Goldman Sachs BDC, Inc. Q3 FY2021 Earnings Call

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. Third Quarter 2021 Earnings Conference Call. Please note that all participants will be in a listen-only mode until the end of the call when we’ll 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 conditions may differ possibly materially from what is indicated in these 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 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, and which include reconciliations of non-GAAP measures to the most directly comparable GAAP measures. 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, Friday, November 5, 2021 for replay purposes. I will now turn the call over to Brendan McGovern, Chief Executive Officer of Goldman Sachs BDC.

Thank you, Erica. Good morning everyone and thank you for joining us for our third quarter earnings conference call. With me on the call today is Jon Yoder, our Chief Operating Officer, and Joe DiMaria, our Interim Chief Financial Officer. Also joining us is Carmine Rossetti who will be replacing Joe as our permanent CFO on November 8th. We want to thank Joe for his interim duties this past few quarters and welcome Carmine back to the Goldman team. I will begin the call by providing a brief overview of our third quarter results before discussing the current market environment for private credit. I will then turn the call over to Jon to describe our portfolio activity in more detail and finally Joe will take us through our financial results before we open the lines for Q&A. So with that, let’s get to our third quarter results. Overall we are pleased to report another quarter of solid income generation for the portfolio. Net investment income per share was $0.63, excluding the impact of asset acquisition accounting in connection with the merger with MMLC, Q3 adjusted net investment income was $0.48 per share. Net asset value per share decreased slightly to $15.92 per share as of September 30th, a decrease of approximately 80 basis points from the end of the second quarter. Excluding the impact of the $0.05 specialty event paid in September, the net asset value decline would've been 50 basis points. The September specialty event is the last of the three $0.05 per share specialty events that we paid in connection with the company's close of the merger with MMLC in Q4 of 2020. As we announced after market close yesterday, our Board declared a $0.45 per share dividend payable to shareholders of record as of December 31, 2021. Peeling back the layers a bit further on the quarter, there are few noteworthy dynamics worth highlighting in a discussion. First, at the risk of sounding a bit like a broken record, elevated repayments continued unabated this quarter. At $672 million, repayments equaled 21% of the fair value of investments at the beginning of the quarter and were 2.4 times greater than last quarter, which itself was the previous high water mark for repayments in the company's nearly 10-year history. Repayments were diversified across the book with the single large repayment only amounting to less than 10% of the total. This is a somewhat remarkable level of portfolio turnover in a single quarter, and there are a few takeaways I would offer for this unusual activity. First, I believe this repayment activity is a reflection of our focus on sectors and companies that continue to grow, perform well, and are therefore increasingly in investor favor. In an environment where M&A activity is high and equity valuations are rising, it's not surprising that high-quality companies are either being sold or transitioning to a lower cost of capital. Next, I would note that relative to the previous quarter, the repayments were skewed towards unique capital which helped improve the seniority of the book. At quarter end, first lien investments represented 84% of the portfolio compared to 80% at the end of last quarter. Finally, I would note that despite the repayment activity, the quarter-end leverage ratio stayed roughly flat at 0.91 times debt to equity. This was a noteworthy achievement and a testament to the strength of the team and our origination platform. Given the competitive environment in which we're currently operating, the team did an excellent job maintaining the portfolio size without sacrificing investment quality. While origination yields were below repayment yields, the overall impact on the portfolio was muted as the yield at amortized cost this quarter was 8.3% compared to 8.4% at the end of Q2. Next, we know that investors are keenly focused on the supply chain disruptions and inflationary pressures that are currently impacting the economy broadly and the performance of companies in certain sectors specifically. Thus far we've observed modest overall impacts to our portfolio as we have generally avoided lending to businesses in sectors such as manufacturing or retail which we believe are most susceptible to part shortages and rising costs of commodities and shipping, for example. As you are aware, the main themes in our portfolio continue to be software, healthcare IT, healthcare services, and professional services. We're mindful that companies in these sectors can see margin pressure from labor inflation which tends to be sticky rather than transitory. That said, strong companies in these sectors can also benefit from pricing power and the ability to pass on price increases resulting from the mission-critical nature of the value proposition they provide to customers in the case of technology companies and lasting demand characteristics of non-discretionary healthcare services. We continue to monitor the impact of the current environment on our book and we will keep you updated on any developments. Given the current environment, we are pleased that the overall credit quality of the portfolio remains strong. Non-accrual investments are just 0.7% of the portfolio at cost and 0.1% at fair value. With that, let me turn the call over to Jon Yoder.

