Harvest Capital Credit Corporation
Q2 2015 Earnings Call Transcript

Published: 10 Aug 2015

[Operator:]

Good morning. My name is Felicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Harvest Capital Credit Corporation Second Quarter 2015 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. I would now like to hand the conference over to Mr. Richard Buckanavage. Please go ahead, sir.

[Richard Buckanavage:]

Thank you. Good morning, everyone. And thank you for participating in this conference call to discuss our financial results for the second fiscal quarter ended June 30, 2015. I am joined today by our Chief Financial Officer, Craig Kitchin. Before we start our call, Craig could you provide the Safe Harbor disclosure?

[Craig Kitchin:]

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. As it’s typical for our earnings call, I will start by covering a few high level topics that I believe are particular interest to our shareholders. Afterward, I'll turn the call over to Craig, who will discuss our financial results in greater depth and then we will open up the lines to all of you to answer any questions you may have. The topics I would like to highlight today include a general overview of our financial results, our deployment activities completed during the second quarter, portfolio performance during the quarter, investment activities since quarter and as well as, our current pipeline of potential investment opportunities, and lastly, some brief comments on the current state of the debt markets. I'm pleased with our financial results for the second quarter. Harvest Capital Credit narrowly missed earning our dividend this quarter with $0.33 per share of core net investment income, compared to our distribution of almost $0.34 per share. This result compares favorably to the prior quarter in which we earned $0.30 per share of core net investment income. Key contributors to this outcome include, positive net portfolio growth, stable portfolio yields and the return of one of our two non-accrual loans to accrual status. These factors enable us to fully offset the impact of higher debt costs associated with our bond offering completed in January, that while beneficial and that has staggered our liability maturities and match funded a portion of our investment portfolio it did add approximately $0.03 a share of additional cost. It is worth noting that the earnings growth trajectory was accomplished with an average level -- leverage level well below our target providing ample room for further future growth. Due to the solid performance of our portfolio and the resolution of one of our previously characterized non-accrual investments, CRS Reprocessing, net asset value per share increased to $14.47 per share from $14.30 per share at prior quarter end. We continue to work on an acceptable solution for our only other non-accrual investments, Solex Fine Foods. And I would point out that we have a verbal agreement with the stakeholders of that business, foreign acceptable restructure, which we hope to complete later this quarter. It’s also worth noting that at $10 million on a fair bases, Solex, is one of our smallest investments, representing less than 1% of the total portfolio at fair value and less than 1.5% at cost. While the second quarter was slower than we anticipated. We were able to closed four transactions totaling $4.8 million in investment commitments. Somewhat disappointing was the fact that only one of these investments was made to entirely new company, bringing our total portfolio to 30 companies. The weighted average yield on this quarter's investment was 12.2%, excluding fees and other forms of yield we may receive. For most of the second quarter, our average transaction volumes was good but not great. Of greater importance was the quality of that pipeline or lack thereof. We remained disciplined and true to our value orientation and chose to close fewer transaction rather than relax our investment standard for growth sake. As of June 30th, continued growth of the portfolio enable us to continue to reduce our reliance on any single investment with our top five obligor concentration declining to 32.6% from 33.4% in the prior quarter and our top 10 obligor concentration reduced from 55.7% to 54.6%. We continue to remain diligent regarding industry diversification as well. And at the end of the second quarter, it’s worth noting that 25 of the end markets that we're invested in, no one sector represented more than 8% of our total portfolio, a metric that has continuously declined over time. Our diversified investment strategy that includes an array of different asset classes continues to benefit shareholders in terms of risk mitigation. At June 30th, our portfolio was comprised of 52% senior secured debt investments, 44% junior secured debt investments and 4% in equity and equity like securities. As a result, 96% of our total portfolio and 100% of our debt investments are secured by at least a first or second lien with no unsecured debt investments. The percentage of floating rate investments relative to our total portfolio will remain virtually unchanged from the prior quarter at 63%. As such, our future earnings have no exposure to rising interest rates. With approximately 40% of our liabilities locked in at a fixed rate and approximately 60% of our assets carrying floating rate, shareholder should be confident that rising rates will not impact Harvest Capital’s distributable income. We backed our earnings with benefit in such an environment. From a credit perspective, the portfolio continues to perform with a weighted average risk rating at June 30th of 1.96. This marks the ninth consecutive quarter, in which the weighted average risk rating of the entire portfolio was below a two rating which is equal to the rating assigned to each investment at the time of the investment is made. At June 30, we had eight debt investments rated 1, 14 rated 2, four 3 rated investments, one 4 and one 5 rated investment. With the restructure of CRS Reprocessing complete, that’s return to accrual status during the second quarter. We currently have only one loan on nonaccrual status. As I mentioned earlier in my comments, we have reached a preliminary agreement to restructure our Solex debt position. We talked about to close the plan restructure later this quarter. As stated earlier because of its size, the Solex Investment represents less than 1% at fair value and less than 1.5% a cost of our total portfolio. So far in the third quarter, we had closed two new financing totaling $11.5 million. Both investments were new portfolio companies. The average floating interest rate for these two investments was 10%, excluding fees and other forms of potential yield we may receive. We also had one exit during the quarter. In July, we exit our investment in LNB construction, our $3.6 million debt investment was repaid in full at par. In addition, we received various exit fees and $100,000 of value in exchange for our equity options in LNB. As a result internal rate of return generate on this investment was 28%. This outcome marks yet another attractive exit for Harvest Capital in which we generated equity like returns by investing in debt securities. Currently, we have two mandates totaling $7.2 million with a weighted average interest rate of approximately 12.8%, schooling other forms and -- forms of potential yields and fees we may receive. I should note that there could be no assurances that these transactions close during the third quarter or that they close at all. However, both financings are targeted for a Q3 closing. While the market remains competitive, we have witnessed what we believe is stabilization in terms of both leverage and yields whether this is a result of constrained liquidity at certain market participants or an uptick in deal activity that more closely matches capital available to be deployed is unclear. But based on late second quarter and early third quarter market dynamics, we are encouraged by what we have seen. Our pipeline is robust with near all-time high volumes and the quality of the deal flow is also high. As such, we are upbeat regarding potential deployment for the remainder of the third quarter and the second half of 2015. That concludes my formal remarks this morning. So I will now turn the call over to Craig Kitchin.

