Golub Capital BDC, Inc.

Hello, everyone, and welcome to GBDC's September 30, 2022 quarterly earnings call. Before we begin, I'd 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 of 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 GBDC's SEC filings. For materials we intend to refer to on today's earnings call, please visit the Investor Resources tab on the homepage of our website, which is www.gollupcapitalbdc.com. and click on the events presentations link. Our earnings release is also available on our website in the investor resources section. As a reminder, this call is being recorded. With that, I am pleased to turn the call over to David Golub, Chief Executive Officer of GBDC.

Hello, everybody, and thanks for joining us today. I'm joined by Chris Erickson, our Chief Financial Officer. We also have a couple of new participants today. Matt Benton, who was recently promoted to a new role as Chief Operating Officer of GBDC, please join me in congratulating him, and Greg Cashman, who heads Golub Capital's Direct Lending Group. For those of you who are new to GBDC, our investment strategy is, and since inception it's been, to focus on providing first lien senior secured loans to healthy, resilient middle market companies that are backed by strong partnership-oriented private equity sponsors. Yesterday, we issued our earnings press release for the quarter and for the fiscal year ended September 30th, 2022, and we posted an earnings presentation on our website. We'll be referring to this presentation during the call today. One element of Gallup Capital's culture is what we call Raise the Bar exercises. These are efforts on our part to improve how we do things. Today, we're going to introduce a new format for our earnings calls that came out of one of our Raise the Bar exercises. We're going to cover five topics. First, I'll discuss highlights of GBDC's performance for the quarter and for the fiscal year-end at September 30th. Second, I'll talk about the macro environment, what we're seeing in the economy, and what we think this means for GBDC. Third, Greg Cashman will give us some real-time market insight on two topics. Think of them as defense and offense. On defense, Greg will talk about the actions Golub Capital has taken and is taking to manage risk in light of the heightened macroeconomic uncertainties we're all dealing with. And on offense, Greg will talk about the opportunity set for new investments and why we think it's quite attractive today. Fourth, we'll go through financial results for the quarter and for the fiscal year in detail. And finally, I'll come back to make some closing remarks and take questions. Before we jump in, I also want to mention that we plan to file a new and improved investor presentation over the next two weeks. We plan to file updates to this presentation on a quarterly basis going forward. We hope that you'll find it to be a useful source of additional information on GBDC and on Gallup Capital. So let me start with highlights for the quarter. The overall headline is that GBDC's performance was solid, and that's despite a second consecutive quarter marked by sharp downdrafts in debt and equity markets. The first highlight is that adjusted net investment income was strong. Adjusted NII per share increased by 6% to $0.33 from $0.31 per share in the quarter ended June 30. The increase in adjusted NII per share was driven by higher base rates, continued credit stability, and GBDC's low cost of funding. That said, we're not immune to market downdrafts. Primarily as a result of spread widening, GBDC booked some unrealized losses this quarter. And that caused NAB per share to decline by 1.7% from $15.14 to $14.89. The good news is, we'll come back to in a moment, is that credit quality looks very solid from a fundamental perspective. Whenever we have a quarter marked by spread widening, you hear me say the same thing. You hear me say that mark-to-market losses from spread widening, they don't matter in the long run. What matters is minimizing permanent or realized losses. If we can avoid realized credit losses, the mark-to-market adjustments reverse over time as borrowers pay off or as their credit attributes improve or as market spreads narrow. The good news is that we think we'll see some reversals of mark-to-market losses in future quarters. And there's even more good news. Given rising base rates and spreads and given GBDC's funding structure, there's potential for further increases in NII in coming quarters. We'll cover this in more detail later in this call. Which brings me to a second highlight, dividends. We announced in our press release a 10% increase in GBDC's quarterly base dividend from 30 cents a share to 33 cents a share, which equates to an 8.9% dividend yield on our 9-30-22 NAV of $14.89. Why are we increasing the dividend? Simply put, higher base rates and higher spreads have increased GBDC's earnings power. On the asset side of the balance sheet, GBDC's portfolio, which is almost all floating rate loans, it's generating more interest income due to higher base rates and higher spreads. The forward rate curve tells us rates are likely to go up further from here, and today's rates and spread widening are not yet fully reflected in this quarter's earnings due to lag effects. On the liability side of the balance sheet, GBDC has locked in low-cost, highly flexible debt capital. About half of GBDC's debt is in the form of fixed-rate unsecured notes, and these notes have an average cost of about 2.7%. We believe interest income is likely to increase faster than interest expense in the coming period, and this means GBDC's earnings power is likely to exceed the 8.9% dividend yield GBDC posted in the 930 quarter. We'll provide more details on this on this call. I'd