Golub Capital BDC, Inc.

Welcome to the Golub Capital BDC, Inc.'s March 31, 2020 quarterly meeting conference call. Before we begin, I would like to take a moment to remind our listeners that remarks made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees for future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in Golub Capital BDC, Inc.'s filings with Securities and Exchange Commission. For material the company intends to refer to on today's earnings conference call, Please visit the Investor Resource tab on the homepage of the company's website, www.golubcapitalbdc.com and click on the Events Presentation link. Golub Capital BDC's earnings release is also available on the company's website in the Investor Resources section. As a reminder, this call is being recorded for replay purposes. I would now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.

Thanks, Celina. Hello, everyone, and thanks for joining us today. I'm joined virtually today by Ross Tooney, our Chief Financial Officer, Greg Robbins, and John Simmons, both Managing Directors at Golub Capital. We and the rest of the Golub Capital team hope that you and your loved ones are all safe in these challenging times. We're grateful that our team is healthy, safe, and working effectively from home. We're going to talk a lot today about the economic impacts of COVID-19, but first I want to take a moment to acknowledge the human impact. About half of Golub Capital's team, myself included, live near New York City, and I'm sure everyone on this call has read about how New York City has been hard hit by COVID with over 170,000 documented cases and over 140,000 confirmed and over 14,000 confirmed deaths. The impact of COVID-19 in our community is palpable. We all know folks who've been sick or worse. What's also palpable is a spirit of resilience and solidarity. In my neighborhood and across the city, we open our windows at 7 p.m. every night to clap and cheer for the health care workers who are on the front lines. We've been doing it for weeks, and it's still a very emotional moment for me, I think for most people. The New York Times recently featured an op-ed by my friend Nick Kristof that highlighted a number of exceptional organizations that are involved in COVID-19 relief. We're proud to support their work, and I hope you'll consider joining us. This morning, we issued our earnings press release for the quarter ended March 31st, and we posted an earnings presentation on our website. will refer to that presentation through the call today. Let me start with the headline on slide four. The headline is that GBDC's results for fiscal Q2 were in line with the preliminary estimates that we filed on April 13th. Adjusted net investment income per share was $0.33, adjusted EPS was a loss of $1.71, and NAV per share was $14.62, which was toward the high end of the NAV range we published previously. Before I go on to discuss these results in more detail, I think it's important to put them in context. COVID-19 is already and is going to continue to have a significant impact on virtually every U.S. company, including GBDC. Following the closing of the rights offering, we think GBDC will be even more well-equipped to navigate in a COVID-19 world. Our goal today is to give all of you a transparent and analytical assessment of the impact of COVID-19 on GBDC to date and to review the risks and opportunities that we see for GBDC going forward. We'll then go through GBDC's results for the quarter in detail. So let's move to slide six. Slide six, you can see we think it's difficult to overstate the impact of COVID-19 on the U.S. economy in March. After a long, steady run of GDP growth of 2% to 3%, Thank you for joining us. Most recent number I saw was 14.7%, a level not seen since the Great Depression. As large portions of the economy effectively shut down, financial markets sold off, as you can see on slide 7. So against this backdrop, how did GBDC fare? We start with two pieces of good news. Turning to slide 9, the first piece of good news is that GBDC's portfolio was designed to be resilient. Thank you very much. mitigate the potential impact of idiosyncratic COVID-19 issues that may affect specific borrowers. The average size of each investment in GBDC's portfolio was less than 40 bps as of March 31. Second piece of good news shown on slide 10 is that GBDC has minimal exposure to many of the areas that have been hardest hit by COVID-19. Sectors like airlines and aircraft finance, energy, hotels, entertainment and gaming. Investments in these COVID-19 impacted industries represented less than 1% of GBDC's portfolio at fair value at March 31. Similarly, GBDC's focus on lending at the top of the capital structure to sponsor-backed companies means that the portfolio has minimal exposure to second lien debt, mezzanine debt, and other asset classes that we believe are particularly vulnerable in today's environments. GBDC's accurate exposure to these asset classes also represented less than 1% of the portfolio at fair value as of March 31. But I don't mean to be arguing that GBDC is immune to COVID-19. Turning to slide 11, you can see that GBDC has exposure to several industry subsectors that have experienced and likely will continue to experience material COVID-19 impact. Areas we're particularly focused on include restaurants, dental care, iCare, fitness franchises, and retail. These subsectors represent a bit less than 20% of GBDC's portfolio at fair value at March 31st. We believe many of the borrowers in these sectors are well-positioned and that they're going to be fine. And let me