Harvest Capital Credit Corporation
Q1 2019 Earnings Call Transcript

Published: 14 May 2019

[Operator:]

Good morning. My name is Mary, and I'll be your conference operator today. At this time I would like to welcome everyone to the Harvest Capital First Quarter 2019 Earnings Call. All lines have been placed on mute to avoid any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to William Alvarez, the chief financial officer of Harvest Capital Credit Corporation. Sir, you may begin.

[William Alvarez:]

Thank you, Operator. Good morning, everyone. And thank you for participating in this conference call to discuss our financial results for the first quarter ended March 31, 2019. I am joined today by our Chairman and Chief Executive Officer, Joseph Jolson and by Richard Buckanavage, our Managing Director and Head of Business Development. Before we start, I will provide a disclaimer regarding any forward-looking statements that we'll make during this presentation. This presentation contains forward-looking statements, which relate to future events or Harvest Capital Credit's future performance or financial condition. These statements are not guarantees of future performance, condition 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 our filings with the Securities and Exchange Commission. Harvest Capital Credit undertakes no duty to update any forward-looking statements made herein. And now, I'll turn the call over to Joe.

[Joseph Jolson:]

Thanks, Bill. As expected, our first quarter results were challenging as a result of the material payoffs of highly rated loans that occurred in the fourth quarter and first quarter combined with the slow redeployment of the capital. In addition, credit costs were disappointing as the resolution of one of our lower rated credits did not progress as quickly as we had hoped and was placed on nonaccrual status and as we also experienced elevated portfolio management costs in the quarter. On a more positive note, we were able to commit $21.5 million of new investments late in the quarter and by period end total investments were slightly below a $102 million, up more than 7% from December 2018. We currently have $31 million in mandated transactions that Rich will discuss and we're working hard to close them over the next few months. We also completed or buyback of $250,000 shares in open market transactions in early April equal to roughly 4% of our shares outstanding and our board just authorized to repurchase of another $250,000 shares through December 2019. we are optimistic that the combination of loan growth that are targeted yields and share buybacks could allow HCAP to fully deploy its current capital at a 1.3 to 1 leverage ratio in the next 12 months. In addition, we continue to be focused on resolving our 2, 4 and 5 rated credits and one smaller aircraft engine equity investment, all of which are non-earning assets currently totaling roughly $11 million. Which if successful, would be highly accretive to our near term net investment income outlook. Now I'll have Bill go through more the financials from the quarter and then Rich will discuss the current pipelining in a competitive environment.

[William Alvarez:]

