BlackRock Capital Investment Corporation
Q2 2017 Earnings Call Transcript

Published: 5 Aug 2017

[Operator:]

Good morning. My name is Greg, and I will be your conference facilitator today for the Blackrock Capital Investment Corporation Second Quarter 2017 Earnings Call. Hosting the call will be Chief Executive Officer, Michael J. Zugay; Chief Financial Officer and Treasurer, Donna M. Milia; General Counsel and Corporate Secretary of the company, Laurence D. Paredes; Nik Singhal, Investor Relations and Business Strategy; and Marshall Merriman, Head of Portfolio Management for BlackRock’s U.S. Private Capital Group. Lines have been placed on mute. After the speakers complete their update, they will open the line for question-and-answer session. [Operator Instructions] Thank you. Mr. Paredes, you may begin the conference call.

[Laurence Paredes:]

Good morning. And welcome to BlackRock Capital Investment Corporation’s second quarter 2017 earnings conference call. Before we begin our remarks today, I would like to point out that certain comments made during the course of this conference call and within corresponding document contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. We call to your attention the fact that BlackRock Capital Investment Corporation’s actual results may differ from these statements. As you know, Blackrock Capital Investment Corporation has filed with the SEC reports which list some of the factors which may cause Blackrock Capital Investment Corporation’s results to differ materially from these statements. BlackRock Capital Investment Corporation assumes no duty to and does not undertake to update any forward-looking statements. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, BlackRock Capital Investment Corporation makes no representation or warranty with respect to such information. Please note, we have posted to our website an investor presentation that complements this call. Shortly, Mike will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the August 2017 Investor Presentation link in the Presentations section of the Investors page. Thank you. I would now like to turn the call over to Mike Zugay, who will provide an overview of the business and second quarter highlights.

[Michael Zugay:]

Thank you, Larry. Good morning. And thank you for joining our second quarter earnings call. I’ll start by giving an update on the quarter’s business and financial highlights, then move to our investment activity during the quarter. Lastly, I will discuss the underlying portfolio performance before turning it over to Donna to discuss our financial results in more detail. For the second quarter, net investment income was $0.19 per share. Based on the $0.18 per share distribution declared by our Board of Directors, there was approximately 106% distribution coverage. Additionally, net asset value per share increased from $8.22 per share last quarter to $8.33 per share as of June 30, 2017 or a 1.3% quarter-over-quarter increase. Our leverage profile remains low by industry standards at 0.47 times and we have ample liquidity of over $300 million to support new investment activity. We had a relatively active quarter, managing the liabilities of the company. First, we redeemed the entire $17 million outstanding of 6.6% senior secured notes that were scheduled to mature in 2018. Then we extended the maturity on our revolving credit facility to June 2022. Next, we issued approximately $144 million of 5% unsecured convertible notes due 2022. There was strong investor demand for our convertible note offering and as a result, the 15% overallotment option was fully exercised. Finally, we prepaid our $15 million L+3.25% senior secured term loan, which was set to mature in 2019. Our current debt maturity profile coupled with our strong liquidity position provides us with operating flexibility for the next several years. As can be expected with this level of debt capital markets activity, we incurred several one-time expenses related to our debt facility, including make-whole premiums, acceleration of unamortized debt issuance costs and registration statement costs. There was also a one-time insurance reimbursement payment related to a previously disclosed legal settlement, which partially offset these one-time expenses. Excluding these items, NII distribution coverage for the second quarter would have been 114% or rounded up to $0.21 per share. Later in the call, I will discuss the portfolio in more detail. But as of June 30, 2017, we are pleased to report that we did not have any investments on non-accrual status. We continue to make steady progress with our goal of restructuring more of the legacy investments and rotating out of reorg equity securities, but we do not have any additional specifics that we can announce at this time. We continue to believe that monetizing non-interest bearing investments and redeploying proceeds into income generating assets is an appropriate strategy, but the timing of such moves is inherently unpredictable. From March 6, 2015, when BlackRock assumed responsibility for managing the investment activities of the company to for the end of the second quarter our team has deployed approximately $565 million into new investments. As of June 30, 2017, approximately 48% of our current investment portfolio by fair market value is represented by investments deployed by the new advisor. Current market conditions for leveraged loans can be generally categorized as having tighter pricing, higher leverage levels and weaker structures than in recent periods. As such, we remain highly focused on credit quality and disciplined with loan documentation. As stated on our previous calls, we continue to seek to deploy capital across three core channels, direct investments in junior capital instruments, our portfolio company investment in Gordon Brothers Finance Company and our portfolio company investment in BCIC Senior Loan Partners, a first lien joint venture with Windward Investments LLC. With regards to BCIC Senior Loan Partners and Gordon Brothers Finance Company, both have underlying investments and diversified pools of primarily first lien loans that generate attractive risk adjusted returns. Turning to our investment activity during the quarter, we had a $49.2 million net decrease in our portfolio as a repayment activity, which included proactive sales, exceeded new capital deployment. The repayment activity was primarily represented by two transactions, selling $35 million of the BMS first lien term loan to a third-party at par and a par repayment of our $20 million second lien investment in U.S. Anesthesia Partners, Inc., USAP. The BMS sale was done to right size our exposure in this relatively low yielding first lien term loan. The USAP repayment occurred in conjunction with an acquisition and subsequent refinancing in the broadly syndicated loan market. Our gross deployments in the quarter were primarily represented by two investments, $10.7 million of incremental equity to Senior Loan Partners and $5.9 million of incremental L+11.00% unsecured debt to Gordon Brothers Finance Company. We had one portfolio company exit during the quarter and now have 34 companies in our portfolio at a fair market value of $893 million. The weighted average yield of debt and income producing equity securities at fair market value was 11.3% as of June 30th. As I just mentioned, we invested $10.7 million into Senior Loan Partners to fund our share of equity commitment. We are now benefiting from Senior Loan Partners use of leverage on its incremental investments as it ramps up its portfolio and is now achieving a dividend yield of approximately 11%. Senior Loan Partners made investments into seven new portfolio companies, which are detailed in our earnings press release. As of June 30th, Senior Loan Partners has committed and funded amounts of $177.1 million and $170.3 million, respectively, to 17 borrowers. On a net basis, our investment in Gordon Brothers Finance Company decreased $7.1 million from last quarter due to timing of investment related activity that GBFC experienced in the quarter. GBFC's strong origination in underwriting platform continues to provide us exposure to its well-structured asset based loans. We will continue to support GBFC's growth initiatives as our portfolio expands. As I mentioned earlier, there are no significant updates with regard to restructuring activity or sales of any our reorg equity positions, but we continue to make progress on these fronts. We continue to work with relevant parities involved in the SVP investment, as we evaluate options aimed at rightsizing their balance sheet in order to better position SVP to execute on its three-year business plan. Some of the more significant increases in valuations this quarter were concentrated in AGY Holding Corp., SOURCEHOV and U.S. Well. The negative movements were concentrated in Advanced Lighting, MBS and SVP. The valuations for many of these investments are highly sensitive to movements in LTM EBITDA and most of these companies experienced EBITDA movements, which drove the increases or decreases in the fair market valuations. In the case of SOURCEHOV, a transaction was publicly announced, which resulted in higher trading levels on the company's debt, which drove the valuation increase. After quarter-end, our first lien and second lien investments in SOURCEHOV were repaid, the first lien at par and the second lien at a 2% premium. Recently, there was an M&A transaction announced regarding another one of our portfolio companies, Waterpik, and we anticipate our $32 million second lien investment to be repaid in the third quarter, assuming that transaction closes. The robust market environment has led to an increase in repayment activity due to M&A and refinancings. With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

