David Golub - Chief Executive Officer Ross Teune - Chief Financial Officer Gregory Robbins - Managing Director.

Jonathan Bock - Wells Fargo Leslie Vandegrift - Raymond James Greg Mason - Ares Management, L.P.

Welcome to the Golub Capital BDC, Inc.'s March 31, 2018 Quarterly Earnings 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 the 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 Golub Capital BDC, Inc.'s filings with the Securities and Exchange Commission.

For a slide presentation that the company intends to refer to on today's earnings conference call, please visit the Investor Resources tab on the homepage of the Company's website, www.golubcapitalbdc.com and click on the Events/Presentations link to find the March 31, 2018 Investor presentation.

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. Please go ahead..

Thank you, Tia. Hello, everybody, and thanks for joining us today. I am joined by Ross Teune, our CFO, and Greg Robbins, Managing Director. Yesterday afternoon, we issued our earnings press release for the quarter ended March 31, and we posted an earnings presentation on our website.

We’re going to be referring to this presentation throughout the call today. The quarter ended March 31, was another strong quarter for GBDC. It continued a string of strong quarters for the Company.

For those of you who are new to GBDC, our investment strategy is, since inception has been, to focus on providing first lien senior secured loans to healthy, resilient middle market companies backed by strong partnership-oriented private equity sponsors.

Our strategy is designed to deliver consistent performance even when market volatility increases, as we saw in February. I'm going to return to the theme of volatility later in the call. I'm going to start by providing an overview of GBDC's results for the second fiscal quarter of 2018.

Ross will then take you through the results in more detail, and I'll come back at the end for some closing remarks. So let's turn to this quarter's results.

Net increase in net assets resulting from operations or net income for the quarter ended March 31 was $23 million, or $0.39 per share, as compared to $21.3 million, or $0.36 per share, for the quarter ended December 31.

Net investment income, or as I call it, income before credit losses, was $18.5 million for the quarter, or $0.31 per share, as compared to $18.5 million, or $0.31 per share, for the prior quarter.

Excluding $0.8 million accrual for the capital gains incentive fee, net investment income was $19.3 million, or $0.32 per share, as compared to $0.32 per share for the prior quarter.

Consistent with previous quarters, we provide net investment income per share, excluding the capital gains incentive fee accrual, as we think this adjusted NII measure is more meaningful. Due to earnings in excess of our quarterly distribution, net asset value per share rose from $16.04 to $16.11, a new record high for GBDC.

Our net realized and unrealized gain on investments of $4.5 million, or $0.08 per share, for the quarter was a result of $600,000 of net realized loss and $5.1 million of net unrealized appreciation. This compares to a net realized and unrealized gain on investments of $2.8 million, or $0.05 per share, for the prior quarter.

New middle market investment commitments totaled $135.3 million for the quarter. Including investments of $3.1 million in Senior Loan Fund, total new investment commitments were $138.4 million.

Approximately 20% of the new investment commitments were senior secured loans, 77% were one-stop loans, 2% were investments in Senior Loan Fund and 1% were investments in equity securities. Overall, total investments in portfolio companies at fair value increased by about 2.1% or $36.4 million during the quarter.

Turning to Slide 4, you can see in the table, the $0.39 per share we earned from a net income perspective, the $0.32 per share we earned from a net investment income perspective before accrual for the capital gains incentive fee, and you can see our net asset value per share of $16.11 at March 31.

As shown on the bottom of the slide, the portfolio remains well diversified with investments today in 189 different portfolio companies and an average size of $8.8 million per investment. With that, I'll turn it over to Ross who'll provide some additional portfolio highlights and discuss the financial results in more detail..

Thanks, David. Beginning on Slide 5. This slide highlights our total originations of $138.4 million and total exits and sales of investments of $105.9 million, contributing to net funds growth of $36.4 million. Total payoffs remained at a normalized level for the quarter ended March 31.

Turning to Slide 6, this slide shows the overall portfolio mix by investment type has remained consistent quarter-over-quarter with one-stop loans continuing to represent our largest investment category at 80%.

Turning to Slide 7, this slide illustrates the fact that the portfolio remains well diversified with an average investment size of $8.8 million. Our debt investment portfolio remains predominantly invested in floating rate loans and there have been no significant changes in the industry classification percentages over the past year.

Turning to Slide 8, the weighted average rate of 8.4% on new investments this quarter was up from 7.5% in the previous quarter. This was due to an increase in LIBOR as well as an increase in the weighted average spread over LIBOR on new investments.

