BlackRock Capital Investment Corporation
Q1 2015 Earnings Call Transcript

Published: 1 May 2015

[Operator:]

Good afternoon. My name is Stringer, and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Q1 2015 Earnings Call. Hosting the call will be Chairman and Chief Executive Officer, Steve Sterling; Chief Financial Officer, and Treasurer, Corinne Pankovcin; and General Counsel and Corporate Secretary of the Company, Laurence D. Paredes. Lines have been placed on mute. After the speakers’ complete their updates, they will open the line for a question-and-answer session. [Operator Instructions] Thank you. Mr. Paredes, will begin with a review of general counsel call information.

[Laurence Paredes:]

Good afternoon. And welcome to BlackRock Capital Investment Corporation’s first quarter 2015 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 documents 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, that we have posted to our website an Investor Presentation that complements this call. Shortly, Steve will highlight some of the information contained in the presentation. At this time, we would like to invite participants to access the presentation by going to our website at www.blackrockbkcc.com and clicking the April 2015 Investor Presentation link in the Presentations section of the Investor Relations page. Thank you. I would now like to turn the call over to Steve Sterling, who will provide an update on our quarterly results.

[Steve Sterling:]

Thank you, Larry. Welcome to BlackRock Capital Investment Corporation’s first quarter earnings conference call, my first since Chairman and CEO of the company. Joining us on this call is [Aaron Class] [ph] who has recently joined our team to oversee Investor Relations, as well as Business Development and Strategy for the company. As you may know on March 6, 2015, BlackRock Advisors, LLC, a wholly owned indirect subsidiary of Blackrock, Inc. entered into a new investment management agreement with the company and the company changed its name to Blackrock Capital Investment Corporation. The ticker symbol remains unchanged at BKCC. With three weeks of tenure in the first quarter as Chairman and CEO, I am enthusiastic about engaging every team member to leverage the breadth and depth of the Blackrock platform to enhance risk return profile of the portfolio, strengthened our distribution, paying capacity and maximize the total return to our client shareholders. Today I would like to discuss market conditions, highlight key elements of our first quarter results and review our portfolio activity. Allow me to begin with current market conditions. New issue market conditions during the first quarter were meaningfully weaker than the comparable quarter in 2014. Similar to large corporate leveraged loans, middle-market leveraged loans experienced about a 45% decline in overall new issue activity. In particular, fourth quarter 2014 volatility associated with energy and U.S. dollar price moves, coupled with high equity valuations in mixed U.S. economic data have given rise to weaker pace of M&A activity during 2015. Notably, refinancing activity which was a significant came in 2014 abated early in the quarter, but in the case of large corporate leveraged loans didn’t evidence the resurgence in the latter half as a reduced new supply created an air pocket that enabled issuers to realize price concessions. Over the near-term and had -- and has already partially evidenced, we believe middle-market will likewise experienced a similar effect on pricing as we believe the asset class continues to see positive fund flows due to offsetting the powerful structural trend of bank retrenchment in middle-market lending. Further, this dynamic will likely drive a reversion on leverage multiples. We believe credit quality role will remain relatively good based on our constructive view on 2015 U.S. economic fundamentals. Further we believe companies access the capital to fund business investment and refinance financial obligations is expected to mitigate investment risk. Our constructive view is, however, tempered by expectations of modest GDP growth and perceived elevated global risk. That together with their reasonable likelihood of monetary policy normalization later this year may give rise to elevated financial market volatility. The consequence of this view in light of the illiquid stickiness of middle-market loans is for us to remain highly disciplined in our investment process, proactive in managing underperforming situations and prudent in regards to portfolio construction and company financial leverage. We believe that earnings power of our investment portfolio affords us the ability to be patient with deployment of client shareholder capital. Run rate net investment income as of quarter end was $0.21 per share, excluding fee income, which covers our dividend of $0.21 per share. I would now like to turn the call to first quarter highlights. Our portfolio generated total investment income of $30.9 million or $0.41 per share during the period. Of which, about 99% was derived from interest and dividend income. These results represent about 5% growth rate over the comparable 2014 period and excluding fee income, about 7% growth rate. Since Q1 2014, total investment income growth benefited from an approximate 12% rise in the size of our investment portfolio calculated at a cost, partially offset by 50 basis point decline in yield on income producing capital. Net investment income totaled $14.6 million or $0.20 per share during the period as compared to $11.1 million, or $0.15 per share in the corresponding 2014 quarter, representing about 32% growth rate on a year-over-year basis. This growth was largely driven by about 60% decrease in accrued incentive management fees from gains. For the quarter incentive management fees based on gains were $1.4 million. The incentive management fees were driven by a $6.8 million increase in net realized and unrealized gains during the period. At March 31, 2015, calculated fair market value, our investment portfolio totaled $1.24 billion representing approximately 111% of cost. Relative to December 31, 2014, this represents a $22 million decrease in investments or less than 2%, which is largely attributed to repayments associated with two equity investments, augmented by a modest net decrease in credit invested capital for its financial leverage remained relatively stable at 0.6 times. Finally, our NAV increased $0.09 per share to $10.58 from year end. Now I'll spend a few moments discussing portfolio composition. The investment portfolio excluding cash remains reasonably diversified across sectors and investments, specifically, no one sector exceeds 15% of the portfolio. As per our stated intention, our mix of instruments continues to bias toward senior secured loans which increased 200 basis points since December 31, 2014, accounting for nearly 55% of the portfolio. Despite the monetization of two equity positions, our portfolio exposure to equities remains relatively unchanged at 21%, given the continued rise in valuations. Our steadfast commitment of monetizing equities remains a core strategic focus. Credit quality was relatively stable with no investments on nonaccrual. During the period, the company reported net cash inflows of $28.6 million, of which $23 million was from net equity proceeds. These flows were result of investments of $46.3 million in repayments of $74.9 million, or specifically, our principal new investment was $25 million 12% second-lien term loan to Foundation Building Materials. Foundation is the third largest distributor of drywall, steel studs, stucco, lath and plaster acoustical ceiling tiles and other related building products to commercial residential contractors. Additionally, we made several add-on investments with existing portfolio companies. Our exited investments included equity positions in M&M Traditional Holdings and Marquette transportation. Both of which were exited at a price above their December 31, 2014 marks. Additionally, we elected to exit our investment in Pay-O-Matic Corp. via par repayment, associated with the refinancing event. Our weighted average IRR on these exited investments was over 14%. We continued to focus our efforts on improving our risk return profile, increasing our net investment income by making prudent investment decisions and by reducing our equity holdings. We expect further equity sales in the future, as we continue to evaluate ways to maximize the value portfolio. I would like to now turn the call over to Corinne for some additional details regarding the first quarter financial and portfolio results.