also note that GBDC is now fully through its catch-up for the income incentive fee, This means that as our portfolio continues to reset to today's higher base rates and as we benefit from further base rate increases, 80% of incremental returns will increase GBDC's NII. Looking forward, we believe GBDC is well-positioned to generate NII meaningfully in excess of the new quarterly base dividend of $0.33, giving us flexibility in calendar 2023 to consider a further dividend increase and or potential supplemental or special dividends. The third highlight from the quarter is that GBDC's credit quality remains strong. As you know, our strategy focuses on investments in resilient companies, in resilient industries, in resilient geographies, and with resilient owners. We don't play in highly cyclical or volatile areas like energy or crypto or real estate or aviation. And so far, the data shows our strategy is working. I'll share a few highlights now, which we'll come back to a bit later in the session. realized losses for the quarter and for the fiscal year were once again low and were more than completely offset by realized gains. For the quarter, we had just less than $1 million of realized losses versus $4 million of realized gains. For the fiscal year, we had just $2.5 million of realized losses versus realized gains of $21.4 million. Over 90% of investments in GBDC's portfolio had an internal performance rating of 4 or higher, as of September 30th. This is a level consistent with our loan performance ratings pre-COVID. And the percentage of investments on non-accrual measured at fair value also remained low at just 1.3% of our portfolio. The fourth and final highlight, GBDC is well positioned for the uncertainties we're all facing in the coming period. This is not our first rodeo. Historically, we've navigated difficult periods well. In fact, difficult periods have tended to be good for our business and good for our investors. We've curated GBDC's portfolio to be resilient to interest rate risk and to credit risk. More than 90% of the portfolio consists of floating rate, first lien, first out, senior secured loans to what we believe to be resilient companies backed by private equity sponsors with whom we have deep and longstanding relationships. GBDC has a highly flexible and durable funding structure with ample liquidity. 47% of its debt funding is in the form of unsecured, longer dated, unsecured notes. and that's complemented by a $1.2 billion corporate revolver with undrawn capacity and that's materially over-collateralized. Because GBDC is defensively positioned, it's also very well suited to play offense in what's become a very attractive new origination environment. We'll go into more detail about our outlook for originations later in the presentation. In short, we believe GBDC's results for both the quarter and the fiscal year were solid. Now let's take a step back, look at the macro picture, and unpack what it means for GBDC. As you know, Golub Capital has a unique perspective on the economy. We lend to hundreds of middle market companies. We receive monthly financials from many of them. We're in constant dialogue with a host of smart private equity firms and management teams. So we're getting actual results and insight on the portion of the economy we lend to almost in real time. What we're seeing is the economy is muddling through. It's not booming like it was a year ago, but it's muddling along with real growth. Companies are able to keep their revenues up, and for the most part, they're increasing prices directionally with inflation. Margins are down a bit. That's a topic we'll come back to. But from our vantage point, consumers are spending, and businesses are doing pretty well. The big question is, where to from here? We're in a confusing environment. It's marked by conflicting vectors and an unusually wide range of possible scenarios. There are a number of vectors that point in a negative direction, including high inflation, rising rates, quantitative tightening, declining fiscal stimulus, worsening consumer sentiment, and there's the wealth effects from the recent sharp losses in both equity and debt markets. But there are also vectors that point in a positive direction. We have very low unemployment, generally healthy consumer balance sheets, corporate profits, which are still strong despite some recent signs of slowing growth. and low inventories in most durable goods sectors, largely as a consequence of supply chain issues. So in short, we've got a bunch of forces that are pulling in different directions right now. And it's all happening against a backdrop of a disrupted international environment. There's the war in Ukraine. There's tension between Russia and the West. There's tension between the U.S. and China. There's tension in multiple democracies between right and left factions. And there's still concern about Iran and North Korea, to name a few. So back to the big question, where to from here? I don't think anybody knows. If you're looking for a historical parallel, if you want to say, well, 2023 is going to be just like, I don't think that you're going to find a good one. I don't think we've seen this combination of vectors before. Now, in looking at it, we think muddling growth is the most likely scenario for the near future, but there's a range of possible alternative scenarios. So what does this mean for GBDC? We think it's prudent to manage GBDC in this environment such that it's going to perform well if we're right about muddling growth. And we want it to be resilient in case the unexpected happens. I'm going to pass the mic to Greg Cashman, head of direct lending at Golub Capital, to say more about how we're playing defense and offense with this macro perspective in mind.