The 40 basis point increase in the weighted average spread over LIBOR on new investments was due to a few larger deals with high relative spread and not a general market move as market conditions remain quite competitive.

Due to a few larger payoffs in existing loans with higher relative spread, the weighted average rate on new investments that paid off increased by 30 basis points to 7.9%. Just as a reminder, the weighted average interest rate on new investments is based on the contractual interest rate at the time of funding.

For variable rate loans, the contractual rate would be calculated using current LIBOR, the spread over LIBOR and the impact of any LIBOR floor. Shifting to the graph on the right hand side, this graph summarizes investment portfolio spread for the quarter.

Looking first at the light blue line, this line represents the income yield or the actual amount earned on the investments which includes interest and fee income, but excludes the amortization of any discounts and upfront origination fees. The income yield increased to 8.2% for the quarter ended March 31.

This was primarily due to an increase in the average LIBOR index rate for the quarter. The investment income yield, or the dark blue line, which includes the amortization of fees and discounts, increased to 8.8% during the quarter and this was also primarily due to an increase in the average LIBOR index rate for the quarter.

The weighted average cost of debt, or the green line, this remained unchanged at 3.9% for the quarter despite the increase in LIBOR as lower unused fees and lower amortization of deferred financing fees offset the increase in the underlying LIBOR index rate.

Flipping to the next slide, credit quality remains strong with non-accrual investments as a percentage of total investments at cost and fair value of 0.3% and 0.1% respectively as of March 31. These percentages remained unchanged from the prior quarter.

The number of non-accrual loans declined from two portfolio companies to one portfolio company as of March 31 as we exited one investment at a value consistent with its mark at December 31.

Turning to Slide 10, the percentage of investments risk rated a five or four, our two highest categories remained stable quarter-over-quarter and continues to represent over 90% of the portfolio. As a reminder, independent valuation firms value approximately 25% of our investments each quarter.

The review of the balance sheet and income statement are on the following two slides. We ended the quarter with total investments at fair value of $1.76 billion, total cash and restricted cash of $48.4 million and total assets at $1.82 billion.

Total debt was $835.2 million, which includes $451 million in floating rate debt issued through our securitization vehicles, $277.5 million of fixed rate debentures and $106.7 million of debt outstanding in our revolving credit facility. Total net asset value per share was $16.11.

Our GAAP debt to equity ratio was 0.87 times, while our regulatory debt to equity ratio was 0.58 times. These levels remain below our longer-term targets. Flipping to the statement of operations, total investment income for the quarter ended March 31 was $36.9 million.

This was an increase of $0.4 million from the prior quarter primarily due to an increase in LIBOR and continued growth in the portfolio. These increases were partially offset by a decline in dividend income from equity investments, excluding our equity investment in our Senior Loan Fund.

On the expense side, total expenses were $18.4 million, an increase of $0.4 million, which is primarily attributable to higher interest and other debt financing expenses caused by increase in the weighted average debt outstanding.

Turning to the following slide, the tables on the top provide a summary of our quarterly distributions and return on average equity over the past five quarters. Our quarterly distributions have remained stable at $0.32, which is consistent with our net investment income per share, when excluding the GAAP accrual for the capital gains incentive fees.

The annualized return for the quarter based on net income was 9.7% and has averaged 9.2% for the past five quarters. The bottom of the page illustrates our long history of increasing NAV per share over time.

For historical purposes, we have presented NAV per share both including and excluding the $0.25 and $0.08 special distributions that were paid on December 29, 2016 and, again on December 2017. Turning to Slide 14, this slide provides some financial highlights for investment in our Senior Loan Fund, which had a disappointing quarter.

Annualized total return for the quarter-ended March 31 fell to 5%, primarily due to an unrealized loss in two portfolio company investments and below target leverage. Total investments at fair value at March 31 declined by 8.5% to $255.5 million as we experienced an increase in prepayments.

Turning to the next Slide, we have over $120 million of capital available for new investments through restricted cash, availability on our revolving credit facility and additional debentures available through our SBIC subsidiaries.

On March 23, 2018, we amended our 2014 debt securitization, which reduced the spread over LIBOR on the $191 million of Class A-1 notes by 80 basis points and the spread over LIBOR on the $20 million of Class A-2 notes and the $35 million of Class B notes by 100 basis points and 110 basis points respectively.

Slide 16 summarizes the terms of our debt facilities. And lastly, on Slide 17, our board declared a quarterly distribution of $0.32 per share payable on June 28 to holders of record as of June 8. I'll now turn the call back to David, who will provide some closing remarks..

