Golub Capital BDC Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 21, 2023

There are 8 speakers on the call.

Operator

Hello, everyone, and welcome to GBDC's Earnings Call for the Fiscal Year and Quarter Ended September 30, 2023. 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. That 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 that we have on the homepage of our website, which is www.gollubcapitalbdc.com, and click on the Events Presentations link.

Operator

That our earnings release is also available on our website in the Investor Resources section. As a reminder, this call is being recorded. That with that, I'm pleased to turn the call over to David Golub, Chief Executive Officer of GBDC.

Speaker 1

Hello, everybody, and thanks for joining us today. That I'm joined today by Chris Erickson, our Chief Financial Officer and by Matt Benson, our Chief Operating Officer. For those of you who are new to GBDC, that we are pleased with our results. Let me start with a quick recap on our investment strategy. Our investment strategy is and since inception it has been to focus on providing that we are very pleased with our 1st lien senior secured loans to healthy resilient middle market companies, generally companies that are backed by strong partnership oriented private equity sponsors.

Speaker 1

That we have received a press release for the quarter fiscal year ended September 30, and we posted an earnings presentation on our website. We'll be referring to this presentation during today's call. I'm going to start as usual with some headlines and I'm going to then lead into a summary of performance that we will be conducting a few questions for the quarter. Then Matt and Chris are going to go through financial results for the quarter in more detail. And finally, I'll wrap up with our outlook for the coming period.

Speaker 1

That we'll take some questions. The headline is that GBDC had an excellent fiscal Q4. You got a glimpse of this in the preliminary fiscal Q4 results that GBDC announced on October 17th, let me touch on some of the highlights. Adjusted net investment income per share was $0.50 that we are not going to be able to record. Also of note, this represented an adjusted NII return on average equity of 13.3%.

Speaker 1

That adjusted earnings per share came to $0.60 This corresponds to an adjusted return on equity of 16%. That credit results were very strong. We had net realized and unrealized gains for the quarter of $0.10 per share. We saw a decrease in non accruals that we saw stable internal performance ratings. These factors altogether drove a $0.19 increase quarter over quarter in NAV per share, that we expect to continue to be a sequential increase of 1.3%, bringing NAV per share to $15.02 as of September 30.

Speaker 1

That GBDC's excellent results for the quarter capped off a very strong fiscal 2023. Over the year, we saw that we have a $1.73 of adjusted NII per share, dollars 1.52 of adjusted earnings per share, dollars 1.40 per share of distributions paid, You'll recall that GBDC increased our base quarterly distribution by $0.07 per share during the fiscal year and introduced a new variable supplemental distribution framework. That we saw strong credit results. I view fiscal 2023 as one of GBDC's best years ever from a credit perspective. That GBDC's investment manager during the year permanently reduced its base management fee rate from 1.375% that we are executing on our investment strategy, we leveraged the competitive advantages of the Golub Capital platform and we're using the bar for shareholders.

Speaker 1

With that, let me hand the floor to Matt to walk through our results in more detail.

Speaker 2

That we are ready to begin. Thanks, David.

Speaker 1

I'm going to start on Slide 4. As David just previewed, GBDC's earnings for the quarter ended September 30 at 4 record 7. That adjusted NII per share was $0.50 a 13% sequential increase from the prior quarter's $0.44 per share of adjusted NII. That this corresponds to an adjusted NII ROAE of 13.3%. Net income per share increased to $0.60 that we are making a significant contribution to our shareholders.

Speaker 1

Our adjusted ROAE of 16%. That GBT's record profitability was driven by 3 key factors. 1st and foremost, 7. GBT had a net realized and unrealized gain on investments that we have a $0.10 per share. This gain was due to both strong credit fundamentals and tightening credit spreads in the market.

Speaker 1

That the second key driver was continued higher base rates. Finally, fiscal Q4 benefited from the previously announced that GBDC's base management fee rate to 1% per annum. The portfolio balance sheet update generally reflects a continuation of that we expect to see a trend from the June 30, 2023 quarter. Net funds declined by $8,400,000 sequentially. While we saw a modest uptick in deal activity in calendar that Q3 relative to the first half of the year, the pace of new investments remain muted.

Speaker 1

This is perfectly fine for GBDC. That this model doesn't depend on fee income from new originations or repayments to drive strong returns. The overall credit performance of that our investment portfolio remains strong. Non accruals continued to decrease. Non accruals as a percentage of total debt investments at cost that the decrease to 1.6% from 1.8% at sixthirtytwenty twenty three.

