Goldman Sachs BDC Inc

NYSE:GSBD

Earnings Call Transcript 2019-Q3

[Operator]

Good morning. This is Ian, and I'll be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. Third Quarter 2019 Earnings Conference Call. Please note that all participants will be in a listen-only mode until the end of the call when we will 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.

[Katherine Schneider, VP, IR]

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 beliefs 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 at www.goldmansachsbdc.com, under the Investor Resources section. These documents should be reviewed in conjunction with the company's Form 10-K filed yesterday with the SEC. This conference call is being recorded today, November 8, 2019, for replay purposes.

With that, I'll turn the call over to Brendan McGovern, CEO of Goldman Sachs BDC, Inc.

[Brendan McGovern, President & CEO]

Thank you, Katherine. Good morning, everyone and thank you for joining us for our third quarter earnings conference call. As usual, in terms of the agenda for the call, I'll start by providing an overview of our third quarter results. From there, Jon Yoder will discuss our investment activity and portfolio metrics before handing it over to Jonathan Lamm to discuss our financial results in greater detail. And finally, I'll conclude with some closing remarks before we open the line for Q&A.

So with that, Q3 net investment income per share of $0.47 resulted in dividend coverage of 104% and equated to an 11.1% annualized NOI return on common equity. As we announced after the market closed yesterday, our board declared a $0.45 per share dividend payable to shareholders on record as of December 31, 2019. This equates to a dividend yield of 10.6% based on net asset value per share at the end of Q3.

Moving on to investment activity; this quarter was characterized by a significant portfolio activity, reflecting a continued robust private capital markets backdrop, as well as solid execution by the team. During the quarter, we made $173 million of investment commitments to 10 new portfolio companies and 7 existing portfolio companies. Repayment totals $241 million driven by full repayment of loans by 9 different portfolio companies. Repayment of nearly one-fifth of the Q2 and a portfolio balance, coupled with diversified origination enabled us to continue to shape the portfolio composition consistent with previously stated goals. First, we improved the asset mix toward more senior loans. New originations were comprised almost exclusively of first-lien investments. All over one-third repayments were in junior capital investments. As a result, the percentage of first-lien investments in the portfolio increased to 72% during the quarter, continuing the execution of our strategy to reposition the portfolio into more senior investments and away from junior capital investments. We are pleased with the pace at which we've been able to execute the strategy. For context, first-lien investments were 33% of the total portfolio just six quarters ago.

Second, we continue to reduce single-name concentrations. This quarter we received the full payment of 4 older vintage investments. All these investments were made prior to a receipt of co-investment exempted relief, which now allows us to cross-allocate loans across our platform. As a result, these older loans were significantly larger on average than the size of new loans added to the portfolio since obtaining co-investment relief. At the end of Q3, our top 10 investments represented 24% of the total portfolio down significantly from 40% at the end of 2016.

Finally, we believe that activity this quarter improved overall credit quality. Our largest repayment was in NPS Communications, a portfolio company that we've discussed at length in prior quarters, which was placed on nonaccrual in Q4 of 2018. Loan was repaid this quarter, consistent with the mark we say built in prior discussions. Notwithstanding the fact that we chose to turn off the NCS interest accrual a few quarters ago per our accrual policy GSBD ultimate earned its 7% IRR and they're greater than 1.3x money multiple on the transaction. At quarter-end non-accruals were just 1% and 1.4% of the total investment portfolio at fair value and cost respectively.

Average portfolio company metrics were stable to improve quarter-to-quarter, as measured by the portfolio's net debt to EBITDA and interest coverage ratios. Portfolio yields did come down this quarter, consistent with our planned asset mix shift towards senior assets but exacerbated by concentrated repayments of higher-yielding earlier vintage investments and the downward trajectory of LIBOR. We do see opportunities over time to Canada's dynamic, by rotating low yielding assets that we received upon the unwind of our senior credit fund into directly related loans having higher spreads. In addition, our success in shifting the portfolio into more first-lien investments with less single-name concentration provides the opportunity to move our debt to equity ratio somewhat higher, which will contribute positively to income generation.

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

[Jon Yoder, COO]

All right, great. Thanks, Brendan. So the third quarter presented an interesting market backdrop to our activities. In particular treasury yields fell precipitously in August and briefly inverted as trade tensions and evidence of slowing global growth provoked expectations of further rate cuts and a flight to safety. Broadly syndicated loan markets should stress in certain industries, which weighed on average bid prices. Investor sentiment regarding leverage loan markets turned more cautious and loan funds experienced outflows while CLO formation was muted. In general, we think that these developments are healthy and over the long run can lead to increased discipline.