explain why. In restaurants, we've focused on proven concepts, mostly in quick service and fast casual, both of which have historically done well in recessions. Many of our borrowers offer drive-thru or carry-out, or they pivoted to doing so. In fact, one of our restaurant obligors reported their highest-ever sales day last week with no traditional sit-down customers. In Dental and iCare, we've focused on market-leading regional franchises, and we believe they'll recover when they're permitted to reopen. In some cases, we believe they may even capture pent-up demand when they reopen. In fitness franchises, we focused on low-cost, high-value concepts that we believe are well-matched to an environment where consumers are more cost-conscious. And in retail, we focused on consumer staples and franchisors that we believe are relatively insulated from cyclical pressure. In fact, the majority of our portfolio has been deemed essential and has remained open during COVID-19. And others in the portfolio that have been subject to some store closures have seen a significant increase in e-commerce revenue. These are all mitigants, but let me be clear, there have been COVID-19 challenges, particularly in this portion of the portfolio, and we're proactively managing GBDC's portfolio to address these issues. But before I and my colleagues describe those initiatives, let's first review how these challenges affected GBDC's results for the second fiscal quarter, for the quarter end of March 31. In short, we saw two main impacts. First on slide 12, there was a downward migration in our internal performance ratings from categories four and five, which are loans performing at or better than our expectations at underwriting, to category three, which are loans that are performing or are expected to perform below expectations. Category three increased from 7.2% of the portfolio at fair value at 1231.19 to 26.5% of the portfolio at 331. The majority of that increase was driven by investments in the subsectors that I identified earlier as the most exposed to COVID-19 challenges. The percentage of the portfolio performing materially below expectations in categories 1 and 2 was essentially unchanged quarter over quarter. Turning to slide 13, COVID-19 also precipitated the widening of credit spreads. The combination of COVID-19 credit issues and wider spreads together caused unrealized losses of $2.06 per share on GBDCs and AD. One way to look at drivers of that unrealized loss would be based on the internal performance ratings. So for investments in categories four and five, we view spread widening as the primary driver of the unrealized losses as we think these borrowers are performing at or better than original expectations. So on average, if you look at loans in categories 4 and 5, they were marked down from 99.9% of par at 1231 to 96.2% of par as of March 31st. That markdown accounted for $1.02 of GBDC's adjusted unrealized net depreciation per share for the quarter, or about half of the total. For investments in category 3, Our view is that the unrealized losses reflect a combination of both spread widening and credit stress. As we said earlier, the majority of the increase in Category 3 came from GBDC's investments in subsectors that we believe are exposed in a material way to COVID-19. On average, loans in Category 3 were marked down from 96% of par at 1231 to 90% of par at 331, a larger average markdown compared to Categories 4 and 5. Markdowns in Category 3 accounted for 86 cents of GBDC's adjusted unrealized net depreciation per share for the quarter, or 42% of the total. In Categories 1 and 2, the average markdown was several points greater than the average markdown in Category 3. Again, not surprising. We believe the markdowns in this category reflect the stress of COVID-19 on top of pre-existing credit challenges. Categories 1 and 2 are a relatively small portion of GBDC's portfolio, about 2% of total investments at fair value. And markdowns in Categories 1 and 2 contributed $0.18 of GBDC's adjusted unrealized net depreciation per share for the quarter, or 9% of the total. Slide 14 provides a bridge from 1231.19 NAV per share of $16.66 to 331.20 NAV per share of $14.62. From an adjusted NII perspective, GBDC generated $0.33 per share, not surprising given our 8% annualized income incentive fee hurdle rate. In the next column, you can see realized credit losses. Net realized losses amounted to $0.03 per share, a very small amount. The clear driver of the NAB per share decline in the quarter was the unrealized depreciation of $2.06 per share that we just reviewed in detail. So how do we think about these unrealized losses? Well, at one level, as long as our underlying borrowers continue to pay their principal and interest, unrealized losses in the portfolio will reverse over the remaining life of the loans. That's just loan math. We're hopeful that a large portion of the unrealized losses will reverse much sooner than that as credit spreads start to normalize over the coming months. This is what happened in Golub Capital's loan portfolios following the 2008 financial crisis. Put differently, unrealized losses offer a snapshot picture every quarter, but at the end of the day, only one thing matters for lenders who hold their loans to maturity. A loan either pays off or it doesn't. Accordingly, as we think about what job one is for Golub Capital, job one's really clear. It's to minimize GBDC's permanent or realized credit losses. With that, let me turn it over to Gregory Robbins who's gonna provide some specifics on how we're approaching that task. Gregory.

