BlackRock Capital Investment Corporation
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

[Operator Instructions] Your first question comes from the line of Jonathan Bock with Wells Fargo Securities.

[Jonathan Bock:]

You had such significant progress as it relates to equity churn as well as your ability to invest in the franchise and deploy. Maybe taking a moment just to look at repayments in this current environment, right, when we think about foundation building materials, perhaps a few others with lofty yields. What’s your view on the likelihood of prepayment of attractive assets in your portfolio in light of the current volatility in credit markets that we’re seeing today?

[Steve Sterling:]

Great. Good question, Jonathan. As you know, this foundation paid out in the early part of the fourth quarter here. I think as we look forward, and we do closely monitor what we anticipate is to prepayments feeds on the investment by investment basis, I think we feel pretty comfortable in terms of the quality of prepayments as it relates to yield, we’re on pretty good shape. Moreover, to the extent that we do receive prepayments which I anticipate some of that to occur in the fourth quarter, we truly believe that we have substantial opportunity for capital deployment on the back of volatility and opportunities to directly engage with the borrowers around existing investment opportunity. So with that being said, I think the opportunity to redeploy capital against the sorts of prepayments that we potentially could envision would be that potentially accretive event for us.

[Jonathan Bock:]

Great, great. And taking two of the new originations in the third quarter in the context of the recorded books as well as Waterpik, my question is how would you describe the process or the ability to which you were able to originate that investment? Obviously, Waterpik is the name we’ve seen in other portfolios, and so, Steve, BlackRock is very opportunistic, but as you move towards the private, more direct originate model, how do you balance what one would as perhaps a bit more syndicated club B versus what folks are very, very focused in this environment because it’s relatively void of true value. And in some cases, the guys that are originating, that are talking to sponsors, that are writing a check, that are doing all the things that we know you’ll be able to do. Just give us some thoughts and color around your direct origination efforts as it relates to those two investments.

[Steve Sterling:]

Sure. Look, as I think I said to you on our last earnings call, our first order of focus is ensuring that we can deploy capital and quality investment opportunities and ultimately generate attractive risk adjusted returns for investor clients. That’s really job one. How we source those opportunities is certainly important, but where you may be able to get an opportunity given a set of circumstances can vary. There are times for which intermediated opportunities can be attractive. And there’s times that they’re not. Certainly, on balance, though, the direct origination is our focus. And even if we were to do something for which there is an intermediated opportunity, the standard upon which we would evaluate that investment would be no different than our direct originations, i.e., we would need to have a direct relationship with a company to be able to do fundamental diligence in support of a direct investment event. So as we think about the two names that you highlighted, first and foremost, recorded books is the more material investment. Recorded books is a direct investment for which we have a very good relationship with a sponsor, a very quality sponsor. It’s a name that we’ve known for quite some time as a company and have a lot of confidence in the prospects of that company. And we’re able to control the structuring of the investment to fit within the parameters of what we would deem to be a quality investment for our clients. So I think it fits very much in the frame of a directly originated investment. With respect to Waterpik, there’s history in there. As you noted, it’s an existing position. But Waterpik is one in which dates back I think more than a couple of years for us as an exposure where we do have a relationship with the management team. We’re very familiar with the company. So when you think about the quality of the business and the opportunity to add on exposure in the name for which, you know, we’re pretty material owner of that tranche, it’s an attractive deployment of capital and the diversifying opportunity for which we believe there’s a lot of downside protection. So we like the name fundamentally. I wouldn’t extract from Waterpik anything more than we had a specific acts in the name that was supported by a fundamental investment approach.

[Jonathan Bock:]

Yes. And I appreciate that because color there is very helpful and given the knowledge base across the franchise makes total sense. The only other question that relates to the two investments, and this is just an item that’s a pervasive theme throughout the space related to second lien. So clearly, we see both our second lien giving yield. And often, we hear the second lien market is extremely heated simply because there are quite a bit of funds, be it [mess] funds or the like, that are competing for high yielding paper, does terms and covenants, et cetera, seem to diminish at times. Certainly aren’t as good as what they were. That we understand. But perhaps, some additional level of comfort given that folks don’t have your viewpoint and can’t see through to the security itself. All they see is the subordinate position originated at time when subordinate credit, some folks would argue, gets tougher and tougher to originate quality transactions. How do we think about risks in those two specifics in light of the second lien heading there?