Thanks Ross. So to sum up, GBDC had another strong quarter despite the continued, now prolonged borrower friendly environment that we've seen over the last 24 months. Contributing to the strong quarter was an increase in LIBOR. And it looks like we're going to continue to see increases in LIBOR, helping results going forward.

Middle market companies continued to show strong operating results. For the quarter ended March 31, the Golub Capital Middle Market Report showed a second consecutive quarter of strong growth in revenues and EBITDA.

In fact, it shows the highest year-over-year revenue growth in any calendar year first quarter since we started the index a number of years ago. I'll close with three points.

First, an update on our market outlook, then I’ll discuss two topical issues, BDC leverage limits and an update on some moves we've made and plan to make on our debt capital structure. First, my update on our market outlook is, no change.

High level of competition for attractive new deals continues to put pressure on pricing leverage and documentation terms. And our response also hasn't changed. We continue to stay selective on new investments to focus on deals where our competitive advantages matter and to prepare to play offense when market conditions improve.

The increase in market volatility during the quarter was a healthy reminder that market conditions can change quickly. Frankly, we would be happy to see a bit more volatility, as it tends to move the market in a more lender friendly direction. Second topic, BDC leverage limits.

As you're most likely aware of a provision of the Small Business Credit Availability Act signed into law on March 23, permits BDCs to take steps to increase the regulatory leverage limit to a 2:1 debt-to-equity ratio. Consistent with our overall business philosophy, we're carefully analyzing our options.

Step one for us is not deciding whether to pursue a shareholder vote or a board vote. Step one is determining if a change in our use of leverage makes sense for shareholders. We're working on that now. We see no reason to be in a rush on this. Third, an update on some moves we've made and plan to make in respect of our debt capital structure.

On December, we amended our Wells Fargo facility bringing down its interest cost from LIBOR plus 2.25% to LIBOR plus 2.15%. As Ross mentioned in March, we repriced our 2014 CLO and brought the weighted average interest cost down from LIBOR plus 1.87% to LIBOR plus 1.01%, a difference of 86 bps.

We still have our 2010 CLO outstanding, and we held off on resetting that facility pending receiving further guidance from the SEC on how, as externally managed BDC, to comply with U.S. risk retention requirements.

We still anticipate receiving greater clarity from the SEC, but it may not arise before we need to address the end of the reinvestment period of that CLO in July. So we're currently exploring a variety of options for new debt facility as opposed to a new securitization.

And we anticipate that if go that route, the new facility is likely to have terms and structure similar to our existing Wells facility. With that, I want to thank you all for your time today and for your continued partnership. And Tia, if you can please open the line for questions..

[Operator Instructions] Our first question is from the line of Jonathan Bock with Wells Fargo. Please go ahead..

Thank you for taking my questions. And David, I wanted to ask a quick question as it relates to the borrowing, your credit facilities.

So can you walk us through whether or not just the push-pull or the problems one is having related to the SEC and risk retention requirements? And I just want to understand this issue a bit more, because it seems to me as GC is a large holder of BDC shares through employment, trust, et cetera.

You already meet risk retention guidelines as it looks as if you're eating your own cooking the whole point was to make sure that if you retain some risk and clearly owning the GBDC shares as GC, you’ve absolved absorbed yourself of that problem.

Can you help us understand that just a bit more?.

So unfortunately, it's not that simple, Jon. The new risk retention rules which were put into effect under Dodd Frank are very complicated and in some ways are still not fully understandable. And what I mean by that is that there is a conflict between the new risk retention rules as interpreted by some and the 40 Act.

And this has led to a lack of clarity about whether an externally-managed BDC can simultaneously be in compliance with the risk retention rules and with the 40 Act at the same time. So we've been in some discussions with the SEC to try to gain greater clarity on this issue. And I remain optimistic that we’re going to be able to get that clarity.

But the discussions have been going on now for two years, and I can't tell you exactly when that's going to be resolved. So we’re making sure that we plan for scenarios that include one where there continues to be an absence of sufficient clarity for us to feel comfortable having GBDC issue a new secularization.

And the good news is we have a number of other financing choices besides new securitizations. So we're exploring those other options.

And we're simultaneously pursuing and hopeful that we're going to be able to resolve the lack of clarity and be in the position to have GBDC return to doing securitizations, because we think that that's the best source of debt financing capital for BDC shareholders..

I would agree and that dovetails into discussion on leverage clearly not related to the votes, not related to anything of that matter. But you mentioned kind of a focus on win-win. I want to see if we can explore that a bit more.