[Donna Milia:]

Thank you, Mike. I will take a few minutes to review additional financial and portfolio information for the second quarter of 2017. GAAP net investment income was $13.9 million or $0.19 per share for the three months ended June 30, 2017. Relative to distributions declared of $0.18 per share, our NII distribution coverage was 106% for the quarter. Excluding $1.1 million of net one-time expenses related to our debt facilities, including make-whole premiums, unamortized debt issuance costs and registration statement costs, net of an insurance reimbursement related to a previously disclosed legal settlement, NII for the second quarter would have been $0.21 per share rounded up implying 114% distribution coverage. Fee income earned on capital structuring, prepayments and administration during the current quarter totaled $100,000, as compared to $600,000 earned during the preceding quarter and $4.1 million earned during the prior year quarter. Excluding fee income and the abovementioned insurance reimbursement, investment income increased approximately 1% compared to the prior quarter and decreased approximately 16% as compared to this quarter one year ago. On June 13, 2017, we issued $143.8 million in aggregate principal amount of 5% convertible notes due 2022. The amount above includes the overallotment option which was fully exercised. The proceeds were used to repay indebtedness under our revolving credit facility and for certain fees and expenses related to the issuance. The 2022 convertible notes will mature on June 15, 2022, unless previously converted, repurchased or redeemed in accordance with their terms. Upon conversion of a note, we will pay or deliver as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock at our election. As compared to the comparable 2016 period weighted average, our six months 2017 weighted average cost of debt increased 113 basis points to 5.36%. This was primarily driven by; one, make-whole interest incurred in connection with the early repayment of our $17 million 6.60% notes and $15 million L+3.25% term loan; two, lower average debt balances outstanding on our revolving credit facility as a percentage of total debt; and three, higher LIBOR rates for the current period. Excluding make-whole interest and other costs incurred in connection with the two early debt repayments, the weighted average cost of debt for the six-month period of 2017 was 4.75%. Net unrealized depreciation decreased $3.1 million during the current quarter, bringing total balance sheet unrealized depreciation to $37.8 million. During the quarter, gross unrealized appreciation of $8.6 million was partially offset by $4.6 million of gross unrealized depreciation, for a net $4 million of appreciation due to portfolio valuations. Additionally, there was $900,000 of unrealized depreciation during the quarter due primarily to the reversal of previously recognized unrealized appreciation on the USAP repayment. As previously disclosed, we announced the waiver of incentive management fees based on income from March 7, 2017 to December 31, 2018. For the three months ended June 30, 2017, $2.8 million of incentive management fees based on income were waived pursuant to this announcement. The cumulative amount of such incentive management fees waived since March 7, 2017 is $3.6 million. During the quarter, there was no accrual for incentive management fees based on gains. A hypothetical liquidation is performed each quarter end resulting in an additional accrual, if the amount is positive or a reversal to the existing accrual if the amount is negative. However, the resulting fee accrual is not due and payable until June 30th, if at all. There is currently no balance accrued for incentive management fees based on gains as of the measurement period ending June 30, 2017. At June 30, 2017, we had total liquidity of $409.7 million, consisting of $15.7 million in cash and cash equivalents, and $394 million of availability under our credit facility. However, our availability for portfolio company investments is limited to approximately $300 million in order to comply with the 200% asset coverage requirement. With that, I would like to turn the call back to Mike.

