Goldman Sachs BDC, Inc. Q4 FY2021 Earnings Call

Good morning. This is Gemaria, and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs BDC Incorporated Fourth Quarter and Year-End 2021 Earnings Conference Call. Please note that all participants will be in listen-only mode until the end of the call, when we will open the line up 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 audio cast is copyrighted material of Goldman Sachs BDC Incorporated, 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 annual report on Form 10-K filed yesterday with the SEC. This conference call is being recorded today, Friday, February 25th, 2022, for replay purposes. I will now turn the call over to Brendan McGovern, Chief Executive Officer of Goldman Sachs BDC.

Thank you, Gemaria. Good morning everyone and thank you for joining us for our fourth quarter earnings conference call. I'm here today with Jon Yoder, our Chief Operating Officer, and Carmine Rossetti, our Chief Financial Officer. I will begin the call by providing a brief overview of our fourth-quarter results before discussing the current market environment in more detail. I will then turn the call over to Jon to describe our portfolio activity before we hand it to Carmine to take us through our financial results. And finally, we'll open the line for Q&A. So with that, let's get to our fourth quarter results. Overall, we are pleased to report another quarter of solid income generation for the portfolio. Net investment income per share was $0.56, excluding the impact of asset acquisition accounting in connection with the merger with MMLC. Q4 adjusted net investment income was $0.48 per share. Net asset value per share decreased slightly to $15.86 per share as of December 31st, a decrease of approximately 38 basis points from the end of the third quarter. 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 31st, 2022. Looking back, 2021 was a remarkable year in many respects with private credit space broadly and GSBDs specifically. As the loose monetary policy environment fueled a strong economic recovery and a record investment activity. As we discussed extensively over the past several quarters, last year was marked by a record recurring activity as the company saw more than 45% of its portfolio from 2020 year-end turnover in 2021. Despite this unusual repayment activity, the team managed to grow the company's investments at fair value by over 7% year-over-year, which is a testament to the platform's outstanding origination capabilities and hustle over the past year. In addition, our investment activity was highly focused on the top of the capital structure. And as a result, our first-lien exposure increased by about 700 basis points from year-end 2020, ending at about 85% of the total portfolio at the end of 2021. With this improvement in lien type, we believe it's prudent to target a funded debt-to-equity ratio of about 1.25 times. For much of the year 2020, our leverage ratio hovered well below this target at about one times, as we balanced the wave of repayments with sensible investment activity in the overall competitive environment. We were pleased to see the leverage ratio kick higher in Q4, with ending an average debt-to-equity of 1.16 times and 1.04 times respectively. In this environment of elevated repayment and investing activity, our focus has been on maintaining a high-quality book with attractive credit characteristics, which we believe will serve the company well in the long term. We maintain our historical focus on middle-market origination as the median EBITDA of the company's logbook stayed relatively constant at just under $40 million. Our focus on smaller companies allows us to maintain strong document standards as we made only one covenant-light loan during the year, which was a follow-on investment since the company has performed well and has seasoned within our portfolio. That said, the combination of high portfolio turnover in the current competitive market environment, coupled with the higher mix of first-lien assets due to pressure on yields during the year. Q4 origination yields were 7.5%, which compares to 7.7% over the course of 2021, reflecting continued competition for high-quality assets. In addition, the weighted average net debt to EBITDA ratio of our portfolio companies moved higher to 6.4 times at year-end 2021, compared to six times at the end of 2020, reflecting a trend towards lower leverage portfolio company exposures being refinanced into new deals during the quarter. In last quarter's call, we discussed the inflationary trends that continue to mark the current environment. And thus far inflationary pressures have not caused significant stress in our portfolio companies, which we believe is a reflection of our focus on high-quality companies with value-added products and services that provide a multi-comm of pricing power in the current environment. We are observing, however, that macroeconomic inflationary pressures are creating pronounced interest rate volatility. With the yield on the 10-year note currently stands at almost 2% versus 1.5% at the beginning of the year. At the same time, 3-Month LIBOR has more than doubled to 50 basis points from the 21 basis points we saw at the beginning of the year. And the forward curve is projecting 3-Month LIBOR at 1.9% by the end of the year. Most economists are predicting seven to nine interest rate hikes by the Fed over the coming year. In light of the changing environment, we want to highlight a few points. First, 99.4% of our portfolio was in floating-rate assets as of the end of the year, typically with LIBOR floors of around 1%. Next, we have been actively managing our debt structure. And at year-end, more than half of our liability structure was in fixed-rate notes. As a result of this asset and liability profile, we would initially expect some pressure on net interest margins as the front of the curve kicks higher, but the contractual LIBOR floors on our assets, because of yields, remain stable. However, once LIBOR exceeds those floors, all other things being equal, the rising rate environment should be a tailwind to net interest margins as asset yields move higher while the majority of our liability costs remain fixed. Finally, turning to asset quality. Non-accrual investments increased to 2.5% and 1.8% of the portfolio costs and fair value, respectively. The increase was a result of the addition of one of our investments to the non-accrual list. As we have discussed previously, this investment has been impacted by the reduction in demand for shared meeting space in the COVID environment and has benefited from capital support from its owners. Replacing investments on non-accrual this quarter, as we expect to monetize this position this quarter at a discount to our clean value. We don't expect this monetization to have a meaningful impact on our net asset value, and we will see to recycle the proceeds back into other income-producing loan assets. With that, let me turn it over to Jon Yoder.