Thanks Brendan. As Brendan mentioned, the continued strong capital markets environment during the quarter enabled the team to again be active on the new origination front. Our new investment commitments remain focused on first lien senior secured loans. During the quarter, we made 27 new investment commitments amounting to $670 million. We originated $312 million in loans to 10 new portfolio companies and $358 million of follow-on investments to existing portfolio companies primarily to finance M&A activity. As Brendan mentioned, sales and repayment activity totaled $672 million driven by the full repayments of investments in 16 portfolio companies. We continue to see a strong pipeline of new opportunities and we're optimistic that we'll achieve portfolio growth in the coming quarters assuming the pace of repayments moderates to more normalized levels. As of September 30, 2021, total investment in our portfolio was $3.1 billion at fair value comprised of 98.3% in senior secured loans including 84.3% in first lien, 5.2% in first lien last out unit tranche, and 8.8% in second lien debt. We also had 1.6% in preferred and common stock. We have $402 million of unfunded commitments as of the end of the quarter, which brings total investments and commitments to just over $3.5 billion. As of quarter end, the company held investments in 111 portfolio companies operating across 37 different industries. The weighted average yield of our investment portfolio at cost at the end of the third quarter was 8.3%, as compared to 8.4% at the end of the second quarter. The weighted average yield of our total debt and income producing investments at cost decreased to 8.6% at the end of the third quarter from 8.7% at the end of the second quarter. So, turning to credit quality. The underlying performance of our portfolio of companies overall was stable quarter-over-quarter. The weighted average net debt to EBITDA of the companies in our investment portfolio was six times at quarter-end as compared to 5.9 times from the prior quarter. The weighted average interest coverage of the companies in our investment portfolio at quarter-end was 2.5 times as compared to 2.6 times at the prior quarter. As of September 30, 2021, investments on non-accrual status increased slightly to 0.1% and 0.7% of the total investment portfolio at fair value and amortized cost respectively, from 0.0% and 0.3% at the end of the second quarter, this modest increase is due to putting Chase Holdings on non-accrual. Finally, during the quarter, we exited our equity position in Hunter Defense Technologies. Hunter Defense is a provider of shelters and ancillary products used primarily by the U.S. military in mobile troop deployments. The sale of the position generated a realized gain of $36 million, which resulted in a 1.54 times return on our investment since inception. Upon booking the realized gain, an unrealized gain was reversed. As a result, the net impact on NAV was not material in the current quarter. Let me now turn the call over to Joe to walk through our financial results.

Thank you, Jon. We ended the third quarter of 2021 with total portfolio investments at fair value of $3.1 billion, outstanding debt of $1.63 billion, and net assets of $1.62 billion. We also ended the third quarter with a net debt to equity ratio of 0.91 times, which is consistent with the end of the second quarter. At quarter-end, 62% of the company's outstanding borrowings were unsecured debt, and nearly $1.1 billion of capacity was available under GSBD's secured revolving credit facility. As noted during last quarter's earnings call, we had engaged our lender group to discuss an extension of the maturity on the revolving credit facility. We're pleased to announce the maturity has been extended by 18 months to August 2026. Given the company's current debt position, available borrowings, and cash of $172 million which resulted from repayments in the last two weeks of the quarter, we continue to feel we have ample capacity to fund new investment opportunities. Before continuing to the income statement, as a reminder, in addition to GAAP financial measures we will also reference certain non-GAAP or adjusted measures. This is intended to make GSBD's financial results easier to compare to the results prior to our August 2020 merger with MMLC. For Q3 2021, GAAP and adjusted after-tax net investment income were $64.3 million and $48.8 million respectively, as compared to $58.2 million and $48.8 million respectively in the prior quarter. The increase in quarter-over-quarter GAAP net investment income was primarily due to an increase in accelerated accretion related to repayments. On a per share basis, GAAP net investment income was $0.63, compared to $0.57 in the second quarter. Adjusted net investment income was $0.48 in both Q3 and Q2. Distributions during the quarter totaled $0.50 consisting of the $0.45 regular distribution declared in August and paid on October 27th, as well as the last of our three $0.05 special distributions, which was paid on September 15th. As Brendan noted, net asset value per share on September 30, 2021 decreased to $15.92 from $16.05 as of June 30, 2021. Q3 now reflects the impact of the $0.05 special dividend mentioned earlier. With that, I'll turn it back to Brendan for closing remarks.

