch rating that we received. And we’d be looking for both financing on the revolver as well as the unsecured markets on a go-forward basis.

The only thing I'd add there, Fin, is recognize and you appreciate, when the change in regulation happens, I think it's like the community by surprise and certainly we see managers by surprising terms of the speed with which it happened. And I think the lending community is in the same position. And as you know, historically they really underwritten in this space based on a very conservative regulatory cap, 1-to-1 debt. 50% loan-to-value against a pools of these assets. The battle testing portfolios include the prices. Lenders are really not lost a lot of money. And now that the regulation has loosened, you have the need of sort of stop to cause and make sure that has a view focus on where and to whom they want to lend. They are doing so in amount that’s going to consistent with loanless management policies. And I think that’s just a process that needs to be worked through. As Jon said, we’re having very constructive dialogue and we suspect we'll get to a good position that’s going to allow us to execute on our business model. For us we’re focused on getting the right structure in place, not the most expeditious structure in place. Obviously we’re in the long term. Anything we could do in the unsecured market helps facilitate discussions with our senior lenders. That improve their collateral coverage if there is more junior debt in the sack. And so as Jon mentioned, we are very pleased despite some of the noise in the rating agency community more broadly to get Fitch to give investment-grade rating. On the back of that we were able to access the unsecured market. And so that's a positive for us. And over the long term we suspect that will be an area where we will be interested in accessing more a debt capital as the business model continues to evolve.

And then one for you, Brendan. I was going to the transcript with you outlining the pitch for leverage last quarter. In one item you mentioned was the benefit of being flexible in distributions. Can you expand on this? Does it mean that you will sort of lever a bit a bit by a flush of outstanding ICTI? Or will there be some change to dividend policy going forward?

I suspect and you will forgive me for not recalling that was listed that last quarter. We were probably referring to the RIC test and the flexibility and the cushion we have relative to the RIC test, which if you were to violate those, it crimps your distribution capability. So simply having the increased flexibility, if you’re a shareholder, that means is there’s a lot more cushion that keeps your dividends all the more the secure. So certainly it was not intending to signal any change in dividend policy. Question we get a lot in light of the consistent over earnings of our dividend, it’s a conversation we have with our board, of course, every quarter. And as we make that analysis, our goal is to maximize outcomes for our shareholders and to be here today. We think better to retain that income into NAV. Where the market is giving the premium evaluation to that NAV, their outcome for shareholder has been then put it in their pocket. So something we will dynamically focus on over time, but no change in that word. And we’re that now regarding distribution policies.

Just one more small question on investment, Businessolver. Can you -- we saw that coming to one of the venture lending BDCs this quarter. Can you outline the nature of that deal? What's the, say, debt to EBITDA or EBITDA levels in general, just some kind of metrics to help us get comfortable with that deal?

We are typically balanced with confidentiality provisions, and so getting into very specific financial attributes of the loan is challenging for us on a single name basis. But rest assured, this is a traditional loan consistent with our investment strategy all along. Businessolver is a Warburg portfolio company. It’s a cloud based health benefits provider to smaller enterprises. So pretty interesting and unique market opportunity for Warburg. It’s a company that is, I would say, a typical size company from a revenue and EBITDA perspective with respective to our portfolio and how we describe the business. And so not withstand fact that Hercules is a co-investor here and they traditionally involved in venture lending, a period of full stop this is not a venture loan. This is a traditional loan historically. Consistent with what we've done and so we can be with that. But if you have any other questions, happy to answer that.

That’s all from me. Thank you guys very much.

And our next question is from Derek Hewett from Bank of America Merrill Lynch.

The yield on income producing investments, clearly it was flat quarter-over-quarter about 11.5% versus some peers which saw modest gains given the rise of LIBOR over the last couple of quarters. I mean, it appears at least some of the – at least some of variant was due to the senior credit fund. So my first question is were there -- is that correct and were there other material factors that impacted the yield this quarter? And then kind of as related question, could you give us a status update on professional physical therapy, which I believe is the only nonaccrual in the senior credit fund at this time?

