Harvest Capital Credit Corporation
Q3 2015 Earnings Call Transcript

Published: 10 Nov 2015

[Operator:]

Good morning my name is Sheila and I will be your conference operator today. At this time I'd like to welcome everyone to the Third Quarter Earnings Harvest Capital Conference Call. [Operator Instructions]. Thank you. I would now like to hand the call over to Mr. Richard Buckanavage. Please go ahead, sir.

[Richard Buckanavage:]

Thank you, Operator and good morning everyone and thank you for participating in this conference call to discuss our financial results for our third fiscal quarter ended September 30, 2015. I'm joined today by Chief Financial Officer Craig Kitchin. Before we start our call, Craig would just please 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:]

Thanks, Craig. I intend to cover six major topics today in my prepared remarks before turning the call over to Craig who will discuss our financial results in depth. And then we'll open up the lines to all of you to see what questions you may have. The topics I would like to highlight today include the completed amendment to our corporate revolving line of credit, third quarters capital deployment. Our growing track record of successful exits. Closed investments subsequent to quarter end. The performance of the existing portfolio. And lastly some brief comments on the state of the credit markets in which we participate. Without being duplicative with Craig's comments. I do want to take a moment to state that we are very pleased to have out earned the Q3 dividend by generating $0.35 per share of NII versus our dividend of $0.33 and three quarter cents per share. It has taken a quarter longer than anticipated while we have now fully offset the higher debt cost associated with our bond offering completed in January. As I stated in the 8K announcing the amendment completed in late September to our corporate line of credit. We achieved several important objectives with this event. We extended the revolving period of the facility by 18 months to April 2017 which was due to expire by the end of October. Furthermore we lowered the LIBOR spread from 450 basis points to 325 basis points. Almost none of the benefits of lower pricing were realized Q3 as is close just prior to quarter end. While not part of the amendment because we are utilizing over 50% of the facility now, the unused line fee has step down by 25 basis points. Q4 earnings will enjoy 100% of the benefits of these two reduced costs features. I'd like to take this opportunity thank our lending group. We appreciate their support. And we are pleased that we're able to accomplish our objectives with our existing relationships. Q3 was a solid quarter of capital deployment for the business. As we stated during last quarter's earnings call we've begun to see a quality pipeline building towards the end of the quarter. We converted that robust pipeline into four new investment closings tolling $17.9 million and three follow on investments to existing portfolio companies totaling $2.4 million bringing the quarterly total to $20.3 million. The weighted average yield on new and follow on investments completed this quarter was approximately 11.5%. This excludes these and other forms of potential yield we may receive as compared to new and follow on investments closed last quarter of 12.9%. However before you draw any conclusions from this quarter over quarter comparison, keep in mind that our typical realized return as demonstrated by this past quarter's exit of LNB to substantially higher than the stated current yield due to other non-current forms of return such as anniversary fees, exit fees, prepayment fees and warrants among others. We expect all investments we make to be accretive to our current dividend. As I alluded to previously we did exit one investment during the quarter, a junior secured subordinated debt investment in LNB Construction. As part of this exit we received full repayment of our debt position at par and exit fee and a combination of cash and notes in exchange for our warrant warm position which generated an internal rate of return of 28% on this exit. There's no better way for shareholders to assess management's investment capabilities and test its investment thesis then through realized investments. The LNB exit represents our 14th exit since inception and with it further validation of our niche value oriented investment style that enables us to generate equity like returns through investments in debt securities. To-date our 14 exits have produced in IRR of 21.8% and excluding placeholder investments of 29.4%. The quality pipeline that began building in late Q2 and which we continue to witness during Q3 translate into three closing subsequent to quarter end. Two follow on investments in existing portfolio companies and one new investment totaling $10.8 million of investment commitments in the aggregate. The weighted average yield on these three investments was 13%, again excluding fees and other forms of potential yield we may receive. With net portfolio growth of 16.7 million during the quarter and increasing the company count to 33 we continue to reduce the portfolios' reliance on any single investment. With our top five obligor concentration declining to 29.4% from 32.6% last quarter and our Top 10 obligor concentration being reduced to 51.1% from 54.6% last quarter. We continue to remain diligent regarding industry diversification as well and at the end of the third quarter it is worth noting that of the 28 end markets that we are invested in no one sector represents more than 8.5% of our total portfolio. A metric that is continuously declined since our IPO. Lastly we have zero exposure to the oil and gas industry. Our investment strategy that includes asset classes throughout the capital structure continues to deliver benefits to shareholders in terms of risk mitigation. At September 30, our portfolio was comprised of 48% senior secured debt investments, 49% junior secured debt investments and 3% in equity and equity like securities. As a result 97% of our total portfolio and 100% of our debt investments is 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 increased again this quarter to 68.5% versus approximately 63% in the prior two quarters. As stated last quarter the intentional migration of the portfolio toward a higher proportion of floating rate investments is largely complete, as such our future earnings have no exposure to rising interest rates. In fact we'll enjoy a meaningful upside as interest rates rise and due to lack of and the level of the LIBOR floors in our portfolio. These benefits will begin to accrue with the first 100 basis points of upward movement. Going forward the decision to pursue floating rate unit tranche investments as opposed to fixed rate junior debt investments will be made based solely on a specific facts and circumstances of each opportunity. From a credit perspective the portfolio continues to perform well with a weighted average risk rating at September 30 of 1.97, this marks the 10th consecutive quarter since our IPO in which the weighted average risk rating the total of that portfolio was better than the two risk rating assigned to each investment at the time the investment is made. We currently only have one loan on nonaccrual status. This loan is one of our smallest investments and represents less than 1.25% of our ad cost [ph] of our total portfolio. As stated last quarter late in the second quarter we began to witness what we believe was a stabilization of both leverage and yields in the lower middle market, we’re hesitant at the time to draw any long term conclusions based on these recent market movements. However in fact after living out the remainder of the third quarter and taking the pulse of the market as we sit here midway through the fourth quarter we do believe the market is turned for the better in the segment of the market which we primarily participate. We are a long way from the lender friendly markets of 2012 and 2013 and while competition remains strong yields have trended upward modestly and we are encouraged by the volume and quality of our current pipeline of investment opportunities. As such we’re optimistic for the remainder of the year. That said we remain vigilant on our ongoing assessment of the macroeconomic environment which we might invest and given where we think we are in the credit cycle. We take a conservative approach to underwriting particularly companies that operate in economically sensitive markets. Should factors ship again towards borrowers we might see our origination slow as a result but this moment we perceive the movements in the lower middle market is trending favorable to Harvest Capital. That concludes my formal remarks. So I'll now turn the call over to Craig.