[Corinne Pankovcin:]

Thanks, Steve and hello everyone. I will now take a few moments to review some of the other details of our 2015 first quarter financial information. For the three months ended March 31, 2015, our basic earnings were $0.30 per share and our GAAP net investment income was $0.20 per share as compared to $0.21 per share as adjusted. The composition of our portfolio excluding cash remained fairly stable in the first quarter. Senior secured loans comprised 55% of the portfolio, representing a two percentage point increase from the prior quarter. Unsecured and subordinated debt securities decreased by two percentage points to 16% of the portfolio, while the composition of our portfolio invested in senior secured notes remain the same at 8%. The weighted average yields of the debt and income producing equity securities in our portfolio at their current cost basis decreased slightly to 11.5% at March 31st, compared to the prior quarter. The weighted average yields on our senior secured loans at their current cost basis also decreased slightly to 11.1%. The weighted average yields on our other debt securities at their current cost basis increased slightly to 12.7%. At March 31st, we had approximately $472 million in debt outstanding and $45 million in cash and cash equivalent. Compared to 2014, our weighted average cost of debt decreased 27 basis points to 4.95%. Subject to leverage and borrowing base restrictions, we have $277.1 million of cash and availability under our revolving credit facility. At March 31st, our asset coverage ratio was 266%. With that, I would like to turn the call back to Steve.

[Steve Sterling:]

Thank you, Corinne. As we mentioned in the previous call, Blackrock believes that taking an active role as the investment advisor for Blackrock Capital Investment Corporation, allows us to leverage the power of the Blackrock platform to provide the company with a potential for expanded investment opportunities. We believe that in the coming quarters, Blackrock's resources, brand and reputation will enhance the company's growth potential, as we seek to enhance the risk return profile of the company, strengthen its distribution paying capacity and maximize total return for our client, shareholders. In summary, our focus is on net investment income growth for 2015, ensuring quality coverage of our distribution and about continuing to raise the ROE of the business. From a portfolio construction point of view, we continue at this moment in the credit cycle to focus on secured risk, certainly with an eye to more asset intensive businesses and companies with durable business models. At this time, I do not anticipate a material change in our approach in the near-term. As we think about distributions for 2015 and beyond, we have set the distribution at a level that we believe takes into account the rates available for the more conservative types of investments that we are comfortable with today's environment. We believe that the retention of any excess earnings derived largely from realized gains is a prudent and cost-effective way to grow available capital and therefore, total income earning assets, any future retention of excess capital maybe available to grow net investment income in distributions. I'd also like to take this opportunity to thank our client shareholders for their support, our team for all their efforts and to thank you for joining the call today.