Great. Thanks, Brendan. The robust capital markets environment during the quarter allowed the team to remain active in new origination efforts. Our new investment commitments continue to be high as we prioritize first lien senior secured loans. During the quarter, we made 32 new investment commitments totaling $723 million. We originated $461 million in loans to 13 new portfolio companies and made $262 million in follow-on investments to existing portfolio companies mainly to support M&A activities. As Brendan noted, sales and repayment activity, although lower than last quarter’s record, stayed elevated at $296 million, driven by the full repayments of investments in seven portfolio companies. Moving to portfolio composition, as of December 31, 2021, our total investments were valued at $3,478 million, with 97.5% in senior secured loans, including 84.7% in first lien, 4.7% in first lien last-out unitranche, and 8.1% in second lien debt. We also had a small amount in unsecured debt and 2.5% in a mix of preferred and common stock and warrants. Additionally, as of December 31, we held $442 million in unfunded commitments, bringing total investments and commitments to $3.920 billion. As of the end of the quarter, the company invested in 121 portfolio companies across 38 diverse industries. The weighted average yield of our investment portfolio at cost at the end of Q4 was 7.9%, down from 8.3% at the end of Q3. The weighted average yield of our total debt and income-producing investments at cost decreased to 8.4% at the end of Q4, compared to 8.6% at the end of Q3. Regarding credit quality, the overall performance of our portfolio companies remained stable quarter-over-quarter. The weighted average net debt to EBITDA of the companies in our investment portfolio was 6.4 times at quarter-end, compared to six times the previous quarter. The weighted average interest coverage of these companies at quarter-end was 2.5 times, consistent with the prior quarter. As of December 31, 2021, investments on non-accrual status rose to 1.8% and 2.5% of the total investment portfolio at fair value and amortized cost, respectively, up from 0.1% and 0.7% at the end of the third quarter. This increase is due to one investment being assigned non-accrual status. Now, I will turn the call over to Carmine to go over our financial results.