So in the event that GC decides that two to one leverage or removal of the regularly constraint is a proper move for shareholders.

Can you walk us through, maybe, a situation where you're looking at increased leverage where you do not believe it is in the best interest of shareholders? And perhaps what are some of the common themes that you are seeing that might have shareholders scratching their heads and choose to trade at BDC at a specific discount?.

When we think about incremental debt, we necessarily think about incremental debt costs and incremental debt risks. Now some of this point is obvious. I think everybody understands that when we lend to the companies who want a higher quantum of debt, we charge them more.

Stretch senior costs more than senior, unsecured debt costs more than secured debt. Well, the same’s true for our lenders. The second piece of what I mentioned is less obvious and maybe more important. In a more leveraged capital structure, a manager's room to maneuver in a downturn is reduced.

There are more limitations that are written into the debt facilities and if it becomes necessary to do some kind of refinancing. That gets harder to get done.

So as we think about these three factors, one that we got a great model today, two that the environment is challenging and three that incremental debt comes with incremental cost and incremental risk. We think the idea of using incremental leverage may be a good idea, or may not be a good idea. We're studying it.

What I think is really clear is that capital structure design and investment strategy questions, these are really important questions, highly impactful questions and easy ones to get wrong.

And if you want to see that illustrated, how easy it is to go wrong on these, take a look at any of the myriad managers who got into trouble in the last downturn, including GE and CIT and Allied and ACAS and a slew of other BDCs.

So we think the right approach here is a methodical and careful thinking through of pros and cons and thinking about investment strategy alongside capital structure design..

And does the fee component factor into this at all, as you think about net incremental spread left investors on net incremental leverage, folks would be interested in how you look at it..

I think that as we think about what would constitute a win-win for shareholders, we need to look at the impact of incremental borrowings, incremental investing on ROE. And the risk of stating the obvious, if there isn't enough incremental return to outweigh incremental risk then that's not a smart thing to do..

Appreciate that. Then finally as we turn to the investment side, clearly being disciplined and focused with significant value portfolio incumbency and growing up with your investments, it's a very strong competitive position to be in a difficult market environment.

The question is, as your obligors likely get calls from the syndicated market, at what level do you feel that providing a unitranche financing, I mean clearly mimic the same terms that someone else's going to be able to get in the syndicated marketplace? And if the answer is yes, can you walk through why an obligor would choose to take a unitranche financing aside from the insurability of close in an environment where we are now at least from syndicated debt perspective that obligor might actually benefit by having multiple owners of the same loan, which in a downturn can be very valuable.

So it’s question of one-stop versus syndicated financing in today's financing environment and if one's at price parity, why would an obligor choose a one-stop when in today's environment, it seems the syndicate option is perhaps one of the easiest paths with less risk?.

Well, I'm not sure I would agree with the premise that it has less risk. I think there are sponsors and deals where a buy-and-hold one-stop is a better solution. And there are sponsors and deals for which a syndicated solution is a better solution. And let me just briefly outline two examples to illustrate the point.

So we've been a provider of one-stop financing in some recent transactions that have involved buy-and-build strategies where the sponsor has wanted to roll a company through a series of successive acquisitions, very challenging to manage that kind of buy-and-build strategy with a traditional first lien, second lien syndicated solution.

Because every time you want to issue more debt, you’ve got to get everybody to agree on letting you and you got to get everybody to agree on the right split between first lien and second lien and it's just candidly, it's just a mess. It's always a mess. The second lien wants you to issue more second lien.

The first lien doesn't want you to issue more debt. It's a mess. So the ability to do scalable one-stops for sponsors and portfolio companies to doing buy and build strategies can be a very compelling solution.

In fact, it's so compelling that in some circumstances, those companies would be well served to pay an interest rate premium for the flexibility of being able to have the one-stop. Conversely, if you look at a sponsor and obligor that perhaps has a meaningful degree of cyclicality or a meaningful degree of volatility in its earnings.

It may see enormous value in a syndicated solution with no covenants. And the biggest difference today between syndicated solutions and buy-and-hold solutions isn't pricing. Pricing is largely comparable.

The biggest difference is that a larger middle market company, companies in excess of $40 million to $50 million of EBITDA, are very often able to achieve cov-lite executions in the syndicated market.

And for some of those companies that cov-lite solution is very appealing because they may be particularly nervous about the potential to trip a covenant if market conditions shift on them. I think we've been in a world, Jon, where one-stops and syndicated solutions compete with each other for, well, since we started doing one-stops.