[Craig Kitchin:]

Thanks, Rich and good morning everyone. Core net investment income for the quarter was $2.2 million or $0.35 per share compared to $2.2 million or $0.36 per share in the third quarter of 2014. The decrease in core earnings is attributable to lower asset yields more expensive debt with the baby bonds outstanding this year and several cents per share in non-recurring fee income last year, these factors were almost fully offset by incremental earnings from growth in the portfolio. Additionally this year we had a penny per share and non-recurring expenses related to our credit facility. We ended up amending it with our existing lending group but it had gotten pretty far down the road with the replacement lender before we reached the amendment. Core earnings this quarter were $0.02 higher than they were in Q2 of this as growth in the portfolio outweighed the decrease in overall asset yields. For the nine months core NII was $0.98 per share versus a $1.1 in the first nine months of last year, higher interest expense on the bond money we raised in January has cost about $0.07 in year-to-date earnings so without that we would be a few cents ahead of last year instead of a few cents behind. One thing to note though about the bonds even though they are more expensive adding that capital junior to our senior lender allowed us to negotiate significantly better terms on our senior facility. As Rich mentioned with the amendment we extended the revolver by 18 months and lowered the interest cost from LIBOR plus 4.5% to LIBOR plus 3.25% and also as Rich mentioned it happened at the end of the quarter so the benefits won't be seen until future quarters but at the end of Q3 we had $29 million drawn on the revolver so on that balance of 125 basis point rate reduction would result in about $0.06 per share in annual interest savings. If the full $55 million were drawn the savings would be about $0.11 per year. So a meaningful reduction in our cost to capital and we continue building on a solid relationship with our existing lenders. Net income per share for the quarter was $0.14 compared to $0.33 per share in the third quarter of last year, the decrease was largely driven by $0.17 per share in that portfolio depreciation. I would point out again that the earnings for the quarter were still lowly levered. We had on average $49.2 million in debt outstanding during the quarter for a debt to equity ratio of 55% which is well below our target leverage level of between 75% and 80%. At the end of the quarter our total debt balance was 56.5 million putting our debt to equity ratio at 63%. As such we have about $15 million of net growth before we hit our target leverage limit which all else equal will provide a boost to future earnings. PIK income in the quarter represented 5.4% of total interest income compared to 6.7% last quarter and 8.7% last year. The percentage of our net income of this PIK has been on the decline as a larger percentage of our investments have been senior unit tranche which tend to have less or no PIK component compared to most deals. As of September 30, the fair value of the portfolio was $144.2 million versus amortized cost of $144.5 million reflecting $270,000 of net depreciation in the portfolio at the end of the period. As of quarter end we had $2.4 million in cash and 25.9 million available on our credit facility. 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 point out that we have about $29 million of lower yielding syndicated loans that could be monetized and invested in core deals with higher yields. The syndicated investments at a weighted average effective yield of 11.3% at quarter end. At September 30 our NAV per share was $14.27 down $0.20 per share from last quarter as net income of $0.14 was outpaced by $0.34 in dividends for the period. With that I will turn the call back to Rich.