Thank you, Jon. We ended the fourth quarter of 2021 with total portfolio investments at fair value of $3.5 billion, outstanding debt of $1.87 billion, and net assets of $1.61 billion. We also ended the fourth quarter with a net debt-to-equity ratio of 1.14 times, which is an increase from 0.91 times at the end of Q3 as investment fundings exceeded repayments for the first time in several quarters. At quarter-end, 54% of the company's outstanding borrowings were unsecured debt, and $837 million of capacity was available under our secured revolving credit facility. On April 1, 2022, the company's $155 million, 4.5% convertible notes will come due. Our current expectation is to use the capacity under our secured revolving credit facility to fund the maturity, but we continue to assess market conditions for other alternatives to term out our debt. I note that at 4.5%, the convertible notes are our most expensive liability, and we look forward to optimizing our liability structure with the maturity of these notes. 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 the company's financial results easier to compare to results prior to our October 2020 merger with MMLC. For Q4, GAAP and adjusted after-tax net investment income were $57.3 million and $48.9 million respectively as compared to $64.3 million and $48.8 million respectively in the prior quarter. The decrease in quarter-over-quarter GAAP net investment income was primarily due to a reduction in accelerated accretion as a result of more normalized repayment levels this quarter as compared to historically high repayments last quarter. On a per-share basis, GAAP net investment income was $0.56 compared to $0.63 in the third quarter. Adjusted net investment income was $0.48 in both Q4 and Q3. Distributions during the quarter totaled $0.45 as compared to $0.50 last quarter, which included the last of $3.05 special distributions that were implemented following the merger with MMLC in Q4 of 2020. Net asset value per share on December 31, 2021 was $15.86 per share as compared to $15.92 per share as of September 30, 2021. With that, I'll turn it back to Brendan for closing remarks.

Thanks, Carmine. As many of you are aware, I recently announced that I'm retiring from Goldman Sachs effective mid-March. In addition, we announced last night that Jon Yoder is giving up his duties as Chief Operating Officer of our BDC vehicles. Going forward, Jon will be focusing exclusively on the Goldman Sachs renewable power platform, which he has led with great success since its inception. Jon and I are delighted to be handing over the reins to the capable hands of Alex G and David Miller who will become co-CEOs of GSBD effective March 7th, and to Gabriella Skirnick who will become the CEO of GSBD and our other B2C vehicles effective March 7th. As new co-CEOs, Alex and David bring a wealth of experience in leadership to the platform, having collectively served approximately 40 years with Goldman Sachs in investment banking and middle-market lending leadership positions, respectively. Together with Gabriella, Alex and David will utilize all the capabilities of the firm and will no doubt improve upon the stewardship of Goldman Sachs BDC. In our decade at the helm of GSBD, Jon and I have been blessed with the opportunity to work with an amazing and talented team. There are far too many people to call out individually, but suffice to say, Jon and I are in debt to the many men and women across Goldman Sachs who have consistently and persistently delivered top-notch results for all the stakeholders of GSBD. Over the years, I've enjoyed ending each of these conference calls by thanking you, the shareholders of GSBD. On behalf of Jon and the rest of the team, it has been a privilege to manage your capital business over the years, and I wish you all the best. With that, let's turn the call back to Gemaria and open the line for Q&A.

Ladies and gentlemen, we will now take a moment to compile the Q&A roster. Your first question will come from Robert Dodd with Raymond James.

Hi, guys. And good luck in future endeavors. Brendan, it might seem a little odd asking you this question since you’re leaving, but I presume there will be no changes. I just want to clarify in terms of forward strategy, what type of asset, etc. are good with maintenance say it.

Yeah, look Robert, I will of course you're right. I think Alex and David at the right time will be speaking with all of you and those shareholders specifically about those go forward plans. I can tell you that in the context of this transition I've been spending a lot of time with Alex and David and Gabriella and the broader team. And I don't think, Robert, you should be bracing for anything dramatically different than what we've been doing over the years. Just for a little context, in our press release that we put out when we announced my departure in December, there's a lot of biographical information on Alex and David; both have been with Goldman Sachs for a long time as partners with the firm. David has been leading an investment platform for the balance sheet that has been focused on middle-market lending and origination. That's been the core of what he's been doing for a very, very long time as a career, including prior to Goldman Sachs. Alex has been here with the firm since 1994 within investment banking. And as you know, Goldman has the preeminent investment banking franchise in the world and Alex has had leadership positions in both leverage finance as well as sponsored coverage. And over the course of the past two years, he's worked within what we historically called our merchant banking division, which is now part of the combined asset management division, focused on larger cap originations and sponsored transactions benefiting from his very long and deep relationships within the sponsor community. So I think broadly speaking, what you can expect, and certainly as a shareholder, will hope to expect will be really continued excellence where leadership can bring to bear the full capabilities of Goldman Sachs to originate transactions for the regular vehicles and the BDCs that we manage. I think we can leave it at that for now. I'm sure you'll have lots of opportunities to engage with David and Alex specifically on a go-forward basis.