Thanks, Joe. And thank you all for joining us for our call. Now seeing the current competitive market backdrop, the platform delivered solid results this quarter and we believe we have the portfolio primarily positioned in segments of the economy that are less vulnerable to volatility associated with the current economic backdrop. We appreciate your time and attention today. And as always, I'd like to thank you for the privilege of managing your capital. With that, let's open the line for questions.

Your first question comes from Finian O'Shea with Wells Fargo.

Good morning everyone. My first question is about the portfolio yield. It seems like you have managed to maintain it at a strong level, with a slight decline from 8.7% to 8.6%, despite the competitive market. Can you discuss how you're approaching this, where you're focusing your investments, or if there have been any changes in your strategy? Additionally, as older investments transition through M&A or mature, what does the new investment landscape look like?

I believe it's widely recognized that the current market environment is more competitive than we have seen in the last ten years of operating this business. We observe that there are fluctuations driven by the market, capital formation, and the specific sectors we are focusing on. This quarter shows some unusual activity in terms of the pace of transactions. The yields from our originations were lower than those from deals coming out of our portfolio, partly due to the mix of investments. We also prepaid some second liens. Our focus remains on ensuring we prioritize quality opportunities as we deploy new capital, rather than just aiming for a certain portfolio composition or leverage ratio in the short term while navigating individual quarters. This quarter demonstrated the platform's strong capabilities and access to diverse opportunities. As Jon mentioned, we originated ten new platforms and investments, with significantly more follow-on investments, totaling 17. These follow-ons were primarily driven by deals structured and negotiated in previous quarters, benefiting from the new issue spreads at that time. We are pleased with our performance this quarter, focusing on our strengths without a few dominant deals. Our largest deal was around $43 million, and we also had a $65 million deal that replaced another that was repaid this quarter. We continue to focus on sectors we have historically targeted, avoiding sectors that are struggling or potentially only providing opportunistic investments. In a dislocated market, we are seeing consistent activity in software, healthcare services, healthcare IT, and similar areas that you have come to associate with us in recent years.

Sure, that's helpful and then I guess kind of building off that, there's still a bit more yield compression it sounds like, obviously this quarter had a big tailwind of repay accelerated fees and so forth. How do you, with all this, you earn the dividend pretty much even without the fee waiver. But there were real tailwinds. So how are you thinking about it, going into 2022, what sort of leverage and yield profile do you envision? Thank you.

Yeah, yeah, for sure Fin. Look, I think we, first and foremost, need to continue to focus on finding attractive investment opportunities that are going to generate attractive risk-reward for the platform. I think this quarter continues to show that we've got that capability, even in this unusual environment. As you know, we still have room to move the total balance sheet up from where we are. We've been really thorough for four quarters, trying hard to stand still here with the pace of repayments coming out as they have here as well. And from sitting here today, we'd have to expect more capacity on the balance sheet to move up higher into a target level ratio. I think, as I mentioned on the call, we anticipate that would be the case in Q4. Obviously, we still have two-thirds of the quarter left to go. But in any more normalized environment, I think that should be the case here. You also heard we talked a little bit about, for example, Hunter Defense, which was a previously non-income producing asset that's been able to be monetized, recycled back into income producing assets. And I think there's also tremendous tailwinds on the liability side of the balance sheet for the company here as well. I'm sure many of the investors in this space are following what's going on in the financial markets for these assets. There's typically a high correlation between if there's pressure on asset yields, there’s also an opportunity on the liability side. For example, we've got our convertible bond which has a 4.5% coupon coming due early next year, that will be recycled. Our current plan would be to refinance that with our existing capacity under our revolving credit facility, which of course comes with a much lower cost of capital. I think there will be ongoing opportunities over the course of next year to do that, as well. So I think those are just a few things that I would point to that give us some optimism that there are still really good opportunities to perform here.