We've been cautious for quite some time. And as Brendan mentioned in his remarks, we made the strategic decision early last year to shift the portfolio away from junior debt. We were very pleased this quarter to get repaid from two of our larger remaining juniors debt investments. This quarter also continued our multi-year effort to enhance the durability of the portfolio by reducing single-name concentrations, as some of our largest single name positions were repaid. At the end of the quarter, the average single name position size in our portfolio is just 1% of total assets, down from 2.5% prior to implementing our co-investment order in January of 2017. In addition, we believe that the sum of the origination in repayment activity this quarter further focuses our portfolio on durable businesses with strong cash flow profiles, which we expect will be resilient if the fears that drove market sentiment this quarter, in fact, do come to pass.

I'll turn to some specific activity for the quarter. New investment commitments and fundings were $172.5 million and $145.5 million respectively, which include net fundings of $6.5 million of previously committed unfunded commitments. 98.7% of new investment commitments were in first lien floating rate debt investments. These new investment commitments were across 10 new portfolio companies and 7 existing portfolio companies. Sales and repayment activity was elevated as Brendan mentioned and it was $240.7 million which was driven by the full repayment of investments in 9 different portfolio companies.

Regarding portfolio composition; at the end of the quarter, all investments in our portfolio were $1.432 billion at fair value comprised of 92.5% senior secured loans, which includes 72.4% in first lien, 2.5% first lien last out unit tranche and 17.6% in second lien debt as well as 0.5% in unsecured debt and 7% in preferred and common stock. We also had $93.4 million of unfunded commitments as at September 30, bringing total investments and commitments to $1.5236 billion.

As of quarter-end; the company had 199 investments across 102 portfolio companies. The weighted average yield of our investment portfolio at cost at the end of the third quarter was 8.3%, down from 8.7% at the end of the second quarter. The weighted average yield of our total debt and income-producing investments at cost was 9.1% at the end of the third quarter, as compared to 9.8% at the end of the second quarter. This quarter-over-quarter decline was driven in equal parts by the decline in LIBOR and the exit from some older vintage higher-yielding investments during the quarter.

Turning to credit quality; performance of our portfolio companies overall was stable to slightly improved quarter-over-quarter. In fact, the weighted average net debt to EBITDA of the companies non-investment portfolio was 5.4x at quarter end, which is down from 5.5x at the end of the second quarter. The weighted average interest coverage of the companies in our investment portfolio was 2.4x which was modestly up from the prior quarter at 2.3x.

I'll now turn the call over to Jonathan to walk through our financial results.

[Jonathan Lamm, Treasurer & CFO]

Thanks, John. We ended the third quarter of 2019 with total portfolio investments at fair value of $1.430 billion, outstanding debt of $732 million and net assets of $685 million. Our net investment income per share was $0.47 which was unchanged from the prior quarter. Earnings per share were $0.22 as compared to $0.40 in the prior quarter. During the quarter, our average debt to equity ratio was 1.22x versus 1.11x in the prior quarter. We ended the third quarter with a debt to equity ratio of 1.07 versus 1.22 at the end of Q2. Much of our repayment activity occurred toward the end of Q3 providing the company with ample available liquidity for reinvestment

Turning to the income statement; our total investment income for the third quarter was $36.9 million, which was down from $38.4 million last quarter. While our average balance of the income-producing assets were up quarter-over-quarter, the decline in interest income quarter-over-quarter was largely attributed to lower prepayment related income. As Brendan mentioned, although we had elevated repayments this quarter relative to prior quarters, the majority of this quarter's repayments were on older vintage loans where prepayment related income protection had already expired. Additionally, older vintage loans have a lower amount of remaining unamortized discount to be accelerated upon a prepayment.

Total expenses were $17.4 million for the third quarter, as compared to $18.9 million in the prior quarter. Expenses were down quarter-over-quarter, primarily driven by a decrease in incentive fees, which was partially offset by higher interest expenses due to higher average borrowings during the quarter. We ended Q3 with net asset value per share at $16.98 as compared to $17.21 from the prior quarter. The company had $48 million in accumulated undistributed net investment income at quarter-end resulting from net investment income that has exceeded our dividends. This equates to $1.18 per share on current shares outstanding.

With that, I'll return it back to Brendan.