Thank you for that. I have a question regarding the debt-to-EBITDA ratio, which increased to 6.4 times. Some of the lower leverage loans have been repaid. Is that 6.4 the same as the loan-to-value ratio? Are there enterprise value businesses included, or has there been a change in the loan-to-value? Furthermore, when we examine the current trends in the public equity markets, particularly with some tech companies seeing compressed enterprise values, does this imply that private equity multiples are also affected? Can you provide any insights on this matter?

Yeah. Look, I think first just on the math specifically because I think it's worth just we have more detail as I highlighted and I know Robert, you and I had a detailed conversation on this last quarter. The repayments environment for the market has been significant. I think for GSBD specifically, it's been really, really unusually high. As I said in the remarks, 45% of the book that we came into January 1st with were repaid over the course of 2021, which is a really significant amount. So you think about the normal cadence of a loan; you make a loan, it tends to deleverage over the course of its lifetime. We've been focused on like we've talked about good document standards. There's of course deleveraging in those structures, so when you see that repayment activity, naturally that's going to be your lowered levered deals coming out of the book that are getting replaced by new market origination. So that math this quarter I think was a little stark. I will tell you we also had a lot of follow-on investing activity, which typically means you're re-leveraging the business back to the original underwrite. And so the numbers you see are still reflective of the current market environment. To your LTV question, I would tell you at underwrite when you're measuring the actual invested capital in those companies, we'll put aside the mark-to-market for a moment, LTV has been trending down despite that leverage multiple moving up and higher. As we know, our focus in orientation has tended to be away from companies and industries that don't attract high multiples, cyclical industries, heavy manufacturing industries, very capital-intensive industries, not a big part of our book in the historical context there. We've tended to focus on technology and software and healthcare services and IT services which produce stable recurring revenues and therefore tend to generate higher enterprise value multiples as well. So again, looking at underwrites, notwithstanding the tick-up in that other leverage metric, LTVs have been coming down. I think it is fair to say if you were to mark-to-market those private equities, just looking at what's gone in the tech space over the course of the past several months, that probably is down. But when you're starting at a 25% loan-to-value range, there's significant and tremendous junior capital beneath you to cushion that loss before you see exposure within our loan portfolio.

Got it. Thank you. Last one for me, if I can. This quarter is the last quarter of committed waivers to get to $0.48 on adjusted NII. Obviously, you've already declared the March dividend of 45, but should we be expecting anymore waivers? None were disclosed, so presumably not. And what's the comfort level of reaching that 45? Obviously, with the rate curve where it is, it's looking pretty good in the second half.

Sure. To address your point, as we've mentioned before, the current environment has led to persistent pressure on yields over the past year or two. Specifically for this quarter compared to the remainder of 2021, we've seen a decrease in early repayments, which has contributed to the acceleration of the Original Issue Discount. These factors remain challenges for us. While we anticipate yields will stabilize based on our past experiences, the last couple of years have indeed presented a lower yield environment. Last year, our leverage was effectively unchanged at one time for most of the year. Considering the company's earnings potential going forward, we must account for these challenges in interest rates. The repayment climate will also be a factor, but we have some strategies in place to help us move back towards our target leverage range, although we may not achieve that fully this quarter. Regarding yields, we expect them to normalize. This quarter, we've encountered a non-accrual situation that has affected our income, but we anticipate converting that into earning assets moving forward. Even without the fee waiver, we're still below the $0.45 per share target, though the fee waiver has been around $0.48 per share, which is a significant point to consider. What's uncertain for the future is how the environment will evolve. There's a lot of information available on this. A key question mathematically will be what transpires with the front end of the rate curve. Given that our business is nearly entirely made up of floating-rate loans, we expect initial challenges, particularly in Q1 as rates rise. However, once we hit the LIBOR floor, it should become beneficial for us. We've also focused on managing our liabilities more effectively, fixing over half into long-term notes. While I cannot discuss future fee waivers in light of my upcoming departure, Goldman Sachs has always been careful in its fiduciary responsibilities. There are several options available to us, and we will see how the landscape changes next year. Overall, the condition of our assets and liabilities is strong, setting a solid foundation for Alex and David to continue moving the business forward.