Okay, that's all for me. Thanks so much.

Thank you.

Your next question comes from the line of Matt Hayden with Raymond James.

Hey, all. Good morning and appreciate you taking my questions. First one for me maybe more so on the general overall market environment, beyond spreads any high-level color you can give on how terms and covenants are holding up?

Yeah. Hey, Matt, good to connect. Yeah, look, I don't know that our commentary is going to be tremendously different than probably what you've heard from other managers. I think there's a combination of things going on in the market right now, in the context of the economic environment or the fiscal stimulus coming out of the COVID crisis that makes it a bit of an unusual time in the market. There’s new capital being formed in this space, etc. And so I would characterize this as one of those portions of a cycle in the market that you go through where things are a bit more competitive than they might be at a different part. Like, as I mentioned, I think that generally ebbs and flows over the course of time. I think for sure the relative opportunity set in this world that we're operating in continues to be really, really attractive overall. In terms of specificity, on changes in terms, etc. I think a few things to note, one is that, when you look at the originations and the cadence this quarter, we continue to be focused on what we think is the core of the middle market. If you look at the size of the companies in our book, it hasn't changed dramatically over the years. I think the median EBITDA of a company in the book is somewhere around $35 million to $40 million. That's a part of the market that we like. Those are companies that are scaled in their own right and have really good opportunities to continue to grow. Our focus is on those sectors with secular tailwinds. But they're not so big that they're really bumping up against the more efficient part of the capital markets and the syndicated parts of the market. But when there are things going on in that part of the market, that does tend to be a little bit of a bleed down into our part of the market. So an example would be, I think there's a little bit of pressure on LIBOR floors for example, a couple of deals this quarter came with 75 basis point floors. I think this quarter, the average for our book was 90 basis points, so nothing incredibly dramatic. But on the margin, we do see a bit of those types of pressures, and same in the spread world as well. As you heard, in terms of how we're navigating, continuing to focus in sectors where we think there's better opportunities, and a platform that's got access to those opportunities, I think really proved to be the case this quarter.

Got it. Maybe just following up on the convert lines. So it sounds like the initial plan is to run the repay through the revolver. Maybe in 2022 would you expect that to be a permanent shift that kind of runs secured mix a little hotter or do you expect to visit the unsecured market again in 2022?

Yeah, look, we are constantly dynamically looking at that. I think there's a few tenets that are really important to us and I think that really came through during the COVID crisis. I think when you're investing in this part of the market as a permanent capital vehicle, you've got to build your balance sheet to withstand any and all environments that might come your way. We've historically been thoughtful about leaning into what has been a higher cost of debt in the unsecured part of the market, but a much more flexible overall balance sheet where obviously you're not pledging all of your collateral to lenders in a somewhat inflexible solution. So we're really, really mindful of making sure we're maintaining that right focus overall and appropriate mix. I think there's also been some dynamics in the unsecured part of the market that are really, really quite helpful to the BD space, B2C space in general, and I think our platform specifically, which is an extension of tenor, we've had seven-year deals, even a 10-year deal getting done in the space. So the opportunity to ladder maturities is one that I think is just really emerging, and I think would be a really good reason to continue to look at the unsecured part of the market and to not just manage that mix of secured versus unsecured but also to matter the laddering of your maturities. So we'll keep an eye on all of that for the course of 2022.

Got it. That's it for me. I appreciate the time.

Our pleasure.

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

Well, thank you, Erica. And of course thank all of you for dialing in. Of course, as always, if you do have any questions, please feel free to reach out directly to the team. I hope you all have a great weekend.

Ladies and gentlemen, this does conclude the Goldman Sachs BDC Inc. third quarter 2021 earnings conference call. Thank you for your participation. You may now disconnect.