Goldman Sachs BDC Inc

NYSE:GSBD

Earnings Call Transcript 2020-Q4

[Operator]

Good morning. This is Erica, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC, Inc. Fourth Quarter and Year End 2020 Earnings Conference Call. Please note that all participants will be in listen-only mode until the end of the call when we will open up the line for questions.

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 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-K filed yesterday with the SEC. This conference call is being recorded today, Friday, February 26, 2021, for replay purposes.

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

[Brendan McGovern, Chief Executive Officer]

Thank you, Erica. Good morning, everyone, and thank you for joining us for our fourth quarter and year end 2020 earnings conference call. I am 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 fourth quarter results, including commentary on the performance of our portfolio following the completion of the company's merger with Goldman Sachs Middle Market Lending Corp or MMLC, which was completed on October 12, 2020.

In addition, I'll offer some perspectives on the current state of the lending environment and the opportunity set we see before us today. Jon Yoder will then discuss our portfolio activity in more detail before turning over to Jonathan Lamm to walk through our financial results. Finally, I'll conclude with some closing remarks before we open the line for Q&A.

So with that, let's get to our fourth quarter results. Our Q4 net investment income per share was $0.59 on after-tax net investment income of $55.3 million. Excluding the impact of asset acquisition accounting in connection with the merger with MMLC, adjusted net investment income per share was $0.48, reflecting solid income performance to support the company's dividend.

Net asset value per share increased to $15.91 per share as of December 31, an improvement of 2.7% from the end of the third quarter. The increase reflected continued improvement in the underlying portfolio company performance, coupled with ongoing market spread tightening. On October 12, we closed our merger with MMLC, which resulted in a number of benefits to GSBD, which we have discussed at length in prior conference calls, including, first a reduction of our net debt to equity ratio from 1.29 times to one time at year end.

Next the merger resulted in an overall improvement in GSBDs portfolio metrics, including, an increase in portfolio yield of cost from 7.7% to 8.4% and an increase in single-name diversification. Finally, as discussed, we expect the merger to be accretive to GSBDs net investment income per share, both in the short and long-term, due in part to our previously announced variable incentive fee cap through 2021, as well as increased asset capacity resulting from the deleveraging.

As we announced after the market closed yesterday, our board declared a $0.45 per share dividend payable to shareholders of record as of March 31, 2021. Further, the first of three installments of our special dividends aggregating to $0.15 per share will be paid on March 15, 2021 to shareholders of record on February 15, 2021. We will be paying the remaining two additional $0.05 per share installments to shareholders of record on May 14, 2021 and August 16, 2021 respectively.

Additionally, during the quarter, our Board of Directors approved a new 10b5-1 Plan authorizing the repurchase of up to 75 million of GSBD shares of common stock subject to certain conditions should the shares trade below NAV.

Moving on to the market environment, during the quarter, the continued rebound in equity and credit markets spurred increased capital markets activities, including mergers and debt refinancings. This trend accelerated into year-end, aided by the improved economic sentiment resulting from the FDA approval of certain COVID-19 vaccines. Transaction activity increased dramatically from the lows of the COVID crisis as buyers' demonstrated confidence in economic growth prospects and increased their bids to meet seller demands on pricing.

Lending opportunities proved to be robust in this environment. And as a result, GSBD had record origination activity during the quarter of $423 million across an extremely diverse set of opportunities, which Jon will discuss in more detail. Repayment activity of over $250 million was also up sharply during the quarter, and we see this trend continuing in the current environment.

As you're probably aware, the syndicated and investment grade parts of the capital markets were particularly robust in Q4. As a result, we took the opportunity to actively strengthen our liability structure by issuing additional attractively priced unsecured debt at historically low levels for BDCs while also expanding our access to secured borrowings.

Our $500 million unsecured note offering priced with a coupon of 2.875%. And we increased capacity under our revolving credit facility from $795 million to $1.695 billion in Q4. We believe this refinancing activity situates the company well with diverse and deep sources of funding. Subsequent to the quarter end in January, Fitch reaffirmed our investment grade rating and revised our outlooks from negative to stable.