[Operator:]

[Operator instructions] Your first question comes from Doug Harter from Credit Suisse.

[Doug Harter:]

Thanks. I was hoping you could just help elaborate on how we should think about the pacing of reducing the equity position into more income producing assets, just as we can think about the potential earnings progression?

[Steve Sterling:]

Great. This is Steve. So as stated, we are single-mindedly focused relative to the equities further just a continuation effectively of the focus of the previous management as well. We had stepped up our engagement with the sponsors or various parties associated with those transactions to seek to move the equities at the earliest opportunity. Clearly, we do not control our positions in these situations, certainly as it relates to material transactions. So our ability to affect change is largely driven by our ability to influence those parties. So we are seeking to bring the bear that perspective and look forward for those sponsors to monetize in those psotions.

[Operator:]

Your next question is from Rick Shane from JPMorgan.

[Rick Shane:]

Hey. Thanks guys for taking my question. I am curious, I mean, given where the leverage is right now and the discount-to-book value, just want to sort of get your sense, again, I am not looking on a quarterly basis, but if you were to look sort of over 12-month horizon, what do you think a realistic pace of capital deployment would be?

[Steve Sterling:]

Good question. Look, I think that, as stated in the call, our asset portfolio today I think as well poised relative to the current distribution $0.21 a share. In the context of the portfolio construction with the equities and just the nature of the overall business in middle market lending, we’ll remain quite prudent as it relates where we take leverage. I do think that there’s opportunity to move up from where we are here in a very modest way. But at the end of the day, I think, to meaningfully increase NII, it will be important to realize the monetization at the equities. We are very mindful of our client’s capital. We want on the right level of leverage. We see this composition of the portfolio in naturally the existence of the equities constraints where we will take leverage.

[Rick Shane:]

Got it. In observation you refer to what is clients capital which I find totally appropriate, but I would say, I think, most folks use investors capital and I -- it’s an interesting perspective, which at least, I wanted to point out?

[Steve Sterling:]

Yeah. I mean, just say the reason that I used that terminology is because the way in which we think about the BDC is it really is an investment vehicle with client capital albeit in the form of shares. But it’s a mentality that’s pervasive from a Blackrock point of view that reflects how we believe our responsibility is set as a fiduciary to those clients. So we look at all of the things that we do through that lens and I am looking to reflect back into the tone and charter of our dialogue as it relates to the BDC.

[Rick Shane:]

Thanks for explaining all that. I am not even necessarily sure when I said that what response I might get but I appreciate that. Thank you.

[Steve Sterling:]

Yes.

[Operator:]

[Operator instructions] Your next question comes from Troy Ward from KBW.

[Troy Ward:]

Good afternoon. Steve, could you just provide us a little bit of color on your quarter to date activity what you're seeing in the market and specifically what kind of activity you’ve done in the BDC this quarter?

[Steve Sterling:]

Yeah. So as it relates to activity post-quarter and reflecting back again a little bit around the narrative shared with this call. Overall activity in the first quarter was rather muted in the middle-market space as it was in other parts of the high yield capital markets. We were not immune to that and so as a consequence the level of deployment of capital was much more modest with really foundation building being the principle point of deployment aside from just add-on exposure to existing portfolio companies. As we look at post March 31 in the tone of the market it is a touch better. But I wouldn’t say it’s dramatically better. We do believe that the dialogues that have sort of rejoined of the yields of the volatility in the fourth quarter should give rise to an opportunity for future deployment. We are certainly engaged in a good number of situations more so then what I saw when I first stepped in. But you never know on these kinds of transactions because there is oftentimes a high level of deferral in terms of timing or they don’t ultimately come together. But generally the tone, I think, is a step better than what we saw in the first quarter, but I wouldn’t call it dramatically better in the overall market.

[Troy Ward:]

Okay. Great. And then on fee income, obviously, this quarter fee income was lower maybe where you are expecting? Can you just talk about the mix that you see going forward? Do you think the fee income levels are going to change materially going forward based on the mix of assets you're doing or is this quarter a bit of an anomaly?