[Brendan McGovern, President & CEO]

Thanks, Jonathan. In closing, Q3 was a solid quarter for our investors, as we continue to produce strong net investment income, while simultaneously strengthening portfolio attributes and secondly on diversification and lean type. We feel the company continues to be well-positioned for the long term to take advantage of opportunities in the growing middle market landscape. As always, we thank you for the privilege of managing your capital. We look forward to continuing to work hard on your behalf over the remainder of the year. With that again, let's open up for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Finian O'Shea form Wells Fargo Securities. Fin?

[Finian O'Shea, Wells Fargo Securities]

Hi, good morning. Thanks for having me on. Just a first question towards the end of your remarks on the LIBOR front. The impact on the top lines seems a little more than a lot of your peers and I know there's a couple of moving parts there. You talked about the season prepays. But looking at more - you have a pretty recent vintage profile so I would have thought that floors would be better as they've been slowly but surely trending up. Can you talk about where you are on the floor side, and what you think the next 25 steps has for a top-line impact for you?

[Brendan McGovern, President & CEO]

I think the last part of the question - we want to make sure we answer the totality of it. Because Jonathan mentioned, if you look at the yield impact to this quarter about half of it was the move in LIBOR. I would say, as a general matter and probably reasonably consistently the LIBOR floors on the asset side of our portfolio is around 1. So given where we are with LIBOR today, I think that in the next 25 basis point we'll continue to be exposed there. I think that'll be consistent across much of the industry. From time to time, you might be able to get - I think we had one transaction this quarter where we did get one better floor. That was transaction the to our private wealth network that we [indiscernible] but in general, I think our profile is going to be consistent with most market participants.

[Finian O'Shea, Wells Fargo Securities]

Thank you for the color there. I think you talked a bit about the market opening up and we're certainly hearing that's the case, especially on the larger end, and therefore, I'm sure it helps. Private part, there's a hole in terms of deal flow. But if you take that backdrop assuming that sustains for some time, along, say your platform growth, is there a shift in portfolio company issuer size that is currently underway? Or perhaps expected? What sort of frame do you view? Your sweet spot? Now and down the road for EBITDA let's say.

[Jon Yoder, COO]

Yes. Obviously a really good question, and I believe you're well in touch with the markets here. What we are seeing a little bit is - you're pulling out is some of the private credit, some opportunities coming for deals that are the type that otherwise would have normally been indicated [ph]. So, you know, I think it's been reported that particularly for lower - companies that would garner lower ratings, and then typically having higher leverage profiles and like - the public capital markets are less accommodating those types of things. And so some of those - at the moment at least, and so a number of those companies are otherwise seeking capital into private - some private assistance. You know, I think we're monitoring it. I don't - I don't expect that - we're, you know, we're not - we're not sort of leading the charge there or expecting to be particularly active.

I think what we want to see is - it was important to us - you know, when you're doing private credit, the value proposition that ultimately we're offering to our investors here is that is that this is a higher return lower better credit protection kind of strategy than what you can get in broadly syndicated market. And so it's old, the private credit participants are - is replicating what otherwise would have been available in the public credit markets, in the same sort of covenant light and in fairly low spread terms. But that doesn't seem like a really value to be adding to our investors. So I'm not thinking that that is what's going on. I'm just saying that that, you know, until there's strong evidence that you can get really good terms and attractive spreads that are better than what are available in public markets, it doesn't feel like something that we would want to stretch into.

For the time being, you know, we're pretty focused continued - pretty focused on what we think is the core of the middle market, find the $15 million to $50 million EBITDA business. You look at the weighted average EBITDA of our portfolio companies. It's right around $35 - $37 million, kind of, right in the middle of that range. Pretty consistent. You know - we're not in quarter-over-quarter, that's - that's kind of where we've been living. And so I don't anticipate any change, again, unless it suddenly became obvious that there was a lot of just really attractive, better than sort of traditional capital markets execution terms that you can get in larger transactions. But at the moment, I don't know that that's true.

[Finian O'Shea, Wells Fargo Securities]

Thank you for the context there, just one more, if I may. A small question on Animal Supply, that's common stock, part of your vault this quarter. One, is that broad-based - sorry, market valuation based or company declining? And then second, that would obviously be, accretive to rotate into earnings; so any update on your pathway to move from that name that you're able to provide? Thanks.

[Jon Yoder, COO]

Yes. We talked a bunch about this one in the past, you know, a recent restructuring. So we currently hold, a really non-encompassing paper, so would agree, in general with the focus on doing our best to rotate that, but doing so in a way that can optimize outcomes. We didn't want a portfolio that put this down, a bit this quarter, I would say that there's a little bit of mixed bag. On one hand, there are some industry headwinds with respect to certain products that the company is distributing with lowered – some volumes there. But on the other hand, I would say we'll be coming - increasingly excited that potential, synergistic, opportunities in terms of industry consolidation that's taking place here, I think you've heard of, described that in the past.