With that, I'll turn it over to Jon Yoder.

[Jon Yoder, Chief Operating Officer]

Great, thanks, Brendan. As Brendan mentioned, the very strong deal volumes during the quarter led to a record amount of new originations. All of our new investment commitments were in senior secured loans as we continue to maintain our focus on lending to sectors that exhibit strong growth despite the macroeconomic headwinds that are being caused by the pandemic.

During the quarter, and excluding the names that we inherited as part of the MMLC merger, we made 22 new investment commitments, 13 of which were two new portfolio companies and nine to existing portfolio companies. This totaled $423 million. Meanwhile, net fundings of previously unfunded commitments were 9.1 million during the quarter.

Sales and repayment activity totaled 252.7 million driven by the full repayment of investments in six portfolio companies. We continue to expect strong deal activity going forward, though perhaps not quite at the same pace as what we saw in the fourth quarter.

Regarding portfolio composition, as of December 31, total investments in our portfolio were 3.243 billion at fair value, comprised of 96.5% in senior secured loans, including 78% in first lien, 4.4% in first lien last Last-Out Unitranche, 14.1% in second lien debt, as well as a negligible amount in unsecured debt, and 3.5% in preferred common stock and warrants.

We also had 242.9 million of unfunded commitments as of December 31, bringing total investments and commitments to 3.486 billion. As of quarter end, the company had 123 portfolio companies operating across 39 different industries. The weighted average yield of our investment portfolio at cost at the end of the fourth quarter was 8.4%, as compared to 7.7% at the end of the third quarter.

This increase as Brendan mentioned was largely driven by the higher yields on the assets that we obtained as part of the merger with MMLC. The weighted average yield on our total debt and income producing investments at cost also increased to 8.7% at the end of the fourth quarter from 8.3% at the end of the third quarter.

So turning to credit quality, the underlying performance of our portfolio companies overall were stable quarter-over-quarter. The weighted average net debt to EBITDA of the companies in our investment portfolio was six times at quarter end versus 5.7 times at the end of the third quarter. The weighted average interest coverage of the companies in the portfolio at quarter end was 2.6 times which was flat from the prior quarter. As of December 31, investments on nonaccrual status were just 0.3% and 0.7% of the total investment portfolio at fair value and amortized cost respectively.

As we discussed last quarter, one holding GK, which is called GK Holdings, has agreed to merge with one of its competitors in conjunction with incremental capital from a SPAC. GK Holdings had been an underperforming asset and as part of the SPAC transaction, we expect to receive a nearly full recovery of our first lien claim. And the recovery on our second lien claim is expected to be in excess of our third quarter end mark.

We expect the transaction to close in the first half of 2021, subject to shareholder approval. However, since the amount of our recovery is now fixed pursuant to the terms of the transaction, we decided to put the investment on nonaccrual until the acquisition is completed. Additionally, another holding called Chase Industries, which is a second lien secured debt investment, is a non-accruing loan that was acquired as part of the merger with MMLC.

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

[Jonathan Lamm, Chief Financial Officer]

Thanks Jon. We ended 2020 with total portfolio investments at fair value of 3.24 billion, outstanding debt of 1.63 billion and net assets of 1.62 billion. We ended the fourth quarter and the year with a net debt to equity ratio of one times compared to 1.29 times at the end of the third quarter and 0.93 times following the close of the merger with MMLC.

As Brendan mentioned earlier $500 million in unsecured notes, with maturity in January of 2026 were issued during the quarter. The notes priced at a fixed rate of 2.875%. Additionally, pursuant to the closing of the merger with MMLC GSBDS revolving credit facility was upsized to a total capacity of 1.695 billion.

At quarter end 62% of the company's outstanding borrowings were unsecured. And we feel we have ample capacity to pursue new investment opportunities, while being mindful of an appropriate mix of secured and unsecured borrowings.