[Steve Sterling:]

Great question. So when we think about risk, I think the first point of focus for us is really understanding the fundamentals of the business model of the borrower and making the determination as to the durability of that business model. Understanding how that business works to discern that view is critical to evaluating then the stability revenues EBITDA and with a that, ultimately, cash flows. So that’s really the first order of business. Behind that, what we look very closely at is management team and the quality of the management team and how long they’ve been with the business, how long they’ve been in the industry. But equally important, what their track record is in performing through time in creating value for the shareholders of that middle market company. I highlight this point because in middle market companies, certainly just by virtue of their size, inherently, they have higher business risk than large corporate. And so you could have a quality business model, but when you add on that a quality management team, it gives them the capability to actually navigate the uncertainties of the economic conditions and protect value and therefore protect our investment position in that tranche. The third piece of this is understanding the ownership itself and who that is and how they behave and what’s their cost basis in the investment and the required return such that we can feel comfortable that the behavior of the sponsor is one in which will be aligned in the interest of us as a debt holder. When we take those different components in the consideration and then we evaluate the instrument, it’s really a question of the allocation of those risk factors against the capital structure. And that could come in the form of first lien, it could come in the form of second lien mezzanine or equity. Obviously, we’re a private credit investment fund. And in circumstances for which we believe the durability of the business model was there or collateral support if that’s what’s required, we will in fact be very comfortable owning second lien exposure for which we can have visibility to what we see the upside of the investment to the downside under different sets of conditions. Now, in a role to the instrument itself is the understanding its fundamental structure in what protections are afforded to us a creditor to ensure that we have the opportunity to come back to the table in the event there’s a deviation from the expected performance. Or alternatively, we at least have the ability to reprise the risk to be more appropriate for the company’s risk and at times, maybe even market pricing at that moment. So it is an all-encompassing, very holistic approach as to how we evaluate where we invest in the capital structure.

[Jonathan Bock:]

I really appreciate that. Thank you so much, guys.

[Operator:]

Thank you. Your next question comes from the line of Greg Mason with KBW.

[Greg Mason:]

Great. First, one quick question on following up on Jon’s question on foundation. Given that that investment, I believe is like six months old and three-and-half-years still left to maturity, are there going to be any material prepayment penalties associated with that repayment in the fourth quarter?

[Steve Sterling:]

There is a prepayment penalty. Donna?

[Donna Milia:]

$500,000 [indiscernible].

[Steve Sterling:]

So there is a prepayment penalty associated with that. Our investment in foundation, though, we actually anticipated that refinancing event on the horizon. It was all certainly taken into consideration moving to the investment in the outset. And as I highlighted with Jonathan in his question, as we look very closely what our prepayments feeds are and with that then, where we need to be relative to deployment of capital given our objectives on growth. That was taken into consideration. So I think you can assume as we move into the fourth quarter, we fully have captured that in how we’re thinking about deployment of capital for that period.

[Greg Mason:]

Okay, great. And then just looking at the liability side of the balance sheet, that’s great news moving that the term debt over to the credit facility. As we look once that’s done, there’s about $160 million left of capacity on that credit facility. And if we do some simple math to get the 0.7 kind of target leverage, that’s $170 million of additional new investments. So slightly more potential to make investments than capacity left on the revolver. So what are kind of your longer-term thoughts about either upsizing the revolver or doing some other type of unsecured debt financing for managing the liability side of balance sheet and your growth.