Okay, thank you. Net investment income for the quarter was $0.8 million or $0.12 per share compared to $1.2 million or $0.19 per share in the first quarter of 2018. Net investment income decreased $400,000 in 2019 as compared to 2018.as a result of a decrease in investment income of $700,000, as result of this small portfolio at March 31, 2019, compared to March 31, 2018, Offset by a decrease of $300,000 in expenses in 2019 period as compared to 2018. Net income for the quarter was $0.1 million or $0.1 per share compared to $2.1million or $0.32 per share in the first quarter of 2018. Net income decreased by $2 million for the quarter ended March 31, 2019 primarily attributable to a $700,000 decrease in investment income. an increase of $2.5 million of unrealized depreciation on investments offset by an increase of $900,000 of realized gains on investments, a $200, 000 decrease in operating expenses and by a $100,000 decrease in interest expense for the 3 months ended March 31, 2019 as compared to the 3 months ended March 31, 2018. We recognize fees amortization income of $250, 000 at 3 months ended March 31, 2019, as compared to $207,000 in the comparable 2018 quarter. The slightly higher fees amortization in 2019 resulted from the company exiting $10.4 million of debt investments in the first quarter of 2019 compared to $6.8 million of exits in a comparable2018 quarter. Our fees are deferred to like they are either earned, amortized into income over the life of the investment or the using effective fees method or fully recognize when an investment payoff occurs. In addition, we also recognize a $140,000 fees which consist primarily of prepayment fees from the previously affirmation first quarter investment exists compared to $55,000 in the comparable 2018 quarter. As a result, our fees will fluctuate quarter to quarter depending on portfolio activity. As of March 31, 2019, the fair value of our portfolio was a $101.7 million, on the cost basis of $106.4 million, reflecting $4.7 million of net unrealized depreciation in the portfolio at the end of the quarter. As of March 31, 2019, we had a death balance of $33.8 million consisting of $5 million of bank debt and $28.8 million in 2020 to notes. For debt to equity ratio was approximately45% compared to approximately 58% at December 31, 2018. At the quarter end, we had $11.2 million of cash and approximately $18.1 million of undrawn capacity or $55 million of credit solely. Our Cash in bar capacity provides us with sufficient liquidity in order for us to execute our business plans for 2019. As of quarter end, our net asset value was $12.11 per share, down $0.19 per share from December 31, 2018. Principally as a result of paying $0.16 per share in distributions for the quarter ended March 31, 2019 compared to $0.1 increase in net assets from our first quarter 2019 operation and enhanced by $0.6 of accretion duty shares repurchased during the quarter. On May 3, 2019, the Board of Directors authorized an open market stock repurchase program to reverse up to $250,000 shares in the aggregate of the company's common stock in the open market. The company's previous stock repurchase program, which was authorized in November of 2018 and provided for the repurchase of up to $250,000 shares of the company's common stock terminated on April 4, 2019, on the purchase by the company of the entire authorize pre-approve limit of shares. Effective on May 4, 2019, the asset coverage ratio applicable to harvest capital, decreased from 200% to 150% pursuant to the provisions of the small business credit availability act. Lastly, at May 10, 2019, we entered into an 8th amendment to our loan and security agreement between the company and Pacific western bank to amend the agreement to provide for a senior leverage ratio of one to one to provide for a total leverage ratio of 1.4 to 1, replacing the prior 1.1 leverage ratio and to provide for minimum utilization of 2.5% of unused commitments below $16.5 million at any time the companies unsecured longer term indebtedness exceeds $30 million which is currently at $28.8 million. Now, I'll turn the call to Rich for some further discussion on the investing environment.

[Richard Buckanavage:]

Thanks, Bill, Well we had a greater number of core lower middle market investments during the quarter. That focus was augmented by leveraging our relationship with one of the James D. affiliates identified by two syndicated loans which by virtue of their attractive price at the time relative to power, We believe will be accretive to our current dividend level. As outlined earlier in our prepared remarks we also close 2 temporary place holder investments to -- in order to deploy idle cash since exited both of these investments as more attractive uses of that capital became available to us. The current state of the market which we compete continues to be challenging. Despite the competitive landscape, we are encouraged on several fronts including a very strong pipeline of new opportunities, Track the quality of our pipeline and 5 pending mandates totaling approximately $31 million, most of which are expected to close prior to the end of the second quarter. Behind these already awarded mandates, we have two additional proposal letters out for consideration totaling another $13 million. Well, unlikely these financings, if awarded to us, we close by June 30, Current timeline suggested that they would close early in the third quarter which would allow these investments to be meaningful contributors to third-quarter earnings. Credit spreads which have been stable since the start of the year, our enabling Harvest to compete where most of the opportunities we choose to pursue. While some aggressively priced unit debt opportunities remain outside or price and capabilities, the access to additional leverage which went into effect this month is providing us with an enhanced competitive position in order to compete for a larger percentage of these types of investments. Assuming the M&A market remains robust and credit spreads are at least stable, we're optimistic about the second half of the year and our ability to deploy capital at levels that will enable us to earn our dividends. With that, I'd like to turn the call back over to Joe for some final thoughts.

[Joseph Jolson:]

Thanks, Rich. I want to thank the HCAP team and our Board for their continued efforts to successfully navigate the overheated market for a lower middle market credit risk in the past few years. While we still have much work to do, we have a clear path forward over the next 12 months to return the company to its historical favorable performance. With that, operator, we'd be happy to answer any questions at this time.

[Operator:]

[Operator Instructions] Your first question is from the line of Brian Hogan from William Blair. You line is now open.

[Brian Hogan:]

Hey, good morning. Quick question on you're kind of made your credit trends, I guess, really your resolution and timing of confluence and incipio [ph] or incident of care. Sorry, if you don't care, what's your kind of expect there from a recovery and timing and want to be back on a cruel because it's pretty meaningful.

