Goldman Sachs BDC Inc

NYSE:GSBD

Earnings Call Transcript 2020-Q1

[Operator]

Good morning. This is Dennis, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. First Quarter 2020 Earnings Conference Call. [Operator Instructions].

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 with the company's SEC filings.

This audiocast is copyrighted 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 homepage of our website at www.goldmansachsbdc.com under the Investor Resources section. These documents should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC.

This conference call is being recorded today, Tuesday, May 12, 2020, for replay purposes.

I'll now turn the call over to Brendan McGovern, Chief Executive Officer of Goldman Sachs BDC.

[Brendan McGovern, President & CEO]

Thank you, Dennis. Good morning, everyone, and thank you for joining us for our first quarter earnings conference call. I'm joined on the call today by Jon Yoder, our Chief Operating Officer; and Jonathan Lamm, our Chief Financial Officer.

I'll begin the call by providing an overview of our first quarter results, including comments regarding our portfolio and COVID-19, and the potential implications for the investment environment going forward. Jon Yoder will then discuss our portfolio in more detail with respect to the current environment before turning it over to Jonathan Lamm to walk through our financial results in more detail. Finally, I'll conclude with some closing remarks before we open the line for Q&A.

Before beginning this morning, all of us at Goldman Sachs BDC would like to send our best wishes for the health and safety of everybody listening to this call and to all of your loved ones. We also want to send our deepest thanks to all the frontline and essential workers around the world, including doctors, nurses, paramedics and hospital staff and all the police, fire and sanitation workers, supermarket and pharmacy employees, and many others whose work every day allows the rest of us to stay home -- to stay safely at home. We are grateful to you for your inspiring example of courage and dedication. I'd like to acknowledge the extraordinary resilience and professionalism of the entire Goldman Sachs team that manages and supports the Goldman Sachs BDC. While not surprising, it was nevertheless amazing to watch the speed at which the team was able to absorb the reality of this unprecedented economic environment. We underwrite every single investment in light of this new reality and seamlessly shift to working from home while maintaining unwavering focus on everything we do to manage our shareholders' capital. I'm very proud to be our colleague and part of this extraordinary Goldman Sachs team.

As the COVID-19 pandemic has unfolded over the last 2 months, we know that our shareholders are revaluating their own portfolios. And therefore, we have made it a priority to communicate information to you about Goldman Sachs -- GSBD quickly and transparently. Can you hear me?

[Operator]

Yes, we can hear you.

[Brendan McGovern, President & CEO]

Great. As you likely noticed, we issued a press release on March 19 that provide an update on the portfolio, our liquidity profile and our balance sheet. On April 20, we provided estimates of our first quarter operating results including estimated net investment income and estimated net asset value. I am pleased to report that the first quarter results that we announced today are squarely within the estimated ranges that we provided. We hope that these shareholder communications have helped you better understand your investment in GSBD, and we look forward to providing additional communications as warranted.

So with that, let's get to our first quarter results. Q1 net investment income per share was $0.45 on an after tax investment income of $18.2 million. The company once again fully covered its dividend during the quarter with net investment income. As we announced after the market closed yesterday, our Board declared a $0.45 per share dividend payable to shareholders of record as of June 30, 2020. This equates to an annualized dividend yield of 12.2% based on net asset value per share at the end of Q1.

During the quarter, all but 1 of our 107 portfolio companies made their expected interest payments, and the investments on nonaccrual status declined from 1% at fair value as of the end of Q4 2019 to 0.1% at fair value as of the end of Q1 2020. We believe that these results are very solid given the economic disruption that escalated over the course of the quarter. While we certainly didn't manage GSBD in anticipation of a global pandemic, we do believe that the long-standing focus on risk management imparted by the Golden Sachs platform has put GSBD in a position of strength in a number of key areas.

First is liquidity. As the impact of the pandemic came into focus in early March, companies around the world began drawing on undrawn loan commitments to shore up balance sheets. In our own portfolio, we were asked to fund approximately 1/4 of our total unfunded commitments during the quarter. We had more than ample liquidity to satisfy these obligations and continue to maintain cash on our balance sheet in an amount well in excess of all remaining outstanding unfunded commitments.

Second is balance sheet strength. Importantly, as of quarter end, our funding mix is weighted toward unsecured debt, with 56% of our outstanding debt in unsecured obligations and 44% in secured obligations. This mix provides us with significant excess collateral to satisfy secured lenders. Equally importantly, none of our debt is scheduled to mature in the near term. The next scheduled maturity is for our $155 million of unsecured convertible notes due in 2022. We currently have more than sufficient availability on our revolving credit facility to repay these notes upon maturity.