[Steve Sterling:]

Terrific. So I think from a capital structure point of view, we will always monitor what is the right and optimal capital structure for the BDC that will maximize value. We believe that the various capital markets as well as the bank loan market is very much available to us. And in fact, we’ll look across those markets at different moments in time to figure out where we think we can optimize that capital structure, taking into consideration of course the mix of assets we have - fixed versus floating - as well as then, appropriately, the alignment of liabilities accordingly, and the diversification of funding sources obviously underpinning the business. So we will take all of these things into consideration. I think that our pre-payable debt outstanding pro forma for the repayment of the notes is about $230 million, which from our perspective is not really a size that would drive toward an efficient capital markets execution, nor would we want to be sitting in a position for which we didn’t have flexibility of pre-payable debt. That wouldn’t be a prudent thing either. So we will continue to monitor it. And as we continue to deploy capital into the market, we will pick points in time of opportunity because I think we think it makes sense to do something in a capital market basis. Or we may very well just leave it in the bank facility. With respect to the bank facility, we’re always looking at that in terms of its maturity, in terms of its size, and quite frankly, in terms of whether there’s opportunities to improve on pricing. And we think on all those points there’s probably opportunity for us to do some additional work if we so elect to do that. So we will continue to monitor that as well.

[Greg Mason:]

You said refinancing the dead end of the credit facility wouldn’t impact the borrowing base capacity. Assuming the size doesn’t change, do you have the borrowing base capacity on the assets to kind of fully utilize that $405 million of capacity there?

[Steve Sterling:]

We do have the borrowing base capacity to utilize the $405 million pro forma for the notes. So I think we’re fine on that. I actually would take a step back and think about where do we see optimal leverage given our views around the future. I’ve mentioned in the past, and I’m not changing that position at the moment, that something in the sort of 0.6 to 0.7 is the right range and we’ll navigate into that zone over time, picking spots of opportunity against volatility that we feel will continue to show itself in the market.

[Greg Mason:]

Great. And one last question. Just going to the portfolio, New Gulf Resources, one of your oil and gas plays pretty decent write-down this quarter, second liens at 11% of cost and the first liens at 70% of cost. So any commentary that you’re willing to give us around the state of that investment and the potential for that going on non-accrual in the future at some point?

[Steve Sterling:]

Yes, sure. A couple of things there. From an investment point of view, our exposure there, it’s our market value at 9/30 is $14.7 million in the senior secured notes and $450,000 in the subordinated notes. We are public level as it relates to our investment in that particular name, as a legacy position for the BDC. We continue to monitor that situation quite closely. It is a real-time developing set of facts. And as we proceed through the month for which there’s an anticipated on [ph] payment in mid-November, we’ll see what they ultimately do as it pertains to the payment of that note. Remembering at least from public level information perspective, the company - as these companies often do, we’re pretty hard and become quite resourceful of finding opportunities to create cash. They have been on the record I think as it pertains to asset sales as well as joint ventures pertaining to the Johnson Ranch property. So it’s unclear to us given our position we set relatively to public information as to where they stand on those efforts. Obviously to the extent that there’s a failure to pay on the bond, that would precipitate a necessity for a non-accrual status relative to the New Gulf investment. So that’s certainly something that we had contemplated. Having said this much, when you look at it from a materiality point of view, for us, we would be looking at something here that is relatively small in terms of the impact around interest income on the portfolio. On an annualized basis, it’s about 3 million and on a cents per share quarterly is about $0.01. So it’s not a material investment for us.

[Greg Mason:]

Great, appreciate that color.

[Operator:]

Your next question comes from the line of David Chiaverini with Cantor Fitzgerald.

[David Chiaverini:]

Hi, thanks. I just wanted to ask a follow-up on New Gulf Resources. So the first lien, you’ve got it marked at $0.70. But on Bloomberg, it looks like it’s quoted meaningfully below that level. Could you just talk about your valuation process and how you arrived at the $0.70 mark?

[Steve Sterling:]

Sure. First of all, one has to be a bit careful about Bloomberg listings. That doesn’t necessarily represent a market. It just represents an indication. And so a market is a function of a two-sided market and trading activity actually in the name. So I’ll just put that out there as just a point of caution. Look, we, I think like others, look toward third party valuation firms as an integral part of a valuation process. And the valuation firms will take a look at secondary activity in the names, will also look at the leverage in the capital structure against cash flow in the case of enterprise transactions or in a case of collateral value in the circumstances of real asset companies like in the oil and gas producers. So the determination of $0.70 is a reflection of the yield associated with that senior note and what was determined to be appropriate in relative to perception of our collateral coverages. So I think at the $0.70, that was as of September 30th, deemed to be the appropriate fair value based upon the available information at that time.

