Harvest Capital Credit Corporation
Q1 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Good morning, my name is Kayla and I will be your conference operator today. At this time I would like to welcome everyone to the Harvest Capital Credit Q1 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Mr. Richard Buckanavage, you may begin your call, sir.

[Richard Buckanavage:]

Thank you, Kayla. Good morning, everyone, and thank you for participating in this conference call to discuss our financial results for the first quarter ended March 31, 2016. I'm joined today by our Chief Financial Officer, Craig Kitchin. Before we get start our call, Craig, could you please provide the Safe Harbor disclosure?

[Craig Kitchin:]

Yes. 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.

[Richard Buckanavage:]

Thank you, Craig. I'm going to address a few topics today in my prepared remarks before turning the call back over to Craig who will discuss our financial results in depth. And then we'll open up lines to all of you to answer any questions you may have. First, I'd like to highlight that Harvest Capital Credit again out-earned its dividend by generating $0.41 per share of core NII as compared to the dividend of $0.34 per share. This quarter's financial results when combined with the spillover income from fiscal 2015 should provide shareholders with comfort regarding the sustainability of the current dividend payout level. Overall we are satisfied with the results achieved in the first quarter of 2016. While the weighted average risk rating ticked up slightly from 1.98 to 2.02, the portfolio continues to perform acceptably. While we did see some NAV degradation during the quarter, a meaningful portion of that decline emanated from lower quoted loan prices on a handful of level two assets. Since the end of the first quarter, the overall loan market quoted prices have firmed, and if the market remains at its current level we would expect to recapture some of that NAV decline in the current quarter. Q1 2016 was a solid quarter of capital deployment for the business. We closed three investments totaling approximately $21.7 million in total capital commitments, $17.8 million of which were debt investments, with the remaining $3.9 million in the form of common equity securities. Our deployment activity for the quarter was broken down between two new investments and a refinance of one of our existing portfolio companies which was acquired by a private equity firm. The weighted average yield on the debt capital deployed during the first quarter was approximately 13.1%. Excluding fees and other forms of potential yield we may receive, as compared to the yield on debt investments made last quarter of 13.6%. It's worth noting that approximately 36% of this quarter's debt capital deployment was in the form of senior secured loans while the remainder was junior secured debt investments. During the first quarter we also experienced a meaningful level of exit activity, experiencing two full repayments totaling $10.4 million in the aggregate. As highlighted during the last quarter's earnings call, we exited our investment in Solex Fine Foods, which eliminated a previously characterized non-accrual loan. Along with a full repayment of our investment in Infinite Aegis totaling approximately $8.8 million. These two realizations in the first quarter represent our 20th and 21st exits since inception. To date, the average internal rate of return for this 21 exits is 20.4% and 25.2% excluding low yieldings indicated placeholder investments. After netting this exits from the deployment during the quarter, we grew the portfolio by approximately $11.3 million and increased the number of portfolio companies from 33 to 34. Subsequent to quarter end, we experienced a partial repayment from one of our existing portfolio companies, WBL SPE I, totaling $1.5 million. Simultaneous with that repayment, we increased our commitment and funded $1.5 million to WBL SPE II, resulting in a net zero change to our balance sheet. We continue to maintain prudent diversification across the portfolio. Our top five obligor concentration remains stable at 33% from 12/31/15, and our top ten obligor concentration decreased from 54.7% at 12/31/15 to 53.6% at 3/31/16. We remained committed to vigilance regarding industry diversification as well. And as noted in previous calls, we have no direct exposure to the oil and gas sector which has served as well over the past few quarters. However, stated last quarter the underlying portfolio in our loan investment in CLO equity does have approximately 2% of its portfolio invested in oil and gas. Because this $1.4 million investment represents less than 1% of our portfolio, we have negligible downside exposure to that sector. At 3/31, our portfolio was comprised of approximately 50% senior secured debt investments, 45% junior secured debt investments and 5% in equity and equity-like securities. As a result, 95% of our total portfolio and 100% of our debt investments is secured by at least a first or secured lean with no unsecured debt investments. The portfolio continues to have the majority of its assets maintained in floating rate investments which at approximately 66% helps to insulate Harvest's future earnings from a possible negative impact to rising interest rates. In fact we enjoy upside as interest rates continue to rise. From a credit perspective, the portfolio continues to perform satisfactorily with a weighted average risk rating of 2.02 at 3/31/16, compared to 1.9 at fiscal yearend. As of 3/31/16, we had one loan on non-accrual status. This loan to PK acquisition represents 1.3% of the portfolio on a cost basis and less than 30 basis points on a fair value basis. From the perspective of the performance of the underlying portfolio companies, we continue to see growth, be it at lower levels than what we witnessed from much of 2015. The portfolio average LTM EBITDA grew by 3% in the first quarter. Based on solid operating fundamentals experienced by most of the companies that comprise our portfolio, average total net leverage remained reasonable at approximately 3.8 times at 3/31/16, compared to 3.7 times at 12/31/15. After analyzing portfolio trends on a company-by-company basis, it's apparent to us that the soft performance that does exist in our portfolio is attributable to company specific factors versus more macroeconomic pressures. As reported last quarter, the board of directors authorized a $3 million stock repurchase program. Unfortunately, because the authorization from the board and requisite shareholder notification did not incur until March 8 which was two days prior to the close of the trading window for that period, the repurchase program was not fully operational in time to take advantage of the stock price activity in the first quarter. Once the blackout period expires, two business days from today's date, we'll be free to repurchase shares in the open market should be conclude that the use of our capital for this purpose is the highest and best use as compared to other alternatives. Current state of the credit market continues to be competitive. We are witnessing private credit funds and SBIC funds continue to aggressively fill the liquidity gap created by the regulatory imposed retrenchment by commercial banks and the capital constraint issues faced by many BDCs. Clearly [ph] entrance of additional liquidity along with a blow average investment pipeline and mediocre quality of that pipeline, the outcome is a questionable investment environment. While this will likely result in muted deployment trends in the short term, our ability to earn the dividend with the current portfolio allows to be, to demonstrate patience and discipline until market indicators turn into a more favorable direction. That concludes my formal remarks, and I will now turn the call over to Craig.

