Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR), secured debt rating and unsecured debt rating of Golub Capital BDC, Inc. (GBDC) at 'BBB-'.

The Rating Outlook is Positive.

Today's rating actions have been taken as part of a broader review of business development companies (BDCs) which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Ratings Completes 2023 BDC Peer Review,' available at www.fitchratings.com.

Key Rating Drivers

The rating affirmations reflect GBDC's first lien focus, strong credit track record, access to investment resources from Golub Capital LLC, experienced management, appropriate asset coverage cushion and solid liquidity.

Rating constraints include GBDC's somewhat limited history of accessing the unsecured debt markets, the potential for funding flexibility to deteriorate if GBDC refinances its April 2024 unsecured notes maturity with secured borrowings and growing exposure to recurring revenue loans, which Fitch believes could experience weaker performance as growth at these portfolio companies slows.

Rating constraints for BDCs more broadly include the market impact on leverage, given the need to fair-value the portfolio quarterly, dependence on access to the capital markets to fund growth and a limited ability to retain capital due to distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid higher interest rates and slower growth at portfolio companies.

First lien (including one-stop) loans represented 94.5% of GBDC's investment portfolio at fair value at Dec. 31, 2022 (fiscal 1Q23), which was above the rated BDC average. Fitch views GBDC's heavy first-lien focus and low equity exposure favorably. That said, one-stop loans, which generally have higher underlying leverage compared to traditional first lien loans, comprised 85.4% of the portfolio at fiscal 1Q23.

GBDC's asset quality metrics have been relatively strong, as demonstrated by the firm generating cumulative net realized gains since inception and no net realized losses, adjusted for merger accounting impacts, on average, from fiscal 2019-2022. Non-accrual levels ticked up over the past year, to 1.8% of the debt portfolio at fair value and 2.7% at cost at fiscal 1Q23, and Fitch believes they will rise further in 2023 given higher debt service burdens for borrowers. Fitch expects GBDC's credit performance will continue to compare favorably to peers' given its focus on first lien investments.

GBDC's core operating performance has been below the peer average, partially due to its above-average exposure to lower-yielding first-lien investments. Net investment income (NII), adjusted for merger accounting impacts, improved to 4.6% (annualized) of the average portfolio at cost in fiscal 1Q23, compared to 4% in fiscal 2022 and 4.3% in fiscal 2021. Fitch believes GBDC's NII will continue to benefit near-term from higher interest rates given the floating-rate nature of GBDC's portfolio and a meaningful fixed-rate funding component.

At Dec. 31, 2022, GBDC's leverage (par debt-to-equity) was 1.23x (1.19x net of cash and foreign currency), which was modestly above the peer average and towards the higher end of the firm's targeted leverage range of 0.85x-1.25x. The leverage ratio implied an asset coverage cushion of 17.1%, which is within Fitch's 'bbb' category benchmark range of 11%-33%. Fitch expects GBDC will continue to maintain its asset coverage cushion at a sufficient level to account for potential valuation volatility and/or credit losses.

Unsecured debt accounted for 46.7% of GBDC's total debt at fiscal 1Q23, which is at the high end of Fitch's 'bbb' category benchmark range of 35%-50% for BDCs. Fitch views the current funding mix as solid, but notes that funding flexibility could deteriorate if market conditions remain challenging over the next year since GBDC has $500 million of unsecured notes coming due in April 2024.

Fitch could upgrade GBDC's ratings if the firm accesses the unsecured debt markets in advance of this date thereby extending its debt maturity profile and maintaining unsecured debt of at least 40% of total debt. Conversely, a decline in unsecured debt to below 35% of total debt, which could result from refinancing the unsecured notes with secured borrowings, could result in negative rating momentum, including a revision of the Outlook to Stable.

Adjusted NII coverage of dividends declared was solid at 103.4% in fiscal 2022 and 113.1% in fiscal 1Q23. Adjusting for non-cash income and expenses, dividend coverage was lower at 94.3% in fiscal 2022 and 97.1% in fiscal 1Q23. Paid-in-kind (PIK) income and non-cash dividends amounted to 5.3% of interest and dividend income in fiscal 2022 and 8.1% in fiscal 1Q23. The increase in fiscal 1Q23 was driven by GBDC revising its policy to include accrued dividends on certain preferred equity investments in investment income (previously in unrealized depreciation). Fitch believes amendment activity in 2023 could drive higher PIK income and will continue to monitor GBDC's ability to collect PIK in cash over time.

The Positive Outlook reflects GBDC's improving funding flexibility in recent years. Fitch could upgrade GBDC's ratings if the firm demonstrates additional access to the unsecured debt markets, allowing the firm to refinance the April 2024 notes while maintaining unsecured debt of at least 40% of total debt.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

An inability to access the unsecured debt markets in advance of GBDC's next unsecured debt maturity in April 2024 could result in an Outlook revision back to Stable if Fitch believes unsecured debt will not be maintained above 40% of total debt. Negative rating momentum could also be driven by a sustained increase in leverage above the targeted range; deterioration of the portfolio risk profile, such that first-lien positions declined materially as a proportion of the overall portfolio, without a commensurate decline in leverage; a sustained meaningful increase in non-accrual levels; meaningful realized losses; weaker cash earnings dividend coverage; or an impairment in the firm's liquidity profile.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Continued access to the unsecured debt markets in advance of the April 2024 notes maturity that results in an extension of the debt maturity profile and the maintenance of unsecured debt of at least 40% of total debt could result in a ratings upgrade. An upgrade would also be conditioned upon the maintenance of leverage within the targeted range, the maintenance of ample liquidity and continued demonstration of strong asset quality metrics, solid cash earnings dividend coverage and consistent core operating performance.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The alignment of the secured and unsecured debt ratings with the Long-Term IDR reflects Fitch's expectations for solid collateral coverage for all classes of debt since GBDC is subject to a 150% asset coverage requirement and has a meaningful unsecured funding component.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a material reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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