Third is portfolio positioning. Our investment philosophy has always been to underwrite each loan based on the assumption that an economic recession will occur while a loan is outstanding. This philosophy permeates the construction of our portfolio, which is focused on first lien senior secured loans to U.S. domiciled middle market companies that we believe are less exposed to cyclical pressures. As a result, our portfolio has limited direct exposure to sectors that have been most impacted by the COVID-19 outbreak, such as energy, travel, restaurants, hospitality and retail. Instead, the largest exposures are to sectors that we expect to have more resilience, namely health care providers and services, software, interactive media and services, health care technology and IT services.

While we believe that our liquidity profile, balance sheet strength and portfolio positioning are significant sources of value in this environment, we are keenly aware that the timing of an economic recovery is uncertain. Our team is bringing extraordinary focus for our portfolio and working with the product key sponsors and owners of these companies and their respective management teams to plan for an extended period of disruption.

We've been encouraged by the speed and thoughtfulness of the planning process that all parties have brought to bear in this time of uncertainty. Businesses are demonstrating remarkable creativity, as they adapt to meet their customers' changing needs and preferences. While much of the pandemic remains to play out, much has also been done to prepare and to adapt.

Before turning it over to Jon to provide more detail on the portfolio and the investment environment, I want to provide an update on our previously announced merger with our affiliated business development company, Goldman Sachs Middle Market Lending Corp., which we refer to as MMLC. On prior calls, we have described what we believe are the significant benefits to the proposed merger -- of the proposed merger to the shareholders of GSBD. While the economic environment has changed significantly since the merger was announced, most of those benefits remain as compelling today as they were when the merger was announced last December, including: an expectation that the merger will be accretive to net investment income per share compared with stand-alone GSBD; an overall improvement in GSBD's portfolio metrics, including a higher portfolio yield and greater single name diversification; and benefits of increased scale, including improved access to diversified funding sources, cost synergy and greater trade and liquidity. However, due to the volatility of GSBD's stock price precipitated by COVID-19, as of today, we will be unable to meet our closing condition of the merger that requires MMLC shareholders to receive shares of GSBD that have a market value in excess of MMLC's net asset value. The outstanding -- the outside date for the merger specified in the merger agreement is December 9, 2020. We and our respective Boards for each of GSBD and MMLC continue to closely monitor financial market conditions and are maintaining dialogue regarding the transaction. We will be sure to provide any update to shareholders regarding the merger as warranted.

In addition to staying in close contact with our portfolio companies and financial sponsors, we also continue to look for new investment opportunities. Nevertheless, we are going to apply our existing disciplined investment approach to all new investments and remain prudent with our capital.

With that, let me turn it over to Jon Yoder.

[Jon Yoder, COO]

All right. Thanks, Brendan. The financial performance of our portfolio companies during the quarter was generally solid, but of course, the operating environment changed dramatically during the last few weeks of March. We are very pleased that, notwithstanding the significant fear and uncertainty that grip the financial community by the end of the first quarter, all but 1 of our 107 portfolio companies made their expected interest payments. This is particularly noteworthy because interest payments are due at the end of the quarter for a significant majority of our borrowers, a time when the pandemic was well underway and financial markets were reeling.

Notwithstanding the generally solid fundamental performance of our portfolio companies during the quarter, we marked down the value of the investment portfolio, primarily in recognition of wider credit spreads that we observed in comparable asset classes. This markdown resulted in a decline in net asset value of approximately 12% during the quarter. While credit spreads have tightened subsequent to quarter end, it is certainly too soon to predict where credit spreads will be at the end of the second quarter or to speculate on any impact to our Q2 net asset value.

Turning to specific investment activity for the quarter. During the quarter, new investment commitments and fundings were $81.8 million and $95.6 million, respectively, including net fundings of $20.5 million in unfunded prior commitments. The new investment commitments were across 4 new portfolio companies and 3 existing portfolio companies. The new investment commitments were comprised of 99% first lien debt investments.

Now since the outbreak of COVID-19, we have seen a significant decline in M&A activity and new deal activity in general. The small number of transactions that we have completed since mid-March have been with companies that we believe are very well positioned to perform in the current environment. For example, we recently provided financing to a company that provides a leading software solution that allows colleges, universities and primary schools to deliver educational content to students digitally. These new investments generally had meaningfully wider spreads and tighter terms. We expect these investment opportunities to be relatively rare, so we are not currently anticipating significant portfolio growth in the near term.

During the quarter, the company had sales and repayments of $46.6 million, primarily driven by the full repayment of investments in 3 portfolio companies. Regarding portfolio composition, at the end of the quarter, total investments in our portfolio were $1,422.7 million at fair value, comprised of 92% in senior secured loans, including 75.5% in first lien, 2.4% in first lien/last-out unitranche and 14.1% in second lien debt as well as 0.5% in unsecured debt and 7.5% in preferred and common stock. We also had $61.3 million of unfunded commitments as of March 31, bringing total investments and commitments to $1.484 billion.