[Craig Kitchin:]

Thanks, Rich, and good morning everyone. Core net investment income for the quarter was $2.6 million or $0.41 per share, compared to $1.9 million or $0.30 per share in the first quarter of 2015. The large increase in core earnings is attributable primarily to the payoff of our investment in Infinite Aegis which resulted in a make old fee of over $600,000. Net of incentive fee to make old added about $0.08 to NII for the quarter. Although a big part of the Q1 NII was due to the Infinite Aegis payoff, our portfolio is seasoned enough but this kind of income isn't necessarily non-recurring. As I mentioned before, we have a very conservative accounting policy toward fees. Any credit related fees deferred and amortized over the life of the loan which allows fee income to be more evenly recognized and spread out overtime. But when deals pay off, there's usually extra income related to the unamortized portion of this fee that gets accelerated. Overtime, we know we will have a fair amount of these but it's difficult to predict on a quarterly basis. But even without them our run rate income is very close to covering the current dividend. Net income for the quarter was a loss of $133,000 or $0.02 per share, compared to income of $300,000 or $0.05 per share in the first quarter of last year. The decrease was driven by $1.2 million in realized losses primarily related to the exit of our investment in Solex in Q1. We were below our target leverage level of at the end of during Q1 we had an average during the first a debt balance of $54.4 million for debt to equity ratio during the period of 61.5%. At quarter end our debt to equity ratio stood at 73.1%, so still additional room to grow the portfolio and earnings before reaching our 80% internal debt to equity target. PIK income represented 2.8% of total interest income in Q1 compared to 7.5% of interest income in Q1 of last year. Additionally the portfolio is at a point where we collect almost as much PIK as we accrue now. In some periods we collect more. In Q1 we accrued $154,000 of PIK but collected $437,000 that's been accrued in prior periods. Overall, the percentage of our income that is PIK has been on the decline as a larger percentage of the investments have been senior or unit tranche which tend to have less of or no PIK component compared to junior deals. As of March 31, the fair value of the portfolio was $148.5 million versus amortized cost of $151.5 million, reflecting $3 million of net unrealized depreciation in the portfolio. It's worth mentioning again that one-half or approximately $1.5 million of the unrealized depreciation on our books comes from level two probably syndicated loans. All of these loans are performing but we have been in a generally poor trading environment for syndicated loans in Q1. As of quarter end we have $2.8 million in cash $18.7 million available on our $55 million line. So with our cash and borrowing capacity we have enough dry powder to fund new investments up to our target leverage level. Additionally, I would not that we have about $28 million of lower yielding syndicated loans that could be monetized and invested in core deals with higher deals. These syndicated loans had a weighted average effective yield at 11.3% in the quarter end. As of quarter end, our NAV was $13.90 per share, down $0.36 per share from last quarter as we had a net loss in the quarter of $0.02 plus the $0.34 in dividends that were paid. One other thing I would mention is that we carried over approximately $1.2 million or $0.19 per share in undistributed 2015 earnings that need to be paid out in 2016. Last year we also had carried over earnings and paid them out as part of our regular distributions in 2016, instead of declaring special dividend. So this should give investors a degree of comfort as to the sustainability of our current dividend levels. And with that, I'll turn the call back to Rich.