[Craig Kitchin:]

Thanks Rich and good morning everyone. Core net investment income for the quarter was $2.1 million or $0.33 per share, compared to $1.9 million or $0.31 per share in the second quarter of last year and $0.30 per share in the first quarter of this year. The increase in core earnings is largely attributable to our investment in CRS coming off non-accrual. This added $187,000 of revenue to the quarter and about to $0.025 to NII. For the six months, core NII was $0.63 versus $0.65 in the first half of 2014. Higher interest expense associated with the bond offering we did in January cost about $0.05 in year-to-date earnings. So without that, we would a few cents ahead of last year instead of a couple of cents behind. As we continue to grow and draw down more of the credit facility, the interest differential gets smaller. When we did the bond deal, we paid down the facility to zero, so we're paying 75 basis points in unused line fees on the entire $55 million undrawn balance. That expense gets diminished as the portfolio grows and the credit facility is more fully utilized. One thing I should mention about the credit facility, the revolver feature expires in October so we're working on either extending the current facility or moving to a new lender. In either case, we are hopeful of getting a meaningful reduction in the L450 rate that we are currently paying. We plan to outline in terms of the extension on the new facility in a press release later this quarter and we will be able to discuss the financing in more depth on next quarter's earnings call. Net income per share for the quarter was $0.51, compared to $0.39 per share in the second quarter last year. The increase to net income was largely driven by capital gain activity. The realized and unrealized gains contributed $0.18 to earnings, versus $0.09 a year ago. Net income for the year-to-date was $0.56, compared to $0.75 in 2014, again mostly due to the timing of realized and unrealized activity. I would point out that earnings for the quarter were still [lowly levered] [ph]. We had $42.3 million in debt at the end of the quarter putting our debt-to-equity ratio at 47%, which is well below our target leverage level between 75% and 80%, which means we have about $25 million to $30 million of net portfolio growth to get our target leverage level to where -- which should boost future earnings. PIK income represented 6.7% of total interest in the quarter, compared to 12% of interest income for Q2 of 2014. The percentage of our income that is PIK has been on the decline recently as a larger percentage of our investments have been senior or unitranche transactions, which tend to have less of or no PIK component compared to more junior deals. As of June 30, we were down to one nonaccrual account, Solex, and, as Rich mentioned, represents less than 1% of the portfolio at fair value and less than 1.5% at cost. Bringing CRS back onto accrual status is very positive for the quarter, as I mentioned, adding $0.025 per share to earnings for the period. Our debt was restructured, which resulted in a lower coupon of 5%. But importantly, the new loan honored about $1 million of prior unpaid unrecognized interest income, which was capitalized into the balance of the loan. The restructured qualified for extinguishment accounting treatment. As such, we realized a loss on the old CRS investment of $675,000, but also reversed $1.5 million of previously booked depreciation. The current carrying value of the restructured loan is $5.5 million and the current principal balance is $7 million. As of March 31, the fair value of our portfolio was $129.9 million versus amortized cost of $129.1 million, reflecting $800,000 of net unrealized depreciation in the portfolio at the end of the quarter. As of June 30, we had $2.6 million in cash and only $14.8 million drawn on our $55 million credit facility. So with our cash and borrowing capacity, we should have enough dry powder to fund new investments for the next few quarters. Additionally, I would point out that we have about $24 million of lower yielding syndicated loans that could be monetized and invested in core deals with higher yields. These syndicated investments had a weighted average effective yield of 11.4% at quarter end. As of quarter end, the NAV was $14.47, up $0.17 from last quarter, as net income of $0.51 per share outpaced the $0.34 in dividends paid during the period. And with that, I will turn the call back to Rich.