As of quarter end, the company had 107 portfolio companies operating across 38 different industries. The weighted average yield of our investment portfolio at cost at the end of the first quarter was 7.7% as compared to 8.2% at the end of the fourth quarter. The weighted average yield of our total debt and income-producing investments at cost was 8.5% at the end of the first quarter as compared to 9% at the end of the fourth quarter. The decline in yields during the quarter was primarily attributable to the decline in LIBOR. However, the vast majority of our portfolio has a LIBOR floor of 1% or higher.

Turning to credit quality. The weighted average net debt-to-EBITDA of the companies in our investment portfolio was 5.6x at quarter end versus 5.7x at the end of the fourth quarter. The weighted average interest coverage of the companies in our investment portfolio at quarter end was 2.6x compared to 2.4x at the end of the fourth quarter.

Let me now turn the call to Jonathan to walk through our financial results.

[Jonathan Lamm, Treasurer & CFO]

Thanks, Jon. During the quarter, we took a number of actions to improve our balance sheet profile. First, we favorably amended our senior secured revolving credit facility agreement to reduce the stated interest rate from LIBOR plus 2% to LIBOR plus 1.875% and to extend the final maturity date from February 2023 to February 2025.

Second, on February 10, 2020, we closed a public offering of $360 million aggregate principal amount of unsecured notes due 2025 and bearing interest at a fixed rate of 3.75%. We used the proceeds from the sale of notes to partially repay our senior secured revolving credit facility. This action left us with no near-term maturities until our convert comes due in 2022, while preserving almost $400 million in availability under our revolving credit facility.

Third, we added excess liquidity to our balance sheet with a goal of maintaining cash on our balance sheet in excess of our unfunded obligations for the time being. As a result, we had $86.4 million of cash and cash equivalents on our balance sheet as of the end of Q1 against unfunded investment commitments of approximately $61.3 million.

Turning to our operating results. Our net investment income per share was $0.45 compared to the prior quarter of $0.48. Loss per share was $1.58, primarily as a result of the net change in unrealized depreciation of our portfolio compared to earnings per share of $0.22 in the prior quarter. Our total investment income for the first quarter was $32 million, which was down from $35.5 million last quarter. The decrease was primarily driven by an early exit fee associated with a repayment in Q4. We ended with net expenses of $13.4 million for the quarter as compared to $15.6 million in the prior quarter. Expenses were down quarter-over-quarter, primarily reflecting the absence of incentive fees for the quarter.

During the quarter, our ending net debt to equity was 1.4x versus 1.13x at the end of Q4. We ended Q1 with net asset value per share of $14.72 as compared to $16.75 from the prior quarter, driven by unrealized depreciation on investments, primarily as a result of widening credit spreads related to the current environment that Brendan and Jon discussed earlier. The company had $46.6 million in taxable accumulated undistributed net investment income at quarter end resulting from net investment income that has exceeded our dividend historically. This equates to $1.15 per share on current shares outstanding. Consistent with prior years, we spilled over all of the undistributed NII into 2020 as we believe the cost of the spillover in the form of the excise tax is a small price to pay relative to the much higher cost of issuing new equity if we had to replace that amount.

With that, I will turn it back to Brendan.

[Brendan McGovern, President & CEO]

Thanks, Jonathan. In closing, while the current environment poses unique challenges, we are pleased that our long-standing focus on risk management puts us in a solid position to withstand the current environment. We are focused on working with the management teams and the financial sponsors of our portfolio companies to navigate through this challenging time. At the same time, we're keeping careful watch for unique opportunities to create value for our shareholders. As always, we thank you for the privilege of managing your capital and are always open to hearing from you, especially as all of us work through this environment.

With that, Dennis, let's open up the line for questions.

[Operator]

[Operator Instructions]. The first question is from the line of Finian O'Shea with Wells Fargo Securities.

[Finian O'Shea, Wells Fargo Securities]

I hope everyone is doing well. First question on the pending merger or proposed merger, understanding the NAV provisions, do you have any color on the respective Boards' and shareholders' interest perhaps, as they understand market conditions right now have changed things? And if they do still have interest, are there ways that you can, I don't want to say work around the NAV provisions, but rework the merger somehow to satisfy that?

[Brendan McGovern, President & CEO]

Yes. Fin. One, glad to hear from you and hope you're doing well. And, yes, let me give you a little background context. And maybe just to refresh everybody's memory regarding the transaction, we announced this back in December of last year. And the way the deal is structured is that there's a fixed exchange ratio and whereby GSBD would issue 0.9939 shares for each MMLC share outstanding. And so that's a somewhat unusual way for that companies to merge. Usually, these transactions are done on a NAV-for-NAV basis. But recall, Fin, when the deal was announced, GSBD was trading at a very significant premium to its underlying NAV, so it was able to do a fixed exchange ratio deal, had the transaction be accretive to GSBD but still deliver a very attractive above NAV outcome for MMLC.