[Joseph Jolson:]

Rich, do you want to take that question?

[Richard Buckanavage:]

Sure. I think we've alluded to both in the last quarter's call in this quarter the resolution of these investments has taken longer than we had expected and certainly hoped. But we are making progress and obviously our goal is to recover as much of that capital as possible, if not 100%, but we are making progress and we're encouraged by first quarter's advances in that regard. And we hope to be in a position, I would think by the next quarter to at least have some, more definitive guidance on that. It's just going to take some time. As you know, with these smaller companies don't get fixed overnight, but we've worked hard and we're working with the teams at the company level to make changes where needed and to improve the profitability of each of those investments.

[Joseph Jolson:]

Yes, Brian and in total, there's including the two other smaller investments, there's a little over $11 million. So, clearly, if we can return much if not all that capital and then redeploy it that's highly accretive, but the current lending rates that we're doing.

[Brian Hogan:]

I guess that's a nice bridge to my next question. I was like -- and you planned politically or capital up to, you're like, I guess the 1.3 ratio in 12 months, I guess is what you said. I guess the yields on those investments compared to what you have been doing is it the same in the quality of those investments? Can you of give me some commentary there please?

[Joseph Jolson:]

Yes, I'll let Rich talk about the -- and I might add something after he comments on it.

[Richard Buckanavage:]

Yes, Brian, the breakdown of the five mandates that we have, we have three unit investments and two junior capital investments. And what we're seeing in the marketplace is as I mentioned earlier in my prepared remarks, the credit spreads have stabled, they're stable for the year since the beginning of the year. I would say that as far as guidance goes, the unitranche investments given where LIBOR is today, would be priced at least at 10%, which is pretty consistent where I think we've been historically. And then on the junior debt investments as expected, we would price those investments a couple hundred basis points in north of that level. I think that's probably a little bit better than where we've been probably over the last 18 months or so. So probably back to maybe two to two and a half years ago. So, we've seen a little bit of an uptick on the junior debt side. Unitranche, as I mentioned last quarter is I think where we've seen the most compression over the last two years. Although as I said, we've seen those credit spreads stabilize in the unitranche asset class.

[Brian Hogan:]

But just to be clear, Rich. You mean Livewire plus 10%?

[Richard Buckanavage:]

No, Livewire plus the credit spread, would be at least 10%.

[Brian Hogan:]

Okay. And I guess the next question would be what is your confidence in getting up to that one point there, I mean you hope to and you plan to and obviously, you don't know the timing of early prepayments and what have you -- but I mean, you've been surprised by prepayments at this point and I guess you got a really pretty young portfolio, I would say. But what is your visibility and getting to that 1.3 leverage in two months?

[Richard Buckanavage:]

Well, it just -- let's just call it dollars. If we complete this buyback that we just got authorized, right -- the 250 shares, we need to get to roughly $160 million of investments to hit that 1.3. And so right now we're a little over $100 million. So that's net growth of $60 million. And there's been a number of years where we've been able to -- not in the last few years but in more normalized credit risk pricing markets. I think that's readily achievable in 12 months.

[Brian Hogan:]

All right.

[Richard Buckanavage:]

Brian, I think if you go back and look at our mandates and total transaction, totals in dollar amounts, I think you'll recognize that the five mandates and the $31 million is probably as high as it's been in two years. So I think we're now, would be up -- that would be a pretty good start on getting the point that $60 million of additional capital we need to get to that leverage level.

[Brian Hogan:]

And last question for me I guess, is do you need to be at 1.3 leverage to fully invested to earn your dividend or do you think you can do it without that?

[Richard Buckanavage:]

We would hope that at one point, three to one, that we would be in a position to increase the current dividend and based on our commentary when we reported year-end know that was after we lowered the dividend to the 24% a quarter level. We're still hoping to earn that in the second half of the year. Obviously it depends on the timing of closing some of these mandates, which is -- colors ends up being cracked and we close a lot of these by, let's say July, some time that are in the current pipeline let alone by the end of this quarter. That should move the ball along pretty nicely to getting closer to earning the current dividend.