[Richard Buckanavage:]

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

[Operator:]

[Operator Instructions]. Your first question comes from the line of Charlie Ward [ph].

[Unidentified Analyst:]

Craig, that last comment you made about lower 29 million of lower syndicated loans. Can you just I mean obviously 11.3% yield don’t feel like broadly syndicated loans for sure and can you talk two things about did you see any weakness in the pricing of those loans as we did another syndicated loans and what is -- how would you describe the liquidity in those loans? How liquid are they and if felt like you want to roll out of those is that a quarterly event or how long would that take?

[Craig Kitchin:]

Of all the depreciation in the quarter several hundred thousand of those from a broadly syndicated loans and not all of the 29 million or what we consider level two assets which would be easy to monetize and liquidate but all 29 are liquid enough that it could we could get out of them in a relatively short period of time.

[Unidentified Analyst:]

And then Craig, one more for you, I know early on in Rich's prepared commentary you talked about the unused commitments you came down by 25 bips, can you give us the parameters there again what needs to be -- how much has to be used and what it comes down by?

[Craig Kitchin:]

It's a $55 million facility in total and as long as more than half of the $55 million is drawn then the end use line fee is at the lower level.

[Unidentified Analyst:]

And what is the lower level?

[Craig Kitchin:]

It's 50 basis points. It's 75 basis points when we're less than way drawn.

[Unidentified Analyst:]

And then on the fee run rate, obviously the fees were higher this quarter I'm assuming due to the exists. Can you give us maybe some comfort and where you think that fee income line can run going forward?

[Craig Kitchin:]

Well it's just hard to predict because it's so dependent on payoffs. And so I don't I can't give you a much more clear guidance on that, Rich might want to have a comment of it?

[Richard Buckanavage:]

I don't think that this quarter is all that unusual, we’re going to have payoffs and not every quarter but certainly if you took the entire year and divided by four and you look back at our last couple of quarters I think that's a pretty good proxy because we're going to have payoffs certainly every year and now the portfolios has matured. We certainly expect to have a more routine track record of exits. So you know these were big from relative to the one deal but it was only one exit. And so we've had quarters where we've had more than one exit and I think we'll have an exit in the fourth quarter as well so but again to Craig's point on a quarter-by-quarter basis it's pretty difficult.

[Unidentified Analyst:]

And then one final one, in the portfolio it looks really clean obviously the selection is what it is it's small it's been on nonaccrual but what I did see movement in a little bit this quarter was the urgent care facility operator and GS I guess is called and where you have a first out and a last out kind of a piece went from -- the second out and last out piece, it went by 10% haircut, can you provide any color there?

[Richard Buckanavage:]

I think what we can say is I guess two things one is yes, the we took -- I think it was around $600,000 unrealized depreciation on the last out portion of that due to some softness in their financial results. The second part I will say is we are working very collaboratively with the owners of that business towards a solution both operationally and from a capital perspective so we feel like we've got a very collaborative approach in process with the owners but again the back end piece is the riskier piece and we thought it was worthwhile just given some softness in the short term to take it down by this amount.

[Operator:]

Your next question comes from Brian Hogan from William Blair.