Speaker 1

That as a percentage of total debt investments at fair value, non accruals decreased to 1.2% from 1.5% at sixthirty

Speaker 2

that we are not accruals. To put

Speaker 1

this in context, non accruals are now back where they were in March June of 2025. That we are pleased with our results. Turning to internal performance ratings, these also remain strong. Investments in rating categories 1 and 2 represented 30 basis points of the total portfolio at fair value. This is the lowest level of loans and tools since March 2018.

Speaker 1

That NAV per share increased by 130 basis points on a sequential basis to 15.2 that NAV per share is now more than 200 basis points higher than at the start of the year, even as GBDC delivered higher distributions to shareholders during this period. That higher profitability and higher NAV, we obviously think this is a good combo. And finally, net leverage declined modestly to 1.21x. That we are now ready to begin. Turning now to distributions.

Speaker 1

The Board declared a regular quarterly distribution of $0.37 per share payable on December 29, that we are committed to shareholders of record as of December 8, 2023. You'll recall that the Board increased GBDC's base that we have a strong contribution from $0.33 per share to $0.37 per share in the quarter ended sixthirtytwenty 3. That adjusted NII per share significantly exceeded the company's regular quarterly distribution, resulting in a distribution coverage ratio of 135%.

Speaker 2

That we have a strong financial performance.

Speaker 1

Moreover, based on the new variable supplemental distribution framework we discussed last quarter, the Board also authorized that supplemental distribution of $0.07

Speaker 3

per share

Speaker 1

payable on December 15, 2023 to shareholders of record as of December 1, that we are committed

Speaker 2

to executing our strategy for the future.

Speaker 1

As a reminder, goal of the variable supplemental distribution framework is to give shareholders a clear line of sight that we expect to continue to generate excess income, all else equal on the one hand, that we are focused on NAV growth and resilience on the other hand. You can find additional detail about the variable supplemental that we have a strong distribution framework on Page 23 of the earnings presentation. In total, the Board approved $0.44 per share of distributions that we expect to be in respect to fiscal Q4 performance. This corresponds to an annualized dividend yield of approximately 11.7% based on GBDC's that we have a strong cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow

Speaker 2

of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of

Speaker 1

cash flow of cash flow of cash flow of cash

Speaker 2

flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of cash flow of

Speaker 1

cash flow of cash flow of cash flow of cash

Speaker 2

flow of cash.

Speaker 4

Thanks, Matt. Turning to Slide 7, you can see how the key earnings drivers Matt just described translated into solid growth that we are making a significant contribution to our shareholders and shareholders. The combination of high short term interest rates, attractive credit spreads and GBDC's locked in low cost leverage profile that we show record adjusted NII per share of $0.50 a level meaningfully higher than dividends paid out. That we

Speaker 2

are pleased with our

Speaker 4

progress on the progress we made in the quarter. In addition, the reversal of prior unrealized depreciation on investments contributed to $0.10 per share of adjusted net realized and unrealized gains. That together these results drove a net asset value per share increase to $15.02 up $0.19 per share from the prior quarter. Let's now go through the details of GBDC's financial results for the quarter ended September 30, 2023. That we've already covered the key points on Slide 9, so we'll start on Slide 10, which summarizes our origination activity for the quarter.

Speaker 4

That net funds growth quarter over quarter was modestly negative as fundings of new investment commitments, delayed draw term loan fundings that positive fair value changes of existing investments were outpaced by exits and sales of investments. Market wide deal activity has been slow since last year that we are confident that we will

Speaker 2

continue to see a significant rebound in the September 30th quarter. While we saw

Speaker 4

a modest uptick in deal activity in calendar Q3 and in our pipeline for calendar Q4, that our sense is that a significant rebound is more likely to be a 2024 event. Amid this relatively slow new deal environment, that Gallus Capital has remained highly selective, closing approximately 1.4% of deals reviewed calendar year to date. That's meaningfully lower than our typical 2% to 4% selectivity rate and reflects our focus on quality over quantity. That the asset mix of new investments shown in the middle of the slide remain predominantly 1 stop loans. That