Before continuing to the discussion of the income statement, and expansion on the quarter-over-quarter change in net assets, it's important that we discuss the merger accounting to provide some context. Under GAAP the merger was accounted for under the asset acquisition framework, whereby fair value of the consideration paid by GSBD for MMLC was determined to be the GSBD the share price at the closing date of the transaction, less than adjustment to account for the illiquidity of the shares given the lockup imposed on MMLC shareholders at close, multiplied by the shares issued pursuant to the exchange ratio.

The final consideration yielded a purchase discount for the assets of MMLC, relative to their fair value at the closing of the merger of $84 million. This purchase discount was allocated pro rata based on fair market value to the former fully funded MMLC assets. As a result, GSBDs initial cost basis for the assets equal their fair value at the time of the acquisition less the purchase discount. Immediately upon the close of the merger, GSBD recognized a onetime unrealized gain equal to the total purchase discount of $84 million as GSBD remarked the assets back up to fair value. This onetime gain is a non-cash event.

Consistent with other market discounts, the purchase discount recognized at the close of the merger will be amortized over the remaining life of the debt investments that were acquired and will be accelerated if those debt investments are repaid early. The purchase discount allocated to common and preferred stock will not be amortized and will be recognized into earnings upon a realization event of the stock investment. The ongoing amortization of the purchase discount on debt investments results in an increase to net investment income and a corresponding reversal of part of the onetime unrealized gain at close.

In order to make the company's post-merger financial results easier to understand and compare it to pre-merger financial results. We have introduced a number of non-GAAP measures to supplement the GAAP financials. These supplemental financial measures are intended to remove the impacts of the purchase discount. Before continuing I'll briefly introduce each of these metrics.

Adjusted net investment income and adjusted net investment income per share exclude the amortization and acceleration of the purchase discount. These measures will be less than their comparable GAAP measures. Adjusted net realized and unrealized gain loss and adjusted net realized and unrealized gain loss per share, exclude both the onetime unrealized gain resulting from the purchase discount write up and the corresponding reversal of this write up.

These measures will be greater than their comparable GAAP measures other than in this initial quarter where the impact of the onetime unrealized gain causes the GAAP measures to be higher. Finally, adjusted earnings per share will reflect earnings per share as calculated using adjusted net investment income per share and adjusted unrealized and realized gain loss per share.

Before continuing to the discussion of the income statement, the final merger impact to consider is the variable incentive fee cap provided by GSAM. Under the cap GSAM will waive any accrued incentive fee necessary for GSBD to earn at least $0.48 of GAAP NII per share. Further, as a result of the impact of the purchase discount GSAM will voluntarily waive any accrued incentive fees necessary to reach $0.48 of adjusted NII per quarter through December 31, 2021.

Having covered all of the merger transaction impacts we will now turn to results for Q4 2020. GAAP and adjusted after tax net investment income were 55.34 million and 45.23 million respectively for the quarter, as compared to 18.2 million of GAAP net investment income in the previous quarter.

On a per share basis, GAAP and adjusted net investment income were $0.59 and $0.48 per weighted average share respectively, as compared to $0.45 of GAAP net investment income per weighted average share in the third quarter of 2020.

GAAP and adjusted earnings per share were $.83 and $0.94 respectively. This yielded a net increase in net asset value per share of $0.42 with ending NAV per share of $15.91 a 2.7% increase quarter-over-quarter.

With that I will turn it back to Brendan.

[Brendan McGovern, Chief Executive Officer]

Thank you very much, Jonathan. As most investors who have followed us for a long time know, I typically like to end each conference call by thanking you for the privilege of managing your capital. Today I'd like to switch things up a little bit to acknowledge the pending departure of Jonathan Lamm who was been our CFO since our inception back in 2012. As a founding member of the GSBD team, Jonathan has left an indelible mark on our company, and has made significant contributions as a steward of your capital. So on behalf of Goldman Sachs, our Board of Directors, and especially the entire GSBD team, I'd like to thank Jonathan for his distinguished service and wish him well in his new endeavor. Joe Dimaria, a longstanding Managing Director at Goldman will assume the role as interim CFO, and will continue to manage a team of top-notch professionals in the GSBD finance function while we identify a long-term replacement for Jonathan.