[Brian Hogan:]

All right. Thanks for your time today.

[Operator:]

Our next question is from the line of Paul Johnson from KBW. Your line is now open.

[Paul Johnson:]

Thanks for taking my questions. So my first question on the professional fees. I know you mentioned on the call that there were some higher portfolio management costs in there but I was wondering if you can explain a little bit further maybe what that was and how could we expect that to remain high or as high as this quarter going forward?

[Joseph Jolson:]

I think that we don't really break out what those -- the nature of those fees but obviously professional fees and it just relates to managing our current problem assets.

[Paul Johnson:]

Okay. I mean...

[Joseph Jolson:]

Presumably, well, our hope is that as those are resolved, those professional fees could drop materially.

[Paul Johnson:]

Sure. Okay. And then my next question on the unrealized appreciation quarter

[Joseph Jolson:]

Let just a pause, sorry. To quantify that for you it was roughly $0.03 a share in the quarter.

[Paul Johnson:]

Okay. That $0.03 in addition to that, to the prior quarter sort of normalized run rate was $0.03 of the total NOI for the quarter.

[Joseph Jolson:]

Total net investment income. I hate to use the word unusual because it could continue for a little while but the abnormally high professional fees.

[Paul Johnson:]

And then on realized depreciation; can you guys maybe talk about if there is any investments, that sort of drove that this quarter?

[Joseph Jolson:]

Rich, you want to go through that or Bill?

[Richard Buckanavage:]

There hasn't been any significant investments that actually drove the unrealized depreciation. I mean, we booked a total of net $700,000 and -- again, we can't think at the top of head any one, particular one that was more meaningful than others but I think Fox Rental Car warrants -- if there is -- I think that was correct, it wasn't really one poster child that represented a lion share of that amount but I would say Fox, warrant which is largely driven by the public comps; Fox is the fourth largest rental car company in the U.S. And in valuing that warrant, we take into account the trading values of the three major rail car companies and this particularly quarter their stocks were off a bit, so we had some depreciation there but not reflective necessarily of the prospects for that company, really just a public market competitive evaluation that resulted in some depreciation there. And quite frankly, if you look back last quarter, we had a pickup in Fox by virtue of the same dynamic in the opposite direction.

[Paul Johnson:]

Great, thanks for that. And then, my last question which is not a particularly investment. You had in the first quarter -- it looks like you sold a postcard with the Dell International. I was just curious, does this belongs that you're talking about -- that you had purchased out of discount to parenting the quarter or resist more just like a placeholder investment. I'm just curious as to you it was on the books essentially for just one quarter. I think it was sold sort of early in this quarter 2Q 19. Put your hands and really bend many investment funded the quarter to-date. It's a low yielding broadly syndicated loan that was a much better yield than what we're getting on our cash and money market account.

[Joseph Jolson:]

So as we deploy y that into investments that are actually accretive to the current dividends. One of the sources of funds was to sell that, and I think we sold it at a slight profit. Didn't we, Bill?

[William Alvarez:]

I think any that was taken.

[Richard Buckanavage:]

And Paul, these are the other one that is off that same [indiscernible]. So Dell and HDA were the two placeholder investments that we acquired during the quarter and then -- since exit above the gross investments.

[Joseph Jolson:]

Paul, one of the main reasons why it's possible for our sequentially if we can deploy this capital for our earnings that go up so much so quickly; is that -- we were in the first quarter, for much of the quarter we had a long-term debt funded with the money market account. So that's actually a big negative carry for shareholders. So we did try to elevate that through some very short-term investments. And there is obviously a lot of earnings leverage for putting the capital.

[Paul Johnson:]

Sure, great. I appreciate all the detail and thanks for taking my questions.

[Joseph Jolson:]

No problem, thank you.

[Operator:]

There are no further questions at this time. Presenters, you may continue. The there are no further questions in the queue.

[Joseph Jolson:]

Yes, I want to thank everyone for their interest in Harvest Capital Credit. And we look forward to updating everyone in early August on second quarter results. Thank you very much.

[Operator:]

This concludes today's conference call. Thank you everyone for joining. You may now disconnect.