Speaker 2

we are

Speaker 4

looking at the bottom of the slide, the weighted average rate on new investments decreased by 20 basis points this quarter. That the decrease was primarily due to tighter spreads on new investments, which tightened by 50 basis points sequentially. That this is generally consistent with what we are seeing in the market. Spreads on new transactions have tightened since earlier in the year, but they're still relatively attractive,

Speaker 1

that we

Speaker 4

are confident that we will continue to see the impact of other deal terms like EBITDA definitions, equity leakage and leverage still remaining more lender friendly. Slide 11 shows GBP's overall portfolio mix. As you can see, the portfolio breakdown by investment type that we remain consistent quarter over quarter with 1 stop loans continuing to represent around 85% of the portfolio at fair value. That we have a strong balance sheet. Slide 12 shows that GBP's portfolio remained highly diversified by Avador with an average investment size of approximately 30 basis points.

Speaker 4

That we are big believers in moderating asymmetric credit risk through position size, which we believe has served GVC well in previous credit cycles that we will continue to be important in the context of future credit cycles. As of September 30, 2023, that 94% of our investment portfolio consisted of 1st lien senior secured floating rate loans to borrowers across a diversified range of what we believe to be that we are pleased to report that we are in the press release. The economic analysis on Slide 13 continues to showcase the asset sensitive nature of GDP's balance sheet that we are in an environment of rising interest rates. Let's walk through how to interpret the chart. Start with the dark blue line, which is our investment income yield.

Speaker 4

That we will

Speaker 2

be conducting a few questions.

Speaker 4

As a reminder, investment income yield includes the amortization of fees and discounts. GVC's investment income yields increased by 60 basis points, that we are committed to achieving a strong balance sheet, primarily from rising interest rates and recognizing previously deferred interest from one form of non accrual investment returning to accrual status during the quarter. That our cost of debt, the teal line only increased 10 basis points. As a result, that our weighted average net investment spread, the Goldline, increased by 50 basis points over the prior quarter. With that, I will turn the floor back over to Matt.

Speaker 4

That

Speaker 1

Thanks, Chris. Let's move on to Slides 1415 and take a closer look at credit quality metrics. That the overall message is that credit trends remain solid and stable. On Slide 14, you can see the non accruals decreased by 30 basis points sequentially at 1.2% of that we have returned 1 investment to accrual status, which was offset by the addition of 1 investment to non accrual status in fiscal Q4. That Slide 15 shows the trend in internal performance ratings on GBDC's investments.

Speaker 1

That as of September 30, 2023, around 85% of GBDC's investments were rated 4 or 5, which means they're performing as expected or better than that underwriting. The proportion of loans we have 1 and 2, which are the loans we believe are most likely to see significant credit impairment, that we remain very low at 30 basis points of the portfolio at fair value. The proportional loans rated 3 increased modestly to 14.6%. That you'll recall in our prior conversations that Category 3 loans are performing below expectations or expected to perform below expectations. That when a loan migrates to Category 3, it automatically triggers heightened scrutiny and oversight.

Speaker 1

It doesn't mean that we necessarily expect a default or loss. That given today's uncertain environment, we think it's prudent to be proactive about moving fronts down to category 2. We'd rather have false positives that we have missed opportunities for early intervention. This idea of airing on the side of enhanced scrutiny results to the motivation for that portfolio resiliency work that we first described in Q4 2022. You'll recall that this work was designed to screen our middle market that we

Speaker 2

have a portfolio for potential vulnerability

Speaker 1

on a number of dimensions. For example, interest rates, inflation, quality of earnings and to focus our resources on shoring up credits that appeared more global. We didn't see meaningful surprises in our recent quarterly that we have a loyal results here with you and we haven't seen meaningful new product products year to date. That we have discussed in prior quarters, we don't believe that backward looking average credit metrics are particularly useful for identifying credit issues. That we believe our approach of evaluating risk, obligor by obligor on multiple forward looking dimensions is a more rigorous foundation for managing the 4th quarter that we expect to review of interest coverage ratios and historical financial results.

