Goldman Sachs BDC : IIIQ 2021 Conference Call – ANNOTATED
Goldman Sachs BDC (NYSE:GSBD) Q3 2021 Earnings Conference Call November 5, 2021 9:00 AM ET
Brendan McGovern – President & CEO
Jon Yoder – COO
Joseph DiMaria – Interim CFO and Interim Treasurer
Conference Call Participants
Finian O’Shea – Wells Fargo Securities
Unidentified Analyst – Raymond James
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 special dividend paid in September, the net asset value decline would’ve been 50 basis points. The September special is the last of the three $0.05 per share special dividends 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 shareholder of record as of December 31, 2021.
BDC Reporter Notes: The adjusted Net Investment Income Per Share of $0.48 was equal to the quarter before and in line with our expectations. (We can’t find the analyst consensus). The slight decrease in NAV Per Share – even after turning a blind eye to the special distribution – was unexpected. We had counted on a slight increase in this metric, but the difference is minimal and may not be worth dwelling on.
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 repayments in the company’s nearly 10-year history. Repayments were diversified across the book with the single large repayment only amounted to less than 10% of the total. This is a somewhat remarkable level of portfolio turnover in a single quarter, 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 evaluations are rising, it’s not surprising that high quality companies are either being sold or graduating to a lower cost of capital.
BDC Reporter Notes: We have to agree with GSBD that the percentage of the BDC’s assets repaid in one quarter is unusual, even in these high activity times. Of course, what we’ll be looking out for is any drastic shift in the portfolio yield that might occur as a result and whether GSBD might take on outsized risks to replace this lost income stream. The answers to these questions are subtle and may not show up for multiple quarters.
Next I would note that … 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 repayment activity the quarter-end leverage ratio stayed roughly flat at 0.91 times debt to equity. This was a noteworthy feat 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 of portfolio was muted as the yield at amortized cost this quarter was 8.3% compared to 8.4% at the end of Q2.
BDC Reporter Notes: By the way, sector-wide we’re seeing a similar small scale erosion of BDC portfolio yields, which is natural enough as the highest priced loans are the most keen to get refinanced. Moreover, troubled loans tend to have higher yields and many of these are getting settled by refinancing or the sale of the underlying businesses. The result is lower yields and that should continue for the next quarter or two at least. That’s why a BDC’s ability to reduce its borrowing cost is so critical at this point.
Next, we know that investors are keenly focused on the supply chain disruptions and inflationary pressures that are currently impacting the economy broadly and 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 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 as opposed 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 [ph] demand characteristics of non-discretionary healthcare services. We continue to monitor the impact of the current environment in our book and we will keep you updated on any developments. Given the current environment we are pleased that overall credit quality of portfolio remains strong. Non-accrual investments are just 0.7% of the portfolio at cost and 0.1% at fair value.
BDC Reporter Notes: Of course, non accrual percentages do not begin to fully reflect credit risk in a portfolio. You can have a very low percentage because of bad investments made and hugely written down. (Note that the value of GSBD’s non-performers is only one-seventh of cost, suggesting very poor recovery prospects). Or there can be an overhang of companies still performing but about to default. That’s why we prefer to look at the value and percentage of assets that are underperforming in the entire portfolio. In this regard, GSBD’s metrics are pretty good, with $171mn of investments underperforming, or 5.5% of the total. That’s marginally better than the quarter before and positive in absolute terms. By way of comparison Ares Capital (ARCC) rates 6.9% of its assets as performing below expectations.
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 of companies and $358 million of follow-on investments to existing portfolio of 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 of companies. [BDC Reporter Notes: There were 114 companies in portfolio as of June 2021] 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.
During the portfolio composition as of September 30, 2021 total investment in our portfolio were $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 unitranche, 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.
BDC Reporter Notes: As we mentioned a couple of days ago, this is another example of a BDC adding a new company to the non accrual list. In this case, the amount is small but does reinforce a trend we’ve been noticing of a relatively large number of non performing newbies popping up at a time when conditions are favorable and many troubled companies are getting rescued.
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 to NAV was not material in the current quarter.
BDC Reporter Notes: A few years ago, Hunter Defense Technologies was a troubled investment. This successful exit is proof positive that there can be second acts in BDC investing.
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 GSBDs 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 the results prior to our August 2020 merger with MMLC. These non-GAAP measures removed the amortization impact from our financial results. 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.
BDC Reporter Notes: Not to quibble, but the lower NAV Per Share does not only reflect the impact of the special dividend, nor the realized gain, which resulted in an equal amount of unrealized depreciation. There must have been other unrealized write-downs to cause this drop in NAV Per Share which should have been discussed here.
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.
Operator[Operator Instructions]. Your first question comes from the line of Finian O’Shea with Wells Fargo.
Hey, good morning everyone. Good morning. First question on the portfolio yield, it sounds like you’re able to keep those at a pretty good level, I think only down to a few basis points, I think 8.7% to 8.6% with all this activity in an obviously competitive market. Can you talk about how — where you’re kind of migrating to or picking your spots if any were different or just color on what, as a lot of the maturing stuff goes out through M&A or graduating what the newer stuff looks like?