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

[Operator]

[Operator Instructions] Your first question is from Finian O'Shea with Wells Fargo Securities.

[Finian O'Shea, Wells Fargo Securities]

Hi, everyone. Good morning. I guess first I echo Brendan's comments and congrats, Mr. Lamb on your notable tenure at Goldman's BDC. I'll start with you here. So appreciate I the -

[Jonathan Lamm, Chief Financial Officer]

Thank you.

[Finian O'Shea, Wells Fargo Securities]

Appreciating the waiver outline you gave. And it looks like a part of this waiver was to shore up the - or stem the - would be capital gains from GAAP accounting, et cetera. You could word all this better than I could. But the question is, now that this is a pretty complicated line item in the model, roughly where do you stand on your normalized incentive fee? Or like are you caught up in terms of your hurdle rate going forward, should we think about that?

[Jonathan Lamm, Chief Financial Officer]

Is your question Fin on the capital gains side or on the - like the -

[Finian O'Shea, Wells Fargo Securities]

Both.

[Jonathan Lamm, Chief Financial Officer]

On the capital gains type we're not we're not fully caught up. That's an annual vesting, but I wouldn't expect that to have any near-term impacts. With respect to the net investment income incentive fee, what this waiver does - and just to make sure that you're got it right. The capital gain or the unrealized gain that was a result of this merger accounting effectively accelerated or caught up previous losses, which caused us on the net investment income side to be able to fast incentive fees that previously GSAM had waived or temporarily waived. But because there is this 12-quarter lookback, this write-up would have caused GSAM to take a significant amount of those previously passed on incentive fees. The waiver though effectively comes in and permanently waives GSAM's ability to ever catch up or take any of that net investment income incentive fee. So hopefully that resolves it, but it's the gain caused in NII incentive fee that GSAM is waving.

[Finian O'Shea, Wells Fargo Securities]

In the NII fee had started, to pierce back to the cap last quarter modestly. And then just so I was assuming it would be somewhere in between given the credit performance, but it sounds like a pretty normalized income incentive fee accrual to resume obviously before the waivers and such next quarter.

[Jonathan Lamm, Chief Financial Officer]

That's correct. Though, for the remainder of the year through the end of '21, the waiver will stay in place to waive any incentive fees in order to cause GSBD to earn adjusted net investment income of $0.48. So if GSBDs incentive - if GSBDs net investment income on an adjusted basis is above $0.48, then GSAM will take an incentive fee, but if it's below then they will effectively waive any of that normalized incentive fee that you're talking about in order to get to that $0.48 of adjusted NII.

[Finian O'Shea, Wells Fargo Securities]

Okay. Well, you're as sharp as you were on your first day. Congrats again Jonathan. I'll switch to one to Brendan or Mr. Yoder on the portfolio. I noticed that the leverage went from 5.7 to 6. Was this more - or was this like a result of refreshing the portfolio? There was a lot of activity this quarter. Or is this perhaps some COVID related EBITDA declined maybe div recaps just any color on there for mostly firstly in portfolio, it's pretty high leverage, right?

[Brendan McGovern, Chief Executive Officer]

Yeah. No, your first comment is - and I think it is correct as we went through it in a lot of detail, a lot of portfolio activity this quarter, both in terms of repayment activity. And when you think about the nature of those more seasoned loans, the trajectory tends to be loans that decrease from a leverage perspective over their life as they grow. And so the recycling of those repayments into a higher number of new issues at higher first allocation cash in point is causing them crazy. Underlying performance of the portfolio companies on a broad basis continues to be strong, as was reflected broadly in marks within the portfolio and company as well.

[Jon Yoder, Chief Operating Officer]

Yeah, and I mean, the only thing that I would add in, for you noted this Fin, but the weighted average interest coverage didn't change. So it's not an excessive - another good indicator that it's not performance related, it's just really mix shift between newer loans, where when you start as Brendan said, they are generally higher leverage, but then the companies if you've done your underwriting properly, they grow over time their EBITDA and that brings down the debt to EBITDA ratios.

[Finian O'Shea, Wells Fargo Securities]

Okay. That's helpful. That's all for me. I'll jump back in. Thank you.