Speaker 1

That said, in the spirit of providing some additional the context around our portfolio even based on the information from portfolio companies available to us as of September 30, 2023, that we did want to provide some specific portfolio level credit statistics relevant. Let's start with interest coverage. That the weighted average interest coverage ratio for GBDC borrowers is 1.9x and 8.3 percent of GBDC portfolio company investments that their value have a portfolio interest coverage below 1x. We also wanted to share how interest coverage might change in the context

Speaker 2

that we are confident that we will be able to achieve our expectations for the full year of even

Speaker 1

higher base rates. When we adjust for potential higher rates, 50 basis points above current base rates, that again based on information currently available to us and as of September 30, 2023, we would expect the proportion of our portfolio at fair value that we have a strong interest coverage to grow only to 10%. We attribute this stability to our focus on lending to resilient borrowers that we are in the range of $1,000,000 and $1,000,000 Finally, we wanted to share underlying portfolio leverage. The weighted average loan to value for the portfolio was 46 that we are confident that we will be able to achieve our full year 2019 guidance for

Speaker 2

the full year 2019.

Speaker 1

As a reminder, these credit metrics are based on financial information received that we are not the only one that we have in the past. It is often provided on a lag as compared to the period presented. Okay. We're going to skip past Slide 16 through 19. These slides have more detail on GBDC's financial statements, dividend history and other key metrics.

Speaker 1

I'll wrap up this section by reviewing GBDC's liquidity and investment capacity on Slide 20 and 21. That we are pleased with

Speaker 2

our results. Let's focus on

Speaker 1

the key takeaways on Slide 29. Our weighted average cost of debt for the quarter ended September 30, 2023 was 5.2%, that we believe is among the lowest in our peer group. 46% of our debt funding is in the form of unsecured notes, that we have maturities in 20.6 and 20.7. We issued these 6 straight notes for the weighted average coupon of 2.7% and did not that we cannot stop any of them out for floating rate exposure. We ended the quarter with almost $875,000,000 of liquidity from unrestricted cash, that undrawn commitments are meaningfully over collateralized revolver and the unused unsecured revolver provided by our advisor.

Speaker 1

That GBDC's robust liquidity represents 4.6 times its current unfunded asset commitments and almost 2 times the amount of our unsecured notes due in April of 20 that

Speaker 2

we will

Speaker 1

be conducting a few key financials. The diversification, flexibility and low cost of GBDC's funding structure is an important element that underpinned our 3 investment grade credit ratings that we

Speaker 2

are very pleased with our

Speaker 1

financial results. I would highlight on the ratings front that Moody's upgraded GBDC's outlook to positive in early October. That we have a strong financial performance. As a reminder, Fitch also has GBDC's outlook as positive. We think this puts GBDC and select company in this regard.

Speaker 1

That we will be conducting a few questions. Thanks, Matt. So to sum up, that GBDC had an excellent quarter and an excellent fiscal year ended September 30. Higher rates helped, a lower base management fee also helped, that the key driver was strong credit results. NGVDC's strong credit results, they didn't just happen.

Speaker 1

They were the result of Golub Capital's that the processes working again. Over the last 13 years that GBDC has been a public company, its credit results have been best in class that fiscal 'twenty three was no different. Our origination team found us opportunities to lend to resilient businesses and resilient industries tracked by top quality sponsors. That our underwriting teams, they carefully selected borrowers that were likely to pay us back across a wide range of different scenarios. That our consolidated net debt to EBITDA was $1,500,000,000 was $1,500,000,000 was $1,500,000,000 on a year to date basis, it shows that deal teams are prioritizing quality over quantity.

Speaker 1

And our portfolio monitoring, it always emphasizes early intervention after careful name by name portfolio reviews. That we will continue to see our outlook. Overall, I'm cautiously optimistic. I want to talk some more about that we are seeing both the reason for the optimism and the reason for the cautiousness. Let's talk about the optimism first.

Speaker 1

The economy continues to surprise to the upside. That's a positive. We're also seeing some improvement in middle market M and A activity. That's also a positive. I think the competitive position of Golub Capital has that we've never been stronger.

Speaker 1

That's a third positive. From a credit perspective, there are also some good signs. As Matt reported, the that the vast preponderance of the portfolio is performing well. And while high rates add a higher fixed charge burden for borrowers, that the flip side is extra interest income for GBDC, and this gives us a greater margin of safety. Finally, we now have over a year's worth of data about how our that portfolio companies are handling higher rates.

Speaker 1

And so we think we have a good handle on where vulnerabilities are most likely to emerge. And where we see that, we're on it. Okay. So that's the reason for optimism. Let me talk now about the cautiousness.

Speaker 1

Why the cautiousness? That I'm cautious because I don't trust anybody's macro predictions these days. Consensus was wrong in thinking we'd see a recession this year. It was also wrong about the post pandemic boom, it was wrong about inflation being transitory, and then it was wrong about inflation being stubborn. It's been wrong a lot lately.