It's not new for us. And I think our experience is that there are lots and lots of opportunities where the one-stop solution is the better answer..

Yes, that I appreciate that. And then as a final - just turning to the portfolio, connection software - diligent corporation only because it's a sizable one-stop loan on balance sheet or at least it was originated this quarter.

Can you give us a sense as to that transaction, its size, its execution, its origination, also because it carries with it a fairly hefty yield relative to some of the other portfolio yields you have on the rest of the rest of the one-stop portfolio. And that's it from me..

So Diligent for those who aren't familiar with it is a company that has a dominant market position in a niche.

And the niche is it provides software that's used by companies to communicate with their Boards of Directors in a similar type needs for secure communications between members of a small group as extremely high recurring revenues and it is a buy-and-build strategy. They have been acquiring a number of competitors around the globe in their niche.

We've been a lender to Diligent for quite some time. We have a lot of confidence in the company, its management and its sponsor. It represents a good example of the kind of software lending that we like to do..

All right. Thank you..

[Operator Instructions] The next question is from the line of Leslie Vandegrift with Raymond James. Please proceed..

Hi, good morning. Thank you for taking my questions. My first one is just you mentioned a bit in prepared remarks on the increase in interest rates and its effect on yield. What do you see is or how much do you see the offset from competition through 2018.

So if rates go up another 50 basis points, how much of that do you think will stick in yields due to competition?.

Thanks for your question Leslie. So the question is, do we think that rises in LIBOR will be matched by competitive decreases in spread? I'd say in general no. Most of our competition is not pricing based on an absolute return. But is a pricing based on a relative return and spreads.

So we continue to see some signs of what you’ve heard me call before credit market inflation, meaning some pressure on spreads and leverage and documentation. But I'd say, what we've seen in the recent period in spreads has been relatively stable, where we see the most impact of continuing credit market inflation is documentation terms..

Okay. And then I know - again, you mentioned, you are analyzing the options on your portfolio whether or not to use it. But as more BDCs do use it and start to use it extra turn, they've discussed doing more pure first lien, et cetera. And I know that the SLF investment, it was a different quarter this quarter.

But those investments tend to be more of the pure first lien senior secured.

So how much of other BDCs using this new leverage, do you think will increase competition on those SLF investments?.

I think it's too early to say with any real clarity. I think there is a fair amount of discussion by some of our competitors about using incremental leverage and guiding their incremental investment toward first lien senior secured lower-spread assets.

I'm not sure how that's going to work for them because as we look at the math, we think it's pretty hard to make money for shareholders using incremental leverage costs and low-spread assets.

So we don't think that we’re likely to see other BDCs develop the degree of low-cost structure that we’ve been able to develop with our fee structure, debt costs, and low rate of credit losses..

All right. Thank you. Those are my questions..

The next question is from the line of Greg Mason with Ares Management. Please proceed..

Good morning, David. Thank you for taking my question. I wanted to talk about just you've been talking about competition in the marketplace. On Slide 8, we see that your new investments spreads over LIBOR has actually been kind of trending up over the last year. I just wanted to get your view on that dynamic of a very tough competitive environment.

But we've also seen yields on new asset spreads over LIBOR actually rising over the past year.

Could you kind of reconcile those two points for me?.

Sure. If you look at the weighted average spread over LIBOR of new floating rate investments on Page 8, it goes 5.4, 6, 6, 6, 6.4. If I had to guess, my guess would be that next quarter will look more like the six than like the 6.4 I think Ross alluded to this in his remarks. We had a small number of investments in this calendar quarter.

This most recent calendar quarter that had higher spread and elevated that number. I don't expect that to sustain. I think we're in a relatively flat average spread environment..

Okay, great. And then on Slide 14 with the senior loan fund over the past year, the size of that has declined a bit.

And just wanted to get your views on that program and potential of increasing that again, or what's kind of led to the shrinkage in the Senior Loan Fund over the past year?.

This is a pure function of the market conditions that we were just talking about. We think that right thing to have done over the course of the last year or so has been to let this shrink some because we've been cautious on new opportunities. When/if market conditions change we would anticipate increasing the size of this..

Okay, great. Thank you..

[Operator Instructions] It looks like we have no further questions at this time. I'll turn the call back to you..

Thank you. Thanks, Tia. Thanks everyone for joining us today. We really appreciate your participation and as always should you have any questions that we did not cover today, please feel free to reach out to Ross or Gregory or to me. We'll talk to you next quarter..

Ladies and gentlemen, that does conclude the call for today. Thank you for your participation and ask that you please disconnect your line..