[David Chiaverini:]

Great. Thanks for that. And I also had a follow-up on your leverage. So the net leverage at 0.45x, we’ve got capacity there to grow. Is there a timeframe or how long would you expect to get to your target leverage level of 0.6 to 0.7 or would it really be dependent on the market environment and you being opportunistic?

[Steve Sterling:]

I think it’s really market environment and opportunistic. Look, we’re not trying to force supply. I think we sit in a very enviable position as an under-levered balance sheet with good NII coverage or distribution at a time for which market volatility is noted in the prepared remarks has come upon the financial markets. We don’t think that’s going to change. And we think in the face of that volatility, there will be terrific opportunities to pick spots that will fit within the investment parameters I highlighted in my responses to Jonathan Bock’s questions. So we will pick our opportunities. We will deploy against that. But I do think that the presence of volatility is sooner than later and more rather than less. And so you can assume that when that happens, we will opportunistically deploy capital against it. So it’s not a specific timeline, it’s an opportunity and we’ll take advantage of those.

[David Chiaverini:]

Thanks very much.

[Steve Sterling:]

Yes.

[Operator:]

Your next question comes from the line of Charles Dicke with Pacific Madrone.

[Charles Dicke:]

Hi, good morning. When looking at your portfolio, I was looking at particularly your energy holdings and I was surprise to find it looked like you actually made money on the year I think on energy holdings. That really comes down to two issues. One would be U.S. Well equity holding has gone from a place of I think about 9 million to 17.7 million. And then the other issue with the write-down was on the bond you were talking about before, New Gulf Resources. Now, New Gulf Resources is one of the few holdings in your portfolio that actually gives its bond [ph], it trades in the market and has trace pricing. And this bond, if you look back traded in mid-September at $0.3125 on the dollar. So I guess how do I get comfortable that, one, the equity of U.S. Well has really increased by that much and, two, when larger than 1 million trade of New Gulf happened in September with a 31 handle and you margined at 70, that the market pricing for energy is correct?

[Steve Sterling:]

Yes. So I think as it relates to New Gulf, I’ve covered that off. Markets are really defined by two-sided markets and flow of liquidity, not a single data point and the circumstances upon which one might transact and the individual investor’s challenges, if you will, may give rise to lower levels. But that doesn’t necessarily reflect where fair value is in an actively traded market. So, as you said, I outlined kind of what the valuation approach is in general and what it was specifically to New Gulf. And as of 9/30, there really wasn’t an actively traded market in that name. With respect to U.S. Well, U.S. Well I think is, as I highlighted in the prepared remarks, is really a quality company. And while one may be predisposed to casting oil participants in the sector into the same bucket, the fact of the matter is U.S. Well I think is differentiating from the larger population of oil and gas participants. The company has performed extraordinarily well even in the face of the challenges. Obviously, I can’t share specific information given the confidentiality arrangements. But what I would say to you is, directionally, the company, with respect to its own performance, is up meaningfully on a year-over-year basis and is exceeding its budget by a good margin. So the company’s quality of its asset utilization rates, the quality of the management team sort of playing on a theme earlier that I mentioned, that it is about management and what management does in moments of adversity was very successful in taking substantial cost out of the business that covered any pricing adjustments that were required in the services business. So the company has done very well. The other thing to note is with respect to an instrument, instruments can be structured in a lot of different ways. And so sometimes you’re going to find circumstances, in the case of preferred instruments, for which they accrete value with the passage of time based upon different triggers. So when you look at the company in the aggregate based upon performance and its valuation, in part, obviously it’s driven by third party valuation. But also, you have to look at the actual instrument itself. So you can end up with some of these anomalies in a tougher sector because you have a standout performer and we would categorize you as well in this regard.

[Charles Dicke:]

Okay, thank you.

[Operator:]

[Operator Instructions] And there are no other questions at this time.

[Steve Sterling:]

Okay, thank you very much. We appreciate everybody’s participation on the call. Have a good day. Thank you. Bye-bye.

[Operator:]

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