Speaker 1

That we are very pleased with our expectations. Yogi Berra had it right when he said, that predicting things is hard, especially about the future. I think that's especially true today. Having said this, the very unpredictability of the environment that we're in, that we are very pleased with our investors today are to particularly value resilient investments. By resilient investments, I mean investments that would do well across a range of different macro scenarios.

Speaker 1

I think GDEC is exactly this kind of resilient investment. That our resiliency is partially attributable to the detailed company by company resiliency analysis that we previously discussed, that we now run on a quarterly basis, we've also stepped up our engagement with sponsors and management teams where we see potential for issues arising. That from the earnings power perspective, GBDC's asset sensitive balance sheet positions the company very well for a high interest rate environment like the one we're in. That GBDC's new lower base management fee rate permanently raises GBDC's ROE profile in any interest rate environment. And GBDC's new variable supplemental distribution policy paves the way for more of this earnings power to be distributed to shareholders when prudent to do so.

Speaker 2

That we are now going to be

Speaker 1

able to take a moment to remind our listeners that we are going to be able to take a moment to remind our listeners that we are going to be able

Speaker 2

to take a moment to remind our listeners that we are going to be able to take a moment to remind our listeners that we are going to

Speaker 1

be able to take a moment to remind our listeners that GBDC has always done well by staying laser focused on credit by continually raising the bar for shareholders. That that's what we're doing now, that's what we did in 2023, and that's how we plan to navigate the coming period. With that, let me open the floor for questions.

Speaker 5

Your first question comes from the line of Finian O'Shea with Wells Fargo. Your line is open.

Speaker 3

That Hey, everyone. Good morning. David, appreciate some of the macro commentary at the end. Just wanted to drill into that a bit. That it sounds like there are green shoots in M and A, which should be good for activity.

Speaker 3

But that we can't do that. Can you, juxtapose that against the meaningful direct lending inflows we're seeing in the non traded that the perpetual BDC channel, how is that impacting the terms and spreads we're seeing today? And do you think there's that we have enough M and A to go around in light of this very powerful fundraising. Thank you.

Speaker 1

Thanks, Fin. So it's interesting. We are seeing some countervailing forces right now. That we started off, say, summer of 'twenty two that we are very pleased with our results. In a particularly lender friendly environment, the BSL market that the market was dislocated as a consequence of the rise in interest rates in the swoon in equity and debt markets generally.

Speaker 1

It wasn't a that the robust ability for borrowers to get new deals done in the broadly syndicated market. And consequently, there was a lot of demand in that the private market in private credit markets, even though M and A was relatively slow, that meant that there was a robust pool of deals for us and for other private credit players to choose from. That in the last, I would say, 6 weeks, we've seen a pretty significant increase that we're going to be able to execute on the level of M and A activity. And I think from an origination standpoint, Q4 will be a markedly higher that we have a very strong quarter for us and for the industry than the last several quarters have been. Having said that, that we have seen a lot of fundraising in direct lending strategies aimed at very large deals, that we are seeing a lot of growth in our business, aimed at this ESL replacement market.

Speaker 1

We play in that market, but that's about that It's about 20% of what we do, whereas we have a whole series of competitors where it's basically 100% of what they do. That we've seen some very significant spread compression and shift toward more that borrower friendly terms and activity in that space. And that's It's been a trend for months now, but I do think that it's accelerated in the last 6 weeks or so. That for us, this is not a great problem because our focus is on the traditional middle market. That we are going to see in this year of spread compression in next quarter's earnings reports that we are confident

Speaker 2

that we will be able to

Speaker 1

take a moment from the players who focus on the larger market.

Speaker 3

That's Helpful. Thank you. And also appreciate the color you gave on interest coverage. That for the names that have tighter interest coverage, I'm sure that's sort of a spectrum. To what extent are you seeing sponsors put money in?

Speaker 3

And if not very much, that do you see 2024 or 2024 as sort of a make or break timeframe in that the need for the sponsor to come up with money and capitalize these companies that you know, that is if interest rates

Speaker 2

that

Speaker 3

we remain high. Just any color on that topic? Thank you.