[Michael Zugay:]

Thank you, Donna. We thank you for your participation in today's call for your continued interest and support. With that, Operator, we would like to open the call to questions.

[Operator:]

Thank you, sir. [Operator Instructions] And our first question comes from Jonathan Bock with Wells Fargo Securities.

[Fin O’Shea:]

Hi guys. Fin O'Shea for Jonathan Bock this morning. Thanks for taking our question and congratulations on another good quarter and it sounds like some positive outcomes following the quarter. Just kind of touching on those actually, it sounds like you'll get another chunk of capital back at least only less than half way through, noticing your commentary and the market and nothing being deployed on the core book. Can you kind of touch upon what we could expect here in terms of deployment and leverage or maybe even more in the SLP, which to that end it sounds like more leverage will be sourcing upcoming deployments?

[Michael Zugay:]

Yeah. Hey, Fin. It's Mike Zugay here. Thank you for calling and thank you for the question. So, look, what we know right now about prepayments, we've got Waterpik out there, SOURCEHOV, actually already closed. There was an announcement on another deal that we have in the portfolio. I don't know if that will happen. But if it does, call it $70 million of runoff that we know of and look from -- that's what we know right now. So that's definitely -- that pace is definitely accelerated, not to be expected in the market that we're in right now. On the deployment side of things, obviously, that's a little bit harder to forecast going forward. We typically don't give guidance on that. But as you mentioned the SLP, Senior Loan Partners, we do have capacity to ramp that vehicle up. Our $85 million commitment is our goal to get to that number and you could see where we're at to-date. So there's room to deploy there. Gordon Brothers Finance Company has -- we have room to deploy there. As well as the second lien goes in the marketplace. What we -- the moves that we have with Senior Loan Partners and Gordon Brothers Finance Company allow us to participate in the really good second lien deals that we do see in the market. The ones where we like the credit even if they price in today's market at L+7.75% to L+8%, we can still book those deals and pair that up with the 11%, 12% moves that we have on the two that I just mentioned, the two portfolio companies I just mentioned. So, I think, look, we definitely want to grow the book. It’s not -- but we want to grow it in the right manner. We don't want to just deploy and get risk adjusted returns that aren't quality risk adjusted returns. So, we're going to be patient. But we are actively participating in the market to deploy where we can. We're just picking our spots.

[Fin O’Shea:]

Sure. And as to the core book as well, the second lien, is that -- what was probably the hold back this quarter and more recently we -- recently the focus has been the SLP. So, is it pricing, is it structure, is it sort of relationship stuff outside you guys will have is like what's the main driver in terms of holding back deployment?

[Michael Zugay:]

Yeah. Look pricing structure those are definitely two very important factors at play. There's -- to a limited extent, also opportunity cost of our team's time. We've deployed into ‘17 borrowers on the first lien side of things and we do the same amount of work on those deals as we do on a second lien transaction. So from the team's perspective, they've been very busy deploying in what effectively now let’s call it 11% returning asset. So that's been better relative value versus where the second lien market is and now that we're ramped up, and we're seeing more of that flow, we're not out advertising the sponsors, hey, we're now in the first lien business, people know that we're in the first lien business, so we're spending less time advertising to the marketplace. We're getting more inbound calls on the senior deals. It's definitely freed up capacity to do more second lien deals. But it is going to be -- for second lien deals the credit quality is on the utmost importance.