Okay. I appreciate that. Thank you. And again, good luck in the future, Brendan. I appreciate everything, all your comments over the years. Thanks a lot.

Sure. Thanks, Robert.

At this time, there appears to be no further questions in queue. Please continue with any closing remarks. Actually, we do have a question in the queue from Finian O'Shea with Wells Fargo. Please proceed.

Hey, good morning. And congratulations, Brendan, Jon, and everyone else coming in as well. Actually, to that matter on the follow-on, Robert's question on platform changes with the new leadership coming from the IOG and banking group. Mr. Yoder is moving elsewhere. So it does feel like there's a lot riding on the wall that things will be a bit different, whether in origination style or management style, and that doesn't have to be bad, it can obviously be good. But I'd say at a high level, if things are going to be completely the same, then why are the moving pieces so different? Any comment you can provide on how the folks at GCM were thinking about the architecture here in the wake of your departure, Brendan?

I wouldn't read too much into the changes you mentioned regarding the broader strategy and structure. As we discussed, I felt it was a good natural time for me to move on and pursue different opportunities. This was a personal choice based on my vision for the next phase of my career. I don't believe there are larger implications beyond that. Jon has been a crucial part of this business since its inception and has contributed significantly to our success. While it may seem like everything is changing, many of these adjustments have been in the works for a while. The overall stability of the group remains strong. David has been here a long time and remains focused on the business. When considering the future of the business, I spent considerable time with David and his teams, and I can assure you there is a strong focus on maintaining a solid credit culture and a disciplined approach to client service—factors that have driven GSBD's success over the years. I don't anticipate significant strategic changes right from the start. In fact, there are new resources that will benefit the company over time. I have great confidence in the future of the company and its team, and I believe you will reach the same conclusion.

Absolutely very helpful. And unrelated follow-up on the capital raising side. The strategy you've been pretty successful with, private retail to public with MMLC and such. That style seems to be emphasized by a lot of your peers in the newer non-traded professional private retail strategy, which are unrelated to BDCs, but they are reportedly cannibalizing a fundraising channel. And obviously, there are others. There are public offerings, ATMs, and institutional. Just any high-level thoughts on that?

Sure. Here's what I would say, Fin, and I believe I can confidently speak for Alex and David on this topic. When considering the private credit space more broadly, especially compared to a decade ago when we launched this platform, being a significant player is essential. The ability to access different pools of capital to compete for various asset types, whether larger cap unit tranche opportunities or more specialized middle-market lending, is crucial. As an asset manager, my approach—which I share with Alex and David—is to remain flexible regarding how investors want to leverage our core capabilities, which include sourcing, underwriting, and managing a portfolio of proprietary loans. Some investors, possibly institutions, may prefer separately managed accounts, while others favor the liquidity of a public BDC. There are also insurance planners who have regulatory requirements influencing how they engage with this asset class. Our role is to create pathways for all these different clients. This leads us to believe there continues to be a compelling opportunity for investors looking to invest privately in a BDC that may go public in the future. Investors in this platform have seen strong success and returns from that strategy. Meanwhile, other investors might appreciate the simplicity and liquidity offered by a continuously available fund that allows for immediate capital investment. I anticipate that will remain a useful tool for the firm going forward. However, this does not change the strategic direction of the platform in any fundamental way. Our aim is to establish as many pathways as possible for clients who wish to access the substantial capabilities of Goldman Sachs. If we achieve this, we will likely find considerable success.

Awesome, hopeful. Thank you and congratulations. Again and best of luck on your next endeavor.

Thanks, Fin.

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

Thank you, Gemaria. Thank you all as always for listening in. If you still have any questions, please don't hesitate to reach out to us directly. And we hope you have a great day and a great weekend. Bye, bye.

Ladies and gentlemen, this does conclude the Goldman Sachs BDC Incorporated fourth quarter and year-end 2021 earnings conference call. Thank you for your participation. You may now disconnect.