Speaker 1

So the question is, what about companies that are that the tight on interest coverage or fixed charge coverage, how are they managing that? And the answer is we're seeing a number of different approaches. We're that we're absolutely seeing sponsors step up and put incremental equity in a large number of cases. That we're also seeing companies undertake other strategies in order to create liquidity. Sometimes that's the creation of that a holdco note or a new pick preferred issuance, sometimes it's also growth.

Speaker 1

That growth has done a good job for many of our borrowers of creating more free cash flow generation that's enabled that the former REIT type ratios to look better. So we're seeing that different companies approach this in a variety of different ways. I don't think there's one clear pattern to point to. That I do think that private equity sponsors are in general being pretty constructive in addressing liquidity needs in their portfolio companies. Awesome.

Speaker 1

Thanks so much.

Speaker 5

Your next question comes from the line of Robert Dodd with Raymond James. That your line is open.

Speaker 6

Hi, guys. Congratulations on the quarter and the credit quality. So two questions. One is kind of follow on to that you've seen some spread compression in the upper end of the market and also that the

Speaker 2

terms are shifting to a little bit more borrower friendly

Speaker 6

at that end of the that we're going to be looking to a little bit more follow-up trends at that end of the market. I think it was Chris or maybe Matt in their prepared remarks that you've seen this the overall spread compression, but the EBITDA definitions and total leverage was still favorable overall. And so intend to imply

Speaker 1

you hadn't seen that shift in

Speaker 6

the bulk of the 80% of the other stuff. How confident are you that that the terms will continue to be diverged between the top end of the market and the more core middle market that as we go into 2024 or do you think that going to converge in 2024 even in the core middle market is that we're going to shift to a much more follow-up friendly set of structures. Hopefully, that question is clear.

Speaker 1

That we have a question. Here's how I would describe this, Robert. There's always think of it as a pendulum. There's always that we're going to be a swing between more borrower friendly and more lender friendly conditions. And the swing tends to happen first that we are seeing a significant market today that market is not terribly active.

Speaker 1

So the first place we're really seeing it is in that the BFL replacement market, the larger end of the direct lending market. And to Fin's point, that's the place that's seen the most inflows, the most capital inflows through these that we have a number of non traded BDC structures. I don't think that middle market and that larger market are disconnected. I think things tend to happen in the middle market with a lag and to a more modulated degree. And I think that's the pattern we'll see again in 2024.

Speaker 6

Got it. Thank you. And then the second one unrelated to that. On your unsecured notes, you do have an April 24 maturity. I mean, you've got plenty of liquidity on the revolver to just pay

Speaker 1

it off that

Speaker 6

you wanted to, but can you give us the thoughts on what that is with a positive outlook? I presume you don't want your unsecured mix To shrink too much, probably that will be the lading agencies that is. So can you give us some thoughts? And obviously, borrowing costs are that you're higher today on fixed rate, but would you be looking to swap or anything like that we're going to refinance it.

Speaker 1

So all the questions that we're actively looking at, I think your that our statement is correct that over time we want to maintain unsecured, so it's a really meaningful portion of the right hand side of the that we're going to be looking at when's the right time to issue that we are not going to be able to get into the right decision.

Speaker 2

And in connection with issuing

Speaker 1

whether the right decision is to swap into floating or not, I think these are all under active consideration. Thank you.

Speaker 5

Your next question comes from the line of Ryan Lynch with KBW. Your line is open. That

Speaker 7

Hey, good morning. The first question I had was just related to credit quality. When I look at your overall that credit statistics, non accruals, loss in your portfolio, they've been really, really good on a bottom line standpoint. That but I'm just curious when I look at your kind of portfolio monitoring and rating scale, that there's been a pretty meaningful uptick, maybe sort of doubling of those rated 3 credits over the last year. That those aren't credits that are significantly underperforming, but there is maybe some worrisome there.

Speaker 7

So how should investors think about overall credit has been fantastic thus far, that those rated 3 credits have maybe doubled over the last year. How should investors think about that?

Speaker 1

So it's a great question, Ryan, and it's one that's that we're not going to be a little challenging for us. It's challenging because we're naturally conservative. So we And Matt talked about this to a degree. We have an internal modus veranda that we're downgrading credits to 3 maybe earlier than some of our peers. And we do that because that it's part of our process.

Speaker 1

It's part of what happens after that is it triggers a higher level of monitoring. It triggers that we have a level of involvement with management teams and with sponsors. It triggers a whole series of activities that we think are that we are in a good position to sustain that long term favorable track record that you just submitted to. The place where we see the that our greatest correlation with future credit losses is in category 12 credits. And you that you didn't mention it, but I will.