[Steve Sterling:]

Look I think when we stop and reflect upon the components of the fee income category, it can certainly be in the context of new issues, which I’ll just go back to the comments I made a minute ago about with that tone is said to the extent that we do see a good conversion over the pipeline, I would envision there’ll be the opportunity than for the recognition of fees. But the other area for which fees come into play, obviously, is in the context of amendments for prepayments. I would say that based upon where our portfolio is currently set up, they don't envision there to be meaningful amendment type fee event, certainly over my visible horizon, which is measured relative to the portfolio in a couple of quarters. So I don't see that really is being a meaningful source of fee revenue. In terms of prepayment fees that’s a possibility but I would also say that while the market activity overall for new issue is much more muted than what we saw in 2014. For example, likewise what we look at in terms of repayments has also been quite muted. So we run a fairly rigorous process of looking forward as it pertains to what we see repayment profiles to be. And at this point, I feel quite comfortable that magnitude of that will start anything that would give rise for conservative but it also give rise for material fee events. Again, we could be surprised. You never know where some things is going to come from. But if I think about the components of fee income, I would characterize it along those lines in each of those buckets.

[Troy Ward:]

Okay. And then just one final one, can you just speak a little bit about kind of what the larger Blackrock platform, now that you've taken the helm here? What you feel like you can bring the bear from sourcing and how maybe you can improve different aspects of the firm versus the legacy platform where it was just partially backed by Blackrock?

[Steve Sterling:]

Yeah. That's a good question. So we are in the process of putting in place a number of different initiatives, if you will, relative to this very point, that’s not just purely about the sourcing aspect of that but also about the establishment of the investment insight, if you will, across the research capabilities of Blackrock in availing access to that to the teams here. Informally, all of that has already started to move. And in fact, I would say that since the time of close, we've had a good number of opportunities that have been referred into the team as perspective opportunities for investing. So these things take a little bit of time to get them fully in stride. But I would suggest to you that I do believe that the energy associated with having a pool of capital that didn't exist in any meaningful way from a BlackRock point of view to the middle market has given a gateway of opportunity for our partners on the liquid platform to refer opportunities that are more suitable to our investment approach. So we do believe that that will be a meaningful source. But also say too that we are moving down the path of some initiatives as it pertains to the group here to drive a higher level of specific focus and perhaps, some degree of sectorization that will further support our objectives relative to sort of proprietary origination activities. Again, we’ll leverage other aspects of BlackRock to enable that to come to pass. But there are number of things in place that I think over time we’ll start to see defer to that be born and awarded to the clients.

[Troy Ward:]

Great. Thanks, Steve.

[Operator:]

Our next question comes from Jonathan Bock from Wells Fargo Securities.

[Jonathan Bock:]

Hi. Good afternoon. And thank you for taking my question. Just a quick one as you mentioned that perhaps, from a leverage standpoint -- I think you are already under the capacity. In addition, you’re sourcing some good opportunities but also looking for ways to enhance shareholder value. There is a stock buyback that I believe is currently in place. And so walk us through the rationale as to why that is not a tool or part of how you're realizing value for shareholders given the stock is trading below book today? And it's very hard for you to replicate a yield similar to what you would get buying back your own stock in the credit market today?

[Steve Sterling:]

Yeah. It’s a good question. And certainly, I think again, going back to a core principle around a good fiduciary for a client shareholder’s, we’ll evaluate all aspects of value creation, which Jonathan, would certainly include share repurchase as an option. However, as you evaluate that decision, you need to take very much a holistic approach. I touched upon that I think in the last call. And a number of different things that will come into play into that is certainly the investment horizon of that you're looking at. But on a more technical level when you think about floating, you thing about friction cost and importantly, then we think about portfolio construction. So when we take all of those things in a consideration in given where our starting point is here and given what we view to be a platform that is enhanced in the presence of BlackRock, we’re poised to be able to originate investments. So on a holistic basis, we think the way in which we’ll serve value to our clients on a sustained basis is really to remain steadfastly focused from originating quality investments that generate current income for these clients.

[Jonathan Bock:]

I mean, it’s a fair answer. I’d say that the market or an institution involve in this space, often kind of look beyond just pure origination to ask, is this manager a good allocator of capital? And so as you discussed this with the Board and others in considering it, certainly it makes a -- it is a smart capital allocation decision as a part of the great changes that are going on. So we appreciate your thinking about that issue and continuing to pursue it. Second question relates to Gordon Brothers. I'm curious on -- I think on the $250 million portfolio balance and please correct me if I am wrong -- there was a $1.2 million loss this quarter. Two items, just walk us through the strategy there maybe some of the way you’re continuing to utilize and grow that JV. And then walk us through the lots and then the last item relates to the amount of leverage embedded on that $250 million portfolio?