Derek, it’s Jon Yoder. So in terms of the yield on – in compression assets, you are right. It’s 11.5%, which is flat quarter over quarter, although fueled with the longer-term trend on that that’s been going up and I think consistent with rising LIBOR. So you are right that the contributors -- I mean all else been equal, you probably would have expected that – if the portfolio was completely segment, you probably would have expected that to go up a little bit this quarter given the increase in LIBOR that we experienced, although not a big move this quarter. I think that there was a couple -- two contributors to that. One is when you mentioned a little bit less from the senior credit fund, the other one is the yield on new investments this quarter, some of the new things we put in. We’re a little bit below what some of the exits were. And so that would be the other reason that was flattish rather than up. So those are two things. I wouldn’t necessarily read a lot into. As we say, every quarter it feels like the origination yield any one quarter relative to the repayment yields anyone quarter. I would not suggest unnecessary trend. If you look at past quarters, in past quarters, we had yields on the originations that exceeded yields on repayment. So it’s including I think most recently two quarters ago. So it’s tough to extract a trend from that, but if you have to say this quarter why was yield uncomplete and assets flat, that would be the reason why.

I think I can crack that pro PT. Maybe just had first frame for context. So the senior credit fund has a $10 million exposure to pro PT. We marked it down I think $0.70 on the dollar this quarter. So we, of course, owned half of the senior credit fund. So that's a $5 million cost basis relative to our $1.3 billion of assets. So relatively small. Exposure, by the way, it is actually our first pool -- in our senior credits fund since inception. So the business is a provider of physical therapy solutions, sponsor-owned business that ran into some issues around questions. So we are working constructively with the owner of the business as well as the bigger lenders in that position. We expect in short order there to be a successful revolution there, which would entail unit capital coming in from the sponsor to show up liquidity in the business and probably a restructuring of the payment schedule where that gives a paper end. That should be corrected. We wrote down to $0.83 on the dollar this quarter. So not a lot to see there in terms of overall positions, but of course whatever we have invested that isn’t performing relative to our expectations, a lot of focused energy in making sure it gets remediated.

Okay, great. And then also could you remind us what is the revised leverage target given that the additional flexibility that you guys are going to have from the adoption of the 150% asset cover ratio?

We haven't put out a formal leverage target. What we discussed in great length last quarter on our call and a little bit with some other caller earlier today is the flexibility and dynamic leverage allocation based on the risk profile of the investments, and so recognize that within Goldman Sachs. We had a risk management function that is quite robust, and that’s getting into the sort of the all the agreement details. Effectively the nature of the investments, whether it’s a junior investment or senior investment, we’ll dictate the read of which -- the amount of call it risk capital it will attract. And so you can expect, Derek, that as our portfolio trends more senior, we can take on more leverage. To extent we continue with a different mix reference, there will be less leverage. But I think in any -- you could probably think of 1.5 as a max leverage that we would like to take on. That would be consistent with the same percentage amount of cushion relative to the regulatory cap that we have in place today. So when you think about 0.75 times being sort of the max comfort level for us, that’s relative to regulatory cushion. On a percentage basis, on 200% asset coverage, it’s a similar dynamic. So dynamic allocation of balance sheet leverage based on the composition of the assets that we are exiting.

And then just in terms of expected ROEs, do you think you will be able to kind of -- is it going to be status quo if you look at the core, say, the core ROE over the last one to two years? Or do you think there should be some upward biased given that the higher leverage asset of it?

Yeah, we spent a lot of time talking about this last quarter. The main reason for asking our shareholders for the flexibility to pursue this is because we do think there are opportunities, one to pursue a broader range of assets because of the flexibility that we talk a lot about, but also to increase returns on equity for our shareholders. And I think further to that, we obviously took very decisive action to reduce our management fee on 100% of the assets by 50 basis points. So when you think about the mere impact of that fees alone, that certainly should contribute positively to better returns under the new regime. So we're hopeful that all those factors of flexibility, the lower expense structure on assets will contribute to better outcomes, which increase the breath of investment that we can pursue and drive those returns.

[Operator Instructions] At this time there are no further questions. Please continue with any closing remarks.

Great. Thank you, Ian, and thank you all for joining us on a summer Friday. We appreciate always your time and attention. If you do have any additional questions, please feel free to reach out directly to the team and we will be glad to speak to you. Thank you so much.

Ladies and gentlemen, this does conclude the Goldman Sachs BDC, Inc. second quarter 2018 earnings conference call. Thank you for your participation. You may now disconnect.