[Brian Hogan:]

Question on your leverage and capital plans and obviously you know relates to your growth of your portfolio. You had 0.63 I believe you said, you targeted 75 to 80, how long do you think you’re going to take to get there I mean by your math it's kind of another two quarters. And then at that point what do you intend to do as SBIC license is that in the picture or just what you’re your thoughts there?

[Richard Buckanavage:]

I think from a capital management perspective as Craig said it was about $15 million of liquidity under the revolver almost $30 million of syndicated primarily second lien transactions. Most of those are level to assets I think about the 20 of the 30 million are level two assets, even the level three assets are large syndicated deals with liquidity just don't meet the definition of level two but we think we can monetize those and then above and beyond that there are some areas in the portfolio that we're looking to optimize the balance sheet you know potentially bring in a partner for you no significant movement but just you know kind of maybe a few million here and there where we think we could optimize the balance sheet maybe some of the lower yielding investments should we have other places to put that capital. Obviously right now the syndicated second lien loans that we have in our portfolio are creative to our dividend so they're not loans that we’re looking to offload. The only time that we would look to monetize the syndicate loans is if we have a more attractive opportunity to reinvest those proceeds. With regards to SBIC, certainly that is -- we think a fairly attractive complement to the existing capitalization of the company. Really is our policy not to comment on strategic initiatives but suffice it to say it will be a nice compliment to what we have in place already and of the direct deals that we have originated since inception other than maybe some of the LNB for example, there is a Canadian company that would qualify and some of the spec fin deals that we've done wouldn’t qualify but the remaining 90% of our direct originations would fit nicely into an SBIC so something that we’re certainly focused on but don't want to comment at this time.

[Brian Hogan:]

Okay. Would you repurchase shares at all?

[Richard Buckanavage:]

Brian, we talk about this at the board every quarter and we look at a couple of different ways one is at 17%, can we earn by making investments in today's market, superior returns than the discount that we're trading at right. And you know to-date almost all of our investments have been superior to that as I mentioned in our exits. The other is you know we look at scale, we look at the business as it relates to you know where we're finally getting to a point where the earnings are being levered and we’re from an overhead perspective gone to a point of some semblance of a scale, arguably an optimal scale and obviously that would take us in the opposite direction and then then there is the look at the daily volume institutional investors have told us, it's challenging to get in and out given the volume and clearly that would work in the opposite direction. And then the other the other factor I guess we look at is you know as we grow although we’re long ways from it today as we grow our shareholders will benefit through the reduction in the base management fee. So it's something we do look at but we look at it out on a lot of different fronts and really make a real time determination based on where we're trading relative than NAV and relative to the investments that we're seeing in the marketplace and right now we're of the mindset that we can continue to deploy capital and out earn that discount and should that change then you might see us take it in different direction.

[Brian Hogan:]

Sure. Remind me of the base management fee step function where--

[Craig Kitchin:]

It's 2% on assets up to 350 million and then drops down to 1.75% on assets up to a 1 billion and down to a 0.5 on assets over a 1 billion.

[Brian Hogan:]

And then kind of last question at the moment, where you’re seeing opportunities I mean you’re pretty broad based investment portfolio. I guess where you see the economy and where you're seeing the most opportunities?

[Craig Kitchin:]

You know I'm not sure that I can say that there's a particular sector. What I will tell you right now is the portfolio -- the pipeline is -- and if you look at our closings you know we seem to be focused on -- the pipeline seems to be prominently non-sponsored transactions. Just seems like where we're seeing opportunities and the opportunities that we find most attractive. So there seems to be a little bit of you know a competitive aspect still in the sponsor space but in the non-sponsor category we’re really seeing some quality opportunities and as I said earlier in my prepared remarks the yields in both segments have increased but we’ve seen an even higher increase in yields in the non-sponsored space. So that’s really one of the takeaways, with regards to industry sector it's really as you said would really across the board since we don't really focus on a particular industry. You know series of industries, it's really pretty broad based.

[Operator:]

Your next question comes from the line of [indiscernible].

[Unidentified Analyst:]

Your CLO investments, just two questions about it. One what is your intention going forward in deploying more capital into the CLO equity space and then two in that CLO investment portfolio how much of that is oil and gas and what is that look like?

[Craig Kitchin:]

I will answer the second question first. There is some oil and gas exposure but not a heavy concentration in fact it's probably below normal levels.

[Unidentified Analyst:]

So will that be like under 5% or?