Thanks, David. I'm going to focus first on how we're managing risk in today's environment. I'll talk about what we are seeing today, what we are doing differently, and what we aren't doing differently. And I'll talk about what we're seeing in terms of new investment opportunities. Let's start with what we're seeing today. As David mentioned, GBDC's credit quality generally remains strong. Realized losses and non-accruals have been low, while internal performance ratings have been comparable to pre-COVID levels. Those are some of the quantitative ways we look at credit performance. We also assess how we're doing on credit with a qualitative lens based on what we see and hear from sponsors and management teams. And what we're seeing today is that our borrowers generally fall into one of three buckets. Most are performing well and seeing growing profits. Then there's a smaller group of borrowers that are growing a bit slower than expected but still doing okay. And finally, there's a group that's seeing falling profits due to margin pressure, usually due to wage pressures, rising input costs, or both. When we talk to sponsors and CEOs of companies in that last group, they typically tell us that they just raised prices or they plan to raise prices shortly. Will those price increases stick? And if they do, will they be enough to offset rising costs? Well, in most cases, they probably will because we seek to invest in market leaders that we believe are resilient to inflation. But the reality is it's too soon to tell. So let's shift and talk about how we're managing risk in light of what we're seeing in the macro environment. Let me start with what we aren't doing differently. We continue to focus on lending to resilient companies and resilient industries and resilient geographies and with resilient owners. We're not involved in interest rate sensitive industries like home builders or heavily cyclical or capital intensive industries like E&P and real estate. Our focus is on defensive businesses with strong free cash flow profiles that will do well in a wide variety of different economic climates, even when we're not feeling very optimistic about the future. What are we doing differently? We think that we're good at what we do, but we also know that we're not perfect. So we're looking hard right now for potential areas of weakness. This isn't different in and of itself. Identifying problems early has always been a key part of our portfolio management. What I want to highlight is that we've enhanced our credit monitoring screen with a view towards identifying tail risks on a granular, bottom-up, company-by-company basis. We're looking hard at five key factors. First, interest rates. We're looking for borrowers who may have potential liquidity or cash flow issues from increased base rates. Second, inflation. We're looking for companies susceptible to contracting operating margins. This means looking closely at cost drivers and pricing power. I mentioned earlier that not every price increase that companies try to push through will stick. So we're focusing on cases where pricing power may have hit a limit. Third, recession resistance. Some companies are more susceptible to recessions than others. In particular, we're working to identify companies with material risk of falling revenues. Fourth, international exposure. We're looking for companies with material exposure to U.S. dollar fluctuations or to customers or suppliers in areas of geopolitical tension or economic weakness. And fifth, Quality of earnings. We're looking at credits with high levels of EBITDA adjustments that may not be realized in practice. The goal of our enhanced credit monitoring today is to find higher risk borrowers and allocate more resources to them, much as we did in March 2020. That covers how we're thinking about risk. Now I want to talk about opportunity. In short, overall deal activity is down and it is a highly attractive origination environment. Why is market-wide deal activity lower? Well, we've just been through an equity market downdraft and buyers and sellers can't agree on value in a climate like this. Sellers want the price they could have gotten three months ago or six months ago. Buyers don't want to pay it. The good news for us is that our 300-plus incumbencies give us a robust access to opportunities, even when the new deal market is slow. A lot of our sponsor clients see dislocations like the present one as great opportunities to grow their platforms with accretive add-ons. This means they need more capital, and the logical party that they want to go to first is their incumbent lender. In the case of hundreds of borrowers, that's us. In these cases, we know the company, we know the management team, and we know the sponsor. We've seen how they perform. And we don't need to negotiate a whole new credit agreement to give them the capital they need. During periods of slower M&A activity, we typically see an increase in the proportion of origination that comes from repeat borrowers. As a benchmark, about half of our origination volume over the last several years has come from repeat borrowers. That proportion is increasing markedly, and we expect it to remain elevated for the rest of 2022 and into 23. And we think these add-on opportunities are particularly attractive. The market is the most lender-friendly that it's been in recent years. Spreads have widened by 50 to 100 basis points. Leverage has gone down half to a full turn. And documentation terms are tighter, especially in areas we care a lot about, like the definition of EBITDA. As a result, we believe the opportunity set in our areas of focus is among the most attractive since the great financial crisis. With that, I'm going to turn it over to Chris Erickson to go through GDBC's results for the quarter and fiscal year in more detail.