[Brendan McGovern, Chief Executive Officer]

Thanks Fin.

[Operator]

[Operator Instructions] Your next question is from Robert Dodd with Raymond James.

[Robert Dodd, Raymond James]

Hi, guys, and same. It will be a sad day to see you go Jonathan, but I wish you luck in your - whatever it is you're heading off to do. So thanks for that.

[Jonathan Lamm, Chief Financial Officer]

Thanks Robert.

[Robert Dodd, Raymond James]

On kind of [Technical Difficulty] more concisely, I think - I appreciate all the disclosure about the waiver as well, et cetera. But if we look beyond '21, right in perpetuity, the discount accretion is not just going to quit unless the whole portfolio turns over this year, it's not going to be just a one-year event. Will the discount accretion, which is obviously non-cash accounting treatment, will that be excluded from the calculation of pre-investment - pre-incentives NII beyond '21? Or will you be taking an income incentive fee on that accounting gain beyond '21?

[Jonathan Lamm, Chief Financial Officer]

It's a great question. And the answer is that the way that the investment management agreement works is that you can't exclude it because it is part of income. That being said, I would not expect for it to have any impact given the way that we have the limiter set up. So for every dollar of income accretion, that's going to come in related to this discount, there's also going to be a corresponding unrealized loss, which would effectively limit the incentive fee anyways, Robert. So it'll be in there, but effectively, all of the impacts are really taken this quarter because of that corresponding up down that you see in the way that our incentive fee is calculated.

[Robert Dodd, Raymond James]

Understood and about the impact on the unrealized. My only point being, of course that it can't be excluded unless the management fee agreement is amended or a permanent waiver is put in place to accelerate to adjust.

[Jonathan Lamm, Chief Financial Officer]

That's right. Yeah, you're hitting on exactly the issue. So in order to change your investment management agreement, you got to go out to shareholders get a vote and all of that. So the calculation will effectively work in such a way that there won't need to be a waiver, but should there have ever been a situation GSAM would have basically - would stand in and obviously wave in that situation post '21, but it won't have an impact, Robert.

[Robert Dodd, Raymond James]

Got it, appreciate that. Moving on to the portfolio, I mean, the originations in the quarter were obviously very strong. I mean, obviously, it's a bigger business now, as a platform, so the previous ones, it should be bigger. But even with that in mind, they're very big. The one thing that did kind of leap out to me is the funded versus unfunded. This time funded three quarters of the new commitments, which seems relatively low compared to historic patterns. Is that a lot of undrawn revolvers, acquisition lines, can you give us any color on what that unfunded is and why it was relatively high as a proportion of new commitments this quarter?

[Brendan McGovern, Chief Executive Officer]

Yeah. So we could sort of go back and take a closer look and give you much more detail about that breakout. But about [Technical Difficulty] unfunded portion based on those new commitments. And so just looking at the nature of the commitments and deals that we did there during this quarter a number of platform acquisitions where M&A is an expected outcome within the sponsors plan and so providing a delayed draw term loan to enable the sponsor or subject to certain conditions, to use that capital to pursue those transactions. So not a bigger increase in revolvers, as a general tool in the toolkit, but more around DDTLs and now say, moreover, when we look at just the total unfunded exposure here, I think it's in the $250 million range on a $3.3 million - $2.3 billion portfolio.

Yeah, I think that's probably pretty consistent with where we've been, historically overall. So certainly recognized in this particular quarter, just looking at the originations, it might be a bit skewed, but overall, yeah, I think we're in a pretty similar spots where we would be prospectively and I'd point out as you're looking at that amount of capital, and we've talked about this a bunch, Robert we certainly within our own risk parameters, view that money as committed, but it is a source of capital that's being used in effect by the company that's not being used to generate income. And so the future findings of that are potential future increases in the run rate income portion of the company as well.