[Richard Buckanavage:]

Thanks, Craig. Thank you to everyone participating in our earnings call this morning. We understand that there might be some questions. So Operator, could you please open up the lines for any questions our participants may have.

[Operator:]

[Operator Instructions] And your first question comes from the line of Ryan Lynch with KBW.

[Ryan Lynch:]

Good morning. I just want to talk about your Q3 originations, you guys have done quarter-to-date and you guys did about $12 million of kind of a weighted average yield of 10%. These are much lower than your kind of portfolio yield right now of 15%. Do you guys consider these long-term assets? Do you intend to hold over the -- over the life of the loan or are these more placeholder assets that you would consider rotating out of?

[Richard Buckanavage:]

Ryan, these are assets that we intend to hold, the 10% compares to the 12.2% in Q2. So they’re little bit lower but also excludes other forms of yield that we may receive, such as upfront fees, exit fees and other various forms of yield. The best way, the only way that we can put on apples- to apples basis by deal because of the variability of the other forms of yields as just to state the all-in interest rate. So the 10% compares to 12.2% in the prior quarter, that 15% for the yield in the portfolio includes other things, such as fees and amortization of warrants or options that we may received, in some cases, royalty agreement. So the only way to really make it apples-to-apples is to quote just the interest rates. So those are just strictly the interest rate. We expect the actual yield on those investments to be higher than the 10%.

[Ryan Lynch:]

Okay. Got it. And then you guys had about $4 million of repayments quarter to date, do you guys have any more visibility and anymore repayments that could be coming in third quarter?

[Richard Buckanavage:]

We don't have any at this time. As you know, in some cases, the repayment is something we’re well aware of in advance of the actual repayment. This was not one of those. This was one that actually was kind of came up rather quickly and we were refinanced out of the transaction. So right now, we don't have any visibility on future repayment and that’s not to say that we won’t expect any but don't have any visibility as it relates to repayments in the third or fourth quarter yet.

[Ryan Lynch:]

Okay. And then just one last one, you talked about potentially refinancing your existing credit facility. Looks like right now you guys have tons of LIBOR plus 450 with a 50 basis point LIBOR floor. Do you guys have any kind of target of what you're hoping to get that where you said, you hopefully will be able to lower that yield a little bit. You guys have any kind of target of what you’d like to get that credit facility down to?

[Craig Kitchin:]

Yeah. This is Craig. We probably shouldn't comment specifically but I think it's a fair categorization to say that it would be meaningful savings.