[Craig Kitchin:]

I think so under 5 is safe to say and in terms of future CLO investments this was a one-off opportunity that came to us and so it's not like we have a bunch of other ones lined up but I will let Rich comment further on that.

[Richard Buckanavage:]

That’s a good point. This investment came to us through our relationship with JMP and as most of your aware we have affiliate JMP Credit Advisors that manages several CLOs and so we found this opportunity to be attractive and it will still end up being an acceptable outcome for us despite the turmoil in the market and the write down this particular quarter, so generated sufficient yield for us to made that investment but as Craig said one-off opportunistic investment, not something that we're looking to grow and we said at the time that we may or may not look to grow that, it's really purely opportunistic this one again came to us not something we're looking for really came to us to our sponsor JMP.

[Unidentified Analyst:]

And are able to look at the oil and gas balance sheets income statements and really get a feeling if they took significant hit, how would that affect the equity piece here?

[Richard Buckanavage:]

Yes we priced the whole portfolio it's one 100% probably syndicate loans. Assets in general probably syndicated loans traded down in the third quarter and obviously oil and gas ones took a bigger hit but there is not a big concentration.

[Unidentified Analyst:]

Last question, in the deals that you’re looking at and then the deals in your existing portfolio. The CapEx that’s being deployed, is the return on the CapEx, are people looking at 15%, 20%, 25% internal rates of return or at these kind of more like buyback use of proceeds, I'm just trying to get a feeling for organic growth through CapEx, is it really there or things just kind of growing side-ways or the 5% rate of return on CapEx?

[Richard Buckanavage:]

I think it's suffice to say that CapEx spending within our has slowed a bit. Just due to I think what you just alluding to the return on those CapEx dollars, that being said I can think of three or four portfolio companies that are actually spending more CapEx this year than last year and doing so based on growth. One in particular that is actually reach capacity or near capacity at its facility and is building another facility and a return on their capital is well north of 20%. So I think it's again across the board I would say it's price slowing a bit just given some slowdown in the economy but it's not -- there is not without its pockets of strength, there are some portfolio companies that are continuing to grow at very solid double digit rates in the portfolio.

[Unidentified Analyst:]

My last question is the EBITDA growth or your portfolio, so are those just kind of you know moving 2%, 3%, 5% or do you see some exciting growth in these EBITDA? And I know what range it's all over the place but--

[Richard Buckanavage:]

It really does and so I'm trying talk in more of the average and then I'll give you kind of the high and low. I think there's the portfolio for certain portfolio companies the EBITDA growth has slowed into the low single digits and then there's some as I said earlier one in particular that's building a homing [ph] facility just to support their growth and growing at solid mid-teens double digit type of growth. I would say this portfolio as a whole is kind of mid-single digits. And that is down from some prior quarters but still very solid relative to I guess the economy as a whole and even some of the cyclicals are continuing to perform well. So we watch obviously, we have a lot of contact with our portfolio companies. We get the monthly financials, we talk to our portfolio companies several times a month in fact informal and formally and we’re not seeing any kind of roll over in any particular sectors, everyone is still growing right now albeit maybe a slightly slower rate than you know the first three quarters of this year.

[Operator:]

[Operator Instructions]. Your next question comes from Mitchel Penn from Janney.

[Mitchel Penn:]

What drove the realized loss in the quarter?

[Craig Kitchin:]

That was two investments, the LNB investment that paid off there was a $100,000 loss on the equity piece, we assigned attributed cost to when we did the original investment of like a 192,000 and the equity realization was under $100,000 and the other realization relates to the CLO equity [indiscernible] it's unusual accounting language or maybe doesn't make a whole lot of sense because we still on the investment but you know we deemed the impairment was other than temporary and took a realized loss on about 193,000 as opposed depreciating it 193,000.

[Mitchel Penn:]

And I assume the change in unrealized was due to just spread widening in the quarter?

[Craig Kitchin:]

Yes it was concentrated in handful of names and it just was probably the biggest one and then couple other names and some of it was due to yield, spreads and some was due to credit.

[Operator:]

And there are no further questions at this time.

[Richard Buckanavage:]

All right well thank you everyone for your interest in Harvest Capital Credit and your participation this morning. We certainly appreciate your interest and we look forward to talking to you to talk about the fourth quarter and full fiscal year.

[Operator:]

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