[Richard Buckanavage:]

Thanks, Craig. Operator, could you please open up the lines now so that we can address any questions our participants may have?

[Operator:]

Absolutely. [Operator Instructions] We will pause for just a moment to compile the Q&A roster. Our first question comes from the line of Brian Hogan from William Blair.

[Brian Hogan:]

Good morning.

[Richard Buckanavage:]

Good morning, Bryan.

[Brian Hogan:]

The question on the spread widening impact on NAV, how much of the unrealized, you said majority or decent amount, but can you quantify that?

[Richard Buckanavage:]

Yes, the question is how much of the unrealized was credit versus the market?

[Brian Hogan:]

Correct.

[Richard Buckanavage:]

We estimate that about 40% of our unrealized depreciation was related to market factors.

[Brian Hogan:]

All right, thanks. And then regarding credit quality, I mean grade [ph] took a decent jump up, can you elaborate on that?

[Richard Buckanavage:]

Yes, we had a sizeable loan move to the four category and obviously with a portfolio with 34 investments, the percentages move around a little bit. We thought it was appropriate for that risk classification. Working with that company very collaboratively currently to resolve the matters. And as I stated in my prepared remarks, this isn't a macro factor that we're addressing, it's a company specific issue, and generally speaking you can more easily address company specific issues than trying to fight more macro oriented factors. So we're cautiously optimistic about getting this result, but in the short term we thought it was appropriate to put that loan into the four category.

[Brian Hogan:]

Is it fair to say, first off, can you state which one it is? And then is that the one that drove the rest of the majority of this, I guess 60% was due to the credit in the NAV?

[Richard Buckanavage:]

Yes, yes, a fair amount of that was attributable to that credit. We don't go into the detail about which ratings, for obvious reasons we try not to highlight those on calls like this. But as I said earlier the percentage looks large by if we look at the overall waiting throughout the risk rating stratosphere, we're pretty comfortable at where we are, the percentage of the portfolio. And ones and twos versus threes, fours and fives. I think this is really just a maturation of the portfolio and quite frankly as I said, we're optimistic long term that we're going to find a resolution for this situation.

[Brian Hogan:]

Sure, and then bigger picture, longer term, what are your thoughts on SBIC funding especially as you get closer to your 80% regulatory target leverage?

[Richard Buckanavage:]

Yes, we intended not to try and talk definitively about that just because if we do, whenever we do decide to pursue that it becomes something that we have to answer as to why things are taking so long. So it's certainly on our radar screen. We think it certainly fits with what we're trying to invest in this sort of sized companies. If you look at our track record, most of the companies from the sides perspective would fit into the SBA program. What we're hearing through the grapevine is that newer BDCs are maybe meeting some stiff headwinds, I think primarily related to where the industry is trading relative to book value. That's kind of what we're hearing, kind of third parties. So can't say that that's actually true, but certainly would stand a reason to be some hesitancy there. However, a couple of the BDCs that had SBIC license is obviously have been awarded the third license to take their exposure up beyond the current limitation. But something we've been evaluating for quite some time.

[Brian Hogan:]

All right, thanks. I'll jump back in the queue.

[Operator:]

[Operator Instructions] And there are no questions at this time. I had the call back over to you presenters.

[Richard Buckanavage:]

Okay, thank you, Kayla, and thank you to all of our participants. We look forward to talking to you in a couple of months regarding our second quarter results.

[Operator:]

This is the end of today's call. You may now disconnect. Have a great day.