[Steve Sterling:]

Okay. So first, I think as everybody on this call was aware Gordon Brothers is a business that is very much focused around the asset based lending space. So circumstances for which company's who have an asset rich balance sheet are seeking to have financing to support their own liquidity requirements or financial requirements. Importantly, for this particular strategy is a relationship that exist Gordon Brothers group, who with over 100 years of experience in the asset liquidation space has afforded us, I think a unique perspective of valuation associated with these assets, so they actually is very much integral part of the investment process to which we can establish our advance rates with much higher degrees of confidence than maybe typically would happen in a more traditional banking environment. So, I think the integrity of the investment process is very much fortified through that relationship and it’s one which creates a comparative advantage to funding requirements of these smaller companies. With respect to the activities in that business, they too not unlike the rest of the market have seen a more muted level of opportunities, not to say they haven't seen opportunities out there. But in terms of picking their spots and trying to make sure that you're cheating their investment objectives for that, that company they’ve been pretty patient about how they deploy that capital. We certainly believe that the sweet spot of where this strategy will play is in a market condition that is more volatile and little more uncertain. I’m sure there are still companies who will need sort of asset piece lending support. But in an environment with more volatility, that’s a rising tide that will yield much greater opportunities to deploy capital. So, as we think about the Gordon Brothers portfolio investment for us, we think about that much over the long term and adding a complementary capability that doesn't fit within Blackrock Capital Investment Corp. as a first practice. So we like it strategically. We think it’s fills a spot in our portfolio of investment opportunities. And we have all the confidence in the world and the partnership that we have with the Gordon Brothers Group. In terms of leverage, the leverage on that business is relatively modest given the nature of the business. In fact, it is comfortably inside of one times lever. So it’s not as if you have a circumstance above very highly leveraged entities to its capital base. And it’s a reasonably well diversified portfolio as well. So, we think they are in the right spot. It is a newer effort but one that has a lot of history behind it, that the opportunities that is in front of us.

[Jonathan Bock:]

Okay. Great. And then just -- the last question as it relates to what you’re pulling in on the second lien that you just originated. So the question of the housing -- my apologies, I’m essentially missing the name. But the building materials loan, that was about $20 million out of the $80 million. Can you just walk us through the actual origination process, just because when we see a smaller portion that would maybe not indicate -- non control second lien in a cyclical industry? Just the question is, how did you effectively get comfortable originating such a loan at this time in the credit cycle, understanding that there is really no right answer, but people are more interest in the thought process?

[Steve Sterling:]

Yeah. No, I understand. So, look this is a situation for one. We as a business unit, there is very meaningful debt to core competency within the building products and homebuilder space. So as we thought about this particular investment, it’s on the basis of what we believe to be some very good insight into the drivers and the risk factors associated with the investment, number one. Number two is our participation in this investment is one in which was alongside another institution that we have had a good history of partnership and sheer thought as it relates to credit principles and so we felt comfortable in the context of that. Number three, this is a larger company. So this is not sort of -- we will call the micro middle market company. This is the company with certainly north of $500 million in revenues. Certainly at the high end of middle-market EBITDA. So that is to say that by virtue of its size and diversity of its business, it has a much [indiscernible] for you financial flexibility than you might otherwise see in much smaller businesses. So the next thing is that, as we evaluated the investment, we pressure tested the business model against a prior real estate cycle, construction cycle. We have to contain back to the ‘08 or ‘09 period. And even under that scenario, our own view is that the company will perform fine, obviously will take a bit of heat relative to the performance because it is a cyclical company. But having said as much, the franchise value there, the business value there and the ability to continue to generate cash flow under that scenario gave us a measure of comfort. And then finally, we do believe that this is a circumstance that the current ownership structure will ultimately seek a monetization event over the next year or so. And so as a result, we found that the alignment of interest with equity and management was one that it proved to be an attractive opportunity to deploy capital at a very attractive level of return in north of 12% IRR expected, where we had a particular level of granular insight into the space. So it's a pretty holistic view because we said in the outset of my comments, we’re pretty constructive on the U.S. economy. And we don't believe that any issues relative to the residential side will give rise to concerns just to the performance of this entity or will newly rate the interests of the ownership structure here to monetize their positions. We think there is a fair mature alignment of interest.

[Jonathan Bock:]

Great. Thank you so much for taking my questions.

[Operator:]

At this time, there are no further questions. Thank you. Do you have any closing remarks?

[Steve Sterling:]

Well, my closing remarks is again, thank you for participating in the call today. We very much appreciate the questions since it’s important for us to ensure the research community representing our client and shareholders here do understand what it is that we are doing so that they can reflect that view properly into the marketplace. So with that, we thank you. We look forward for future conversation and do not hesitate to reach out to me, if you would like to have a follow up. Okay. Thank you. Have a good day.

[Operator:]

Ladies and gentlemen, this does conclude today’s conference call. Thank you for participating. At this time, you may now disconnect.