So overall continue during an optimistic, in terms of the trajectory in the path here. And, you know, when we look at these types of situations, there's the balance as you're describing between, you know, you know, perhaps quickly locating position into something that could be more income producing versus optimizing. And I think we're quite aware of that, and think about that all the time. And in here, you know, I think specifically with this - with this investment, you know, we're hopeful that just given some of the industry trends ran consolidation. That could be an opportunity, but nothing to report yet. And of course, if and when there is, we'll be forthright and quite descriptive about that.

[Finian O'Shea, Wells Fargo Securities]

Thank you for the color there. That's all from me.

[Operator]

And your next question comes from the line of Robert Dodd from Raymond James.

[Robert Dodd, Raymond James]

Hi, guys. Looking at obviously, the rotation you've gone through in the portfolio, like I mean, firstly is up a lot. You've reduced, particularly the second lien exposure versus a year ago or more. Yet when I look at where the big marks were, that seemed to be this quarter. They seem to be not surprisingly, primarily in the junior side of the portfolio. So can you give us any color on how much if any there's adverse selection? Obviously in the second lien side, the ones that are doing relatively well are the easiest ones to encourage to refinance etcetera, et cetera, and the ones that stick with you longer can be more problematic.

So, could you give us some - some color on the relative quality of what's left on the junior side of the book, particularly in light of the marks this quarter.

[Jon Yoder, COO]

Yes, Robert, appreciate the question. I think - I think a fair observation as well. When you look at this at this quarter, the remarks aren't terribly large, but yes, the biggest one was NPI, which - which you're actually describing with an earlier vintage - 2014 vintage. Secondly, investment that we made there, and, I think, that's a company that is, bigger business, at those precision auto parts, it's our own auto type exposure. So I think when we look at that business, you know what's impacting the mark in this go-around is a pretty significant evaluation changes taking place in that specific industry. Yes, I wouldn't read anything sort of that would impact other parts of the investment as very much, function of the specific industry that that company sits within [indiscernible] is that, you know, that's actually a bigger company. We look at that business. There's been, I'd say some, management missteps.

The fundamental value proposition for the business, it's basically branded cleaning supplies. Yes, pretty stable market trends and a little bit of some management missteps around a sales force reorganization. Nothing, I think that's going to permanently impact the earnings profile of that business. And we're looking at things stabilizing there. It's also, you know, a little bit of an unusually large in terms of the size of the business. The company's on the bigger end of the scale. We actually knew that company through our senior credit fund. You're going back ways and opted to move into secondly lien a bit more opportunistically. And I would say that's one where we look at that position, it's marked, you know, where it is. But longer term, so optimism with respect to the final outcome for that investment.

I don't think, Robert, that there's much more across the portfolio that we would point it to you. In fact, and John in his prepared remarks. Much of our repayment activity this quarter was in some of those older vintage second lien investments, Vetco's, for example, would be one that comes to mind. So we're actually quite pleased when you look at the sort of the quarter-over-quarter portfolio quality. So on the one hand, as we talked about in the discussion, improving lien type - significantly also improving the overall portfolio concentration; and also at the same time, many of those older ventures investments were actually repaid into a pretty significant degree this quarter.

So, in other words, the vintage and the cleanliness, if you will, of the existing portfolio, you know, feels like that about.

[Robert Dodd, Raymond James]

Okay, got it. I appreciate the color of that. If I can, a near term question, a question about your pipeline because if I look at, obviously, you know, a lot of the repayments occurred late in the quarter, so you're starting off the fourth quarter with a lower wordings runway. Add on to that liable. Add on to that that, hypothetically, if anybody is stable this quarter, incentive fees are higher. And it looks like you may be in a position where, where NII earnings perhaps wouldn't cover the dividend in the fourth quarter based on the portfolio, so at the end of the third quarter. So can you give us any color on the pipeline and the ramp rate tea to get the portfolio size back up to your point, lower yields more leverage, et cetera. I mean, I don't think there's any long term, my view, questions about your ability to earn it, but when's it going to happen?