So obviously, a lot has changed in the world since December. Today, given where GSBD trades, at negotiated exchange ratio, the value, the market value of the consideration that MMLC would get would be below MMLC's NAV. So with that, we wouldn't today be able to meet an important condition precedent to closing that deal, which is based on the '40 Act concepts around deals not being dilutive to shareholders overall.

So all that being said, when you step back and look at the situation in totality, all the strategic benefits of the transaction that we discussed way back in December, and I'm sure with you, Fin, a handful of times, all that still applies. So for GSBD, the overall portfolio construction metrics would improve. The yield of the portfolio would improve the NII per share metrics would be better for MMLC. They will get the benefit of the liquidity events and certainly in this environment, getting liquidity without, for example, having to sell at tough environments, that's a potentially a very attractive opportunity. And I think very importantly, in this environment through the MMLC lens, when you think about the benefits of being in a bigger, larger BDC with more scale, more access diversified funding sources, as we've talked about a lot, GSBD has certainly very diverse funding sources, which is a big benefit in this current environment. That would also then be available to MMLC as well.

So, yes, as we sit here today, we, obviously, had come through our Board meetings. I think both Boards recognize all those big picture benefits to transaction. They continue to maintain a dialogue with both GSAM and with each other. And so I think we can leave it at that, Fin. We'll be sure to keep you posted if anything changes regarding the transaction or if there's any update as warranted here.

[Finian O'Shea, Wells Fargo Securities]

Fair enough. And just a reminder on the fee waivers that you proposed for GSBD related to this transaction, are those still independent on schedule? Or is there any time...

[Brendan McGovern, President & CEO]

Yes, all of those are -- all of those kind of are part of the merger agreement, and there's been -- yes, there's been no change to that merger agreement. So all those fee waivers would continue to apply through the course of 2020.

[Finian O'Shea, Wells Fargo Securities]

But if the merger doesn't happen, do they reverse?

[Brendan McGovern, President & CEO]

Well, so again, we're looking at the way the merger document is structured today. There's basically a concept called the outside date by which something has to happen or termination provisions start to kick in. That's really not until December of 2020. And so we have no expectation or no reason to think that in the short term, anything would change to that dynamic, which would cause us to change the fee waivers.

[Finian O'Shea, Wells Fargo Securities]

Okay. And just one final question for me. Can you touch a bit on your investment strategy? I assume you want to keep in -- to be mindful of your investment grade position, and they're warning on total leverage from here. Are you going to really dial it back on new investments? Or are you going to deleverage? Or any color you'd give us on how you're looking at -- sure.

[Brendan McGovern, President & CEO]

So yes, look, I think a good important question, Fin. When you look at the current environment, I think it really highlights the benefits of being investment grade-rated corporate, and having access to be able to issue unsecured debt gives a lot of financial flexibility to us. And we talked a lot about this, both in early press releases during the quarter, reminding the market about how we're capitalized. When you think about the benefit of having unsecured debt in your capital structure, what that means is through the lens of the secured lender, and the secured lender is the ones to whom you pledge your collateral, there's generally -- there's covenants in those transactions. Having them being in a very comfortable position is where you want them to be to provide stability and runway to your capitalization. So as we sit here today, our secured lenders are covered almost 3x over by our collateral, so that's a very good position to be in.

When we endeavor to get a rating and issue the bonds, we articulated a leverage strategy where we're now operating at the high end of what we articulated by virtue of adding a couple of assets in the quarter and, of course, marking down the NAV. And so we do think it's smart to be thoughtful and prudent. The bar is certainly high for any new investments. And of course, we want to make sure that there's capital available, if necessary, to support some of our portfolio companies.

And so in that context, we think we're overall in a very good position with the agencies, with our capitalization overall, and we wouldn't expect just to take up leverage, to take on new opportunistic, higher-yielding opportunities because they're available. Our hope is that they'll be more organic deleveraging. That would give us that opportunity here.

So it's a balanced approach, Fin. We want to be thoughtful and mindful. We certainly are in a very, very unique operating environment. And I think in any case, the bar will be quite high for new investments.

[Operator]

[Operator Instructions]. And at this time, there appear to be no further questions. Do you have any closing remarks?

[Brendan McGovern, President & CEO]

Thank you, Dennis. I suppose that means we did a nice job throughout the quarter of talking to our shareholders, and we certainly did put a priority on that. So we do appreciate everybody's time and attention. And if you do have any additional questions, please don't hesitate to reach out directly to the team. So with that, Dennis, we can close the call.

[Operator]

Ladies and gentlemen, this does conclude the Goldman Sachs BDC First Quarter 2020 Earnings Conference Call. Thank you for your participation. You may now disconnect.