[Ryan Lynch:]

All right. That’s all for me. Thanks.

[Operator:]

[Operator Instructions] Your next question comes from the line of Bob Napoli with William Blair.

[Bob Napoli:]

Hey, good morning, Rich and Craig. How are you guys?

[Richard Buckanavage:]

Hi, Bob.

[Bob Napoli:]

So, seems like you’re getting some momentum on the origination front more so than what we’ve seen. What is driving the momentum that you seem to have on the origination side?

[Richard Buckanavage:]

Bob, really, it’s nothing more than just a better pipeline. Our -- the volume is up, but I think you've heard me on the number of these calls talk about quality is being much more important than volume, but we’re fortunate right now to have both. We have very robust pipeline in terms of number of deals that we’re looking at and the quality is strong. So we, obviously, want our fair share here in quarter-to-date and have a couple of mandates yet to close and a lots of other things we’re working on. So it’s -- we can’t control unfortunately, what the pipeline looks like. We’re not really doing anything different, I guess, that’s at the heart of your question. We’re really just continuing to do what we've been doing and the market is turned such that there's quite a few transactions to look at and many of those transactions are setting up well for us.

[Bob Napoli:]

Okay. Then, I guess, as we should -- how we should we think about your yield over the, say the medium-term over the next couple of years, just still getting a very attractive overall yield, including fees now closed to 15%. Would you expect that to decline couple 100 basis points maybe over the next few years or doing a little more senior, but also your cost of funds, sounds like it could decline as well.

[Richard Buckanavage:]

I don’t think it’s going to be a couple 100 basis points, Bob. I do expect to have some further yield compression. Not because so much that the markets continuing to slide in terms of yield. We've actually seen some stabilization there. But just as you said, just because we're looking at a lot more unitranche investments…

[Bob Napoli:]

Right.

[Richard Buckanavage:]

… which carry lower yields than do standalone managed investments and as we do more of that the portfolio yield will creep down. Obviously, the culinary there is that the risk at the portfolio improves, I did senior secured debt and we like to have that balance.

[Bob Napoli:]

Right.

[Richard Buckanavage:]

But we will make some future yield compression in the portfolio, but we don’t expect to be a couple 100 basis points.

[Bob Napoli:]

Okay. And is there, on a competitive front, getting seeing more deal flow? Are you seeing -- is there somewhat less competition? Or do you just think that the M&A market is picked up some steam on the low-end side?

[Richard Buckanavage:]

It’s definitely that volume is up. And so, one, I guess, can infer from that is that there is an up deal flow or at least more deal flow today than there was in the first half of this year to satisfy the amount of capital available to be deployed. So I think there's certainly some of that. But I will say that we seem to be in a period where there is fewer competitors. I don't -- we don’t really tough to quantify that. But just it seems that way relative to what we saw in the first half of the year. And late last year it just seems like there's a fewer and less -- it’s kind of less frenzy environment for financings and maybe short-lived. But it seems to be a little better balanced here in the late second quarter and early third quarter.

[Bob Napoli:]

Okay. And then your risk rating weakened here this quarter, as what are you seeing on the credit side relative to your expectations for companies and how do you feel about the economy today looking at your companies?

[Richard Buckanavage:]

Obviously, as I stated, we are still operating below two, which is a very good sign. We did have a couple move to the three-rated category which pushed that up a little bit. But still within very -- I would say further it continues to perform very well. So, no great concerns there. And as far as what our 30 companies tell us about the economy. We have not seen any sort of warning signs out there in any of our portfolio companies. In fact, some of the more cyclical companies are still doing very well. So that's obviously an encouraging sign. The two that went to three this quarter very much company specific issues that are being not mine but addictively addressed. So we are pretty upbeat on the performance of the portfolio and expected to continue to perform throughout the year.

[Bob Napoli:]

Great. Thank you. Appreciate it.

[Operator:]

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

[Richard Buckanavage:]

Thank you everyone for your participation in our call this morning. We look forward to talking to you again in early November to talk about our third quarter results. Have a good day.

[Operator:]

Thank you. And this does conclude today's conference call. You may now disconnect.