[Brendan McGovern, President & CEO]

We're certainly not going to do projection Robert about next quarter. We will be happy to answer with you and your team on model questions off line. All that being said, getting the portfolio optimized from calculation perspective is not something we've got a lot of concern with. The pipeline continues to be quite good again. We gave that commentary, this quarter in terms of the portfolio activity, highly, highly diversified, 10 new portfolio companies into the book this quarter. Yes, I think you hear from a lot of other management teams. Most of what they're doing is following along through different portfolio companies. We get some of that benefit, but we've been a bit more skewed towards closing new deals. If all goes well for the continued growth in the business, I think - I think speaks well of just our position within the market. So in terms of all the variables that sort of go into the net investment at the end of the day, getting the portfolio ramps, relative to G&A portfolio down is not one we have to think and worry.

[Robert Dodd, Raymond James]

I appreciate it. Thank you.

[Operator]

And your next question comes from the line of Derek Hewett from Bank of America Merrill Lynch.

[Derek Hewett, Bank of America Merrill Lynch]

Good morning, everyone. Circling back to MPI products, and given that it's seems to be a sector specific issue, will this be, rolling off the books shortly? Given the near term maturity, or will the investment need to be restructured over the next two to three months?

[Brendan McGovern, President & CEO]

Yes. So, as we mentioned, you know, Derek, it's a fluid situation right now. The company is in a sale process. As I mentioned, when you - when you look at the mark today, I think what we're looking at is industry valuations in particular coming down quite dramatically. So, in terms of the range of outcomes, it could be, a full repayment. It could be a partial repayment. It could be a variety of different outcomes. I think specific to the sector commentary. In any event, you know, we're talking about a quite, quite small exposure. We had one other company that was your way to the auto industry that would repay this quarter.

Even if this one contains to be part of the exposure, it would be literally the only exposure in the sector and would be quite, quite small. And I think as a general matter when you do look at where we do have most of the capital, it certainly is away from more cyclical, more capital intensive, more industrial types of businesses and much more focus on areas like health care and IT, business services, technology, which is exactly where we want to be, based on where we are within the global economic cycle. And as you heard, it really has been a focus for us in terms of active repositioning to get - to get to where we are.

[Derek Hewett, Bank of America Merrill Lynch]

Okay, thank you. And then could you provide a little bit more color on the yield? I realized roughly 50% of the 70 basis point decline was due to lower benchmark rates in older vintage loans, but at this point, will the yield trend a little more closely to benchmark rate? Or could we see additional pressure due to further portfolio rotation from older vintage investments?

[Jon Yoder, COO]

Derek, I don't think so. If you look at the totality of, kind of, you know, where our portfolio looks like today, remember, one of the big driving factors on the top line is that we brought on balance sheet all of the lower yielding loans that used to be in our joint venture, our senior credit fund. And if you remember the strategy in that joint venture was upper middle market. It was not our directly originated deals. It was like mostly nearly syndicated type deals that generally came with lower spreads. And so, if you look at the, you know, the average yield at cost from that legacy - that portfolio from that we took on, it's just under 8%. Compare that to what we are originating today, and we've been pretty consistent in recent quarters of being just right around 9% in terms of the yields on the direct originations that we do on balance sheet.

I think one of the opportunities that we have and that, you know, and you've seen it execute on is, you know, to rotate some of those senior – the old senior credit fund assets into higher yielding, directly originated deals. So, we think that's a pretty powerful sort of toggle that we have here to fight any further decreases in rates should they come to pass. Obviously, the rate environment has been fluid. At the moment, it feels a bit more stable. But obviously, you know, things can change as they have been throughout the course of the year. So, I don't I don't think that broadly speaking, you know, we feel like, - just broadly speaking we do feel like there are opportunities to maintain attractive top line here, you know, even in the face of potentially further decline in rates.

[Brendan McGovern, President & CEO]

I'd only add Derek to one specific part of your question, with respect to the potential for future repayments of someone's earlier vintage investments. I think when you look at our [indiscernible], and when you look at this quarter, I think - I think you'll see that there's - there's not a ton of exposure remaining. And so we wouldn't expect that to be that continued trend of getting repaid out of some of those - some of those earlier, much higher yielding deals. I think we've borne the brunt of that, at this point, I think examination of our SOI would show that quite clearly.

[Derek Hewett, Bank of America Merrill Lynch]

Okay, great. Thank you very much.

[Operator]

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

[Brendan McGovern, President & CEO]

Thanks, Ian, and thank you, of course, everyone for joining us for this conference call. As always, if you have any additional questions, please don't hesitate to reach out directly to the Management Team here. Enjoy your weekend. Thank you.

[Operator]

Ladies and gentlemen, this does conclude the Goldman Sachs BDC Inc. Third Quarter 2019 Earnings Conference Call. Thank you for your participation. You may now disconnect.