Thank you, David. Turning to slide 16, we've been focusing on two key strategies. First, proactively managing our portfolio, and second, fortifying GBDC's balance sheet. Let's discuss each in turn. The first focus area on slide 17 has been proactive portfolio management. There have been three phases to this. In the first phase, which began earlier this year, we opened up lines of communication with our portfolio companies private equity sponsors, and industry consultants to gather data and assess COVID-19 risk by bar. In support of these efforts, the Golub Capital Direct Lending Team, consisting of more than 130 professionals, pivoted from loan origination to portfolio management. We undertook detailed analyses using 13-week cash flow forecasts, real-time sales figures, and other proprietary data to segment the portfolio and identify the most affected borrowers. In the second phase, we developed and executed on short-term game plans for the borrowers most affected by COVID-19. We also helped many of our borrowers apply for loans under government programs where this was appropriate. In the third phase, which is where we are now, we're designing and executing on longer-term game plans for all of our borrowers. We're doing this collaboratively with the management teams and sponsors of each company. In the many cases where the borrower is doing fine despite COVID-19, the game plan is business as usual. In more challenging cases, we are focused on credit enhancing amendments or on incremental investments where we, as first-ling lenders, may contribute to a solution alongside capital support from the private equity sponsors. Every deal is different, but we think our deep partnerships with sponsors and our lead position on the preponderance of our loans has given us the power and the nimbleness to structure win-win solutions. Responses are unable or unwilling to support a company, we're also prepared to take the keys. And in the small number of cases, we expect we will do so. We have deliberately built out our workouts team over the last 12 months to prepare for an economic downturn. The second focus area, as outlined on slide 18, has been fortifying GBDC's balance sheet to support existing investments and create future opportunities. We've spoken about this in the context of GBDC's rights offering, which subscription period concluded on May 6th and is expected to raise approximately $300 million of new equity for the company. GBDC intends to use the rights offering proceeds for three key purposes. First, to repay outstanding indebtedness Second, to make credit-enhancing incremental investments to support existing portfolio companies. And third, to make selective new investments. Performer for the rights offering, GBDC's gap leverage will decrease from 1.22 times to 0.92 times as of March 31st, which is at the low end of our targeted range and well within our 150% asset coverage test. We have developed a use of proceeds plan, which we anticipate will give GBDC a significant amount of additional flexibility, liquidity, and borrowing capacity. We expect to be able to provide you with more detail on that game plan shortly. We also believe that the rights offering has bolstered GBDC's flexibility to play offense on new transactions in the future. Right now, New Deal M&A is on hold, with buyers and sellers unable to agree on the day of the week. That's okay because for now we want to stay focused on credit enhancing incremental investments in our portfolio. But if we go out three to six months, I think this will change. History has shown that some of the most attractive opportunities exist during and after significant market dislocations. As illustrated on slide 19, leverage levels decreased dramatically after the global financial crisis, and Golub Capital was able to capitalize significantly on those opportunities. We believe recent market events will likely lead to a sustained lender-friendly environment, much like we saw after the last recession. Lower leverage, higher spreads, improved covenants, and enhanced downside protection are components of what we expect to see come out of the current market environment. So to summarize this portion of the presentation, while we recognize that uncertainty is high and likely to persist, we believe GBDC is well-positioned to navigate COVID-19. As shown on slide 20, we believe GBDC has developed a number of powerful competitive advantages. In our experience, sustainable competitive advantages are the key to consistent, replicable, premium shareholder returns. With that, let me hand it over to John to go through our results for the March quarter and more to tell. John?