[Fin O’Shea:]

Very well. And then just a couple of quick company specific ones. Very good marks in AGY, U.S. Well, is that at all -- is that as mentioned, EBITDA type movements or is this at all indicative of potential activity?

[Michael Zugay:]

The movement for those two it's AGY and U.S. Well, those were really due to improvements at the underlying portfolio company EBITDA -- the EBITDA improvements.

[Fin O’Shea:]

Okay. And then, SVP which, as discussed in the past, you're actually working on and I, of course, do you guys nothing new today, but sort of a technical question on it. How much of that balances is capitalized PIK and why continue to accrue it given the current mark?

[Donna Milia:]

Sure. For this quarter about $1.2 million was PIK that was capitalized and the way we treat that is we take a haircut on the PIK if we think there may be a collectability issue.

[Fin O’Shea:]

Okay.

[Donna Milia:]

So due to the level of both the recent mark we set our haircut.

[Fin O’Shea:]

Very well. Thank you, guys. And thank you for taking my question and congratulations.

[Michael Zugay:]

Thank you.

[Laurence Paredes:]

Thanks Fin.

[Operator:]

[Operator Instructions] Next we'll move to Ryan Lynch with KBW.

[Ryan Lynch:]

Good morning and thank you for taking my questions. First, I wonder, you talked about the competitive environment for deploying capital that -- there is a lot of pressure on pricing and leverage and structures, and that's evident by the limited growth in your balance sheet portfolio and a limited originations you made in the quarter. However, we did see strong growth in your SLP. So can you just talk about the disparity of attractive investment opportunities that you found for the balance sheet versus attractive investment opportunities found for the SLP, because I would think if the environment is competitive, it's going to be competitive both in -- in both senior loans and junior loans. So I would have thought that either we would saw decent to strong growth in both the balance sheet and the SLP or limited growth in both the balance sheet and the SLP, but this quarter we actually saw a limited growth in the balance sheet and strong growth in the SLP. So can you just kind of provide some commentary around that?

[Michael Zugay:]

Yeah. Look -- hey, Ryan. It's Mike here. A couple of points, well, first of all, the SLP is focused the underlying investments are in first lien loans. And the first lien loan market has not seen the same price spread compression as the second lien market. We're still seeing spreads in the L+4.25% to L+4.50% range in the middle market and so you're not seeing the same, call it 100 basis point contraction that there is in the second lien market. So, from a leverage level, from a pricing level, first lien is more attractive in the vehicle -- in the SLP vehicle, because it's a levered vehicle. So to get 11% returns being in a diversified pool first lien assets were in most cases all but a couple we have leverage covenants and better documents than what we're seeing in some of the larger second lien deals out there. So it -- the first lien market, just to answer your question bluntly is more attractive right now than the second lien market in my opinion.

[Ryan Lynch:]

Okay. Well, then to add on that, if the first lien market is more attractive than the second lien, do you guys ever think about placing some of lower risk, but also lower yielding first lien investments on your balance sheet, if even temporarily, as you guys are under levered with this whole process of these are lower risk and then eventually basic place order investments, so that eventually down the road. These have very limited credit losses for these investments and then potentially down the road you could rotate out of those into some higher yielding second lien investments.

[Michael Zugay:]

Yeah. Look, it's something we definitely think about. The only problem with booking those first lien loans on balance sheet, it is -- they're not liquid, right. So when you do want to sell you really can't. There's limited buyer universe for those assets, but it's definitely something that we've thought about even more so on the unit tranche side. So not booking L+4.50% type assets on balance sheet, but taking some of that lower risk L+6.50% type unit tranche product on balance sheet. That is absolutely something that we consider and we're looking for those assets quite frankly in the marketplace.

[Ryan Lynch:]

Okay. And then one last one, credit has held up well. You guys don't have any non-accruals. But when I look at grade four investments, which are investments for you guys listed in your 10-Q as that are performing materially below expectations. Look like that jump from about $6 million to $40 million from the first quarter, second quarter suit. Can you just talk about there was one investment that you guys marked down or were there several investments or what drove that increase in the quarter?

[Michael Zugay:]

There was one investment that drove that. We don't give detail on that. But there was one investment that moved in that category four.

[Ryan Lynch:]

Okay. All right. Thank you for answering my questions. That's all from me.

[Michael Zugay:]

Thanks, Ryan.

[Operator:]

And at this time, it looks like we have no further questions from the audience. I'd like to turn the floor back to Mr. Zugay for any additional or closing remarks.

[Michael Zugay:]

Thank you everybody for participating. Thanks for the questions and we'll talk to you next quarter.

[Operator:]

All right. Ladies and gentlemen that does conclude today's conference. We appreciate your participation. You may now disconnect.