[Jon Yoder, Chief Operating Officer]

One thing that I would add Robert, is if we take a longer-term historical view of unfunded commitments, I would say that relative to maybe five or eight years ago, a lot of the unfunded commitments that you were asked to make were in the form of revolving commitments that were kind of rainy day type of funds, they never really expected to get drawn on. I think as we've - as the sponsor community has kind of developed into a wider use of strategies where, as Brendan mentioned, they're investing in platforms that they then expect to do a lot of follow on or sort of tuck in acquisitions for them.

It means that a lot of the unfunded today is really more specifically for those acquisitions, for those sort of delayed draw to make acquisitions. And so the impact to us is that we now expect that most of our unfunded - or many, probably the majority of our unfunded commitments will actually be funded and generally speaking, what we're seeing is that they get funded relatively quickly. It's not the kind of thing where that sits out there for three, four or five years and never gets drawn. But again, because of the strategy, the sponsors to make tuck in acquisitions for their companies. It tends to get drawn reasonably quickly. So it's becoming - as Brendan said, it's not the most efficient use of our balance sheet to make those commitments. But the trends are positive in that we don't stay unfunded for terribly long.

[Robert Dodd, Raymond James]

Understood, that kind of ties into to a follow up, I had to one of your comments where you said you expected strong field activity, but not at Q4 levels. I mean, Q4 is obviously very, very strong. So from that - presumptively that means you expect commitments and new commitments to be continued to be strong through 2021, which is certainly consistent with what we're hearing. I mean, and then on top of that you expect the unfunded commitments you have to be drawn as well. So I certainly don't think you have a leverage problem, obviously, you do leverage with MMLC, et cetera. But where's your comfort level in this environment for leverage, obviously, you've got a target range, but kind of where's the comfort level given if those unfunded sat out there a little bit, but you expect them to be drawn? Where's the comfort level in the Intermediate Period?

[Brendan McGovern, Chief Executive Officer]

Yeah, there's a lot embedded in that, in that question and I'll hit on the specificity and maybe a little bit of a backward looking. We look at having gone through the COVID crisis, as we always do from a risk management lens. As we've talked about, we feel really, really confident in the risk management approach with a lot of oversight and decades of experience here in the firm. I think our models and our approach proved to have worked looking back. We went through a severe crisis, the balance sheet certainly took a hit, we've marked down the assets significantly, and we're never really close to being in violation of any of our covenants or any of the regulatory issues that we had. We're obviously, quite pleased that our assets have performed. And so I think through that lens investors should take comfort, even though we went into the crisis at a higher historical leverage. I think things turned out quite well. Certainly, the merger of MMLC was a further deleveraging event.

All that being said, obviously, in the context of that crisis, in the context of the industry moving to two to one, a lot of discussions with fixed income investors, a lot of discussions with rating agencies. And I would say you're looking at that through the lens of our risk management models as well, 1.25, 1.3 times debt to equity is where I think we end up. There's a more nuanced discussion, as you know, based on loss given default, and asset quality, and lien type, et cetera. But I think in the interest of just sort of giving a number that you can orient to that's what I described to you. And I will tell you that also when we're factoring that in, we're including those unfunded. And so we're not excluding - we certainly have seen those are obligations, we've always viewed those as obligations that can get called at any given point in time. So that's something to be aware of, as well in thinking that - then that point through.

[Jon Yoder, Chief Operating Officer]

And Robert, the only thing I would add to that is just specifically on the comments that I made about we're seeing and continue to expect fairly robust deal activity in this year. Remember that we also - when we see periods of elevated deal activity of new originations, it tends to be highly correlated with high levels of repayment activity, just like we saw in the fourth quarter. So that's the other side of the coin here is that that kind of tamps down on overall portfolio growth.

[Robert Dodd, Raymond James]

Got it. Thank you, that's it for my questions. I appreciate it and Congrats.

[Brendan McGovern, Chief Executive Officer]

Thanks Robert.

[Operator]

At this time, there are no further questions. Please continue with any closing remarks.

[Brendan McGovern, Chief Executive Officer]

Great, thank you Erica and thank you all for your time today. It's been obviously pretty brutal winter here in the northeast, but we're finally looking like we're getting a break in the weather here. So you might say February came in like a lion was going out like a lamb. So thanks everyone.