Speaker 1

It's actually fallen over the course of the last year. It's gone from 1.3% to 0.3%. That that's an exceptionally low number. So I think you've got to look at the whole picture. Anybody who says that that the increase in interest rates that we've seen is irrelevant from a credit perspective doesn't know math.

Speaker 1

Math does make that interest coverage, fixed charge coverage, much harder at today's interest levels than they were in 2021, all things being equal. That our rating system reflects this. Our approach to credit decision making and credit monitoring reflects this.

Speaker 7

Okay. That's helpful background on all that. The other question I had was, that you mentioned spreads sort of compressing, maybe some of this is more focused on some of the upper middle that, but certainly spreads compressing a little bit, maybe some borrower friendly terms more in the upper middle market. We'll see if that translates to that we're going to continue to see the growth of our business. So my question is kind of why?

Speaker 7

Why is that occurring? Just because from a high level, that And that's not something that's something commonly you've heard from others as well. But I'm just curious as that there's been a lot of capital raised, and it's been, I feel like, pretty consistent throughout 2023 as you know from that private credit looking to deploy. But now that it seems that there's starting to become some increases in deal flow and deal activity, that Now there's a pretty big supply potentially of coming on from marketplace of guys looking for that additional credit out there. And so it seems like that would actually better balance the supply and demand issue, but it seems that that now that there's actually an increase in deal flow and activity, it seems that that's actually becoming more borrower friendly, which seems a little bit counterintuitive for more people are coming to the market looking for credit.

Speaker 7

That it seems like that would maybe work a little bit more in favor of the lender side. So I'd love to just hear you explain what you're seeing and why?

Speaker 1

I don't have an answer for you on that. I think you're correct in your description of what we're seeing. That we have a better explanation than you do on the why. Dynamics like this tend to be a function of supply and demand. That we'll get a better sense for those dynamics over the course of the coming months.

Speaker 7

That I think it may get worse

Speaker 1

from a spread standpoint, Wouldn't shock. Okay.

Speaker 7

And just the last question I had was, that you and others have talked about kind of seeing a little bit of green shoots and maybe a pickup in activity. That in order for that activity, you're talking about maybe a little bit of a rebound now and into the year end and then potentially a bigger pickup in activity in that we're going to be looking forward to 2020 4. I'm just curious, in order for that deal activity to actually cross the finish line and come to fruition, that Do you get the sense that market conditions just have to sort of stay the same and stabilize right around here? That we're just there anything have to change like a cutting base rate, a much stronger sort of growing economy? Or do you think if we just kind of that stabilized right around these sort of levels from an economic standpoint, do you think you'll continue to see a big uptick in deals crossing the finish line in 2024?

Speaker 1

I think the things that reduce uncertainty would help. That we have a number of questions. So by way of example, if we get more data suggesting that the economy is that we're continuing to grow, that inflation is continuing to grind lower, that would be helpful. That if we got internationally some good news in respect of the 2 wars that are underway, that would be helpful. That I think the biggest obstacle right now to seeing a significant that the rebound, the significant and sustained rebound in deal activity is the level of uncertainty out there.

Speaker 1

Having said that, that we've had a fair bit of time go by since June 2022 when that the M and A environment took a sudden slowdown in the context of higher rates in the swoons in both equity and credit markets.

Speaker 3

And I

Speaker 1

think that's helped a lot in recalibrating valuation expectations on the part of both buyers and sellers. That there's still, in many cases, a gap, but I think that gap has narrowed, and I think continued reduction in uncertainty would help in further narrowing.

Speaker 7

Okay. Understood. That's all for me today. I appreciate the time.

Speaker 2

That we will be conducting a few questions.

Speaker 5

There are no further questions at this time. I will turn the call back to Mr. David Golub for closing remarks.

Speaker 2

That we have a very strong quarter.

Speaker 1

Well, thank you all for giving us a bit of your time today. I hope you found this call helpful. That we look forward to talking to you next quarter. And as always, if you have any questions in the interim, please feel free to reach out. Have a great Thanksgiving, everybody.

Speaker 5

This concludes today's conference call. We thank you for joining. You may now disconnect your line.

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Earnings Conference Call
Golub Capital BDC Q4 2023
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