Yeah, look I think it’s well known and appreciated that the current market backdrop is more competitive than most market backdrops that we’ve experienced in a decade we are running this business. Our general observation is that there’s ebbs and flows to that, some of which are market driven, and some of which are capital formation driven, and some which are a function of the sectors in which you’re focused. So I think the headline, definitely some unusual activity in this quarter in terms of the pace of the game. It’s safe to say, the yields on the originations were below that of the deals that came out of the portfolio. Part of that was also a function of the mix as I mentioned in my remarks upfront. We did have some second liens that we prepaid as well. And so obviously, the goal and the focus is to — as we’re putting out new capital; one, ensure that we’re focusing on quality opportunities and not really just trying to get to an overall portfolio composition or leverage ratio in the short-term for the persons just managing any specific quarter. I think this quarter really showed that the platform has tremendous capabilities, access to different opportunities.
When you look at the originations across this quarter, I think, Jon gave the stats, it was 10 new platforms, 10 new investments, plus some the follow on investments. And those follow-ons in numerosity were much greater, I think, it was 17 versus that 10 and a bit bigger, in terms of just the total aggregate amount of capital that we’ve invested this quarter. So I think we do benefit this quarter from that follow on amount really being a function of deals that were structured, negotiated in previous quarters. So those follow-ons generally coming out of the new issue spreads that were in place, at the point when we did those deals. But even just looking at new platforms, I think we did a really nice job this quarter, continuing to focus on areas that are our strengths. There’s no one or two deals that dominated the activity this quarter. If you look across the schedule, you’ll see that our biggest deal was, I think, around $43 million. We had another deal for $65 million, which was really a replacement of a deal that was repaid in the quarter as well. The sector’s continued to be the ones that you know us to be focused on historically. We’re not leaning into any of them, or damaged sectors of the economy where there could be some opportunistic opportunities. In a dislocation, what you see is a lot more of the same, which is a lot of software, a lot of healthcare services, some healthcare IT, and things that you’ve come to come to GSBD over the last several years.
Sure, that’s helpful and then I guess kind of building up 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?
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 environments. 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, running pretty 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 have more capacity on the balance sheets move up higher into a target level ratio. I think, as I mentioned on the call, we do anticipate that would be the case in Q4. Obviously, certainly 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 generally 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’ll 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 point to that that give us some optimism that there’s still really good opportunities to perform here.
Your next question comes from the line of Matt Hayden [ph] 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 of 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, and again 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 medium 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 our own right, 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 little 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 in 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.
BDC Reporter Notes: There’s an endless and fruitless debate – typically triggered by the BDCs themselves – as to which segment of the market offers the best opportunities. Having done this for twenty years, we’ve seen BDCs being successful – and failing miserably – in all size segments of the market, so we’re agnostic in this debate. What we do like to see, though, are BDCs “sticking to their knitting”, which is what GSBD has done. Shifting from one segment of the market to another is not just a matter of writing bigger or smaller cheques. The personnel, methodology and market knowledge involved is different in each segment. Moreover, being a big fish in one of these ponds does not necessarily translate when one moves to a new pond, leaving the BDC lender at risk of not getting access to the “better” deals. Nor do “brand names” of famous asset managers necessarily result in getting to the top of the deal chain as borrowers have very focused, prosaic needs from their leveraged lenders. GSBD has stuck to the middle market for a decade with relatively good credit results, and that has allowed the BDC to pay an unchanged $0.45 regular distribution since going public in 2015.
Got it. Maybe just following up on the convert lines. So 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 run secured mix a little hotter or do you expect to visit the unsecured market again in 2022?
Yeah, look we are 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 BDC 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 matter just the laddering of your maturities. So we’ll keep an eye on all of that for the course of 2022.
BDC Reporter Notes: Just to pile in briefly: We can’t agree more that finding the right mix of secured and unsecured debt is critical for the long term health of a BDC. We don’t know if every BDC has to follow the example of ARCC – which has unique capital market access – but a large percentage of unsecured debt spread over several maturities is an almost iron-clad guarantee against damaged in a sudden market downturn. BDC managers and investors should be ready to pay a little more in debt service – and receive a little less in earnings – to avoid the dislocations than can occur when secured debt facilities freeze up during crises. Thankfully, most BDCs out there – encouraged by this low yield environment and a flood of available capital – have bought into this approach. The proof of the pudding will not be felt till the next crisis. As the saying goes: “In good times prepare for the bad, and in bad times prepare for the good”. This shift in BDC financing that has been underway all year but dates back to 2012 is one of the key reasons the BDC Reporter believes we are in a golden age in this sector and have the capacity to remain there for some time.
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Overall, neither a great nor a terrible quarter for GSBD.
The big realized gain for selling Hunter Defense is worth acknowledging because the BDC’s business model of having a very low percentage of equity stakes rarely results in significant realized wins.
Also a plus is that fee subsidies have become – for this quarter at least – almost immaterial in their impact on NII.
The under-leveraged nature of the balance sheet and plenty of firepower leaves open the prospect of higher earnings in the future, even if portfolio yields get eroded here, as is the case most everywhere else.
Some pennies a share could be saved from lower borrowing costs next year as the 4.5% convertible gets repaid.
Less compelling was the addition of a new non performing loan (Chase Holdings) and a related dip in NAV Per Share.
Still, we don’t share the negative outlook of the analyst consensus which projects NIIPS will drop to $1.73 in 2022 from $1.92.
We believe unsubsidized earnings should “cover” the $1.80 dividend at the very least and allow GSBD to continue its long track record of paying out the same regular distribution every quarter.
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